Re: Came across this - interesting watch the bond markets

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The Japanese economy began to stagnate in the early 1990s because its
national goal of export became dysfunctional after the Cold War. The
introduction of central banking in 1998 reduced Japanese banks to
financial basketcases in a liberalized financial market, instead of the
healthy service institutions in support of a national policy of export
under a national banking regime. Under central banking and a liberalized
global financial market with floating exchange rates and full
convertibility, the price to be paid for having trade surpluses
manifests itself in a rising yen. This in turn causes domestic general
deflation in Japan.

Japanese policy of keeping the yen's exchange value lower than that
dictated by market pressure has now become an attempt to eliminate
domestic deflation. But a below-market yen leads to a larger trade
surplus in dollars, causing a net shrinkage in the yen money supply,
thus shrinking the yen asset economy, leaving it with overcapacity and
making yen assets less valuable. What Japan is doing is investing in the
dollar economy while disinvesting in the yen economy through its trade
surplus. This is the real cause of deflation in Japan.

To restore strong economic growth in Japan, deflation needs to be
stopped. Under a central banking regime, the most straightforward way to
stop domestic deflation is to force the yen to depreciate in
foreign-exchange value. But this would go against market forces
generated by Japan's trade surplus. Yet if Japan keeps the exchange
value of the yen low merely to sustain its export prowess, it will
continue to feed domestic deflation. This is because the rate of
shrinkage of the yen economy from a huge trade surplus denominated in
foreign currencies, mostly dollars, is greater than the rise in yen
money supply released by a reluctant central bank.

Domestic deflation can be stopped if there are more yen chasing after
the same amount of yen assets. But more yen in circulation will lower
the exchange value of the yen. A low yen in turn will increase Japan's
trade surplus, which, because it is denominated in foreign currencies,
mostly dollars, is a mechanism that transforms yen input into dollar
output, reducing the yen money supply. This reduction of yen money
supply increases the amount of under- or non-performing yen assets,
reducing their market value.

Thus Japan's trade surplus contributes to increase in the US dollar
money supply. Normally this would push down the value of the dollar. But
dollar hegemony forces the Japanese and other trade-surplus nations,
such as China, to finance their trade surplus with a capital account
deficit in favor of the dollar economy. This expands investment in the
dollar economy and pushes up the price of dollar assets and pushes down
the price of yen and other non-dollar assets. Thus dollar hegemony keeps
both the exchange value of the dollar and the price of dollar assets
high, while other non-dollar economies must choose between a weak
currency and domestic deflation. China is insulated because the yuan is
not fully convertible. When the US Treasury allows the dollar to fall
against the yen, it is in fact condemning Japan to more domestic
deflation through yen appreciation, if all else remains unchanged. By
allowing the dollar to fall, the United States is in fact exporting
deflation.

To stop domestic deflation, Japan not only needs to inject more yen into
the yen economy but it must also keep the yen in the yen economy by
reducing its trade surplus without shrinking its economy. This is
because the trade surplus coupled with a capital account deficit is
leaking yen into dollars faster than the Bank of Japan (BOJ), the
central bank, can inject more yen into the yen money supply because of
the so-called liquidity trap. Thus Japan needs to shift its historical
national role by changing its investment policy from one of promoting
ever-increasing export for trade surplus in dollars that are of little
use to the Japanese yen economy. Japan needs to adopt a new national
goal of developing and expanding the global economy, particularly the
Asian economy, from which the relatively overdeveloped Japanese yen
economy will derive sustainable expansion in tandem.

This is true with all the Group of Seven (G7) economies: they can only
grow by making sure that the rest of the world grows at a faster pace.
There was a period during the Cold War when the more advanced US economy
grew at a slower pace than those of its Western allies, much to the
benefit of the whole Western bloc. The future of the world economy
depends on more economic equality, not by shrinking the size of the G7
economies, but by expanding the economies outside of the G7 at a faster
pace. It is doubtful whether this shift toward equality can be achieved
through neo-liberal globalized trade. This is because trade without
global full employment does not yield comparative advantage to the
poorer trading partner. Say's Law, which asserts that supply creates its
own demand, is only true under conditions of full employment.
Comparative advantage in free trade is Say's Law internationalized, true
only under conditions of global full employment and shrinking disparity
of wages.

Dollar hegemony makes trade surplus denominated in dollars a mechanism
to drain wealth from the trade surplus economy to the dollar economy.
Development needs to replace trade as the dominant driving force of the
world economy. In the long run, Japan will benefit from an Asian common
currency not dominated by yen hegemony. And the world will benefit from
a global currency not dictated by dollar hegemony or by any other single
national currency.

Deflation wreaks havoc with business balance sheets: it discourages
investment; it leads consumers and corporations to postpone spending.
With the consumer price index falling at about 1 percent per year, and
the broader gross domestic product (GDP) deflator falling at about 2
percent per year, deflation has become persistent in Japan in recent
years as the country continues to enjoy a substantial trade surplus.

Aside from a temporary increase in 1997 when the consumption tax was
raised, prices have been falling in Japan for the past decade. Deflation
is damaging to the operation of the banking system, and this is one of
the key links between monetary policy and banking policy in a central
banking regime. With deflation, interest rates are forced to become very
low - close to zero. Yet near-zero interest rates only postpone, not
eliminate, the need for banks to deal with problem loans, because,
notwithstanding Milton Friedman's famous pronouncement that inflation is
everywhere and anywhere a monetary phenomenon, deflation, the reverse of
inflation, is not everywhere and anywhere just a monetary phenomenon.
Deflation is a problem that cannot be cured by monetary measures alone,
as Japan has found out and as the United States is about to. Global
deflation can only be cured by reforming the international finance
architecture to allow trade to be replaced by development as the engine
for growth.

With near-zero interest rates, borrowers find it easier to meet their
interest payments to banks, allowing loans to remain performing even if
the borrowing firms are structurally unprofitable. And deflation makes
it harder for borrowers to repay loan principal. High interest rate in
an inflationary environment can be a negative real interest rate after
inflation adjustment, in which case banks are actually paying their
borrowers. Conversely, a zero interest rate can be a high real rate in a
deflationary environment. Under a national banking regime, banks are
performing their duty as long as they support the national purpose. In
Japan's case, the banks' role was to support export. Even if the banks
did not make a profit or their corporate borrowers could not meet debt
service temporarily with current cash flow, the banks were serving the
national purpose as long as the borrowing corporations were gaining
market share in the global market.

Postwar Japan was prepared to export the national wealth created by its
people in exchange for gold or gold-backed dollars. This mercantilist
national purpose for a war-torn economy worked until 1971 when the
United States took its dollar off the gold standard. Yet it took another
three decades before the full impact of exporting for a foreign fiat
currency took its toll on the Japanese economy. This adverse impact was
finally brought home by the globalization of financial markets after the
end of the Cold War, and exacerbated by the Tokyo Big Bang on April 1,
1998, and the adoption of the Central Bank Law on the same day. The end
of the Cold War robbed Japan of its geopolitical guarantee for exclusive
access to a huge market in the United States. The Tokyo Big Bang
subjected the Japanese financial system to international market
pressures and the Japan Central Bank Law forced the Japanese banks to be
profit centers rather than service institutions.

