The Strange Discourse between Japan and America
Viewed through history’s lens, Japan and the US are a study in ultimate contrasts. Japan is set on tight volcanic islands; the United sprawls luxuriantly across a continent. America has been an open society thriving on immigration. Japan is turned inward, emphasizing social solidarity, focussed purpose, education, and a high symbolic sense of destiny. From its earliest days, with the better half of a continent behind it, the US has been an importunate knocker on other folks’ doors. That found early expression in the Monroe Doctrine, refurbished by Teddy Roosevelt at the turn of the century, and now sent into orbit as the Dubya Doctrine. Inevitably this has led to epic interactions, negative or positive between the world’s two largest economies – from Commodore Perry to Hiroshima. At a great disadvantage in physical and military arsenals, the Japanese have been noted for the subtlety of their strategies.
On the subject, we wrote, "Over the decades the Japanese have developed special skills for keeping their overseas rival-mentor, the United States, appeased, while holding their own and occasionally better" (ER, 7/99).
Even today, in spite of the sickly state of its economy, the Japanese automobile industry is painting circles around Detroit on its native turf. Toyota sales in Canada also doubled to 127,754 last year from 67,956 in 1995.
That Other Dodge Circumvented
A classic factor in this achievement is how Japan reorganized her goals after WWII.
"In 1945, Joseph Dodge, an old-line Detroit banker, arrived in Tokyo to implement the US reconstruction policies. In a country devastated by war, mass unemployment, and industries bankrupted by unpaid wartime government bills, Dodge insisted on absolute budget-balancing with only short-term debt to be issued. All new subsidies and further loans from the Reconstruction banks were ruled out. The policy was to be severely deflationary on the assumption that the problem was too much demand, not the grievous lack of production." No, just in case the thought may have crossed your minds, that Dodge was not a relative of the current governor of The Bank of Canada.
"The Japanese were in no position to argue with their conqueror, but they did tactfully contact the US General Headquarter Economic Scientific Section and persuaded it to issue a "Tight Money Neutralizing Measure." Under it the Bank of Japan provided credit to buy the government bonds held by financial institutions, so that they might serve as money base for the creation of further bank credit. And then the Korean War providentially increased both Japanese exports and spending in Japan by the American military personnel." That allowed the Japanese to lay the footings for their economic miracle.1
The Rising Sun of the Low Yen
In a broad way their approach can be useful to the world today.
"Its essence was to focus its scant financial resources on export industries that would show the greatest value added and the least import component." This would have been ruled out today by Globalization and Deregulation. By shifting to heavy and chemical exports from the pre-war emphasis on cheap textiles, they concentrated on improved output of steel, coal, large generators, hydro-electric dams, to prepare for the next stage of export-oriented development – earth-moving machinery, automobiles, domestic appliances, synthetic fibres. To such strategic industries the government made available inexpensive financing, tax advantages, but avoided taking up ownership positions. Cartels were tolerated, and when an economic downturn seemed ahead, a single corporation each year was allowed to carry out the only expansion in the industry. This made it possible for firms to pursue aggressive policies at less risk. Labour relations were nurtured with an informal policy of lifetime employment.
Note the immense difference between this and recurrent proposals originating in the US to have lesser countries adopt various forms of a "common" currency with the US. Thus the Argentine’s strict dollar-backing of their currency contributed in a major way to the collapse of its economy.
Eventually exports boomed in highly profitable areas and the vast influx of foreign currency actually became something of an embarrassment. A yen low vis-a-vis the dollar was kingpin of the plan. The Ministry of Finance (MOF) directed financial institutions to load up with long-term US securities. David Stockman, a pillar of the early Reagan regime, has written that the US government was surprised to find Japan providing Washington with the means of coping with the craters the Laffer Curve policy left in its budget. Soon up to 30% of American Treasury issues were being sold in Japan, and the influx of Japanese money was driving up the value of the dollar. Heavy US equipment makers like Caterpillar anguished.
The US parried by proposing that the yen become an international reserve currency. But losing control of their low yen was the last thing in Japanese minds. "They smiled across the table at Donald Regan, the Secretary of the Treasury, described as ‘the greatest bond salesman in history,’ gratified at his cluelessness, and offered to help in the super-marketing effort." But they went their own way.
