Overall, the Tokyo and Osaka stock exchanges raised about ?1.5 trillion (about $13 billion) in initial and secondary public offerings in 1995-1999; the equivalent for the same period on the combined New York and NASDAQ exchanges was considerably more than $600 billion, a truly staggering difference. To get a sense of the scales of magnitude involved, consider that in the first three months of 2000 alone the NYSE and NASDAQ raised $92 billion through public offerings, far more than the total raised in Tokyo and Osaka over the entire past decade. The original purpose of a stock market is to provide a forum for companies to sell equity to the public, but the TSE abandoned this role for ten years; for most intents and purposes, it was shut down.
Remarkably, in spite of all this, very little has changed in Tokyo. It is important to realize that as Japan enters the new millennium its financial system remains essentially intact, with only a nod to what Americans and Britons would consider universal reality. Banks and real-estate companies continue to keep properties on their books at exorbitant values; the stock market remains high when measured by P/E ratios, and the big players stay obedient to the system and never blow the whistle. It might seem that Japan has gotten away with it. Western theorists, convinced of certain invariant laws of money – like the laws of physics – find themselves baffled.
The paradox lies in the fact that money is to a great degree determined by society and its belief systems. If everyone agrees that Japan's failed banks are still functioning, then they function. If everyone agrees that unrealistic land and stock values are acceptable, then this is indeed so. And this explains the paralysis, because all these artificial values are linked, each propping up the other.
One must also remember that the collapse of the Bubble was slow, not fast. When it began to deflate, MOF officials took the situation in hand and did their best to manage events, and so controlled was the deflation that some have even speculated that MOF itself initiated and directed the entire crisis. While the theory of MOF invincibility is unrealistic – during most of the 1990s the ministry was fighting one long rearguard action – the fact remains that Japan escaped with remarkably little apparent pain.
Or did it? Japan's success over several decades shows that the laws of money are not immutable; they can be altered to a great degree by such systems as Japanese-style credit ordering. However, post-Bubble paralysis shows that the laws will reassert themselves if such systems are carried to an extreme. Most interestingly, the pain may come in unexpected places. Japan protected its system on the surface: bankrupt banks kept their doors open for business, and the stock market appeared to have stabilized-but the trouble, driven underground, surfaced elsewhere.
The authorities are in a position similar to a player of the Whack-a-Mole game in arcades a few years ago. In front of you is a big box punctured with little portholes out of which a mole pops up now and then. You grab a rubber hammer, and your job is to hammer the mole. As the game goes on, the mole moves faster and faster-when you hammer the mole over here, it pops up over there. One of the busiest mole games played by MOF goes by the name of the Bank of International Settlements. BIS, the world's central banks' central bank, prescribes that banks must maintain a minimum «capital adequacy ratio» of 8 percent of capital to outstanding loans. This means that in order to lend $100,1 need to have at least $8 of my own money as supporting capital. If a bank's capital falls too low, it will face restrictions on its international lending ability.
The Japanese mole game began in the early 1990s, when stocks began to fall. Banks, which own large stock portfolios, found their BIS ratios sinking below the 8 percent cutoff point, so MOF ordered insurance companies and pension funds to buy stock to support the market, pounding the BIS mole back into its hole. But soon other moles were popping up in unexpected places: insurance companies and pension funds, after years of investing in low-yield stock, are receiving near-zero, or even negative, returns on their assets. Save the stock market, and you bankrupt the pension funds and insurance companies. Relieve them, and the banks have to curtail international lending. Allow the Nikkei to fall below 10,000, and P/E ratios would return to health, attracting domestic and foreign investors, but at that level it would no longer be possible to pretend that the banks are solvent-and belief in the system is the keystone that props it all up. So, on goes the mole game, fast and furious.
One unexpected consequence of the Bubble was the discovery that Japan's financial community was becoming irrelevant to the developed world. The barriers raised by MOF were so high that when the crash came, others could hear the sound of crumbling columns and smashing glass, but it had very little impact on local economies elsewhere. Japan lost more money than any nation had ever lost in all of human history, from the Sack of Rome to the Great Depression of 1929, but it affected the United States and Europe not a jot, and the bourses in London and New York went on to flourish as never before.
The Ministry of Finance assumed that Japan's national borders are absolute barriers, and within them it did indeed command absolute obedience for decades. But with money now flowing in an instant from one country to another at the news that interest rates have shifted one-tenth of a percentile, old ways of controlling the market no longer work. MOF discovered this when it tried to restrict the futures market in Osaka, only to find that Singapore and Chicago had grabbed the lead in Osaka's absence.
