Further Comments on Asset Deflation

Peter Tasker (Arcus Investment)

This commentary originally appeared in the "Japan-U.S. Discussion Fourm" (http://lists.nbr.org/japanforum) on May 14, 2003: posted here with the author's permission.

In response to the question, "what particular reforms did asset deflation stall?", one answer would be the whole Big Bang project, announced by Hashimoto in 1998 and now dead in the water. In order to the transform the Japanese financial system from a bank-centred system to a capital markets system, it's not enough to remove regulations. You need vibrant markets for risk assets and a commitment to reward risk-takers by prioritizing growth.

Re-read the propaganda pumped out by Japanese officials at the time. Anyone who believed them has suffered enormous losses and will probably be unwilling to provide any more risk capital for the rest of their lives. Hence thirty year bond yields below 1%. Asset deflation has strangled Japanese capitalism at birth.

Another answer concerns the so-called zombies. At the very low interest rates caused by deflation, there is very little difference between a performing loan and a non-performing loan and thus little incentive for banks to cut them loose. At higher nominal interest rates banks would be heavily penalized for carrying bankrupt borrowers.

But I think the broader issue….is driving at is that there will be no reform in a depression. On the contrary, the likely response will be defense of the status quo, nationalism, protectionism, and a shift away from liberal values. This is the psychological and political reality. In fact I would go as far as to say that the reason Koizumi's support ratings haven't dived further is that nobody believes structural reform will amount to anything.

Now here's the same question in reverse. What specific reforms would override the malign effects of asset deflation and return the Japanese economy to a growth trajectory? Bromides about re-allocating resources or raising the return on assets will not suffice. You will have to show, for example, that the substantial rise in bankruptcies and unemployment of the past seven years are leading to more start-ups and faster revenue growth for incumbents.