Worst Case Scenario

  • Japan's ministry of trade occupies a 17-story granite tower in the heart of Tokyo's political district. The building looks as sturdy as ever. The bureaucrats inside are still recording trade surpluses with the rest of the world, month after month after month. This is the powerful agency--known as MITI, or the Ministry of International Trade and Industry--that two decades ago provoked fear and loathing in Washington because it was masterminding a protectionist and predatory strategy that vaulted Japan to the summit of the world's economies. Or so it was thought. But that era of Japan bashing has been made irrelevant by stuff nobody had heard of then, like portals and dotcoms and e-business software.

    The interior of the ministry is still outfitted partly with rotary-dial phones. And typewriters. Bells chime every workday at 3 p.m. to remind employees to do their calisthenics. Small things, of course, but they are signs that while the U.S. zipped along a new technological path in the 1990s, Japan was stuck in a slow-motion devolution from economic miracle to financial debacle, doing things the old way by subsidizing money-losing industries. "I used to be asked quite a lot to give advice to Americans, to explain our success," says Ryozo Hayashi, a vice minister. "But it's been a long time since Japan was seen as a rising sun."

    Setting sun is more like it. The stock markets plummeted last week to depths Japan hasn't seen since 1984. By the end of this month, total government public debt will top $5.5 trillion, a head-spinning 130% of GDP. (America's $3.4 trillion in federal public debt is 35% of GDP.) "Japan's public finances are very near collapsing," Finance Minister Kiichi Miyazawa said in uncharacteristically blunt remarks on March 8. He wouldn't say he was trying to drive down the price of the yen, but that's exactly what happened. The next day he backtracked.

    While the economy appears close to imploding, the political machinery is grinding to a halt. Prime Minister Yoshiro Mori, who plans to meet President Bush in Washington this week, has overseen a scandal-ridden administration. His political colleagues are maneuvering to replace him within a month. Bush, meanwhile, has promised to treat Japan less as a pupil and more as an equal, which sounds diplomatic but not perhaps helpful. "They're going to have to figure out for themselves what to do," Treasury Secretary Paul O'Neill told MONEY magazine.

    If Japan is suddenly registering on Washington's radar screen again, it's because a Japan in free fall coupled with a U.S. slowdown could imperil the world's economy. A deflated yen, already at 20-month lows, could tilt the trade imbalance further in Japan's favor. And the noise of a bursting stock-market bubble heard across the U.S. last week sounded eerily similar to what Japan experienced a decade ago. "It wasn't a miracle for Japan in the 1980s," says Tadashi Nakamae, an economist who co-authored the alarmist tome Wake Up, Japan! "And it wasn't a miracle for the U.S. in the 1990s either."

    While there are important differences in the two economies' slumps, the parallels are instructive. The strong-yen policy of the 1985 Plaza accord sucked money into the Japanese stock market, which soared 300% from 1985 to 1990. Treasury Secretary Robert Rubin's strong-dollar stewardship did much the same for the U.S. stock market in the 1990s. The boom was characterized in Japan by inflated land prices, in the U.S. by the NASDAQ. Japan in its heyday, and the U.S. in its later boom, both experienced huge boosts in worker productivity, high growth and low inflation. Japan's manufacturing and management prowess were held up as a new model; in the U.S., technology was the salvation. Both countries were thought to be on to something revolutionary, and a resulting euphoria deluded people into thinking the booms could be permanent.

    The differences between the two countries, however, are in America's favor: U.S. banks are in better shape; businesses are quicker to react; and workers are more mobile. Even if the U.S. follows Japan into recession, that doesn't mean Americans will experience a decade of descent. At least not if they learn from Japan's mistakes.

    "It's very simple," says Eisuke Sakakibara, a former Ministry of Finance vice minister for international affairs. "Japan delayed the structural reforms that were needed." It's not as if Japan did nothing. Sectors long shielded from competition, like financial services, have been opened to foreign investment. Foreign firms that now run car companies Nissan and Mitsubishi are closing factories and revamping inefficient supply systems. And the Sonys and DoCoMos of Japan have flourished in part because they separated themselves from the old cartels and figured out how to combine technological know-how with marketing savvy.

    But at the core of Japan's problems are its banks. Starting in 1998, when the banks were on the verge of collapse, the government authorized spending 70 trillion yen (nearly $600 billion) to shore them up. Trouble is, the government hasn't forced banks to reconcile bad debts, which now total at least $246 billion. Meanwhile, corporations are beginning to whack away at the cross-shareholdings, the financial bindings of the old business networks. These reforms are necessary. But they are also a big part of why the stock market is reeling, as corporations and banks alike sell off their investments. That process is expected to accelerate this week and next because of the softened yen and because the end of the fiscal year--March 31--is near, and under new accounting rules, banks will have to write down their market losses.

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