Japan's Downturn Is Bad News for the World

Japan's Downturn Is Bad News for the World. By Michael Auslin
The U.S. can't count on Japanese savers.
WSJ, Feb 17, 2009

As Hillary Clinton visits Tokyo for her first trip as secretary of state, she will find a country in the midst of its worst recession in 50 years. Japan's economy is contracting across the board: Exports have cratered, industrial production is on track to plummet 30% from a year ago, and the Japanese government projects that GDP will drop 12% from last year. The world's second largest economy, Japan is also the largest holder of U.S. Treasury bonds.

Recently, many economists and scholars in the U.S. have been looking backward to Japan's banking disaster of the 1990s, hoping to learn lessons for America's current crisis. Instead, they should be looking ahead to what might occur if Japan goes into a full-fledged depression.

If Japan's economy collapses, supply chains across the globe will be affected and numerous economies will face severe disruptions, most notably China's. China is currently Japan's largest import provider, and the Japanese slowdown is creating tremendous pressure on Chinese factories. Just last week, the Chinese government announced that 20 million rural migrants had lost their jobs.

Closer to home, Japan may also start running out of surplus cash, which it has used to purchase U.S. securities for years. For the first time in a generation, Tokyo is running trade deficits -- five months in a row so far.

The political and social fallout from a Japanese depression also would be devastating. In the face of economic instability, other Asian nations may feel forced to turn to more centralized -- even authoritarian -- control to try to limit the damage. Free-trade agreements may be rolled back and political freedom curtailed. Social stability in emerging, middle-class societies will be severely tested, and newly democratized states may find it impossible to maintain power. Progress toward a more open, integrated Asia is at risk, with the potential for increased political tension in the world's most heavily armed region.

This is the backdrop upon which the U.S. government is set to expand the national debt by a trillion dollars or more. Without massive debt purchases by Japan and China, the U.S. may not be able to finance the cost of the stimulus package, creating a trapdoor under the U.S. economy.
So far, Japan's politicians have been unable to find a way out of this mess. While another $53 billion stimulus package works its way through parliament, fully one-third of Japan's prefectures have instituted emergency economic stabilization measures.

But the big issues elude short-term solutions. Though Japan's leaders are currently cutting back on military expenditures and domestic services, they're unable to agree on budgets or reform plans. They have no strategic road map for reining in the yen, opening up to international competition, or taking an economic leadership role in Asia that will promote growth and strengthen democratic, market-oriented societies.

Things don't have to turn out this way. If Japan's leaders can craft a monetary policy that ends Japan's deflationary spiral by carefully expanding the money supply, recommit to structural reform, and halt the yen's rise, they can jump-start economic growth. They should also ignore the powerful domestic agriculture lobby and embrace a robust free-trade agenda, which would help them as well as the rest of Asia.

Mrs. Clinton's visit cannot be a simple photo opportunity. This trip needs to result in a clear U.S.-Japan approach to restoring confidence and rebuilding a robust and open international system. Without action, Japan and America may go over the cliff together, dragging Asia and the world down with them.

Mr. Auslin is a resident scholar at the American Enterprise Institute.