The Sun Also Sets

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When Japanese talk about their country, they cling to cliché. A resource-poor land ... rising from the rubble of World War II ... Japan as number one. Even in the past decade of flounder and drift, the wisdom was always conventional. Increase government spending ... tighten the belts ... no pain no gain.Of all the things Japan has lost since its economic bubble popped 12 years ago—the van Goghs, Rockefeller Center, national confidence—add one more: the comforting, all-accepted platitude. You don't hear the whens, hows or ifs of economic recovery anymore: the unspoken question these days is whether some seismic collapse is on the near horizon. Lifetime employment, a pillar of the Japanese miracle, has been supplanted by the specter of lifetime underemployment for today's twentysomethings and brutally early retirement for the salarymen who rose out of that rubble. A lot of Japanese are shaking their heads and muttering, Times are bad, but ... and the sentence goes unfinished. No one can find a consoling conclusion.The Japanese have finally got it: 12 years isn't a mere recession, and the rising sun doesn't inevitably follow the dark of night. Everybody's afraid because we know we are getting poorer, day by day, says Yoshiharu Nakashima, who ought to know: he's a pawn-shop owner in Tokyo's Ueno district. When U.S. President George W. Bush visits next week, he'll undoubtedly spend some backroom time telling the Japanese to get their acts together. His host will be Prime Minister Junichiro Koizumi, who achieved rock-star popularity by promising to do just that, but whose public support vanished this month when he caved in to Japan's troglodytic Old Guard—the bureaucrats and Liberal Democratic Party (LDP) hardliners—robbing the population of the hope of change. At the end of next month, Japan's reform-repellent banks will close theiryearly books and reveal whether their assets, many of them shares on the super-depressed stock exchange, are substantial enough for solvency. (There's serious talk of the government having to nationalize a big part of the banking sector.) Beginning April 1, the government will no longer guarantee bank deposits above $75,000. That signals that the country's downhill coast of the past decade could pick up truly dangerous speed: at the very least, Japanese thought—both collectively and individually—they could live a long time on the savings accrued in better times. Maybe not. And then earlier this month, two numbers that were never again supposed to cross—the Nikkei and Dow industrial average—converged when the Japanese index dropped below the Dow—portending finally, truly, absolutely, that Japan was now back where it started—trailing the West.Japanese now realize that their great prosperity machine, a wonder in its day, has run down. Even the best machines—especially the best machines—need regular re-engineering: parts that hummed along in one era get jettisoned in the next. Japan is loath to do that kind of tinkering. Throughout the '90s, with most voters comfortably well-off and complacent, leaders were able to subvert the kind of creative destruction that could have reinvigorated Japan's economic infrastructure. As a result, no entrepreneurial phoenix is rising from Japan's industrial ashes. Real-estate values are at 1982 levels. Manufacturing has been siphoned off to China and other cheaper countries and unemployment is at a post-war high of 5.6%. A survey by Koizumi's office finds that 65% of the population are feeling insecure and fearful of the future—higher than at any point since 1958. Our wealth, says former Vice Minister of Finance Eisuke Sakakibara, now director of an economic think tank and professor at Keio University, is slipping away.So Japanese are now shopping at second-hand stores; residents in upper-class districts comb through their neighbors' trash for used furniture. Potential entrepreneurs, the Akio Moritas of the future, are doomed to remain dreamers: the banking system is so swamped with the remembrance of debts past it doesn't have the money—or will—to help new businesses get off the drawing board. For the first time since the end of WW II, Japan is facing the concept of personal and corporate obsolescence. We hope this is the bottom, but who really knows? asks Masayuki Watanabe, a 48-year-old meat wholesaler who gave up his faltering business three months ago (and with it a $70,000 annual income) and now peddles $5 lunch boxes in Tokyo's depressed financial district. We have no choice but to start over. Even, it seems, if that means leaving the country. Laid-off Japanese engineers are now lining up for jobs in China. Salarymen work, live cheaply and send paychecks home to support their families—much like the world's other economic nomads, the Philippine maids of Hong Kong or Turkish factory workers in Germany. They'll look at a job in China even though the pay is half what they were making in