With a central banking regime in a neo-liberal globalized market
economy, firms and banks are separated from any national purpose, except
as affected by domestic tax policies or by national security
restrictions. Banks and firms exist mainly to make profit for their
shareholders of any nationality. It has become possible for the global
banking system to prosper at the expense of national economies,
including the home economies of transnational banks.

Monetarists argue that loan default decisions will surface at a more
timely stage if interest rates, both nominal and real, stay steady and
appropriately low for sustainable expansion of the economy and its money
supply, which generally requires an inflation rate between 1 and 3
percent. As a result of delays in confronting de facto default due to
near zero interest rates, business failure, liquidation, and loss of
jobs when they finally occur can be much more severe than if the finance
restructuring were made earlier. Near-zero interest rates dull the
sensitivity of interest payments as a barometer of business robustness.

In March 2001, the BOJ, then a three-year-old central bank, made an
important change in monetary policy. It announced that it would provide
ample liquidity until the inflation rate was equal to or greater than
zero; that is, until deflation is ended. That policy is in essence one
of inflation targeting.

The BOJ conducts monetary policy and its business operations under the
Central Bank Law of April 1, 1998, which was established on the
principles of "independence" and "transparency". The BOJ implements
monetary policy by adjusting the supply of funds in line with demand for
them in the money market through market operations. Since February 1999,
the then barely one-year-old central bank has kept the uncollateralized
overnight call rate, the operating target, at virtually zero percent.
This is known as the zero-interest-rate policy. This means that the BOJ
will inject funds into the money market without limit whenever
necessary. In fact, the BOJ has been supplying funds in such large
volume that excess funds continue to remain in the banks, but the funds
have not found their way into the market.

The BOJ, at its Monetary Policy Meetings (MPMs), decides the guidelines
for market operations that cover the inter-meeting period of about half
a month or a month ahead. Market participants, on the other hand, often
engage in funds transactions that become due in three or six months.
This requires them to forecast movements in the overnight call rate
during the period between the next MPM and the maturity date of their
transactions. Consequently, when the outlook for interest rates is
uncertain, market forces will set interest rates on term instruments,
such as three- or six-month instruments, substantially higher than the
prevailing overnight rate.

To avoid such an outcome, the BOJ has announced its intention of
maintaining the zero-interest policy "until deflationary concern has
been dispelled", suggesting possible continuation of the policy beyond
subsequent MPMs. This announcement aims at ensuring that the effects of
the zero-interest-rate policy permeate the economy. As a result,
money-market rates, including those on three-to-six-month instruments,
have stayed around zero percent.

This is an application of Nobel economist (1995) Robert E Lucas's theory
of "rational expectations". The theory postulates that expectations
about the future can influence the economic decisions independently made
by individuals, households and companies. Using mathematical models,
Lucas showed statistically that the average individual would anticipate
- and thus could easily neutralize - the impact of a government's
economic policy. Rational expectation theory was embraced by president
Ronald Reagan's White House during his first term, but the theory worked
against Reagan's "voodoo economics" instead of with it.

When the BOJ first adopted the zero-interest-rate policy in February
1999, the economy and the financial markets interacted in a downward
spiral. Sluggish economic activity had made market participants
increasingly worried about the stability of the financial system. Had
extreme pessimism spread in the financial markets, Japan's economy could
have plunged into a catastrophic crisis. This situation could create an
abrupt freeze on economic activities, such as business investment and
household spending.

The zero-interest-rate policy in effect stopped the toxic interaction
between economic activity and the financial markets by removing concerns
among market participants that they might face difficulties in funding
due to a liquidity shortage in the market. In the meantime, the
Financial Function Early Strengthening Law and other legislation enacted
in the autumn of 1998 attempted to provide a framework for the
stabilization of the financial system. In March 1999, about a month
after the adoption of the zero-interest-rate policy, major banks were
recapitalized by injection of public funds. But the "convoy system" of
bank mergers shelters the weakest banks at the expense of the strong.
Moreover, fiscal spending was increased significantly to stimulate
economic activity. But the yen money supply did not expand because of a
recurring trade surplus denominated in dollars. The zero-interest-rate
policy masked the symptoms, but it did not address the disease.

Japan's economy has shown no signs of a self-sustained recovery in
private demand despite the zero-interest-rate policy. Under these
circumstances, the timing of a policy change and the meaning of "until
deflationary concern has been dispelled", which is generally regarded as
the criterion for terminating the current policy, have again become the
focus of attention.

The BOJ describes the condition "until deflationary concern has been
dispelled" as meaning "until a self-sustained recovery of the economy
driven by private demand can be forecast with a certain degree of
probability". A fall in prices of goods is not necessarily deflation,
for it may be the effect of a rise in productivity from the same cost
base. When computer prices fall from productivity gains, it is not
deflation. Generally, deflation is defined as a spiral of declining
prices, particularly in asset prices in addition to prices of goods,
accompanied by contraction in economic activity. An overall decline in
the level of prices brings about a fall in corporate profits and wages,
and this fall leads in turn to a contraction in economic activity,
resulting in another price decline. This indicates that the economic
momentum behind price developments is an important criterion in
identifying the risk of prices declining further.

While interest-rate policy can be a stimulant or a depressant in an
inflationary environment, a zero-interest-rate policy can have
unintended adverse effects in a deflationary environment. Since the cost
of money is near zero, there is no compelling reason for banks to lend
money, except for earning fees to refinance loans made earlier at higher
interest rates. This creates problems for banks down the road by
reducing future interest income for the same loan amount. The narrow
spread in interest will also force banks to raise credit thresholds,
shrinking the pool of qualified borrowers. It can also cause a
distortion in income distribution in the household sector by denying
interest income it would have otherwise earned by savers. It can create
problems for pension funds and insurance companies.

Structural reform can be delayed by too much easing of the necessary
cash-flow pain. Market participants' risk perception can be dulled.
Institutional investors, such as life-insurance companies and pension
funds, can then face difficulty in finding good investment opportunities
to pay for long-term commitments made at high interest rates. In the
United States, where loan securitization is widespread, banks are
tempted to push risky loans by passing on the long-term risk to non-bank
investors through debt securitization.

The BOJ's zero-interest policy combined with general asset deflation has
caught the Japanese insurance companies in a vise. Both new loan rates
and asset values are insufficient to carry previous long-term yields
promised to customers. Japan does not have a debtor-friendly bankruptcy
law, as the United States has. At any rate, insurance companies, like
banks, cannot file for bankruptcy in the US. They are governed by an
insurance commission, which normally has a reinsurance fund to take care
of insolvency. The fund is nowhere near sufficient to handle systemic
collapse. The same happened to the US Federal Deposit Insurance Corp
(FDIC) in the 1980s. The insurance sector in the United States will face
serious problems as the Federal Reserve further lowers the Fed Funds
Rate (FFR). Several segments of the insurance sector, such as health
insurance and casualty insurance, have already collapsed for other reasons.

In the era of industrial capitalism, a low interest rate was a
stimulant. But in this era of finance capitalism, lowering rates creates
complex problems, especially when most big borrowers routinely hedge
their interest-rate exposures. For them, even when short-term rates drop
or rise abruptly, the cost remains the same for the duration of the loan
term, the only difference being that they pay a different party.

