When the Italian merchant-adventurer Marco Polo returned from China he claimed to have seen a unicorn in the East Indies.
Being as honest as the next traveler, he admitted it was black not white, had a hide not fur, and instead of being gentle and delicate was the size of a battering ram and seemed to be permanently angry. It did, like the fabled unicorn, have only one horn in the center of its head. It was, of course, a rhino- ceros. It was easier for Polo to fit what he saw into a category he understood than to conceive of something fundamentally new and different.
No society on earth has the unicorn/rhinoceros problem worse than Japan, a point brought home on a recent visit. Put simply, the Japanese regard the last decade of economic stagnation and wealth destruction as perhaps unfortunate, but as an eminently rational response to circumstances as they unfolded. Foreigners, on the other hand, including, I suspect, most active international fund managers, regard the Japanese government and bureaucracy as little better than time-serving incompetents and Japanese companies as the 4,000 stooges of international capitalism.
The anger on both sides is palpable. One expatriate brokerage analyst told me that, for the average Japanese, "it would be easier to climb Mt. Fuji on his or her hands than to construct two consecutive logical thoughts." (An interesting echo of the outrageous statements made by Japanese ministers in the 1980s, when Japan appeared to be economically invincible, that the United States was severely handicapped because it was a "mongrel" society). Similarly, one Japanese bank CEO told me quite angrily that if he had to choose between the U.S. economic system and poverty for him and his family he would chose poverty.
How did we get to this ridiculous pass? By avoiding a fundamental reality of international economics - that Japan is no more like a modern capitalist society than a rhino is like a unicorn. The United States has spent 30 years claiming the Japanese are "changing" and becoming "more like us." Japan has spent 30 years pretending to be interested in the project and open to change. In fact, Japan has no intention of fundamentally revising its export-oriented and highly regulated society. It will change, and fairly radically, but for reasons neither side currently accepts and which have enormous implications for international investors.
The current situation, it goes without saying, is beginning to border on farce. Japanese companies, which no longer can borrow from banks buried under the weight of nonperforming loans, are issuing corporate debt. Well over half of these bonds are being purchased by the Bank of Japan, which also is continuing to lend money to bankrupt borrowers of failed banks. For the real financial lepers such as Nissan Motors, which has now lost money for six consecutive years, quasi-government lenders such as the Development Bank of Japan are now being used as lenders of last resort. Combined with the bank bailout (almost $500 billion) and another "stimulus package," government debt as a percentage of gross national product in 1999 might exceed 10%. The flood of bonds will be partly absorbed by the Postal Savings System, where most Japanese keep their savings, and which is under the control of the government. As far as I can tell, the only pieces of traceable paper in Japan not ultimately being propped up by government lending and purchases are "E" tickets to Tokyo Disneyland.
This is clearly not sustainable and is doing permanent damage to the underlying economy. Japan clearly has a huge overhang of productive capacity from the investment frenzy of the late 1980s bubble-era economy, as well as capacity added in other Asian economies in the early part of this decade.
So why doesn't Japan simply deregulate and downsize its economy following the example of the United States? After all, the U.S. lost 1 million jobs in the post-Cold War defense industry alone and managed to keep its unemployment rate within reason, even with simultaneous corporate downsizing on a gigantic scale. It's an obvious question, and the Japanese would have several responses.
First and foremost, the Japanese see themselves as a weak and vulnerable nation and there is a distinct and, in the short-term, correct belief that letting the market work its way would create an unequal society of winners and losers, a notion the Japanese genuinely find to be repellent.
Secondly, the Japanese economy is structurally unable to cope with large-scale unemployment. Japanese unemployment benefits, as several Japanese executives pointed out to me, are not sufficient for an individual to survive on. Firing someone in Japan is literally the equivalent of tossing them in the street. Even the fiercest American corporate downsizer would hesitate under similar circumstances to initiate mass firings. And creating a real social safety net for the unemployed would have ominous implications for the already huge budget deficit.
Lastly, Japanese corporations have evolved under a postwar system in which expansion of production was emphasized over profitability and access to capital for investment over credit quality. "Administrative guidance" from the bureaucracy to both Japanese banks and corporations created a fundamental disconnect over the last several decades between the ability to borrow and the ability to repay lending - credit quality was not a concern at the level of individual corporations. It was a matter for the Bank of Japan and the Ministry of Finance which, believing their own press releases, created the largest financial bubble in history in the late 1980s. Several company officials I spoke with were indignant that their access to credit should be conditioned on their ability to repay the loan. It sounds ridiculous, but it's been the system for decades.
If the attitude in Japan is "can't change, won't change," should the country simply be written off as an investment destination? I would argue strongly no. Not because of anything the Japanese are likely to voluntarily do for themselves to end the economic mess, but because of the experience of our own country, much of which has been forgotten in the current climate of exuberance.
If an outsider looked at the United States in 1979, he or she saw a president giving a somber speech "about a new era of limits" while inflation soared well into double digits. In response, Paul Volcker, the head of the Federal Reserve, was planning interest rate increases that would lead to the extremely ugly recession of 1980-'82. Abroad, American hostages in Iran languished for months as the U.S. increasingly was depicted as a "helpless giant."
It was exactly this level of desperation and despair, combined with the obvious economic challenge from Japan, that created the conditions for the turnaround in the United States. Nations don't change their fundamental economic and political orientations except under extreme duress. So the question for Japan is not "is the situation bad," it's "is the situation bad enough to lead to fundamental change."
At this point the evidence is primarily anecdotal, but based on my recent trip there I would clearly be in the camp that sees the beginning of the end of the postwar Japanese economic model. On the macro side, the unwillingness of already strapped banks to lend to nonperforming borrowers and the general tightening of credit standards is a more significant change than most observers acknowledge, as is the withdrawal of many of the larger banks from overseas operations.
But it's on the social level that the most interesting signs of stress are occurring. I was genuinely shocked to hear from a foreign property analyst one of the least known changes in Japan - the murder rate per capita was now higher than that of the United Kingdom. That is an extraordinary change in what has been historically one of the most crime-free societies on earth. Similarly, the rate of homelessness in metro Tokyo is at unprecedented levels - shades of Manhattan 1982.
Another significant change, in that it affects a fundamental and cherished value in Japanese life, can now be seen in educational spending. "Cram schools," where families pay for extra instruction, are for the first time seeing students drop out for financial reasons. It is hard to even begin to explain the pain and anger such a change would cause the average Japanese family.
Perhaps the most moving, if somewhat cliched, indication of the rising pressure on ordinary Japanese is reflected in a news story that has obsessed the media for the past two months. Three friends, small-businessmen, gathered together for a night of drinking and complaining about their bankers. Then they checked into separate hotel rooms and committed suicide. It would be a tragic story anywhere, but in Japan the idea has extraordinary cultural resonance.
Now it's entirely possible the Japanese political system, which often seems like a factory for producing moral and intellectual pygmies, will not produce a Ronald Reagan or Margaret Thatcher capable of harnessing the growing social distress into the fuel behind positive change in the economy. But it's equally possible the circumstances will produce the right combination of individuals and policy responses as distress and alienation from the current system continue to rise. We had better hope so.
Japan is the world's largest creditor, and you don't have to be Chicken Little to realize it is more than a large enough player in the global economy that its failure to cope successfully with change could well sink all of our boats.
Ted Tyson is chief investment officer of Mastholm Asset Management LLC, Bellevue, Wash.