There is one important area in which Japan's financial system may not be globally irrelevant, and this is the nation's enormous dollar holdings. This brings us to another artificial financial system, one that has perhaps the most far-reaching repercussions of all: Japan never took the dollars earned over decades of trade surpluses and exchanged them back into yen.
The economist R. Taggart Murphy and Mikuni Akio, a pioneer of independent rating agencies in Japan, have examined this issue in some detail, and the gist of their analysis is as follows: For Japan to repatriate all the dollars earned abroad (net holdings came to a colossal $1.3 trillion by the end of 1998) would put pressure on the yen and drive it upward, increasing imports and weakening Japan's ability to export, and the point of MOF's financial system was to repress imports and allow Japan to keep exporting at all costs; so manufacturing firms and the government left these dollars abroad, while funding their external balance with «virtual yen» – that is, yen borrowed at almost no interest from domestic lenders. This system worked well for decades, but by the 1990s it had come under huge strain. It is now more difficult than ever for Japan to repatriate its foreign reserves, since if it did, the dollar would drop like a stone, which would drive up inflation in the United States, raise interest rates, and put an end to America's long economic expansion; at the same time, it would result in a shockingly high yen, bringing Japan's exports to a crawl. So it is not only Japan that wields power over the United States; it goes both ways. Murphy says, «Japan and the United States have realized the financial equivalent of the nuclear balance of terror-mutually assured destruction.»
It's sobering to realize that the supposedly «rational» United States, too, relies on an artificial system to support its economy, persistently ignoring the mountain of dollars piling up in foreign ownership-it has been called America's «deficit without tears.» For the time being, foreigners continue to finance the U.S. economy with money earned from America's huge trade deficits, but sooner or later they will cash in those dollars and the American economy will suffer severe pain.
Or maybe not. If Japan suddenly sold off its dollars, it would hurt the U.S. economy but damage Japan's far more. Furthermore, Japan is not the only country to hold dollars; all of America's trading partners do, and China, running the largest trading surplus with the United States, is building up the biggest reserves of all. In coming years, Japan may not necessarily exert the determining influence on what happens to the dollar. The very existence of so many dollars abroad is also a plus for the United States, because it makes the dollar the de facto world currency-so there is less need for foreign nations to trade their dollars in for local money. Perhaps the United States will turn out to have practiced a bit of financial magic of its own, holding those dollars hostage indefinitely-or, at least, until a time beyond the horizon when economists can make predictions.
Meanwhile, Japan continues to keep most of its dollars abroad, diverting ever more «virtual yen» at home to fund its huge external surpluses, and this is getting harder and harder to do. Uncontrolled bank lending in the 1980s (the Bubble) could be seen as an early attempt to inflate the domestic money supply without bringing the dollars home. We have seen what the effects of the Bubble were. In the 1990s, the government tried another approach: pumping money into the economy through public works, paid for with a burgeoning national debt. This, too, cannot go on forever. Another crash may be coming, and this one could drag Japan down – and with it the entire world economy.
It might seem incongruous that while a great sword hangs over the world's head in the form of Japan's external dollars, its domestic markets are becoming irrelevant. The paradox, however, lies in the fact that each is the complement of the other: Japan's external reserves exist only because domestic markets, in order to preserve MOF's system, are cut off from the world.
The most vivid demonstration of the irrelevance of domestic markets to world finance is the collapse of the Tokyo Stock Exchange's foreign section, launched in the late 1970s in a bid to make Tokyo an international capital market. At its height in 1990, the TSE's foreign section boasted 125 companies. However, the rules hedging in foreign firms were so restrictive that fees far outweighed the anemic trading in foreign stocks. By the spring of 2000, the number of companies had dropped to 43. Average trading volume shrank nearly to the vanishing point: during the week of June 1-5, 1999, only 19 of the remaining companies traded at all on an average day. In an era of international finance, such a foreign section goes beyond failure to farce.
In the meantime, foreign listings on other stock markets skyrocketed. By April 2000, London listed 522 foreign firms, the three American stock exchanges featured 895 foreign firms, and even Australia (60 foreign listings) and Singapore (68) had surpassed Tokyo. Foreign stocks in New York accounted for just under 10 percent of all trading, while trading volume on the TSE's foreign section came to a fraction of 1 percent of the trading on NASDAQ's foreign section alone.
