Bill Emmott - International Author & Adviser


Japan´s lessons for the financial crisis
Ushio - October 2007

August is usually a quiet month in the financial markets. Even traders in bonds and shares take holidays. And, since markets generally become volatile in response to news, and since typically there isnít any economic news in August, it is a good time to go to the beach. This year, though, was a big exception. It started me thinking back to Japan in 1990.

            This yearís financial crisis began in the United States, and spread to Europe. It was triggered off by bankruptcies and big losses in the home mortgage-loan market in America, and in other risky debt markets attached to it. It had little to do with Japan, although the Tokyo stockmarket did fall as a result and the yen was volatile. So why did I think of Japan?     

            The reason is that the way in which the financial crisis unfolded in Japan in 1990 may offer some clues about what might happen in America from now on. It may also offer some lessons for how policy makers should respond, and what innocent onlookers should think about what is happening.

            One important memory of 1990 in Japan is that dramatic things were happening in the equity markets, with share prices falling day after day. But the economy seemed to be unaffected. It went on growing quite strongly, in fact, for almost two years. A lot of economists and other observers concluded that the financial drama was therefore meaningless. It would prove quite temporary. An economist at one of the big securities houses told me that the Japanese economy was in a golden age, and this financial crisis would make no difference to it.

            I remember getting into a taxi in Nihombashi one day, and the taxi driver thought I had come out of a securities company and asked if I had any stock tips. I had in fact been giving an interview at Toyo Keizai, so I said no. He told me he had been a Buddhist monk but had given it up in order to earn money on the stockmarket. He just drove a taxi to use up time and pick up stock tips. I asked if he was worried about the marketís fall. He said no: things would be normal again soon. I wonder what happened to him?

            Similar things can be heard in America today. There is a financial crisis, but the economy has so far not been affected. As a result there is a sense of unreality. The lesson from Japan in 1990 is that when a financial crisis occurs that involves property markets and debts, it takes quite a long time before the true size of the losses and true nature of the crisis becomes known. That is also true this fall in America, and in the European banks that have got involved in the crisis. No one knows how big the losses might be.

            The amount of debt that is involved is huge: not just debt connected to property but also debt raised at cheap rates for a lot of other financial games. It is very unlikely, therefore, that this crisis will just go away quickly. It is likely to force America into recession. If other countriesí banks get into serious trouble, then those economies could also be damaged. So will those of economies that export heavily to America, including both China and Japan.

            In that sense, the parallel with Japan is rather a pessimistic one. But another comparison provides more optimism. This is that in Japan, the problem caused by falling stock and property markets and by big losses at the banks was actually made worse by the efforts of the Ministry of Finance and by the banks themselves to conceal the truth. They hoped that by delaying disclosure of the truth, they would gain time and the losses would go away by themselves as the economy recovered. It didnít happen. The losses got worse. Once it became clear that losses had been concealed, no one trusted Japanese banks any more, so they charged a premium to lend them money. This made the crisis even worse.

            In America, such concealment is impossible. The stockmarket is too open for that, and the rules governing public companies enforce disclosure. So it is likely that the losses will be disclosed much more quickly in America, as banks and other financial firms are forced to revalue their assets and obligations according to the new market prices. Although that may make the crisis look bad when the losses are disclosed, it will actually help to mean that the crisis is short-lived. Market prices will adjust quickly. Trust will return.

            There is, moreover, an important difference between now and 1990. This is that globalisation of trade and capital flows is far more advanced today than it was when Japanís crash began. In 1990, China was a small factor in global trade and capital flows, and its economy was anyway in crisis following the Tiananmen Square massacre of 1989. India had not really begun to liberalise its economy. The Soviet Union still existed, and most of Eastern Europe was still not free.

            Our economies are linked together by trade and so are our financial markets. That means that none of us can hide away from problems in other big economies. However it also means that there are many more sources of demand, many more consumers, many more savers, many more business opportunities than there were in 1990. So there is a good chance that even if America has a recession, growth in China, India and other new economies will carry on and will also help support America itself by creating markets for its exports. Globalisation, in other words, could act as a stabiliser, as a support.

            The August crisis almost certainly does mean that bad times lie ahead, especially for America. But the crisis does not need to turn into a catastrophe.


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