Japan's Policy Trap: Dollars, Deflation, and the Crisis of Japanese Finance

Akio Mikuni, president of Japan's leading bond-rating agency, and R. Taggart Murphy, a professor at Tsukuba University, relate how Japan, the world's second largest economy, became trapped in deflation. Japan is the world's top creditor nation with huge holdings of bonds, equity, loans and foreign investments. It has vast trade and current account surpluses with most countries in the world. The floating exchange rate is supposed to adjust automatically to prevent such payment imbalances, but these are now far greater than they ever were under the fixed rate system. In the 1980s, Japan's landowners and speculators used huge real estate and equity market bubbles to take wealth from the working class. In the early 1990s, the bubbles burst, and the largest pile of non-performing loans ever seen buried much of Japan's banking system. Every monetary and fiscal policy failed, including a 72-trillion-yen reflation and bank bail-out package in 1998. During the US state's postwar occupation of Japan, it had seized control of Japan's currency. As the authors point out, "No matter how much capacity you have accumulated, no matter how many claims you have the theoretical right to exercise, unless you control the currency of your international trade, investments, and finance, you are at the mercy of those who do control that currency." So Japan accepts payments for its exports, and returns from its investments abroad, in the dollar. It keeps its ever-growing hoard of dollars in the USA, which transfers buying power to the USA, funding, for example, Silicon Valley. The US state's control of the yen is the key to the dollar's strength, allowing the USA to depend on imports and to run huge trade and current account deficits. It also fuelled the US bubbles in credit, bonds and equity markets. Japan has paid a huge price for this special relationship with the USA, because the dollar has lost two-thirds of its value against the yen since 1972. Now the falling dollar is hurting Japan even more.

I've only read half of the book for about a month now. I'm sLOWLY digesting the information. Quite a good read and interesting to note the author wrote, " The current account surplus [of Japan] will probably keep expanding until the world collectively cannot run.... Or else until the surplus buries the Japanese economy under an avalanche of deflationary dollar claims that can neither be exchanged nor redeemed." Interesting to note Japan is now bailing out the US for some 50 Billion US dollars . Their neck is on the line for sure. Interesting

This is a brilliant book on economics. Its contribution to economics is no less significant than Keynsian General Theory.Keynes demonstrated how investment and savings could balance at suboptimal level of economic activity.Keynes paid little attention to balance of payments constraint(although he did analyze it thouroughly in Consequences of Peace). Balance of payments situation was not explored in his Generel Theory, since it would have brough the whole theory off track.Contemporary economic theory is best expressed by IMF officials in that current account surplus is not a grave concern for any given country. Structural account surplus is usually thought of as an additional powerful stimulus for a country to grow quicker than its defecit prone neighbours.Modern economic thinking takes as given that authorities have fiscal and monetary tools to bring the country to full employment. The only problem is to coincide full employment with balance of payment constraints ie long term current account balance coincing with full employment income.Akio Mikuni and Taggart Murphy demonstrate how a current account surplus can coincide with suboptimal economic growth. They also demonstrate how a country under certain conditions, may lack fiscal and monetary means to bring about full employement under conditions where current account is positive at full employment.Before reading this book, I never thought such situation might be possible. I recomend this book to anyone seriously interested in economics. PS I would be very interested in learning more about economic situaiton of European Union. Suboptimal economic performance of EU is just as contradictory to all that modern economic thinking has to offer.

Akio Mikuni & R. Taggart Murphy have produced an excellent critical piece on the multiple troubles that Japan now finds itself, as well as realistically outlining how the elites are still very much unaware of the full consequences of their actions, and indeed inaction. This book also raises a number of interesting indepth parallels in Japanese history, illustrating that Japan has been in similar waters before and like the past, cannot adapt and change policy before disaster causes havoc. It is furthermore explained that, like all previous merchantile and/or socialist regimes, Japan's production capacity approach to trade is of little use unless profits and risk management are approached seriously. There is some hope for Japan, but the authors wisely find that Japan's war production approach (which is indeed ancient), coupled with its ministerial fiefdoms (whom act like warlords of old.....and control things like banks and until recently the Japanese equity markets), weak liberal democratic structures, non-guilded unions, and lambish populous, coupled with a mountain sized foreign (US$) currency reserve, {which as they argue convincingly, cannot ever really be swapped for Yen....it would destroy Japan (and cause much angst elsewhere)}, all need fundamental revision. Fundamentally, this book highlights the enigma of Japanese power. It should be read along with books like Cartels of the Mind (Ivan Hall); Japan's Big Bang (Declan Hayes); Dogs and Demons (Alex Kerr);The Enigma of Japanese Power (Karel van Wolferan); and Hirohito and the Making of Modern Japan (Herbert P. Bix). Having lived in Japan for four years, I would highly recommend this book.