In many ways, the Japanese economy is in uncharted waters. It has been 60-plus years since such conditions have been experienced in the U.S. and even then it is not clear that policy prescriptions ever really resolved the crisis. In 1932,
campaigned partly on balancing the budget. Between his electoral victory over
and his inauguration, the economy worsened. FDR responded with a battery of programs that we associate with the
. In 1936 and into early 1937, the U.S. economy appeared on the mend. Industrial production had finally surpassed 1929 levels and the stock market rallied.
With the recovery underway, the punch bowl was taken away. FDR cut back on spending by New Deal agencies. Between January and August 1937, relief efforts were drastically reduced as the federal budget was cut by 3%. The U.S. economy entered a renewed recession by early in the third quarter of 1937. The economy hit the trough in the middle of 1938, and the severity of the downturn was roughly on par with 1931. It was not until 1940, with the war in Europe underway and American rearmament, that U.S. GDP rose above 1937 levels.
By tightening fiscal policy at the first signs of recovery in the second half of 1996 and again in April 1997, Japanese policy makers repeated the same mistake that the U.S. made almost 60 years earlier: tightening fiscal policy too early. In 1996, Japan enjoyed the fastest growth among
countries. Last year and this year, it is likely to slip to the bottom. Japanese policy makers have begun formulating a new strategy, and the broad outlines are becoming clear.
On the surface, it may appear that Japanese officials will provide more of the old medicine. Japan will ease fiscal policy through tax cuts and increase public works spending. It will continue to pursue a very accommodative monetary policy. However, there has been a significant shift in emphasis toward supporting land and equity prices. Arguably, asset prices are the weak link in the deflationary chain. By bolstering the equity market and the real estate market, Japanese officials hope to bolster bank balance sheets, end the credit crunch and fuel a domestic economic recovery.
Because Japanese banks are allowed to count unrealized profits on their equity holdings toward capital reserve requirements, the stock market may hold the key. Two fresh initiatives will likely help support the stock market. The ability of Japanese companies to buy back their own stock is severely limited. It is some function of their dividend payments, which are traditionally quite low. The ceiling will likely be lifted and many cash-rich companies are likely to announce significant share buyback programs. Many analysts suggest U.S. corporate share buybacks have played a key role in fueling the great bull market.
Another initiative that is expected to be unveiled shortly will be the creation of a new equity investment vehicle for Japanese savers. Japanese households fled to the security of the state-run postal savings system in December amid the collapse of two private-sector banks. A record JPY3.34 trillion (roughly $24.9 billion) was invested in the postal savings in December. As of the end of 1997, Japan's postal savings held JPY236.8 trillion (about $1.77 trillion), making it the world's largest pool of savings. The bulk of this money is currently invested in Japanese government bonds. A shift of even a small fraction of these vast sums may help bolster Japanese equity prices.
Japanese officials are also considering changes in accounting practices that will allow more favorable treatment to real estate investments. An
-like entity is reportedly looking at ways to securitize real estate that has been used as collateral. The decline in land prices has already begun losing momentum, and these measures may help bolster market conditions.
One of the attractive elements of these proposals is that they are not costly to implement. No additional government spending is required. A consensus in Japanese politics that favors new significant fiscal measures has yet to congeal. There seems to be a reluctance to make the temporary JPY 2 trillion income tax cut announced last December permanent. This said, the constellation of political forces in Japan is in flux. While the scandal swirling around
captures many imaginations, the scandal at Japan's
Ministry of Finance
may prove to have farther-reaching implications. The MoF was seen as a conservative bureaucratic bulwark largely against fiscal stimulus.
Prime Minister Hashimoto
appears to be using what appears to be a relatively minor bribery scandal (by domestic and international standards) to weaken it.
These developments, real and anticipated, have helped fuel a 15.8% gain in the
so far this year and a strong recovery in the yen. There are three distinct sources of yen demand. First, yen carry trades were unwound. Sales of the yen were used to finance the purchase of other assets, from U.S. Treasuries and global bonds to international equities. Profit-taking is occurring. Second, there are some indications that Japanese banks may be selling foreign assets, ahead of their fiscal year-end. While January may be a bit early to see such repatriation, new rules regarding capital requirements may be encouraging an early start. Third, some global equity fund managers are reassessing the relative valuation of Japanese equities and are finding value. The poor performance of the stock market in recent years has encouraged many global equity funds to be underweight Japanese equities. Foreign investors have been net sellers of Japanese stocks in recent months.
Japan is expected to unveil new initiatives formally on Feb. 20, just ahead of the G7 meeting scheduled for the next day in London. Contrary to market rumors, it seems unlikely that the major industrialized nations will intervene to support the yen. The strengthening of the yen that has already materialized makes it less necessary. European officials seem to regard the yen's weakness as largely limited to the dollar and therefore see little national interest at stake. Lastly, if the yen does weaken after the new initiatives are announced, it will be seen as a reflection of the market's judgment that they are insufficient to the fundamental problems. In such an environment, many officials will be less likely to sanction intervention, including the
Marc Chandler is vice president and senior currency strategist at Deutsche Morgan Grenfell. The thoughts reflected in his writings here are his own and not necessarily those of DMG. His column appears on Wednesdays in TheStreet.com.