Sunday, October 12, 2008

Not Entirely Blameless is this Japan

In this week's Business Week a parade of English-speaking analysts are lamenting that Japan's markets and companies are being mowed down as innocent by-standers in the drive-by shooting of the worldwide financial system.

This is not surprising: it is in the interest of these analysts to talk up Japanese companies.

It is true that the companies, the banks included, of Japan are worth far more than their current stock market valuations. It is also true that the punishment of Japan's markets is not due to a lack of confidence in Japan but to international investors cashing out their Japan positions in order to fill holes in their balance sheets.

However, it is not entirely true to say that Japan was a totally innocent bystander.

A tremendous amount has been written about the venal and possible criminal mispricing of risk by finance companies and accountancies, particularly in terms of the value of bundled U.S. housing mortgages. Overcompensation of executives, under-regulation of derivatives markets, deregulation of the financial system have all been given their day of excoriation.

However, greedy financiers, corruptible politicians and deviously creative ways of leveraging up have always been with us. What made the catastrophe possible were

1) the complete collapses of the mechanisms pricing risk and
2) the failure of the main government indicators of economic stress

in what was believed to be the best regulated and most transparent economy in the world.

And what made those breakdowns possible was...the misallocation of Asian savings.

In particular, the decisions of the governments of Japan, then China, to pay any price to keep the dollar value of their currencies low, this in order to preserve the price competitiveness of their export industries.

The building up of Himalayas of currency reserves, much of them recycled into U.S. Treasuries, Agencies and U.S. coporate bonds, made it possible for Americans to buy East Asian-produced goods with money borrowed from East Asia (vendor financing, ooooh baaaaddd) without suffering a fall in the value of the dollar.

The low dollar cost of Chinese-produced goods kept U.S. measures of inflation low, confusing the U.S. Federal Reserve and lulling it into complacency about ferocious asset inflation. The lack of a rise in interest rates made assets, particularly houses, seem far more affordable than they really were. Persons who had no business lending offered loans to persons who had no business borrowing.

Catastrophe ensued. Surprised?

Now the Bank of Japan got out of the active currency intervention game in the year 2004, making it possible for Japan to claim something of an innocent bystander status in this crisis.

Nevertheless it was the East Asian export model pioneered by Japan which made this particular crisis possible. China and up-and-comers like India have been keeping their own currencies artificially low, emulating the conditions that fostered the so-called Japanese miracle economy -- which in retrospect looks a heck of a lot less miraculous now that South Korea, Taiwan, ASEAN economies and China have pushed their economies into the upper reaches of the league tables at even faster rates. American consumption may have been the locomotive of world economic growth this past decade -- but it was the East Asian economies that shoveled way too much fuel underneath the locomotive's boiler...

...which, given the severity of the screwup on the other side of the Pacific, means that the nations of Asia including Japan will need a whole new growth-and-sustained-prosperity model.


ross said...

Hear, hear. Japan and China (along with a variety of other reserve accumulators) have kept the cost of long-term borrowing down which has been, at least as much as Greenspan's low short-term rate following the tech bubble, an important part of the mispricing of risk and asset misallocation in the US over the past half decade. Combined with horrific oversight of banks by the FED and of other financial institutions by the SEC, we find ourselves in the present credit crisis.

Now, though the low short-term rates and the regulatory failures in the US preclude the US from blaming others for its current travails, the blowback in Japan and China is their own fault given their own contributions to the US credit bubble.

OperationNorthwoods said...

Of course China and Japan deserve a lot of the blame, and they should have seen what was coming. But you might want to focus a bit more on the whole swindle of the US moving to a finance-driven economy, and living on bubbles.

Perhaps Japan, as a US friend, should have been much more vocal about the serious decline of the US over the last 20 years or so.

On the bright side, Russia recovered pretty quickly after their empire collapsed, so maybe the US can, too.