Comment: Things look even worse in Tokyo

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The Independent Online
If things seemed gloomy in London yesterday, they were worse in Tokyo. Not only did the Bank of Japan's cut in the discount rate to 3.25 per cent fail to revive the stock market, which fell to a six-year low; new figures showed that sales at Japan's large retail stores were down 4.3 per cent on the year, while sales at supermarkets were down 4.7 per cent. By comparison, London's stock market was merely at a one-year low, while our retail sales are actually running up a little year-on-year.

It is worth making the comparison, partly to underline the point that since cuts in interest rates in the US and Japan have failed to stimulate the economy it is not at all certain that a cut in British rates (even if one were possible) would do much to boost demand here.

But of course there is a more fundamental issue here. The world's biggest economy, the US, is making only a slow recovery. If the world's second biggest, Japan, were now heading into recession, the economic forecasters would have to revise down yet again their forecasts for growth next year.

Up to the past two or three months most economists have tended to see the problems of Japan's financial markets as independent from the performance of the real economy. The situation in Japan appeared a mirror image to that in the US: in the US share prices were hitting new highs despite the hesitant nature of the recovery, while in Japan share prices were hitting new lows despite the encouraging economic growth. Japan's financial problems - it seemed - mattered only in as far as they might threaten the banks' capital position: they were not affecting the underlying economic performance.

Now the most interesting way to look at Japan is to turn that conventional view on its head and examine this proposition. Maybe the collapse of financial markets does not really matter, for that adjustment is in its final stages. What does matter is the weakness of the real economy, for that has only just begun. There is a link, in that the principal reason for the weakness of consumption is the negative wealth effect of low share and property prices. But if the collapse is really in its final stages, that will reverse itself soon.

It was certainly disturbing yesterday that the cut in the discount rate (which came rather earlier than many local commentators had expected) failed to boost share prices. That signals that the market is psychologically on its own. Even at this level dividend yields on Japanese equities are very low by UK standards, so in terms of fundamental valuation it could be argued that share prices are still too high.

The consensus view in Tokyo is that prices have further to fall, and given past experience it would be deeply unwise to bet against that. However a decent argument can be made that, even if there is a further fall in the offing, at least the market is back into an acceptable trading range in which it can move over the next three to five years. The present 15,000- plus level might not be the floor, but it would be an acceptably modest ceiling.

In other words, the worst that might happen to a new investor would be to find in three to five years that the portfolio was back to its present level at the peak of the next market cycle.

This 'trading range' view is not yet accepted wisdom in Tokyo, where investors and brokers alike are so shell-shocked as to find it hard to think long-term about anything; nor is it a view that can easily be sold to investors here in London, where the Japan bulls have been so wrong for so long that they have little credibility left. But the notion of 15,000 as an acceptable ceiling represents a new idea in an area where most people are too numb to think at all.

If share prices have made most of their adjustment, the same cannot be said of property prices. Equities have fallen by more than 60 per cent from their peak, while property prices have typically fallen by only about 20 per cent. The process of disinflation will probably have further to run in property than in shares.

Still the fears of a fall in property prices have, so to speak, been 'in the market' for a year or more; the prospect a collapse of economic growth is relatively new.

The official target for the Japanese economy this year is for 3.5 per cent growth. Nobody believes that that is possible. The question is more whether the OECD's latest forecast of 1.8 per cent is attainable, and the pessimists are suggesting that there will in fact be negative growth this calendar year, followed by another year when the economy shrinks in 1993.

This would be very serious indeed, for the recession would be coming just after Japanese industry has undertaken an enormous investment boom. (People who worry about Britiain under-investing might be surprised to realise that one of Japan's problems is over-investment.)

The possibility that Japan might move into a recession as serious at that in the UK, and more serious than that in the US, is not yet in any mainstream forecasts. But something close to recession this year is: for example the latest Yamaichi forecast has growth at only 0.2 per cent this year, with industrial production down a stunning 7.8 per cent.

If Japan does move into recession, what are the implications for the world economy? Statistically, overall growth of the OECD countries will of course be lower. The more fundamental issue is whether recession in Japan would have a knock-on impact on the rest of the world.

Here it is possible to a little more cheerful. It would be serious for the East Asian region, where Japanese companies have shifted much of their component production, but since US and EC exports to Japan are not really material to the North American or European economies, the impact on these areas would not be so serious.

Much will depend on the movement of the yen. In the long term the yen is set to strengthen. Yesterday, by coincidence, the Research Institute on the National Economy reported that it expected the dollar to fall to Y115 in 1995 and Y95 in 2000. But in the short term Japanese companies need export profits to maintain cash flow and boost dividends. A rise of the dollar against the yen would be very helpful to underpinning the whole economy through the next few months.

Without it, though, the outlook for Japan Inc is discouraging indeed.