Central banks are still applying industrial-capitalism monetary
economics to the new finance capitalism. That is the main cause of the
multi-wave financial crash that began in 1982 in Mexico and developed
with full force of contagion in 1997 in Asia. In fact, in more than two
years since the zero-interest policy announcement, the BOJ has
significantly expanded money as measured by the monetary base, which is
bank reserves plus currency in circulation. The monetary base is up 34
percent since the Bank of Japan began its new policy. However, broader
measures of liquidity that are more closely associated with general
price increases have not grown nearly as rapidly for reasons stated
above. The growth rate of broad money, which includes individual and
business deposits at banks, has hardly increased at all. Moreover, bank
lending has not increased because of a liquidity trap. As the Japanese
trade surplus adds to Japan's dollar reserves, yen deposits and loans
remain stagnant. Even after adjusting for loan writeoffs, bank lending
was down 2.6 percent in 2002 and consumer prices continue to fall.

The reason the increase in the growth rate of the monetary base has not
resulted in higher growth of loans and deposits at banks, or a rise in
prices, is not, as some economists suggest, that the increase in the
monetary base has not been sustained for long enough. Nor are more
increases needed in reserve balances banks hold at the BOJ, a key
component of the monetary base. The traditional anti-inflation bias of
the central banking regime has deprived policymakers of any historical
guide in overcoming persistent deflation.

The current round of global deflation is caused by weak demand resulting
from the effects of dollar hegemony as sustained by a global central
banking regime regulated by the Bank of International Settlements (BIS).
The neo-liberal globalization of trade and finance prevents all
non-dollar economies from effectively increasing their local currency
money supply for domestic development. To avoid speculative attacks on
their currencies, all increases in local-currency money supply must be
channeled to fuel export for trade surplus in dollars. This shrinks the
exporting economies' own money supply while adding to the dollar money
supply to fuel the dollar economy at the expense of non-dollar
economies. Consumers in non-dollar economies are robbed of purchasing
power because low wages are necessary to compete in the global export
market to accumulate trade surpluses in foreign currencies, mostly US
dollars. At the same time, state credit cannot be used to finance
domestic development to raise income, for fear of inducing speculative
attacks on the local currencies. Neo-liberal economists argue that the
main reason the increase in the monetary base has not yet worked in
Japan is non-performing loans (NPLs) in the banking sector. They point
out that funds lent by commercial banks and spent by borrowers create
deposits at other banks that can then be lent to other borrowers.
According to neo-classical monetary economics, this is the way an
increase in the monetary base (high-power money) leads to an increase in
the amount of broad money and higher prices, through the money-creation
power of banks. But banks that are burdened by NPLs do not seek out new,
profitable loan opportunities, even when they have excess reserves.
Neo-liberal economists argue that a change in banking policy that
effectively deals with the NPL problem will lead to more banks and more
businesses seeking out new opportunities and creating new loans. They
make this argument all over Asia - in fact, all over the world.

For Japan, they argue that solving the NPL problem would significantly
increase the ability of the BOJ to increase broad money, increase bank
lending, and raise the price level. This is like arguing that after you
leave the gas running in the kitchen stove without first lighting it, an
explosion will result when you finally light it. Therefore you must now
turn off the gas and open all the windows and there is no alternative to
suffering uncooked food for a while until the air is clear. But
neo-liberals are careful not to tell you that it was they who first
suggested that you blow out the pilot light of national banking. If the
pilot light of national banking had remained lit, the economic kitchen
of Japan would still be producing delicious hot food. Turning the gas on
without a lit pilot light will cause an explosion again, no matter how
many times you open the window to clear the air temporarily.

A recent BOJ report highlights the nature of the NPL problem, in effect
arguing that NPLs are not simply the legacy of the old bubble days, but
reflect continuing problems in the banking sector. There is truth to
that observation, but the BOJ report fails to note that the NPL problem
is a bastard child of central banking. The BOJ argues that the NPL
problem must be addressed quickly. And there is also truth to that view.
Problem loans do exert a heavy toll on banks. Heavily burdened banks
lose the ability to focus on new lending to new business opportunities.
A banking system that is weighed down by bad loans cannot fulfill its
role of gauging risk and return and channeling savings to the most
profitable investments. Banking problems also exert a heavy toll on the
economy. Borrowers who are not servicing NPLs are frequently owners of
assets - property, buildings, capital equipment - that are not being
used productively or profitably in a free market.

All this is valid, but only in a central banking regime. Under a
national banking regime, these problems remain, but they take on a very
different character. Under national banking, rather than private bank
profits deciding what should be financed, the national purpose decides
what is financially profitable. Furthermore, the claim that cleaning out
NPLs in the Japanese banking system under a central banking regime will
revive the Japanese economy has not been empirically verified. It is
only part of the snake-oil cure promoted by the Washington Consensus to
perpetuate US dollar hegemony.

It is true that unresolved NPLs freeze non-performing assets in place
and prevent them from moving to more profitable activities. But it is
also true that under central banking, some profitable activities may
well be detrimental to the economy as a whole. The US economy is full of
examples of this truism. The result is a robust financial sector and a
sick real economy.

Under conditions of excess capacity, failure to deal with NPLs locks in
excess capacity, worsening deflationary pressures. But solving the NPL
problem in the wrong way, through massive layoffs, for example, will
only add to deflationary pressure. The solution requires more than
simply reducing or writing off debt. Over-indebted borrowers are almost
always overextended businesses, having expanded into activities with
little economic benefit. In the case of Japan, the overextended business
is export of manufactured products for money that is useless in Japan.

Addressing the problems of the distressed borrowers requires substantial
restructuring in order to identify a profitable business core, and in
some cases liquidation of the borrower is the only alternative. The
Japanese economy has been historically structured toward export. It
would be unthinkable to liquidate the entire export sector. However, it
is quite possible to make the export sector earn yen instead of dollars.
A yen trade surplus would contribute to curing deflation in Japan. But
it will still not solve Japan's economic malaise.

The Japanese export engine has become unprofitable not only because
world trade is shrinking. The solution to the NPL problem lies not in
liquidating the export sector, but in redirecting it toward yen-earning
developmental institutions. The catch is that this redirection from
trade to development cannot be accomplished by relying on neo-liberal
market fundamentalism operating in a central banking regime.

The market favors trade over development because the market treats
development cost as an externality. When someone other than the
recipient of a benefit bears the costs for its production, for example
education and environmental protection, the costs of the benefit are
external to its enjoyment. Economists call these external costs negative
"externalities". These externalities amount to a market failure to
distribute costs and benefits fairly and efficiently within the economy.
Globalization is basically a game of negative externalities. Inhuman
wages and working conditions, together with neglected environmental
protection and cleanup, are other negative externalities that protect
corporate profit. It is by ignoring the need for development and by
externalizing its cost that the market can deliver profitability to
corporate shareholders. Development can only be done with a revival of
national banking in support of a new national purpose.