Japan, says Tomoko Hata, a manager at a Tokyo employment agency. It sounds very sad. But they're desperate.Yoshihiro Matsumoto knows that sinking feeling. It comes over him like a bad hangover every morning at 5 o'clock when he and his wife head out to a large, chilly warehouse next door. He climbs up a loft, pulls out a 2-m-high bundle of blue-green straw called igusa, carries it downstairs and dumps it in the hopper of a weaving machine where it will be made into tatami mats. The Matsumotos have worked in Kagami, on the southern island of Kyushu, for three generations; it was igusa that turned a poor country backwater into a modern middle-class town, one of the wealthiest farming communities in all of Japan. The farmers had a nickname for their prized crop: Blue Diamond.Today igusa is, well, straw. The farmers in and around Kagami ply an anachronistic endeavor propped up for decades by protectionism. When Japan was booming, the government thought it could have it all. Farmers, who traditionally voted for the long-ruling LDP, were shielded from competition from imports; Japan's consumers shouldered ridiculous bills for homegrown farm products. Today, thanks to the weak economy and the wrenching opening up of Japan's markets, tatami prices are half what they were 10 years ago. Farmers can't pay off the loans they were once encouraged to take. Thirty farmers have committed suicide the past four or five years, says Yoshiharu Takahama, a town assembly member.In the relentlessly confident 1980s, the tatami makers of Kagami sent a delegation to teach Chinese farmers how to raise igusa and weave tatami. I had a slight feeling of dread, admits 33-year-old farmer Yasushi Furushima, who visited China a few years afterward. But their quantity wasn't very good. China, of course, caught up fast: today, its exports account for more than two-thirds of the tatami market in Japan. In a last ditch measure to protect its farmers, Japan last year slapped import duties on Chinese tatami, along with leeks and shiitake mushrooms, other endangered cash crops. Bad move. China retaliated by putting tariffs on Japanese cars, air conditioners and mobile phones, businesses worth $700 million annually—seven times more than the farm products Japan was protecting. (The two countries began meeting last week to hammer out a settlement.)The farmers' rut is a small one compared to that of manufacturing, the heart of the Japanese miracle. Yahaba, a town of 21,000 north of Tokyo, was once an electronics boomtown, home to an Aiwa compact-disc factory and six other manufacturers. In January, loss-making Aiwa shut down the plant—and all of its factories in Japan. People working there, at first, said, oh, this won't affect us, says Genkichi Kon, who operated a snack shop inside the plant. But gradually, one by one, people were restructured [translation: fired]. Two other factories have also closed. People in our town are spending their savings for their everyday life, says Yahaba mayor, Mitsuro Kawamura, echoing a trend the government reported in January: the jobless are now dipping into their savings accounts to make ends meet.Across the archipelago, manufacturers big and small are cutting salaries, asking workers to job-share and shuttering facilities. A decade ago, fewer than 20% of manufacturers had operations overseas; today the number is 35% and climbing. In most cases, the jobs are moving to China. All the parts for Sony's market-leading PlayStation video-game console and its final assembly take place there. In fact, of more than 1,000 companies surveyed by the Japan External Trade Organization, 42% said they are considering shifting some or all of their manufacturing operations to the mainland. Labor is cheap, of course. But also, according to Tadashi Matsumoto, senior vice president in charge of manufacturing for Toshiba Corp., Chinese workers are more highly motivated and harder working compared to the Japanese.Ouch. I couldn't accept it as reality, I couldn't believe it was happening to me, says 54-year-old Tsuneo Tokoro, who lost his job last spring when his factory—where he had worked for 37 years making water faucets—shut down. But if companies like mine can't go to China to make things, then they will go broke. Masami Sato, 36, who left his electronics company in Yokohama after 16 years and is now training to be a health-care aide, says he will be earning half of his previous salary in his new job. None of my experience can be utilized, he says. I am starting from scratch.The government's tack: to weaken the yen, make Japan's exports a little more affordable, buy a little time. Most people consider that a bankrupt solution for a nearly bankrupt nation. A weak yen certainly won't help the wide-eyed man with a two-day growth of beard wandering the tunnels connecting subway stations in central Tokyo. HELP ME, reads a sign around his neck. RESTRUCTURED. There were nearly 20,000 bankruptcies last year—the second-highest yearly total since World War