Today Japan, tomorrow the world

the far east meltdown

It is the good fortune of most people, most of the time, that they never have to think about Japanese politics. Consider yourselves lucky. Of all the world's industrialised countries, none is run by such a gruesome cast of bores as Japan, a First World country (as it has been described) cursed with a Third World political system. Japanese politicians have all the vices of their foreign counterparts with none of the redeeming colour: they are arrogant but faceless, self-important but humourless, impotent and complacent at the same time. Luckily, this doesn't often matter, since the country is effectively run by its bureaucrats (equally arrogant, but reasonably talented). But, sometimes, Japan's politics get the better of it, and the country's leaders are faced with a genuine and dramatic set of events upon which depend livelihoods all over the world.

This is one of those times. For the Japanese, the stakes could hardly be higher: in the next few weeks or even days, the decisions made by the prime minister, Ryutaro Hashimoto, and his government have the potential either to deliver Japan from half a decade of sluggishness and gloom or plunge it into its most serious economic crisis since the end of the war. But the consequences will be felt far beyond Tokyo, in the emerging markets of Asia, in the United States, Europe, and certainly in Britain.

For the past five months, a financial contagion has been spreading through south-east Asia and, in the last fortnight, it has hit Japan. Beginning in Thailand, and passing successively through Malaysia, Indonesia and now, most cripplingly of all, South Korea, Asian currencies have lost their value. This makes imported Japanese goods, such as cars, for instance, more expensive in Bangkok, Jakarta and Seoul. Asian companies are also finding it much more expensive to pay back loans from Japanese banks. The strain produced in Tokyo by this Asian meltdown has come after a five- year-long headache, caused by the collapse of the Eighties boom, what the Japanese refer to as the "bubble economy".

At home, the Japanese who 10 years ago were the world's most conspicuous consumers, have stopped spending; and now the stricken manufacturers have seen their markets in Asia suddenly dwindle too. Japanese banks were already burdened with bad debts and mortgages from the effects of negative equity at home; now their Asian creditors are defaulting as well. The result has been a series of drops in the Tokyo stock exchange; on Monday, one of Japan's big banks went down permanently under the weight of bad loans. Companies are laying people off and, as if things weren't complicated enough, the country is also in the middle of a painful course of deregulation. "Asia is collapsing," says Andrew Shipley of Schroder's in Tokyo. "In Japan we expect record high unemployment in the next set of figures. The situation is quite scary because it's a synchronised global slowdown."

Until now, Japan's pain has not been felt much abroad, and the changes have, to a degree, benefited foreign companies. Deregulation has opened up previously closed markets - the recent abolition of tariffs on whisky, for instance, allows Scotch to compete on equal terms with Japanese spirits. But unless Japan's leaders get their act together soon the rest of the world will know about it. "We shouldn't underestimate what a big problem this is," says Gerard Lyons, chief economist of DKB International in London. "The financial contagion is already apparent in Latin America, and it could spread to Europe."

If it does, it will be felt here as painfully as anywhere; of all its European competitors, Britain's fortunes are uniquely tied up with those of Japan. It is a measure of how importantly the relationship is regarded that, since the election, six Labour ministers have visited Japan (the latest, the Foreign Office minister, Derek Fatchett, left this week; John Prescott flies in at the weekend). Next year sees a year-long "British Festival" of art, drama and science; British diplomats in Tokyo are cock- a-hoop about the visit to London next spring of the Japanese Emperor and Empress. Officially, these events are all about building goodwill and promoting mutual understanding; the underlying reality is that they are the latest in a series of highly successful strategies designed to attract Japanese money.

For diplomats and politicians, it is a source of justifiable pride that in the past 10 years - against tough competition from France and Germany - some of the biggest names in Japan have set up shop in the UK, including Nissan and Toyota. Nearly half of all manufacturing investment in Europe is in Britain; no self-respecting bank or brokerage is without a London office (Britain is home to the third biggest Japanese community outside Japan). If Japan's downward spiral continues, and its investors are forced to repatriate their funds, these will be under threat.

Every year 650,000 Japanese tourists visit Britain; last year they spent pounds 430m. Apart from earning less from their investments and feeling increasingly insecure about their jobs, those tourists have much less to spend: a pound, which was worth about 188 Yen over the summer, costs 217 Yen this week. British exports to Japan were worth pounds 4.3bn last year, and have trebled over the past 10 years, even as imports have decreased; suddenly everything British is more expensive.

A Japanese meltdown would affect you if work in a hotel or live in an area with big Japanese investment (South Wales, Sunderland, Derbyshire). It will affect education - more than 60,000 Japanese students spend pounds 350m in Britain annually. Japanese sponsorship has built galleries in the British museums, and extensions to Oxford colleges. There are few areas of cultural life in Britain (sport is perhaps the exception) which have not benefited from Japan's remarkable post-war prosperity.

Japan is a country where disasters, of a natural kind, are common, and even these provide a lesson. When the city of Kobe was devastated by a huge earthquake, the delayed shockwaves were felt in Britain as strongly as anywhere. The sudden dip in Japanese share prices which occurred as a consequence of the quake ruined the plans of a young British banker, Nick Leeson. His increasingly desperate attempts to recoup huge trading losses were scuttled once and for all; a month later his employer, Barings Bank, was ruined. The collapse of a few more Japanese banks, the further slide of the Nikkei share average, could make the Kobe earthquake look, in financial terms, like a minor wobble. Time, perhaps, to drink a strong cup of coffee, take a deep breath, and take a hard look at what is happening in Japan.