For the 44 trillion yen in loans to corporations classified by Japanese
banks as bankrupt or in danger of bankruptcy, the harsh choices are
clear. But a more corrosive problem arises with loans that are
technically performing but are owed by companies that are barely able to
keep afloat, have little prospect for long-term survival, and have no
possibility of ever paying back the loan. These firms may be able to
scrape together their required interest payments in Japan's
low-interest-rate environment. How many of the roughly 100 trillion yen
in loans that "need attention" fall into this category and are likely to
become non-performing loans is at the heart of the dispute about the
size of Japan's bad-loan problem. This highlights the futility of a
central-bank interest-rate policy as a tool to deal with deflation.

Dealing with these walking-dead firms before they spiral into
bankruptcy, and while there is still value and employment that can be
salvaged, is a critical issue. But the answer is not retrenchment
through layoffs. The answer lies in turning these distressed firms from
export dinosaurs to development dynamos domestically, regionally and
globally. Instead of exporting cars and video games, Japan can export
education, health care, environmental technology, management know-how,
engineering and design, etc, systems to generate wealth rather than
products to absorb wealth from overseas.

Yet the delay in addressing the NPL problem has not spared Japan the
pain of unemployment. Thus the NPL problem is merely a symptom, not a
cause, of the economic malaise Japan has placed on itself by continuing
to pursue export for dollars as a national purpose.

For economic growth to increase in any country it is necessary not only
for productivity growth to increase; it must also accompany productivity
growth with consumption growth. Productivity is the amount of goods and
services that workers can produce in a fixed period of time, such as a
day or year. Productivity growth is driven by the ability to move
productive resources - labor and capital equipment - from
low-productivity activities to high-productivity activities. Consumption
growth in a modern economy cannot rely merely on quantitative increase.
It must take the form of qualitative improvement. A higher level of
living standard includes a rising level of culture, morals, aspirations
and sensitivities.

The Japanese economy combines industries where productivity is the
highest in the world with industries that lag behind their counterparts
in other countries. This is unavoidable for most economies because
culture demands more than efficiency. The trouble is that in Japan the
high productivity is heavily concentrated in the export sector, while
the lagging productivity is concentrated in the domestic sector. And as
mentioned repeatedly before, export earns US dollars. And dollars cannot
be spent in the Japanese yen economy. So Japan is dollar-rich but
yen-poor. The more Japan prints yen to finance export, the more dollars
it will supply to the dollar economy to make it stronger and richer, and
the yen economy poorer.

Economists have pointed out that in no other major country are the
differences between leading and lagging sectors as large, or the
potential productivity gains so great from closing the gaps. Food
processing is an industry that employs 11 percent of Japan's
manufacturing workforce. Analysts have estimated that if productivity in
Japanese food processing were raised to the level of France, a country
with equal attention to quality, freshness, and presentation, then
productivity in the Japanese economy as a whole would rise by 1.64
percent. Yet this would only exacerbate deflation in Japan by making
processed food cheaper.

The Japanese government is developing measures to deal with the NPL
problem. Financial Services Agency (FSA) Minister Heizo Takenaka has
outlined principles that will guide its approach to banking policy. The
first is assuring that banks accurately classify their loans and that
they hold sufficient provisions against losses. The second is assuring
that banks are adequately capitalized. And the third is improving the
corporate governance of banks, to assure that they operate both
effectively and profitably.

Yet these goals are music only to the ears of neo-liberal monetarists.
They do not address the real problems facing the Japanese economy. The
real problems are caused by a crisis in national purpose. Without
addressing the issue of national purpose, cleaning up the banks would
merely be dealing with the symptoms. In fact, Japanese banks can again
be healthy institutions if a national banking regime is revived to serve
a new, viable national purpose. Otherwise, forcing the distressed banks
to clean up their NPLs under a central banking regime governed by BIS
regulations would risk destroying the entire Japanese economy.

Japan has already used public funds to try to strengthen its banking
system, and more will be required. Yet public funds are not a viable
solution for a wrong-headed national purpose. Effective banking reform
can be aided by the use of public funds. But using public funds without
condition is a recipe for moral hazard and damaging delay.

A healthy, vibrant Japan is a Japan that can take its proper place on
the world stage - a critical factor in the security of the region and
the world. Yet a prosperous region and a world without poverty will
enhance the security of Japan more than any military alliance or
rearmament program. Japan can contribute toward a more secure world by
focusing on economic development by exporting wealth-creating technology
rather than wealth-absorbing products.

In December 2001, the government forecast that Japan's gross domestic
product for fiscal 2002 (April 2002-March 2003) would post zero growth
in real terms. Because of the slumping economy, investment in plant and
equipment was expected to drop 3.5 percent, while housing investment was
forecast to decline 1.9 percent. Because of the difficult employment and
wage environment, personal consumption was expected to grow only 0.2
percent. This weak domestic private-sector demand would push down real
growth by 0.5 percentage point. Public-sector demand, meanwhile, was
forecast to boost real growth by 0.3 point through increased spending on
the new national nursing-care system and other programs. As for external
demand, exports were forecast to increase during the latter half of
fiscal 2002, bolstering the real growth rate by 0.2 point. Even these
bleak forecasts proved to be over-optimistic. The Cabinet Office had
insisted on forecasting negative growth for fiscal 2002, in line with
the actual state of the economy in fiscal 2001. But the Ministry of
Finance (MOF) and the Ministry of Economy, Trade, and Industry (METI)
were opposed to a government forecast of negative growth that might be
self-fulfilling. In typical Japanese style, the two sides agreed on a
compromise. The government would prevent the economy from bottoming out
in the first half of fiscal 2002. It would make use of the second
supplementary budget of fiscal 2001, totaling 4.1 trillion yen, to
continue to implement public works, which usually experience a lull in
the first half of the fiscal year due to administrative procedures.

In the meantime, exports were optimistically forecast to improve,
especially those bound for the United States, which was expected to get
back on the path of recovery, notwithstanding that the decline in value
in the US equity market between March 2000 and March 2003 has exceeded
90 percent of GDP, as compared with 60 percent during 1929-31.

Since this scenario was a compromise, however, there was criticism of it
even within the government. One high-ranking official said presciently,
"Since it depends on a recovery of the US economy, the figure 0.0
percent [growth] is nothing more than wishful thinking." These forecasts
had not even taken into account the adverse impacts of the then
unforeseen Iraq war and the surprise SARS (severe acute respiratory
syndrome) epidemic.

Private-sector economists predict that a second consecutive year of
negative growth as inevitable. Behind these predictions lies the
judgment that it is difficult to foresee any pick-up in personal
consumption and investment in plant and equipment, the two main engines
of growth, when the economic situation will worsen because of structural
reforms, mainly progress in the disposal of NPLs.

Private-sector economists remain skeptical that business can act as the
locomotive pulling the Japanese economy out of recession because of
continued shrinking profits as a result of falling prices and severe
competition from China and other low-wage countries. Because of
increasing overseas Japanese production, a weak yen can no longer boost
exports as much as in the past. In the draft budget for fiscal 2002,
public-investment-related expenditures, which include both the
construction and operation of public facilities, are down 10.7 percent
from the previous year to 9.2525 trillion yen, which will add to
deflation. With the unemployment rate rising, consumer attitudes toward
personal spending will continue to worsen.