Because the MOF discouraged the development of a domestic debt market, Japanese issues had to be floated overseas. This was to prevent the development of a powerful constituency of domestic bond traders that would strip its central bank of control of the commercial banks.
This was the opposite of the Bank of Canada’s course in the 1950s when it bribed Bay St. firms to morph into short-term money traders. Before these legendary "young men in red suspenders," its very own creation, the government has ever since cringed in terror whenever the slightest problems arose.2
"It was through the use of its banks to shovel out to second-tier Japanese firms credit created by the BoJ, that the MOF frustrated the Plaza Accord to bring down the dollar-yen ratio."
Fiat – Let There Be Darkness
But how did MOF ensure that such credit would not end up just stoking inflation? "The answer is in the collateral principle underlying Japanese banking. Japanese bankers are not trained to analyze business projects; they depend largely on the collateral in stock market shares and land put up to back their loans. The valuation of either of these items is highly rigged by the MOF. This ultimate security for bank loans becomes something not dissimilar to the fiat money of the West, where a dollar or a mark is worth largely what the government says it is – so long as the system goes on working. A whole school of Japanese economists have summed it up as a ‘land standard.’" The shortage of space on their islands reinforces the effort. And the shift of so much North American money-creation to Wall St. via the deregulated banks makes the comparison less fantastic. Our stock market valuations are now exposed to have been largely fiat.
"Ultimately, the brazen confidence of Japan’s banks rested on their cushion of hidden assets. On the surface Japanese banks might look thinly capitalized. But financial reporting there did not require the banks or companies to adjust their assets to their market values. In a pinch the banks or companies could dispose for $50 million a small parcel of land kept on its books since the last century at $300." This was in notable contrast to the recent Wall St. boom when land and all other assets tended to be booked at tipsy levels.
"The moment of truth arrived in installments. First there was the collapse of the American real estate market in which the triumphant Japanese banks had been bemused to plunge. Their domestic pattern may have disposed them to picking up major interests in American icons like Rockefeller Center. And then came the hammer-blow of the 1997 East Asian meltdown."
Two Fiat Systems Collide
"Under American pressure, the Japanese had agreed to many things that finally destroyed their insular financial system. A major instance is the Bank for International Settlements’ Risk-Based Capital Requirements. ‘Japan’s negotiators at Basel could not say, "Look, it makes little difference what the reported capital bases of our banks are. They are going to price loans to get the business, and we will support them in that. Moreover, MOF controls the value of their assets and the extent of their capital cushions." So they ended up agreeing to the BIS capital adequacy guidelines, even if with a lot of exceptions for Japan. That gave the banks incentives to do things the authorities wish they hadn’t done."3
The Japanese financial system was caught in the crossfire of two incompatible fiat systems – that of their own MOF valuation practices on land, and the collapse of the US model in Eastern Asia in 1987.
That explains the daunting news out of Tokyo. Reuter’s News Agency recent report: "Japan’s central bank, moving to allay fears of a financial crisis, has announced unprecedented plans to buy corporation shares directly from banks. Sailing into uncharted waters for a central bank, the Bank of Japan said the plan was aimed at preventing market volatility and banking system instability from feeding on each other." More bluntly put, the Japanese central bank proposes relieving the commercial banks of the highly dubious corporate debt that prevents them from making the further financing that its industries need. "The Economics minister was taken by surprise."
"The move – described by ratings agency Standard & Poor’s Corp. as ‘shocking’ – follows a fall in the Nikkei share average to 19-year lows this month. That raised concerns about a financial crisis ahead of the half-year book-closing on Sept. 30.
"The announcement came just an hour after the bank decided to leave its monetary policy unchanged. The bank has kept short-term money market rates at virtually zero under its 17-month-old ‘quantitative-easing’ policy."
A Dress Rehearsal for the Next US Bank Bailout?
The Wall Street Journal (19/09, "Japan’s Central Bank Will Buy Stock Held by Troubled Lenders" by Phred Dvorak): "The unexpected announcement from the central bank came just a week after Prime Minister Junichiro Koizumi promised President Bush faster action on banking problems." Here again the addiction of the lone superpower to barking out orders from the bridge hasn’t been helpful.
