Normalization

Ichiro Suzuki

For Japan it’s been a long, long three decades and a half of sometimes cozy but mostly painful experiences. Since the burst of the infamous Japan Bubble, which has already secured its place in history firmly, the Japanese economy struggled immensely, in an attempt to shed its excesses from the 1980s, cleaning up the banking system and fitting its structure to the post-deflation Japan as well as modernizing itself through digitalization.

What needed to be done has been obvious through those years and decades. Necessary changes, however, were not delivered because politicians didn’t have the stomach for material changes. Behind these politicians there were, and still are, voters who didn’t want changes. At the turn of the 21st century, Japan still was one of the wealthiest countries on this earth, and this made people feel the country was allowed to sit back and weather the storm until it was gone. As it turned out, however, the changes that had engulfed the global economy was so radical that had left the wait-and-see Japan completely behind. Japan, or Japanese people, has opted to adjust itself gradually to the changing world that was moving faster than Japanese people felt it was. They still wanted to go slowly hoping to hold onto what they thought they had in abundance. Most other countries didn’t have such a luxury. The market simply didn’t allow it. Market forces crushed inefficient and outdated structures with absolutely zero concerns for people. The 1997-98 Asian Financial Crisis just did it. The Greek Government Debt Crisis in the early 2010s was also a case in point. Both crises forced violent structural changes throwing a huge number of jobless people out on a street. Latin American countries have a long history of market-forced changes. The AFC forced especially South Korea to fit to the 21st century and the country got back on a renewed growth trend. Greece reduced its government debt outstanding, allowing the country to stay on in the euro-zone. 

With its massive foreign exchange reserves, Japan was too rich to be forced violent changes by the market. Such reserves have allowed the country to muddle through for two decades. Abundant savings in the private sector, both in corporates and households, enabled the government to boost demand through a number of fiscal stimulus packages that kept the economy from sinking deeper. The price Japan paid for dodging severe economic downturn was stagnation that was disguised as stability, and Japanese people didn’t dislike it.

As stagnation persisted, it was evident that Japan needed a shockwave to wake up the country, a kind of disruptive event that hit South Korea in 1997. The 2007-09 Global Financial Crisis could have shaken up the Japanese economy violently but it didn’t. A few years ahead of the biggest banking crisis since the 1930s, Japan had at last cleaned up its bank balance sheets through injection of tax payers money to write off bad loans that had plagued the economy since the beginning of the 1990s. On top of it, having been long mired in balance sheet problems, Japanese banks missed a chance to participate in the frenzy of exotic securities created out of mortgage backed securities that took U.S. and European banks down. Ironically in 2007, Japanese banks were too healthy to be brought down by the global crisis. 

It was thought that the mega earthquake that hit the coast of the northeastern region in March 2011 might bring changes, it but didn’t. As it turned out, the disaster still wasn’t big enough to force the country changes through the market mechanism. The Nankai Trough Earthquake, which the government expects to hit western Japan any time, is expected cause the damage several times the size of the 2011 earthquake, not only with physical damages to infrastructure and lost economic activities but also with a sharp spike in long-term interest rates and the currency’s plunge due to a surge in funding needs for reconstruction. The Northeastern disaster just wasn’t it. 

In the mid-2020s, however, what politicians has been unable to do is being delivered by market forces. Such forces are still gradual and nothing comparable to the ones that hit South Korea in 1997, but inflation and rising long-term interest rates are meaningfully affecting the Japanese economy’s structure, correcting the malaise that ruled for the past generation. 

Inflation originally showed its first spike by a disruption to the global economy caused by Russia’s invasion into Ukraine in 2022. Dislocations in the global supply chain kindled inflation that was beginning to rise amid the post-Coronavirus boom as a result of liquidity overdose. Inflation has reawakened Japan on prices at long last. For the first time in a generation, Japanese consumers have found that prices can rise, and companies and stores have found that consumers still bought their products when higher input costs were passed onto retail prices. In response to a sharp economic turnaround, the labor market had tightened. It was a global trend but in Japan tightening was accelerated by a demographic factor, too. Slow disappearance of baby boomers is adding to an upward pressure on wages and salaries. Higher pay has been promoted by the government in recent years and market forces are driving the trend. Large corporations are competing for higher salaries for new recruits to make themselves attractive to them. Small and medium enterprises are forced to follow the trend even if their balance sheets are far less healthy than large ones. One major problem in the Japanese economy has been an absence of wages/ salaries growth despite vastly improved productivity of Corporate Japan. Its fruits disproportionately went to shareholders amid belated rise of shareholder capitalism in Japan. Today’s shift in economic circumstances is driving companies to give more to employees. While large corporations are competing for higher salaries, small and medium-sized enterprises are having a tough time in keeping up with the new trend in the labor market. Large corporations have built abundant liquidity, or excess capital, on their balance sheets but SMEs are afflicted with with higher debt burdens. Many of them have been kept alive only on absurdly low interest rates that have lasted for a generation. Some of them have found it hard to repay emergency loans lent to them amid the coronavirus-driven economic downturn. In a nutshell, some of them are zombie companies that had to be folded. Politicians, notably the ones in the ruling Liberal Democratic Party that is supported by SME owners, have been reluctant to force closures on them, but rising interest rates are doing the job. SME’s productivity has been a drag on the economy. Weeding out inefficient ones would contribute to higher productivity growth. 

Rising interest rates are forcing Corporate Japan to seek greater efficiency. Since the burst of the bubble at the beginning of the 1990s, they have built a massive wall of cash for fear of banks’ refusal to lend them when they really need it. Their adherence to cash might have proved to be right in 2020 especially amid the outbreak of the pandemic. Such a period of emergency, however, turned out to be short-lived. The Tokyo Stock Exchange has been pressing the listed companies to lift their depressed price-to-book value ratios, and bloated liquid asset position is an easy target. Excessive cash on balance sheets is not only a drag on efficiency but also costing more as rising prices everywhere is lifting return opportunities. Inflation is a contributing factor that forces management to work harder for greater efficiency and higher value of their company. 

In the first week of June, SoftBank had dethroned Toyota Motor as the largest Japanese corporation by market value, after 22 years of its reign in the TSE. Toyota has always been known for its brutal efficiency, and is the least likely company to face financial difficulties. The market has been giving premium on Toyota’s financial safety by keeping it as the largest company. Rise of highly leveraged SoftBank to the top symbolizes a shifting sentiment in the market. Investors are more willing than ever to reward aggressive management that is thirsty for growth. After a meteoric rise in the recent weeks, SoftBank suffered a sharp collection the following week falling back into the second place again. That said, the tone was set in the market. 

Then, there is government finances. After decades of severe revenue shortfalls, the Japanese government is enjoying stronger than ever tax correction. Inflation, coupled with the Bank of Japan’s not-yet-tight monetary policy, is boosting asset prices. The stock market is hitting all time high while real estate prices have gone out of reach for an average man and woman on the street. Higher prices are driving consumption tax revenue up though this can be condemned as a typical inflation tax. The recent trend in tax collections displays how devastating deflation was for public finances for a generation. The government’s primary balance has markedly improved over the last few years. From one perspective, Japan enjoys the healthiest government finances in G7 despite towering debt outstanding. 

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.