The biggest cause for concern in the near future is the stability of the
financial system, the backbone of the economy. The financial system has
been facing recurring crises, as evidenced by the continued drop in the
value of bank shares that began in the fall of 2001, reflecting the drop
of the equity market of which the banks own substantial holdings. The
Japanese economy has fallen into a vicious circle. Deflation leads to
the emergence of new bank NPLs, worsening the problem, which in turn
exacerbates further deflation. The disposal of NPLs must be expedited,
but banks are clearly threatened by the combined weight of the economic
slump, the collapse of the equity market and their own falling shares.
Recurrent instability in the financial system would destabilize the
financial capital market beyond a credit crunch. Banks may then be
forced to call in an excessive number of loans, a move that would be
disastrous for the real economy.

Additionally, the government introduced a so-called "payoff" cap in
April 2002 under which individual bank accounts are guaranteed only up
to 10 million yen plus interest in the event of a bank failure. So dark
clouds hang over the economy after fiscal 2002. The FSA has been
pressing local financial institutions that are short of capital to speed
up efforts to reorganize and consolidate, and it stands ready to prevent
any chaos, such as a run on banks, from occurring as a result of the
introduction of the payoff system. But in 2001 alone a total of 46
credit banks and credit cooperatives were forced into bankruptcy. If
this wave spreads to regional banks and second-tier regional banks, and
there are more cases like that of Ishikawa Bank, which collapsed at the
end of 2001, serious effects are expected. Because regional and
second-tier regional banks occupy a weightier position in local
economies than credit banks, local industries may be unable carry on. As
for a recovery in the US economy, on which the government's zero-growth
forecast was premised, the correction after the collapse of the
information-technology bubble has been more severe than expected.
Despite the recent rebound of the tech sector, US recovery when it comes
will not be led by high-tech industries, but by military hardware, heavy
construction and financial services, which will not have a major effect
on Japanese exporting industries.

Ever since the United States abandoned the Bretton Woods international
monetary agreement in August 1971 and took its dollar off gold, the
global monetary system has been plagued by a fiat currency at the core.
Countries that have been hit by currency runs suddenly realized that the
promise of market capitalism had been a cruel joke to rob them of their
wealth and dignity through an unjust international finance architecture.
In the absence of a stable, equitable international monetary order
consistent with open global markets, the US continues to push for
financial globalization. The unregulated free-to-manipulate approach to
currency-exchange relationships engenders only monetary nationalism and
ultimately fosters a protectionist backlash in all countries. The
currency carnage rages on with disastrous economic and political
consequences around the entire globe. Economic war, like all wars, are
recognized as undesirable by all, yet it happens because of an
inequitable world economic order.

Japanese sovereign debt does not face the issue of the Japanese
government not able or willing to pay its obligations. It is because
both Japanese debt and currency are freely traded in the open, largely
unregulated global market that credit ratings become important.
Recurring and persistent Japanese government budget deficits impact the
price of JGB (Japanese Government Bonds). For the past three years, ever
since the BOJ reduced short-term rates to zero, Japanese banks, as well
as a host of international speculators, have been borrowing cost-free
funds to invest in 10-year JGBs at about 1.3 percent. The banks have by
the end of fiscal 2002 some 67 trillion yen ($540 billion) in
fixed-income securities, doubling their holdings in February 1999 when
the BOJ first introduced its zero-interest hyper-loose monetary policy.
The banks have sold roughly 10 percent of their holdings in the first
half of fiscal year 2002.

This interest-rate spread has allowed Japanese banks to earn profits to
cover some of their losses from distressed loans and equity deflation.
Prime Minister Junichiro Koizumi's cabinet is not expected to be able to
keep its promise to cap new bond issues to finance further deficits.
Banks, already weaken in their capital base by asset deflation, cannot
sustain a sudden collapse of the bond market. Under BIS guidelines to be
introduced in 2005, government debt rated with a single A standing
carries a 20 percent risk rating, meaning that holders must set aside
capital reserves to cover 20 percent of the assets. The latest rating
for JGB has dropped from AA+ to AA. Although a local regulator can
ignore these BIS guidelines, it would still be a serious blow to Japan
and its banks' international standing, which would cost Japan a high
risk premium in the international debt market.

There is open political pressure for the BOJ to adopt a reflation
target. Ironically, the bank lobby is most among the most vocal in this
pressure group. Japanese banks have been selling their JGB holdings as a
risk management move. There is also political pressure to depreciate the
yen to the 150-160 range from its benchmark of 120 to the dollar. Yet a
148-yen dollar would trigger regionwide competitive currency
depreciation, including China's yuan, which is considered undervalued in
relation to that country's current account surplus.

With Japan caught in a liquidity trap, zero interest has had the effect
of pushing on a credit string domestically. But profits are being made
by those who borrow cost-free yen to invest in US treasuries, Japanese
deflated real estate and distress debts. The purchase of US treasuries
caused a temporary reverse-yield curve in US debts in the late 1990s,
making long-term rates lower than the short-term Fed Funds rate target
set by the Federal Reserve. This amounts to a black hole of unlimited
drain on the future of the Japanese economy. With potential yen
depreciation, this problem is further exaggerated, motivating market
participants to borrow yen to invest in instrument-denominated in
dollars. Overseas investors had built up arbitrage positions between
bonds and yen swaps on the assumption that swap rates would not fall
below JGB yields. But 10-year swap yields were about 1.3 percent (as of
November 27, 2002), 9.5 basis points below the 10-year cash JGB yield.
This prompted liquidation of JGBs against swaps, leading briefly to
serious contagion to other markets. This type of mini-crisis is now
commonplace and hardly attracting notice in the financial press. One of
these days, it will add up to a major crash.

The fact is that Japan, and really the whole world, cannot solve its
financial problems without facing up to the reality that no free market
or regulated markets exist now for foreign exchange, credits or even
equity anywhere. Arbitrary, secretive and whimsical intervention on a
massive scale hangs as an ever-present threat over the global system of
financial exchange. Individual self-preservation moves and short-term
profit incentive will bring the system crashing down some Tuesday
morning. This is what Alan Greenspan, chairman of the US Federal
Reserve, means by the need of central banks to provide "catastrophic
insurance".

The BOJ stunned the market on September 19, 2002, by announcing that it
would buy shares directly from Japanese banks. On October 11, it
announced that it would buy 2 trillion yen ($16.5 billion) of bank
shareholdings to make them less vulnerable to stock-market swings. The
BOJ also urged the government to use public funds to accelerate the
disposal of banks' NPLs. The share-buying plan would last up to the end
of September 2003 and would cover more than 10 banks. Masaru Hayami,
BOJ's then retiring governor, said: "If liquidity problems emerge from
declines in stock prices, the BOJ is ready and has the means to provide
additional funds."

