Time Up for Koizumi

Peter Tasker (Arcus Investment)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on April 17, 2003: posted here with the author's permission.

There is a definite feel of fin de regime in Japan. Last weekend's elections for local assemblies and big city governorships were just the latest indication of the public's disillusionment with the established political parties.

The one big name who can look back on the results with satisfaction is maverick nationalist Shintaro Ishihara, who swept to a second term as governor of Tokyo. The irrepressible Ishihara is the one Japanese politician with street-level popularity, winning support from 70% of unaffiliated voters. Judging from his carefully ambiguous comments, he has not given up hope of leading his country. Like others in the wings, he is waiting for Prime Minister Junichiro Koizumi to be totally discredited, preferably by a financial crisis that will remove the word "reform" from the political lexicon for many years to come.

In September there will be a ballot for the leadership of the Liberal Democratic Party, and hence the job of prime minister. Given the tense geopolitical situation and Japan's financial fragility, it is by no means impossible that a group of senior politicians might be dispatched to "persuade" Ishihara to head a government of national unity - rather as de Gaulle was invited back to power after the collapse of France's Fourth Republic.

Whether Ishihara makes his move in September or waits a little longer or concentrates on his promise of delivering "even more provocation" from Tokyo city hall, it seems increasingly likely that Koizumi will disappear down the trapdoor of history, having achieved next to nothing.

It wasn't supposed to end like this. When Koizumi took over in April 2001, he was welcomed as a breath of fresh air. His structural reform agenda was widely applauded, not least in Washington, as the first genuine attempt to tackle Japan's problems.

Unfortunately Japan's reformists and their international boosters misdiagnosed Japan's ills and were wildly over-optimistic about the chances of recovery. Structural reform was a 1980s-type solution to a 1930s-type problem. In the aftermath of an unprecedented collapse in asset markets, the government chose to squeeze demand by slashing public works and hiking stealth taxes. Meanwhile monetary policy remained inconsistent and reactive and nothing was done to relieve a banking system being crushed by a Mount Fuji of bad debt.

The result has been that the markets have gone into toxic shock. The Nikkei Index was already flat on its back when Koizumi walked into the prime minister's office in April 2001. It has subsequently plunged another 45%, to levels not seen since Boy George was topping the charts and Leonid Brezhnev was in the Kremlin.

Even more startling, interest rates are at the lowest level in recorded history, with ten year government bonds yielding the princely sum of 0.65%. But such is the all-pervading pessimism that rather than borrowing money, companies are rushing to pay it back.

This spring Koizumi had a chance to make a difference by installing a reflationist as governor of the Bank of Japan. He blew it, opting instead for a member of the financial nomenklatura who was closely associated with the policy failures of the past fifteen years. It has now become painfully apparent that the government has no ideas on how to engineer a recovery, other than the Micawberish tactic of waiting for something, such as the US economy, to turn up.

Accountability and cohesion have decayed to such an extent that last week one senior cabinet minister publicly described another as a liar. Even Koizumi's saving grace – his clean reputation – has been tarnished by a corruption scandal which, after much backroom horse-trading, finally forced out another member of his cabinet. The Japanese media was quick to note the contrast with Britain, where Robin Cook had just resigned on a point of principle.

Japan has been here once before. In the 1920s, when the rest of the world was booming, Japan had already slid into a morass of deflation and bad debt. Rather than cleansing the financial system and boosting consumption, Japan's policy elites did nothing. Then, just when it seemed that they couldn't make the situation any worse, they managed exactly that.

On the eve of the Wall Street crash a new prime minister was selected. Osachi Hamaguchi was a charismatic individual known, like Koizumi, as the "lion". He appealed directly to the Japanese public, speaking eloquently of the need to endure pain in the service of national revival. The 1920s equivalent of Heizo Takenaka, the hardliner Koizumi appointed to oversee banking policy, was Minister of Finance Junnosuke Inoue. It was Inoue who managed Japan's disastrous return to the gold standard and plunged the economy into depression..

Hamaguchi was succeeded by a pragmatic growth-oriented administration. The economy responded to the treatment soon enough, but Japan's social and political fabric had suffered irreparable damage. Disillusioned by incessant corruption scandals and the bumbling incompetence of the technocrats, Japan turned its back on liberal democracy and chose the dark path of nationalism and militarism.

According to Karl Marx history repeats itself, the first time as tragedy, the second time as farce. It is improbable that Japan, permanently traumatized as it was by the wartime experience, will ever opt for military adventures. But it is quite likely that the collapse of the Koizumi project, which was supported by an entire class of bien pensant internationally-minded technocrats, will be a major turning point.

Iraq and North Korea have highlighted Japanese vulnerability and also the unpredictability of its only ally, the United States. The financial shambles has exposed the Japanese elite's lack of basic competence. Corruption may not be increasing, but it has become a lot more difficult to cover up. This is fertile territory – if not for Ishihara himself, then for a younger generation of like-minded politicians. Over the coming years Japan is likely to experience bull markets in populism and nationalism, if nothing else.