II. It's simple, says Andy Xie, Morgan Stanley's chief economist for the Asia Pacific region. Japan has not evolved into a postindustrial econ-omy. Its dominant role in manufacturing isn't sustainable, not with countries like China gradually taking over this role. According to a recent study by the Japan Research Institute, an economic think tank, if Japanese companies continue to shift production to China at the rate they are now, Japan's envied $48.96 billion trade surplus will slip away entirely and become a deficit within five years. Japan has to move up the economic ladder, and shift trade from goods to services and intellectual property, Xie says, unless it wants to go back to being a poor country again.There's a joke making the rounds in Tokyo these days. Mr. Suzuki goes to his local bank branch, rents a safety deposit box and locks away some cash. The next day he comes back and takes some money out. He does this again and again. Finally an exasperated bank manager asks, Suzuki-san, why don't you open a bank account?Suzuki-san responds: I'd love to. What collateral are you offering?The banks are Japan's immediate problem, the weakest part of the whole crumbling structure. The essential question now: are they chronically metastasized with bad loans—very sick but possibly curable—or are the banks on the point of complete implosion? The largest banks expect to collectively lose $17 billion this fiscal year. The latest official stat on irrecoverable loans is $135 billion, though nobody has ever trusted that figure: the only sure thing was that the mountain of bad loans from the bubble period, troubling enough at the time, has grown exponentially with bankruptcies and the decline in the stock market. Kenneth Courtis, vice chairman of Goldman Sachs in Tokyo, describes Himalayas of debt crashing down on the economy. In January, Yoichi Masuzoe, a parliament member from the ruling LDP, gave voice to many unspoken fears when he pronounced, By the end of March we will have a financial crisis—that is 100% true.Japan's fatal misstep was to avoid the short-term pain of closing down dud companies and faltering banks after the bubble burst, the so-called creative destruction the U.S. allowed in the 1990-91 recession and after the savings and loan collapse of 1988. Tokyo said it wanted to avoid layoffs, that companies would recover when the economy perked up. The real story is that Tokyo's instinctive reaction has been to dole out government contracts to construction companies and make banks provide cheap capital to keep retail empires going. (In January, the government backed a bailout of struggling Daiei Inc., a retailing giant that needs $3 billion from its main creditor banks to stay afloat.) This kind of propping up and bailing out is expensive: healthier parts of the economy and eager entrepreneurs get starved for loans. Until 1998, Tokyo couldn't even admit how bad its banks' balance sheets were: it had no money in its deposit insurance fund. (Filling that up cost $142 billion in 1998.) Within three years, it had sunk $600 billion in a recapitalization plan that was too little, too late.The drama now revolves around what Koizumi's government can do. On a tough-love trip to Tokyo last month, U.S. Treasury Secretary Paul O'Neill warned that if Japan didn't do some stiff brooming fast it could face economic upheaval. In the Japanese context the meaning was clear: a loss of confidence, bank runs, financial collapse. Tokyo's greatest hope is a stiff restructuring of banks—one that keeps them afloat while at the same time forces them to drop deadbeat creditors—that doesn't freak out savers.But there's another danger too: that Japan's complacent public will go along with some muddle-through plan, and no creative destruction will take place. I've heard of one woman closing her account and then renting a safe at the same bank and stuffing her cash in there, says financial planner Masayuki Kihira. But that's a rare example. Eighty-one-year-old Sachi Matsuyama of Tokyo recently closed her account, but with no particular urgency. Interest rates were so low, there was no reason to keep my money there, she says. I just have enough saved to pay for my funeral. That's becoming a kind of national mantra. We are rich enough to sustain ourselves for another five years, says Sakakibara. That, he says, is the problem—an excuse for not acting. Because we can do nothing, that's what we'll do. And that will only make things worse. Like the individuals who draw on their savings accounts to pay the rent and buy food, Japan is tossing money at propping up rotten banks and failing companies, building highways to nowhere and becoming poorer by the day. If the situation continues for another five or 10 years, predicts Sakakibara, then Japan will drop out of the group of developed countries. Japan now faces its toughest manufacturing challenge in decades: it must manufacture a future.With reporting by Daisuke Igarashi/Tokyo and Toko Sekiguchi/Tokyo