Time For Hardball?
President Bush fears that Japan's economy, weakened by a decade of decline, could pull the rest of the world down too

When Junichiro Koizumi was invited to Camp David one day last June, the Japanese Prime Minister brought along his baseball glove, and the two ball-playing leaders of the world's most powerful economies had a mutually admiring game of catch by the pool. This week, as George W. Bush flies to Tokyo, the first stop in a one-week Asian tour that includes Beijing and Seoul, he has to be wondering if it's time to play hardball. Despite his bold promises of reform when he took office 10 months ago, Koizumi has accomplished little. Japan's decade-long economic slide is only picking up speed, and Bush Administration officials are concerned that further inaction in Tokyo may trigger an economic crisis with global reverberations.

Yes, we've heard tales of Japan's looming economic Armageddon before. But Washington is worried that the fallout from Japan's malaise could hamper a U.S. recovery. Worse, there's no quick-fix option. The world's second-largest economy, Japan labors under the globe's highest level of public debt—140% of gdp. Across the nation, bankruptcies and unemployment are soaring. Practically everything else—stock values, consumer prices, confidence—is in free fall. The biggest crisis of all is the yen. With the Bank of Japan printing money to offset a liquidity crisis, the currency is sliding fast. It hit 134 to the dollar last week, a 15% decline since a year ago. The decline has prompted cries of foul from U.S. manufacturers over the competitive edge a weak currency gives Japanese products. But an equal concern is that an ever weaker yen will force devaluations throughout Asia, worsening trade tensions everywhere. Says Kenneth Courtis, Goldman Sachs Asia vice chairman: "It is now really important to get Japan back on track economically, because their problems are about to become ours."

Bush is unlikely to bash Koizumi in public. In keeping with his chummy, fraternal approach to fellow leaders, he is expected instead to toast Japan's help in the war on terror. But privately, Bush and his aides will try to persuade the Japanese to move quickly to avoid catastrophe. "We're not going to tell them how to reverse deflation," says a senior Treasury official. "But we'll certainly tell them they need to." The most important—and toughest—message will be that Koizumi must force Japan's insolvent banks to write off more non-performing loans before the nation's estimated $5 trillion mountain of public debt crushes the economy. Says a top Administration official: "There needs to be a sense of hurry-up."

Here's why: Although Bush won't see much of it, he is visiting a Japan that is being shaken to its roots by a decade of economic decline. The excess and hubris that once bought Rockefeller Center and Pebble Beach golf courses have been replaced by a growing malaise. Joblessness, bankruptcy, crime and suicide, once rare in Japan, are now just average headlines. In the recession-ravaged hot-springs resort town of Yufuin, citizens are hedging their futures by resorting to barter trade. Taxi rides, sake and even hospital bills can be paid for with a local scrip called the yufu. What backs it? Locals do odd jobs in return for yufu. "Our wealth is slipping away," moans Eisuke Sakakibara, a former Vice Minister in the once all-powerful Ministry of Finance.

This is the moment Japan watchers have long feared. Although the country is enduring its fourth recession since 1990, government largesse has prevented most citizens from feeling the pain. These days the debt crisis is squeezing almost everyone. In Tokyo's parks, permanent communities of homeless live under standard-issue blue tents. As for homeowners, real estate values have declined to 1982 levels, which means houses now are often worth less than their mortgages.

In a land that once guaranteed employment for life, no job is secure. In a recent Kyodo News survey, 70 of 100 Japanese business leaders said they plan to cut wages this year. Wide-eyed men walk the subways begging for money. help me, the signs around their necks read, restructured. That's Japan's euphemism for "fired."

The worse things get in Japan, the harder it is for a leader like Koizumi to get anything done. Although he cruised into office 10 months ago as the crusading anti-establishmentarian who would truly reform Japan, the dashing, outspoken Prime Minister with the finely tuned coif is in trouble. When he fired popular Foreign Minister Makiko Tanaka last month under pressure from anti-reform conservatives, his approval rating plunged 20% from last year's high of 80%. As confidence in his leadership sagged, the Nikkei stock average hit an 18-year low. "If he wouldn't support her, it's unlikely he'll make any other bold moves," concludes Masatoshi Sato, a senior strategist at Mitzuho Investors Securities in Tokyo.

Koizumi's challenge is to orchestrate another bailout of Japan's banks (the fifth since 1998) while forcing them to call in nonperforming loans. For four years, Washington has been urging Japan to resolve its banking woes by setting up a government bailout fund, as the U.S. did during its savings-and-loan crisis in the 1980s. But Japan's bank debacle dwarfs the S&L crisis in both size and political complexity. Real reform means unraveling decades of interlocking commitments blessed by a system that rewards support with favors.

It is not that Koizumi has done nothing. Analysts applaud his decision to guarantee only the first $75,000 in new time deposits, beginning April 1. The regulation is a warning that Tokyo cannot back the status quo forever. Still, as bankruptcies and layoffs increase, it's harder to introduce tough reform measures. "They are writing off loans, but the bad loans are growing faster," says C. Fred Bergsten, director of the Institute for International Economics in Washington.

Made in Japan? That may be a disappearing concept. These days most of Japan's manufacturing jobs are migrating to China, where quality is high and labor is cheap. Sony, for instance, makes all its first-generation PlayStations there—about 7 million of them last year—and has plans to move PS2 manufacturing to China as well. Nearly half of Toshiba's 45 plants are now in China, cranking out air conditioners, mobile phones, TVs and whatever the next hot product is likely to be. In an astonishing twist, Japanese engineers and factory managers are lining up at employment agencies in search of jobs in China. "People here will take a job there even though the pay is half what they were making," explains Tomoko Hata, a manager at PaHuma, a private employment agency that finds jobs in Asia for unemployed Japanese. "They're desperate."

Abroad, the overarching fear is that Japan's woes will ripple through the rest of the world, triggering a financial crisis of unprecedented proportions. When its economy dipped precipitately in 1997, Japan allowed the yen to devalue, eventually destabilizing currencies in the rest of Asia and touching off the December 1997 financial crisis. In Beijing and elsewhere, leaders are determined to avoid a similar contagion this time around. —TIME, February 18, 2002

Questions

1. Describe the economic challenges facing Japan.

2. Why is Bush concerned about Japan's economy?