Is the Japanese recovery for real?

International Economy, The, Spring, 2004

After all, for more than a decade, Japan's economy has experienced a series of false starts on the road to recovery. Is the current economic upswing for once the real thing? If so, to what extent is Japan's expansion too dependent on exports to China? If China experiences a bursting of an economic and financial bubble, to what extent would the Japanese economy be affected? For a number of years, the Bank of Japan has targeted the yen/dollar exchange rate through currency intervention within a relatively narrow range. If the current economic upswing is real and lasting, to what extent should the G7 community pressure Japanese policymakers to change their approach to foreign exchange matters? On all these questions, TIE asked twenty well-respected experts.

HOWARD BAKER

U.S. Ambassador to Japan

Japan's economic recovery will prove durable if government and business leaders maintain momentum on corporate restructuring, economic reform, and ending deflation. If Japan continues the reform efforts of the past several years, the foundations for sustained strong growth will be in place.

The Japanese government has made major progress in addressing the problems that limited Japan's economic growth in recent years. It has forced banks to value their assets and capital more accurately, and the resolution last year of the situations at Resona and Ashikaga showed that the recent reforms have real teeth. The government has also made steady progress in improving accounting and financial disclosure standards and taken other measures to improve corporate governance and facilitate corporate restructuring. In addition, regulatory reform is opening more and more sectors of the economy to domestic and foreign competitors. And perhaps most important, deflation shows signs of easing thanks to aggressive monetary stimulus by the Bank of Japan.

Japan's private sector has also done its part. Japanese banks have accelerated the disposal of their non-performing loans, and the corporate sector has made steady progress in strengthening its balance sheets and improving its operating efficiency.

The process is not yet complete. Banks and large parts of the corporate sector remain weak, too many regulatory barriers to competition have yet to fall, and deflation persists. But I am confident that, under Prime Minister Koizumi's leadership, Japan will avoid the trap of complacency and continue on track toward a brighter economic future.

BARTON BIGGS

Managing Partner, Traxis Partners

I think (and hope) Japan's economy is in the early stages of a sustained recovery. I am not going to repeat the economists' gibberish. My conclusion is based on going to Japan again just recently for perhaps the fiftieth time in the past twenty years. This time it was different. Under the force of leveraged buy-out and private equity pressure from U.S. firms, Japanese companies are changing. Restructuring is beginning to pay off. Already these efforts are showing up in profits. The Takenaka plan for financial institution reform is happening.

Yes, Japan's recovery depends to some extent on China, and if the much-discussed bubble does burst (which I doubt) and capital equipment demand collapses, Japan would be affected. Already China is a bigger export market for Japan than the United States. A real bust in China might subtract one full percentage point from Japanese GDP, which is a lot when real GDP is only growing at 1.5-2 percent annually. However, the main engine of the Japanese recovery story is a domestic demand recovery which the most recent retail sales numbers suggest is already underway. I am convinced there is massive deferred demand for consumer durables because of the long period of deflation which encouraged the deferral of purchases.

I also heard directly from the big real estate people that the Tokyo and Osaka office markets have turned around after a ten-year bear market. This is an important straw in the wind for the economy, the banking system, and for confidence. Furthermore, a rise in real estate prices will be another signal that the deflation which has debilitated the economy is finally ending.

As for the yen, the Bank of Japan made it clear to me that their intervention is because a strengthening yen is deflationary. Once the recovery is sustained and nominal GDP growth is rising at 5 percent, I suspect they will step aside.

GARY HUFBAUER

Reginald Jones Senior Fellow, Institute for International Economics

When Chris Flowers, a former Goldman Sachs banker, can personally scoop $1 billion from Ripplewood's bargain acquisition of Shinsei (formerly the Long Term Credit Bank), the question is not whether Japan's recovery is for real. The question is who is going to be the next Chris Flowers. In fact, despite the avalanche of negative press, Japan's economy was never close to collapse. So long as Japan kept adding to its mountain of foreign reserves, so long as markets wanted to drive the yen higher, and so long as the monetary problem was deflation not inflation, the Ministry of Finance could run massive budget deficits at near zero interest cost, and the Bank of Japan had almost unlimited power to refinance the banking system. Under these circumstances, there was no similarity between Japan and the crisis countries of recent years Korea, Russia, Brazil, Argentina. Indeed, throughout the 1990s, Japan's real per capita GDP never really declined, but just stagnated at a comfortably high level. The real problem was that asset prices took more than a decade to fall to realistic values. As Ripplewood's bonanza shows (multiplying a $1.2 billion initial investment six times in three years), Japan has reached a magic trifecta: distressed assets, zero interest rates, and tremendous human talent. With this combination, the true question is not the speed of recovery, but who gets rich reorganizing Japanese corporations and real estate.