Mrs Thatcher, please report to Tokyo
Sunday 16 August 1998
When you get a barrage of trouble, the difficulty is to separate what is new and matters from what has been around for some time but never really noticed properly.
As far as the UK is concerned there is nothing new. There was a wodge of information from the Bank of England's latest Inflation Report, which warned of a slightly worsening inflation outlook and, for the first time, the (still small) danger of recession. But this was all within present expectations.
Of course, it is interesting to know the Bank's views because these colour the decisions of the monetary committee. However, as far as interest rates are concerned, this new data merely cemented the present perception that we have reached the peak, even if the first decline may take a while to come through.
With Russia, the information is also not new, although it is much more alarming. George Soros is brilliant at understanding and articulating a market's mood at any one time and last week he caught the imagination of both East and West through his dire warnings. The fact that Moscow's finances are in an unsustainable deficit and the country is suffering from capital flight has been known for ages. The new turn is really only the way in which the markets ratcheted up their own sense of misery.
The balance of probability now is that the IMF's rescue package will not be sustained and that there will be a devaluation of the rouble. In fact, the currency is not overvalued on a purchasing-power parity basis, and in theoretical terms, therefore, should not be devalued. But if the price of keeping the rouble up is 200 per cent interest rates then that price is too high. BNP says to expect a devaluation following a visit by its analyst to Russia. That looks the most likely.
But does it matter? Well, it does if you are a Russian or running a bank that has lent to Russia, but for the rest of us the answer is "not very much". The interface between the Russian economy and that of Western Europe is very limited. We buy raw materials from them; they buy a few manufactured goods from us.
It matters more to Germany than to Britain, but for Europe as a whole, Russia is not a sufficiently large trading partner to threaten its economic stability - unlike Japan.
For me, the most alarming news of the week came from Tokyo. The Japanese economy does matter. It is the second largest in the world, and without recovery there, the whole East Asian time-zone cannot recover.
There were several pieces of worrying information, the most troublesome being not the further plunge in the yen, but the evidential delay in the bank rescue plan.
First in the firing line is the Long Term Credit Bank, generally recognised as the weakest bank, but clustering behind are perhaps half a dozen of Japan's 19 top banks which are generally reckoned to be bust. The governor of the Bank of Japan, Masaru Hayami, warned that a sudden failure of any one of them could destabilise the financial system.
The rescue plan is held up in the Jaspanese parliament, and while it is clear that something will eventually emerge, it is not so clear whether Japan can escape an actual bank failure beforehand.
It is also possible that the plan itself will prove inadequate and have to be redrawn.
It has become increasingly obvious that the new Japanese government is only transitional and there will be some political upheaval later. If the government cannot cope with the immediate political difficulties of assembling a bank rescue package - something that lots of governments around the world have had to do - what hope does it have of making the deeper structural changes needed in the economy?
To catch a feeling for this malaise, look at the parallel with the US in the 1920s and 1930s, shown in the graphs which have been pulled together by the Bank Credit Analyst (BCA) team in Montreal. In the second half of the 1920s, the US experienced a speculative boom, followed by the Great Depression. The pattern of interest rates rising to temper the boom, share prices soaring then plunging, and the government moving from substantial surplus to deficit financing are charted in each of the graphs.
There are obvious parallels, some significant differences, and some practical conclusions.
The parallels are that while in the US interest rates were very low from 1933 to 1939, and the fiscal position was in a sizeable deficit, the economy failed to recover until rearmament in the 1940s. Japan's interest rates are very low, its budget deficit sizeable, and yet it, too, is failing to recover. When you have the combination of a speculative bubble, a loss of confidence in the banks, and falling prices, it is clearly very hard to dig yourself out.
The principal difference is that the fall in Japanese economic activity in the 1990s has been much less than that of America in the 1930s.
The policy errors have been different: the US responded to a fall in demand by bringing in protectionism, which caused retaliation and shrank its export markets, whereas Japan's main failure has been the Bank of Japan's tardy easing of monetary policy once it was clear the bubble economy of the 1980s had burst, compounded by a rise in the consumption tax last year.
While Japan has not brought in any additional protectionist measures, the collapse of demand from the rest of East Asia has had a similar effect on exports. The conclusions are, I suppose, that Japan has to press on with cheap money and fiscal reflation, but it should not expect too much joy from either.
It has to restore confidence in the banking system. Most of all it has to regenerate the economy by supply-side changes, deregulation and tax reform. But it cannot do much on the last front until it has a government that has popular support or sufficient self-confidence.
I was talking to a Japanese official the other day and he said: "What we need is a Mrs Thatcher." I suppose he could (had we been looking at those graphs) suggested a Franklin D Roosevelt. Both those politicians pushed through reforms which were extremely unpopular at the time and were by no means optimal. But they eventually helped the economy turn the corner.
The worries, therefore, are twofold. First there is the immediate one that Japan will make a mistake in its banking rescue; and second that it will fail to make deeper reforms and accordingly be unable to pull up the region's economy. Both of those dangers clicked up a couple of notches in the last few days.
All gloom? Well, no. The other two main economic regions - North America and Western Europe - are still growing, albeit more slowly. Global inflation, the great scourge of the 1970s and 1980s, is dead; we are not generating that much of it in spite of all our efforts here in Britain.
There are always dangers. I found the investment conclusion of the BCA people quite comforting. Yes, one should favour bonds over equities because share prices still had not reflected the squeeze on company earnings from the downturn. But there was not necessarily going to be a crash in equities worldwide; just a period where it would be much harder to make money.
As for East Asia, at some stage it will be right to plunge into those markets as they hit bottom and the fundamental economic strengths of the region reassert themselves. But that time has yet to come.
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