The move signaled a more coordinated approach between the BOJ and the
government, which had for some time been at loggerheads over tackling
Japan's weak economy, deflationary environment and bank NPLs. But the
BOJ decided to keep its monetary policy unchanged, despite a call from
Masajuro Shiokawa, the finance minister, for further easing. The Nikkei
dropped almost 20 percent within months after September 19. The
benchmark Nikkei 225 average had difficulty closing above the key 8,500
mark. It hit new 19-year lows almost every day for the week ending on
October 11, on uncertainty regarding the government's plans to clean up
NPLs. Analysts say that if the Nikkei falls to 7,000-7,500, bank
capital-adequacy ratios could fall below the BIS requirement of 8
percent. The 2003 first-half low was 7,607.

Japan's banks are estimated to have 40 trillion yen ($322 billion) in
equity holdings, making them vulnerable to market swings. At the same
time, an export slowdown is threatening to derail recovery in the
world's second-largest economy, largely because of a decline in US
consumer demand for Japanese products such as cars and electronic goods.

Japanese government data show that the country's jobless rate in October
2002 rose to 5.5 percent, its highest level of the postwar era and a
figure last seen in December 2001.

Reform is seldom an engine of growth. It is also never a timely cure for
emergencies. Instead of concentrating on making the economy roll,
government bureaucrats devote most of their energy thinking up ever more
ingenious ways of pandering to official directives while at the same
time ensuring that their own official turf is not reorganized out of
existence. This tends to stop the economy in its tracks. Japan's banking
crises greatly reduced the impact of any macroeconomics policy to
stimulate demand. Regardless of measures to stimulate domestic demand in
the economy, Japan is structurally condemned to no growth for the
foreseeable future, unless its national purpose shifts.

Even if Tokyo does all that Washington wants it to - spurring demand
with monetary and fiscal policy, cleaning up the banking system and
vigorously pursuing systemic reform - its estimated contribution to
stability in the global economy is overstated. US export to Japan is a
mere 1 percent of US GDP, to all Asia 2.4 percent. Rising European
economies are filling in the Asian gap in world demand.

The Japanese insurance companies offered below-market yield during the
boom in return for safety to customers. The insurance companies then put
their assets in real estate, fueling the bubble, not only as lenders but
as investors to capture capital gain. The long period of deflation that
followed the bursting of the financial bubble in 1990 has caught Japan's
life insurance in a double bind. On the one hand asset values are
falling, while on the other hand high returns to policyholders are still
being offered in an effort to stave off a collapse of new policy
subscriptions. A vicious circle of insolvency then arises when liquidity
needs oblige these funds to liquidate depreciated assets. Bankruptcies
have multiplied. These institutions are at the heart of Japan's economic
system but have now become a source of uncertainty, leading to
deflationary pressures.

The bankruptcy of Nissan Mutual Life in May 1997 pushed the most
protected sector of Japan's financial system into open crisis: of the 18
life-insurance funds that have developed historically in Japan, six have
gone into liquidation. In expectation of further bankruptcies, the
Financial Services Authority got the Japanese Diet (parliament) to
revise substantially the Insurance Code and the Framework Law organizing
the restructuring of the financial system. Of the various modifications
adopted, the most notable involves state commitment to providing public
funds for supporting the restructuring of the sector. This type of
decision can only be justified economically if the social cost of
bankruptcy is considerably greater than the direct costs borne by
shareholders and creditors, and hence shows clearly the importance
Japanese authorities have given to these financial institutions in the
economic stability of the country.

The deterioration of the financial health of Japanese life-insurance
institutions is the direct consequence of their aggressive commercial
policy implemented during the speculative bubble, and pursued for a
further five years during the subsequent deflation. Between 1985 and
1986, the 50 percent appreciation of the yen led to colossal portfolio
losses in foreign-currency holdings. In order to maintain the overall
returns on assets, institutions were subsequently tempted to compensate
for losses by participating in Japan's rising stock-market euphoria. To
increase the scope of their investments, and hence raise profits, the
funds sought to attract more savings, through aggressive marketing.
Returns of 6-7 percent, if not 10 percent, to clients were thus offered
constantly. Given the long-term nature of such savings, only continued
rises in asset prices could support such payments.

But the bursting of the bubble in 1990, followed by the long period of
financial deflation, put the life-insurance institutions in the position
of having asset returns that have fallen below interest payment
commitments to policyholders. Their own reserves have been insufficient
to absorb this shock. On the one hand, reserves were reduced to a
minimum during the bubble as regulations on the use of capital gains and
constraints on reserves were relaxed. On the other hand, market values
have depreciated considerably since the euphoria has ended. Under these
circumstances, the life-insurance funds had to reduce their guaranteed
returns on new policies as soon as possible, for their financial
position to be restored. But this revision did not take place until
1995, when the guaranteed rate went from 4.5 percent to 3.5 percent, the
latter still being excessive given Japan's deflationary context. Thus,
these institutions continued to sell policies likely to generate losses
up until the second half of the decade.

The importance of these financial institutions led the MOF, as well as
the institutions themselves, to conceal the weaknesses of the sector
while waiting for a recovery. As long as policies were not canceled or
did not mature, the opaque accounting system allowed losses to be hidden
from public view. But, as the deflation took hold, such losses rose.
Despite the level of returns offered, market saturation and economic
recession led to a fall in new policies. This in turn led to a
persistent cut in the current resources available to the insurers.
Reimbursing contracts reaching maturity by liquidating corresponding
assets would lead to the forced revelation of losses. To prevent such a
liquidation of assets, the insurers must therefore ensure that current
resources are higher than those in use: hence they are forced to bid up
returns to attract new investors. This has led to the development of
Ponzi-style finance. Savings are attracted at a high cost and are meant
to be invested, but in reality are used to mop up losses on existing
policies. Financial charges rise as high-yield policies reach maturity.

From 1996 onward, the losses associated with the returns gap were
declared. The fall in stock market values and the leveling-off of
interest rates led to a collapse in investment incomes and latent
capital gains. This double bind on the profit-and-loss account led to
the failure in May 1997 of Nissan Mutual Life, whose disastrous
management triggered a slump in household confidence. The fall of new
subscriptions has been aggravated by an explosion of policy
cancellations; in short, there has been a run on the funds, though less
violent than in a real banking crisis. The weak macroeconomic and
financial situation of the late 1990s thus led to a self-fulfilling
deterioration of solvency. To satisfy their rising liquidity
constraints, the life insurers, which found it increasingly difficult to
borrow, were led to liquidate depreciated assets in ever-increasing
volumes.

Since 1997, each new bankruptcy announcement has reduced the credibility
of the sector as a whole and intensified the crisis. While all the
institutions are not in the same situation, low accountancy standards
tarnish all actors and reduce the solvency of the sector as a whole,
thus becoming a self-fulfilling prophecy. Official pronouncements by the
authorities, as well as from the profession itself, have been that
latent capital gains in life-insurance portfolios should make it
possible to mop up losses, a position that was previously applied to
banks until their recapitalization in 1999. This argument is still
faulty. On the one hand, latent capital gains (net of latent capital
losses) have in essence been exhausted. On the other hand, cleaning up
balance sheets by liquidating assets in the middle of a crisis actually
nourishes the downward pressure on asset prices, reduces the solvency of
asset owners and worsens the need for liquidity. This aggravates a
vicious circle of financial deflation, from which life-insurance
companies cannot escape by themselves. At the heart of the Japanese
economy, these institutions have now become an important factor in
worsening uncertainty and sustaining deflationary macroeconomic pressures.