For clearly when the BoJ buys corporation shares of questionable value to restore the banks to liquidity, it gooses the value of the shares on the stock market. And that can inject not only the shares involved but eventually the stock market itself with fiat value. "The stock-buying plan also marks a significant departure for Japan’s conservative central bank: Not only is it highly unorthodox for central banks to purchase stocks from private companies, but it could be dangerous. Indeed, Bank of Japan Gov. Masaru Hayami has long resisted calls for the bank to combat price deflation by buying unconventional assets such as stock or bad loans, arguing that such tactics could destroy the credibility of the nation’s lender of the last resort."
Is this just another instance of Washington’s irrepressible need to pressure the rest of the world to do its bidding, or might there be another factor involved? The US Federal Reserve has abdicated much of its control over the monetary system at home to the short-term money-traders. By virtually doing away with the statutory reserves (without doing so formally as in Canada) it will be impossible to design another bank bailout – should that become necessary – by reducing the reserves further. There is simply nowhere further to go along that road. Hence the immediate effect of this proposed Japanese "solution," if carried out, would certainly be closely followed by other central banks. For they all have their faces to a wall, as the consequences become apparent of their deregulation of their banks shortly after their massive bailout in the early 1990s.
The words of BOJ Governor Masam Hayami have suggestive overtones: "There is no central bank n the advanced world that buys shares. But I think the BOJ should take steps to eliminate worries. Call it crisis prevention or stabilization." That novel device has in fact been brought in as a sort of monetary Prozac rather than on other merits. On 12/10, The Globe and Mail carried a Bloomberg News dispatch reporting that the BoJ will buy US$16B of Japanese corporation shares from 10 banks to help them cut their losses.
We have often emphasized the advantages of using statutory reserves rather than short-term interest-rate as the main lever for stabilizing the economy. The main disadvantage of the latter course is the screeching conflict of interest it involves. Interest does happen to be the revenue of money-lenders and can devour the producing classes in society. That policy adopted by central banks in the 1970s is in fact the Mother Conflict of Interest that became the model of the countless others that have made our financial sector a bordello. Moreover, high interest rates as the one tool against "inflation" hits everything that moves or stands still in the economy. In military terms it maximizes "collateral damage."
So destructive are its effects that eventually it may inflict damage beyond the power of central banks to remedy by reducing interest rates. If the economy is still on its back when the rate of interest reaches zero, there is nothing left for the central bank to do with its proudly proclaimed "one blunt tool." Moving to a negative interest rate is tantamount to subsidizing insolvent banks in open public view – not behind screens of silence, as in the epic bailout of the Canadian banks in 1991. And all the while the ever impatient US Treasury is pressing the Japanese to "address the nonperforming bank loans and deflation so that it [can] play the role that it should in the world economy" (R. Glenn Hubbard, chairman of the president’s Council of Economic Advisers, The Wall Street Journal, 27/09). Presumably, this includes resuming purchases of US government debt to help finance Washington’s overseas adventures.
Another factor entered the picture in the 1990s. With ongoing Deregulation and Globalization banks acquired brokerage, underwriting and merchant banking firms that live by their stock-market gambles. To almost anything connected with the stock market high interest rates are poison. This has caused the banks to see their survival interests pass from high interest rate spreads to low interest rates. That means that the spread between boom market rates and zero has remained lower than at any other time in our history.
Hence the BOJ, distraught with the pressures on it to do something about the collapse of the stock market, has decided to continue descending the interest scale by single steps into negative territory. Given the risk factor in the shares of insolvent companies, what might result is not a careful one-step descent, but a headlong tumble into the abyss.
1. The Postwar Japanese Economy, Its Development and Structure (Takafus Nakamura, University of Tokyo Press, 1995) and The Real Price of Japanese Money (J. Taggart Murphy, Weidenfelt & Nicolson, London, p. 164) provided much of the material for an article "Rearmament for Japan" in Economic Reform (7/99) from which I quote.
2. "Fashioning the God of Clay" by W. Krehm in Krehm, William (ed.) (1999). Meltdown, Money, Debt and the Wealth of Nations. COMER Publications, p. 226.
3. Murphy, R. Taggart. The Real Price of Japanese Money. London: Weidenfeld & Nicolson, p. 164.
— from Economic Reform, November 2002