My first impression of the book was that here was another treatise dwelling on only one aspect of the Japanese 'Lost Decade' advocating that Japan urgently undertake even greater deficit financing - this in the face of the constant advice from Japan's Western friends and the Koizumi Government's own position that Japan must carry out structural reforms and reduce deficit financing. But on reading the book� that I was persuaded that the author had a deep understanding of the financial world and that his advice was practical and opportune.
Essentially, the points made by the author on the Japanese situation are as follows:
? The problem started with the bursting of the asset price bubble at the beginning of 1990. With fast rising prices of assets like real estate and shares, companies had been able to borrow more and more from the banks against these inflated assets and the banks, flush with cheap deposits, had been ready to oblige. The debt-equity ratio of Japanese companies was already pretty high - five times the average in USA. After the real estate prices crashed by 85% and share prices by 70%, every company had to concentrate on repaying its debt to clean up its balance sheet.
? While it was prudent and correct for the individual company to reduce its debts to the banks, the effect on the nation's economy was ruinous because all companies were taking such action at the same time. Thus, instead of the traditional focus on market share and profits, the companies' attention shifted all at once to massive debt-reduction, bringing the economy to a halt and continuing deflation.
? Monetary policies i.e. providing increasing liquidity and continuously lowering the interest rate were no answer because, while the Japanese households continued to be outstanding savers, there was a famine of borrowers.
? Given this situation, the only solution, according to the author, is for the Government to borrow more to absorb the high savings and spend it through public sector projects. This would bring profits to the companies and banks and eventually return the country's economy to normal health. The Government has been doing this in the past but only in driblets and in reaction to the economic decline. Even these limited actions have at least kept the economy afloat. It should now be more proactive and pump-prime the economy in a massive way back to health.
? Long outstanding structural reforms are no doubt required but some of these would have to wait until the companies bring their balance sheets back to reasonable health. In 1997, the then Prime Minister Hashimoto tried to remove some fiscal stimuli, with disastrous results to the economy. The present Government's declared policy of fiscal rectitude and structural reforms would prove equally disastrous, if carried out.
? Efforts by banks to reduce their NPLs (Non-performing Loans) too actively would lead to massive foreclosures of companies which, in turn, would cause even greater deflation. Instead, the banks should be allowed to reduce their NPLs in an "orderly manner".
? It is true that the savings and loans problem in USA in 1989 was resolved by letting the concerned banks go down the drain. But they constituted only 5% of the US banking system. Even so it cost the US exchequer $180 billion at that time. In Japan, 95% of the banking system is in systemic crisis. Hence the same solution cannot work.
? Japan's situation is more comparable to that obtaining in the major Latin American countries in the 1970s, right up to 1982. In the latter situation, all the major banks of USA, Japan and Europe were heavily exposed to these countries. Instead of forcing the Latin Governments and institutions to declare bankruptcy, Mr. Paul Volcker, then US Federal Reserve Chairman, managed to persuade the American banks (and even the Japanese banks through the Governor, Bank of Japan) to "stay on and keep lending". At that time all the Latin American Loans had become NPLs but Volcker managed to have them treated not as NPLs through the issue of the well-known Brady Bonds which were essentially junk bonds.
? Structural reforms and fiscal prudence are no doubt sorely required in Japan but the author believes that all that would have to wait until the economy is stabilized He compares the situation to treating a patient who is simultaneously suffering from pneumonia and diabetes. Surely, he says, priority has to be given to first curing the pneumonia, even at the risk of the diabetes becoming worse temporarily.
I am persuaded by the author's plea that the Japanese authorities would do well not to act too hastily on the World Bank type of advice for giving priority to structural reforms. However, I do wish he had given greater attention to the factors that brought about the massive asset inflation in the 1980s leading to the crisis in 1990. To understand these causes would do service not only to Japan in the future but also to other Asian countries who could land themselves in a similar situation.

What were these factors? It was perhaps the very policies and practices that had brought about the "miracle" that turned sour. They were carried to excess after they had outlived their purpose. They were policies more appropriate to a reconstructing economy, a post-feudal and post-war-construction age. While that system could succeed for a while, and that too because of the special traits of the Japanese people, it obviously could not go on for ever. Once the economy had reached the post-industrial age, it became too complex to be guided by mere bureaucrats.

Allies like the Americans, who were indulgent in the earlier post-war decades, became strident in their criticism when their own houses were on fire in the 1980s. They began to complain about Japanese trade surpluses and business practices. At the Plaza Accord of 1985, Japan was compelled to remove many of its financial controls and to allow its currency to appreciate from Y240 to Y120 to a dollar. It appreciated even further, to Y79 to the dollar in the mid-1990s, before falling back to its present level of around Y120.

The high exchange rate of the yen resulted in reckless purchases of real estate and companies abroad - a number of which proved to be bad investments. It also led to the moving out of production facilities to other countries including USA and Europe, thus hollowing out the Japanese economy. Anyone living in Japan at the time was astounded at the high price of goods and services in Japan. The chief culprit was the inflated exchange rate.

The simultaneous application of WTO protocols, globalisation, and the aggressive competition from the new tigers like Korea and Taiwan, and to an extent China, have made it even more difficult for Japanese industry to remain competitive. The greater problem to be attacked should be the exchange rate. Mr. Koo himself perhaps concedes this when he says "if the yen's exchange rate were Y200 to the dollar today, Japan would be booming without any trace of a balance sheet recession". If the author does not follow up on this line of thinking it is because, given the economic situation in USA, he does not expect that the Americans would allow Japan to devalue the yen. He recalls how the Japanese attempt to push the yen down in June 1999 had met with fierce opposition from USA. Notwithstanding Mr. Koo's realism, I think it should remain one of Japan's diplomatic objectives to persuade its friend, USA, to allow a gradual devaluation of the Yen.

For those of us who have been brainwashed into thinking that the only solutions for the Japanese economy are urgent structural reforms, reduction of fiscal deficit and liquidation of bank NPLs, this book provides a timely nudge towards greater pragmatism.
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