As with the banks, Japanese life-insurance companies are "not just
another financial services institution". They have a systemic influence
on the economy, which is directed through three major channels: 1)
household savings; 2) long-term financing; and 3) financial markets.

Pensions in Japan are mainly financed by capitalization. Within this
system, the life-insurance institutions manage the major share of
individual, long-term savings, as well as a substantial share of the
savings collected by pension funds. Overall, the financial holdings of
the 18 mutual funds are drawn from 96 percent of households and account
for more than one-quarter of their savings. Confidence by savers in
these institutions is vital to the stability of behavior and the
long-term equilibrium of the economy. Conversely, doubts concerning the
solvency of mutual life-insurance funds are leading to a general feeling
of insecurity about the future, encouraging cautious behavior and a fall
in consumption, which in turn is feeding deflationary pressures. The
last two bankruptcies have affected 3.5 million savers, and may cause
them to lose part of their long-term savings.

As an integral part of Japan's large financial and industrial groups
(the keiretsu), mutual life-insurance funds play a structural role in
the organization of finance and industry. They are dormant shareholders
and providers of stable finance. During the 1970s and 1980s, their
long-term liabilities along with the continued growth of their markets
ensured that they did not suffer from liquidity constraints. They were
protected from competition through a cartel structure, and from
shareholder pressure by their status as mutuals. Thus, they are bound
little by the obligations of short-term profitability, by transparency
rules or the need to build up equity resources. Above all, they are
protected from hostile takeover, which makes them very stable core
players in the financial cross-holdings of Japan's large groups, and in
particular in their cross-holdings with banks.

When the life-insurance institutions weakened, the solidity of the whole
financial system came under threat. As stable funds became rarer, the
expectation horizon of numerous economic agents shortened. Debt
reduction and the buildup of equity have become priorities over
investment projects, while the downgrading of the latter stifles
economic growth and future profits. Since the first bankruptcy in the
sector in 1997, the solidarity and links between life insurers and their
partners have been called into question, clouding the outlook for
painless restructuring of the keiretsu and the whole of Japan's market
sector.

Last, the most powerful and visible channel for propagating tensions is
that of the financial markets. The concurrence of significant financial
weight, high concentration and homogenous behavior in terms of portfolio
investments gives the mutual life institutions particular power. Under
these circumstances, the worsening of their financial situation is
likely to provoke highly sensitive market movements that could weigh
down on the liquidity and solvency of all investors, especially the banks.

Since the collapse of Nissan Mutual Life revealed the absence of a
framework for managing bankruptcies in the sector, significant progress
has been made with respect to guaranteeing saving-insurance contracts,
accounting rules and prudential policy. However, problems still persist,
necessitating substantial progress. The life sector's Policies
Protection Fund was set up in 1995, and reformed in March 2000.
Henceforth, it has become an essential tool for restructuring the
industry. Its present capital stands at 460 billion yen, but is set to
rise by a further 100 billion yen contributed by the industry itself by
this year, plus 400 billion yen in the form of government loans. The
fund may also borrow in the markets, with the state underwriting such
borrowing. The fund will thus guarantee life-insurance policies through
to this year, in the case of bankruptcy.

But the terms under which such guarantees are met lead to harmful
uncertainties. In effect, the measure stipulates that if bankruptcy
procedures go ahead, then the returns on policies already sold may be
revised, retroactively. This amounts to the ending of obligatory
liabilities for policyholders. Thus, it is already clear that some
households holding policies with Chiyoda Life will see their assets
depreciate by at least 10 percent. These measures have a strongly
negative impact on private consumption behavior. They may also worsen
the instability of the insurance sector, by accelerating the pace of
contract cancellation. The debate surrounding a satisfactory resolution
of the crisis thus remains open.

The governing Liberal Democratic Party (LDP) has put forward a
proposition that would allow mutual life-insurance institutions to
modify the guaranteed rates of return on existing policies. This
proposal is being supported by the largest institutions. They are less
vulnerable to savings flight than the smaller institutions because of
their renown, and they hope to capitalize on this at the expense of the
rest of the sector. But the proposition does not provide a way out of
the crisis. On the contrary, it risks provoking a macroeconomic shock
and aggravating the crisis of confidence faced by the whole
life-insurance industry.

The errors of the banking crisis are being repeated. By liquidating
depreciated capital assets to meet obligations, the life institutions
have weakened themselves day-by-day. These institutions need to be
recapitalized by an injection of public funding, as finally happened
with the banks. A major lesson from the Japanese crisis is that
institutional investors can raise systemic risk by intervening in the
financial markets. All such investors must therefore be subject to
supervisory rules and strict prudential standards. This has been common
knowledge concerning banks for a long time. It is a lesson learnt with
respect to Long Term Capital Management (LTCM) hedge fund crisis in the
United States and it is beginning to be learned for pension funds and
for the Japanese life-insurance industry.

The BOJ policy board said on March 25 that it would buy more stocks from
the nation's lenders and flood the credit markets with yet more yen in
hopes of stabilizing financial markets unnerved by the fighting in Iraq.
The decisions came after the board met in a one-day extraordinary
session, and are the first policy steps taken under the bank's new
governor, Toshihiko Fukui.

In the weeks since he was nominated for the post, Fukui has been pressed
by lawmakers to cooperate closely with the government on measures to
revive the economy and rid the banks of NPLs. By calling the special
meeting, the bank's first since it became independent from the Finance
Ministry five years ago, Fukui signaled his willingness to go along. For
five years, the "independent" central bank worked at cross purposes
against government efforts to halt deflation, revive the economy and
rebuild business and consumer confidence. Now many economists and
analysts in Japan say it has become clear that the situation will not
improve unless the two act in concert. They raise questions whether the
"independence" of the central bank is in the national interest. Richard
A Werner's best-selling Princes of the Yen (En no Shihaisha) documents
how the Japanese economy has been manipulated by its central bank. Based
on its arguments, several well-known LDP politicians in Japan recently
founded a new Central Bank Reform Research Group, which Werner advises.

Fukui's predecessor, Masaru Hayami, guarded the bank's independence
jealously and often was dismissive of suggestions from outsiders. The
new governor's modest moves signaled that the central bank will now be
more accommodating. The Bank of Japan slipped into a shaky position
under Hayami. The message now is that this central bank will be proactive.

Significantly, Fukui assembled his policy board just five days into his
term, and did not wait for the regular two-day meeting scheduled to
begin April 7. The Japanese fiscal year ended on March 31.

The central bank's plan to buy an additional 1 trillion yen ($8.3
billion) in equities from the nation's banks comes even though Japanese
stock prices have largely stabilized after hitting 20-year lows in early
March. It expands the bank's appropriations for stock purchases by 50
percent, to 3 trillion yen. Through March, the bank had actually spent
only 1.032 trillion yen of the 3 trillion.

Japanese regulators have for years allowed banks to count as capital a
portion of their immense stock portfolios, which often include
substantial stakes in their customers. But the regulators have recently
started insisting that the banks revalue their portfolios to match
market prices at the end of each fiscal year, making the banks' balance
sheets highly vulnerable when share prices fall. The central bank has
tried to aid the lenders by agreeing to buy portfolio holdings from
them, especially holdings that could not be sold in an orderly way in
the open market.

