Japan, the European Crisis, and Global Governance

The euro crisis is in a lull, as has happened several times since its onset. Starting with the loss of confidence in Greece’s sovereign debt that emerged late in 2009, the situation has developed into a veritable existential crisis for the European Union and a source of instability for the global economy. The European Central Bank managed to ward off a liquidity crisis for the time being, however, by providing commercial banks a massive sum of three-year low-interest loans last December. And in mid-February the finance ministers of the euro area reached an agreement that has averted the near-term prospect of a disorderly default by Greece. In this article I will discuss the crisis from a Japanese perspective, considering how Japan should view the situation and what it should be doing during this lull.

The Three-Pronged Impact on Japan

First let us look at the direct impact of the crisis on Japan. This has three aspects: the rise of the yen, the slowdown of Asian economies, and the latent danger of a crisis in the Japanese government bond market.

Toward the end of February this year the yen dropped back a bit from the stratospheric heights it had reached in 2011, but it has yet to settle to a level at which Japan’s manufacturers and other export industries can operate comfortably. The weakness of the euro, which has been a major factor behind the yen’s rise, is in part a reflection of the unstable credit situation, but it is also a result of the low interest rates that must be maintained to counter the low or negative growth rates accompanying fiscal austerity, particularly in the countries of southern Europe. Given these factors, the current softness of Europe’s single currency can be expected to continue for some time.

Meanwhile, Europe’s sovereign debt crisis has had a negative impact on the economies of Japan’s Asian neighbors. Asia’s dynamic growth in recent years has been due in part to the growth of China’s exports to the EU and the lending to Asian borrowers by European banks. The crisis has caused an economic slowdown and reduced lending by European banks both within the region and outside it. The reduced lending within the euro area has in turn caused European countries to import less from China, and the cutback in external lending has put a crimp on production in Asia. The Chinese economy was already feeling the effects of a real estate bubble, rising wages, and social unrest—developments that had become more pronounced since the collapse of Lehman Brothers and the subsequent global financial crisis; the contraction of European economies has aggravated the situation further. And the slowdown in China and other Asian countries has hit Japan, dealing a blow even to the small workshops that had been making profits from the parts business.

The rise of the yen and the economic slowdown in Asia, along with the flooding in Thailand, which forced many Japanese-owned plants there to suspend operations, have already caused a major deterioration in Japan’s trade balance, which has dipped into the red. And the current account balance is clearly heading in the same direction. It is still within the realm of possibility that Japanese industries will regain their competitive strength and the current account will return to steady positive figures. But if the deficits in the balance of payments become chronic, the financial markets are liable to take an even harsher view of Japan’s public debt, which is equivalent to over 200% of the country’s gross domestic product.

There is no magical prescription for treating the huge national debt. We need to trim government spending, increase revenues, and try to keep the economy growing. But the current coalition headed by the Democratic Party of Japan is feeble, and the DPJ itself is split. The government has proposed increasing the consumption tax, but if it fails to get the hike enacted, there is a strong chance that, given the circumstances described above, market participants will require higher yields on Japanese government bonds. As we can see from the example of Italy, whose competitive strength has dwindled under the burden of a heavy national debt, once the market turns its back on a country, restoring investors’ confidence entails tremendous political and economic costs. Acting before that happens should help limit the pain.

A Mature Vision for Financial Globalization

Aside from its direct impact on Japan, the crisis in Europe has raised an issue that requires longer-term consideration, namely, the current of financial globalization, which is carrying us all along however we may try to paddle against it. This requires us to come up with an appropriate system of global governance.

According to an April 2010 survey by the Bank for International Settlements, the average daily volume of turnover on foreign exchange markets was $4 trillion. This includes dealings in derivatives (such as forwards and swaps), but even if we just consider spot transactions the figure comes to $1.5 trillion a day. As of 2004 the daily average was $0.6 trillion; this means that the turnover grew by a multiple of 2.5 over a period of six years. And if we assume that transactions were conducted at this pace for 250 days during 2010, the annual turnover comes to 66 times the value of global trade for the year. It has been conservatively estimated that more than 90% of forex transactions are speculative in nature. If we allow this state of affairs to continue, it is only a matter of time before the current lull ends with the outbreak of a major new crisis.

The 1990s were called the age of globalization, but the process did not stop when that decade ended; the current of globalization has continued to flow since the start of the 2000s. Japan, meanwhile, has experienced two “lost decades” and has been turning ever more inward. It has gradually lost the will to involve itself in the management of global affairs, even though it has the world’s third-biggest economy and is a beneficiary of globalization.

That is not to say our country has done nothing at all. The Japanese government lent $100 billion to the International Monetary Fund shortly after the onset of the 2008 financial crisis, and it has upgraded its currency swap arrangements with South Korea and Southeast Asian nations so as to be ready to deal with possible liquidity crises. Also, Tokyo and Beijing recently agreed to cooperate in strengthening the functioning of the IMF and to respond jointly to any request from it for additional funds. Japan has thus, in a broad sense, been responding to the current crisis. But for the most part the moves have been stopgaps addressing only the symptoms; the government still lacks a basic vision of how to deal with the deep-rooted destabilizing effects of globalization.

Meanwhile, if we look closely, we see the leaders of France and Germany coming out with the idea of a tax on international capital transactions and the US treasury secretary proposing measures to deal with countries that are piling up current account surpluses. Japan has been granted a breather until the next crisis. We should take advantage of this break to examine our policy resources and the possibility of taking moves in partnership with other countries. We need to take the next step toward effectively governing an increasingly globalized world, and thereby fostering a more stable international community less prone to financial crises. (February 24, 2012)

(Originally written in Japanese)