The world economy is facing a full blown crisis with its epicentre in Japan.
The world's second largest economy -- and Australia's largest trading partner -- has failed to address is severe structural problems and is now running out of policy options. What is worse the Koizumi Government is proving bereft of leadership.
The Japanese miracle burst in late 1989. While the Japanese economy contained many world class manufacturers, its service sector, which makes up over 60 per of the economy, remained highly inefficient and uncompetitive. The economy was badly bloated and distorted by unsustainable levels of corporate debt. On top of this, the banking system was opaque, corrupt and incompetent and the political system was incapable of leading changing.
In 1989 when the bubble economy started to haemorrhage, instead of trying to address its root causes -- as the US did for it savings and loan crisis in the mid-1980s -- the Japanese tried to stem the leak with government largess. The government put in place one massive spending spree after another, to no avail. The economy limped from one recession to another. Now there are no more rivers to straighten or bridges to be built and Japan has become the most indebted nation in the developed world. Goldman Sachs estimates that total household, corporate and government debt in Japan at about $58 trillion or six times Japan GDP. (US debt levels are about twice GDP).
The government also tried to stimulate the economy via monetary policy, but again to no avail. The official interest is now virtually zero with no room for further cuts.
The trend on the asset side of the ledger has been if anything been worse. The Japanese stock market (Nikki 225) has lost 75 per cent of its value over the last dozen years and last week hit a18 year low. Indeed the Nikki which at its peak in 1989 was 15 times higher than the Dow Jones Industrial Average is now below the Dow Jones for the first time in 45 years.
The reasons for the decline in asset prices are clear. First they were grossly overvalued in the first place. Second, investors knew that that many firms and their banks were loaded with dud debt and discounted them accordingly. Third the Japanese economy became trapped in a deflationary spiral with the wholesale price index declining at an annual rate of 4 per cent. Deflation not only makes the debt burden greater but puts down ward pressure on profits and asset prices.
The concerns for the world is threefold. First, it means that the world's second largest economy will remain a drag on the world economy. Second, Japan could drag the rest of the world into its deflation spiral -- remember deflation was a major cause of the great depression. This is real risk if Japan tries to solve it problem by devaluing the yen. Finally despite rapid build-up of debt, Japan remains the world largest creditor and largely responsible for funding the current account deficits of the US and Australia. If its banks are panicked into calling-in overseas loans -- to for example shore up losses at home -- a economic disaster could well sweep the world.
Even the Australia's teflon economy would not be able to shrug-off a tsunami from Japan.
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