The central bank said recently that it would go on flooding the money
markets with cash in excess of its formal target of 20 trillion yen, and
that it would loosen its restrictions further on making money available
to borrowers. Some analysts said these measures would do little to blunt
the longstanding criticisms of the central bank and the government, and
that they seemed capable only of piecemeal steps, and then only under
duress. Exhibiting this distrust of the central bank's efficacy, the
Japanese stock market fell both before and after the BOJ policy
announcement. On May 16, nearly a decade into Japan's banking crisis,
the Resona Group, Japan's fifth-largest banking group, with $360 billion
in assets, announced that it needed an estimated $17 billion cash
infusion to shore up its capital base. Koizumi offered to put up the
cash, giving the government majority ownership. It was the use of
deferred tax assets to calculate core capital that sank Resona, and the
same accounting device could trigger other bank bailouts. Deferred tax
assets are in essence future tax refunds banks anticipate collecting
once they clean up bad loans. The government figured that this
accounting technique, which is used also in the United States, would
encourage a financial cleanup. Auditors have allowed the uncollected
refunds to be counted as part of capital even though they aren't a
concrete asset. On Resona's books, these yet-to-be-earned credits
represented an amazing 77 percent of its core capital. But the bank's
auditor, Shin Nihon, refused to count more than three years' worth of
deferred tax assets as capital, slashing Resona's capital to 2 percent
of its assets. That pushed it below the 4 percent capital-adequacy ratio
mandated for domestic lenders, forcing Resona's senior execs to go hat
in hand to the government.

Resona Group appealed to the government for a giant funding injection to
bring itself back to fiscal health. The call triggered the first ever
meeting of the Financial Crisis Management Committee, and the money was
immediately granted. The 2 trillion yen government bailout and de facto
nationalization of Resona is a major development in Japan's struggle to
right its economy.

Kozo Yamamoto, a member of the LDP's Finance Committee who questioned
key figures in the debacle over Resona bank, which received 1.9 trillion
yen ($16.6 billion) of public money, said that if the criteria used to
calculate Resona's capital are applied to other Japanese banks, "there
will be a flurry" of banks that will need public funds.

BOJ governor Fukui said the country could suffer a financial crisis "at
any time" unless its near-crippled financial sector is fixed, with the
banks becoming more and more vulnerable to shocks.

http://www.atimes.com/atimes/Japan/EF28Dh02.html

Gary Santos wrote:

> "You could just about overlay the bond charts of any
> major currency nation on top of each other and they would match."
> Got it from Nick. Gary
>
>
> Good Folks:
>
> I have been a lurker, but a situation is setting up that I want to
> draw everybodys attention to.
>
> When the heavy currency interventions started in the fall, I noticed
> that the bonds would rally every time the dollar got hammered. This
> inverted the normal relationship where US bonds should sell off when
> the dollar sells off. Heck, even Sinclair himself ( I think around
> Sept) was buying bond puts figuring the dollar fall would start the
> collapse of the US debt bubble. But it didn't happen, and bonds pulled
> off a completely unexpected rally in the face of an improving economy.
>
> Well, we all now know why. The Japanese, Chinese, et. al. were issuing
> debt (bonds) in their own currency, taking the cash proceeds, selling
> the proceeds (their own currency), buying dollars, and with those
> dollars buying US treasuries, Agency bonds, and who knows what else
> (could they be buying up the stock market too).
>
> Well come December of 2003 and the news stories started hitting about
> size of the monthly BOJ currency operations and the Japanese Ministry
> of Finance increasing their own foreign currency holding limits to
> some unbelievably huge number of trillions of Yen for 2004 to further
> facilitate the USD currency operations(with the requisite Japanese Gov
> Bond issuance to finance the whole thing).
>
> I had to say to myself "what idiots would buy Japanese Government
> bonds (JGB's) at almost zero yield", and thus give the BOJ the ammo to
> fight with. I pulled up the JGB chart fully expecting to see the bond
> selling off in the face of such huge additional issuance (300+ Billion
> USD worth of additional JGB's issued that the market was not
> expecting) .... and what I saw totally confounded me. The JGB bonds
> were not selling off, but were in fact rallying to new intermediate
> term highs!
>
> As I researched the JGB market I found that almost all advisors (Dawa
> Securities, Mizho Securities, etc.)were calling for increased demand
> for JGB's, which totally confounded me. I couldn't understand why with
> such huge issuance, with such a risky and nontraditional Central bank
> ploy, junk-bond status, why would Japanese citizens, banks,
> corporations, and foreign investors buy this junk paper yielding
> almost nothing. (Japanese government debt was downgraded to below junk
> status in Spring of 2003 by Moodys and Fitch.)
>
> http://gabeharris.com/JapanBotswana.html
>
> I was totally confounded why the JGB continued to rally, and in fact
> broke out to the upside while the massive currency interventions were
> going on. Japan had to issue over 200 Billion USD worth of JGB's in
> 2003 and well over 100 Billion USD worth so far this year just for
> currency intervention alone.
>
> Well, I finally arrived at the answer. It seems the reason that
> Japanese buy the JGB is that their banks are insolvent, and with
> greatly reduced government deposit insurance, large holders of cash
> have nowhere else to go for safety.
>
> So I have been monitoring the JGB chart to see if/when it breaks out
> to the downside. This would put a huge crimp in the Japanese Ministry
> of Finance currency operation (very similar to the carry trade sell
> JGB's yielding almost zero and buy US treasuries yielding 2% - 5%
> depending on maturity).
>
> http://customer1.barchart.com/custom/alaron/4015.htm
>
> As you can see from the chart the JGB has broken out to the downside.
> Five days in a row down which is unprecidented in recent times.
>
> Well, yesterday I also looked at long term government bonds of most of
> the other economically important nations like Britain, Euroland,
> Germany, United States, etc. (Bund, Shaatz, EuroBond, US Treasury, etc.).
>
> ... and guess what?
>
> They are all sitting on their lower uptrend line and are one down day
> away from also breaking out to the downside.
>
> So it looks like in spite of what anybody is saying about lowering
> rates anywhere in the world, the bond markets are smelling the rat,
> and rates may be ready to rise on a world wide basis.
>
> You could just about overlay the bond charts of any major currency
> nation on top of each other and they would match. It is uncanny but
> makes sense all of the world's bond markets are linked together, where
> the carry trade of borrowing where rates are low and lending where
> rates are high (could this be the reason for the huge amount of
> financial derivatives at JPM, Citibank, hooligans, et. al.) Rates are
> gonna rise, but it looks like they are going to rise for all countries
> simultaneously. Looks like the end game in rates/currency is about to
> start.
>
> The holders of debt worldwide are fixing to be in a world of hurt if
> the US, British, German, Euro, etc bonds confirm the Japanese JGB
> breakout to the downside.
>
> MONITOR THIS SITUATION MY DEAR FRIENDS.
>
> There is no coincidence that the CRB is rallying and the PPI hasn't
> been released while all of this is setting up. Could this be the start
> of the worldwide debt meltdown?