International Herald Tribune
Japan plays it safe
Thursday, August 9, 2007

HONG KONG: Shinzo Abe may be near the end of a short and inglorious stay as prime minister of Japan, reform may have stalled, consumers may be still hyper-cautious, the birth rate may still be abysmal - and the next big earthquake may be close. Yet Japan now looks about the safest major country for your money in a world gorged with monetary excess.

Events unfolding on Wall Street bear many similarities to those that marked the ending in 1990 of the great Japanese property-lending and financial-engineering bubble. But whereas the Japanese inflicted their boom and bust on themselves, Wall Street has been successful in selling Ponzi-type schemes to the wider world.

Ponzi? Wall Street's financial inventions have been rather more sophisticated than those of Charles Ponzi, who created the illusion of earnings by using funds from new investors to pay out earlier ones. But mortgage lending excesses made possible by credit leveraged by fancy derivatives devices have achieved much the same result.

No single individual or firm can be blamed for the modern version, but there is the same exploitation of investors' lack of information or understanding. The sub-prime disaster was possible only because of the sleight of hand by which high-risk loans were repackaged as prime securities.

Wall Street instruments are also far more sophisticated than those seen during the Japanese version of Ponzi. But the basic ingredients were similar - the interaction of ultra-cheap credit for the real estate sector with financial engineering at the corporate level. The Japanese called it zaitech. Rising real estate prices enabled companies to generate apparent earnings increases, which pushed up share prices, which created more credit and so on . . . till the music stopped. (Twenty years on China has discovered zaitech, reflected in the extraordinary rise in corporate profits, driven by share trading, that have then been used to justify even higher stock prices).

There are differences between the United States now and Japan back then. The U.S. mortgage binge was confined to households. Corporations, unlike those in Japan, generally did not join the game. However, U.S. financial corporations saw surges in profits, which sent their total contribution to U.S.- listed company profits to 40 percent, or roughly the same as the zaitech contribution in 1989 Japan.

The case in the United States, however, has much bigger global implications because it is tied to the other great problem of the U.S. economy - foreign debt. As a big global creditor, Japan did not need to borrow overseas to fund its lending excess. The United States has had to borrow on a monumental scale, as have Britain and Australia, two other economies with incipient mortgage crises. The results are already showing up - huge losses by foreign banks and funds that bought the repackaged U.S. loans in the naïve belief that they could get extra yield with no extra risk. To date, German and Singaporean banks have admitted losses. But these are early days. Expect many more such announcements, particularly in Europe.

Yet, what is unfolding now internationally looks less like post-1989 Japan than the financial meltdown of 1974-75, which claimed such scalps as Herstatt Bank in Germany and Franklin National Bank in the United States and wiped out the whole British secondary banking sector - the equivalent of the U.S. sub-prime lenders.

The recession of the 1970s was often blamed on the huge 1973 oil price rise, but the preceding real estate and takeover-lending bubbles were as important, especially in Britain. Oil prices may not be a major problem today, but the U.S. situation is worse and its potential to hit the rest of the world is much greater because of the globalization of finance.

Which brings us back to Japan. Its savings institutions will doubtless be among the big losers from U.S. credit failures. But having been hurt so badly before, the Japanese themselves remain reluctant to borrow, despite years of minimal interest rates, which have caused the yen to become extraordinarily cheap. Japan is awash in cash and has a currency that has nowhere to go but up - which it will do dramatically when overextended borrowers in high-yield currencies can stand the interest-rate pain no longer.

While countries from China to the United States try to sustain growth at any cost, clean, energy-efficient Japan has become accustomed to modest growth, putting security before ambition, fear before greed.

For the long run, that may be an uninspiring prospect. But for the next two or more years Japan will be able to view turmoil elsewhere with equanimity, fretting only about the impact of the yen's rise on corporate profits - and the losses sustained on all those once supposedly prime foreign currency assets.