Pacific Perspective
Pacific Perspective
Japan’s ailing banking
industry needs leadership,
but sticks with establishmentWhat looks to be Japan's most recent and possibly most significant squandered chance for economic reform occurred last month when a new governor was chosen for the country's central bank.
Japan Prime Minister Junichiro Koizumi's choice of 67-year-old Toshihiko Fukui, former senior deputy governor of the central bank is likely to be a misstep that will lead the country further into a deflationary spiral.
Plagued by non-performing loans, government debt, nontransparent financials and networks of crony capitalism, Japan is entrenched in the worst recession in its history. It's widely known that Japan's economy can only begin to right itself if these issues are tackled head-on, starting with settling public and private debt and closing unprofitable businesses and corporations. This concept of "creative destruction" -- while believed in western society to be a necessary evil to free up inefficient use of capital for investment in viable enterprises -- has been widely resisted in Japanese culture.
Fukui now has the power to take radical steps to ease deflation and revive the economy. One of Fukui's first tasks should be to raise Japan's zero interest rate policy, instigated by Fukui's predecessor Masaru Hayami. For three years, banks have been able to borrow at no cost. This policy has only worsened the situation, creating a culture devoid of risk management where bureaucrats and politicians -- not financial markets -- deciding which companies are given these zero-interest rate loans and which are not. Those with political connections are often spared; those without are not. Raising interest rates would trigger an immediate depression in Japan, however, coupled with the central bank promoting creative destruction -- closing money-losing operations -- that would in the long run promote growth in the economy.
There's no doubt that a solution to Japan's recession will be painful. What is most needed is reform of structural problems in the economy. Under Hayami's leadership, interest rates were kept low to entice banks to lend out, however, that hasn't worked. Furthermore, inflation targeting alone will only delay the need for structural reform. Japan's current deflation is merely a symptom of weak demand. Fukui would do well to push the government to clean up the long-running bank mess, while supplying the monetary support needed during the difficult process.
Historically, Japan's government and bank leaders have been extremely reticent to instigating reforms. Koizumi, prime minister since last April, has promised to clean up massive debts at Japanese banks, decrease public spending, and turn over money-losing businesses to the private sector. He has yet to deliver on any of these goals. Indeed, Koizumi has passed over many opportunities to make firm change in the system.
As for Fukui, he is an establishment player who spent 40 years at the Bank of Japan before quitting in 1998. Critics believe that he is unlikely to do anything very different from his predecessor. To his credit, Fukui has advocated the need for more market-based selection. Historically, he's never been afraid to step over political interests aimed at maintaining the status quo. In his first task on the job, Fukui chose two less conservative candidates for the deputy governor positions, a former vice finance minister and an economist known for favoring more aggressive monetary policy. Still, Koizumi's selection of Fukui over a private-sector candidate is a blow to many critics and investors, especially since it's Fukui's old guard that got Japan in its mess in the first place.
It's no secret that the current geopolitical environment is sending many world economies through a whirlwind ride of volatility. Add to that mix a loss in the markets due to corporate governance issues, weak earnings and shaky consumer confidence. It's no wonder that many investors including fund managers are staying clear of the market at least until the geopolitical environment gains stability. The result is world markets that are especially susceptible to hearsay and other news. The combined effect is volatility across the markets.
In Japan, this global economic instability only magnifies its own internal troubles. Japan's economy is now in its second decade of economic despair. The benchmark Nikkei 225 Stock Average fell recently to a new 20-year low. The recent string of equity offerings by Japanese banks is evidence of the increasing urgency for capital to prop up their ailing balance sheets. In response to the growing number of flailing banks, the government has asked the central bank to buy more bank stocks, essentially affixing yet another short-term "band-aid" to prop up the nation's banks.
What Japan needs is central bank leadership that is stable, market-oriented, focused on the long-term health of the economy and will speak up against Japan's politicians and corrupt bureaucrats who shy away from painful reforms. Under such a system, healthy companies will thrive and weak companies will be allowed to fail and give rise to more efficient allocation of financial resources. Like America's independent Federal Reserve under Alan Greenspan, Japan also needs a truly independent central bank, not only in law but also in practice. Only then will Japan -- and other areas dependent on its economy, including Hawaii -- be free to grow in the face of slowing demand and war.
James R. Wills Jr. is associate dean of the University of Hawaii at Manoa College of Business Administration. Reach him at wills@cba.hawaii.edu.