After the fallout, it’s boom to bust

The economic slump in Japan has lasted 20 years. Now, just as the gloom seemed to be lifting, has th

I always arranged for my Asian investor road trips to end in Japan. After schlepping from airplane cabin to limo to air-conditioned office in Hong Kong, Singapore and Taiwan, I would feel a sense of enormous relief when we landed at Narita or Haneda and started the long car ride into Tokyo. It began to feel almost like coming home. Making Japan the last port of call meant that I could stay a little longer there than in the other countries on the itinerary, and I would spend the evenings walking the day-bright streets of Akihabara, the weekends amid the calm, tree-shaded temples of Kyoto.

On these trips, I had the dual task of raising money for the funds I managed from new customers and visiting existing clients to discuss their investments. Encounters in Hong Kong and Taiwan could be brusque and incoherent - interpreters barely justifying their title would give one-word translations of my most complex discourses on the state of the European credit markets, and often investors lit cigarettes or abruptly walked from the room as I was speaking. In Singapore, the meetings were incredibly formal, the investors wearing cold, distant smiles throughout. Only in Japan, with the elaborate rituals and lavish hospitality, did I ever feel welcome.

I first visited Japan at the age of 18, in the middle of the country's "Lost Decade", and over the years I came to love the idiosyncrasies of doing business there. The exchanging of gifts, the bowing until elevator doors hid you from your clients, the protracted examination of business cards - all of this became second nature to me. I was usually the junior member on these trips, and I learned to sit nearer to the door than my boss in meetings, a relic from the days of the samurai, when the most disposable warriors would be placed closest to any potential threat from outside.

What I liked best about those visits to Tokyo was that, once the meetings were finished, and contrary to popular stereotype, the people opened up. Financial-industry workers in Tokyo take the work hard, play hard ethos of their western peers to a higher plane. While we in London complained bitterly of having to pull the occasional all-nighter, or of the times we were called in to work on a Sunday afternoon, it was customary in Japan for all but the most senior staff at the major investment banks to work until at least nine, and often past midnight. When deals are being done, the sight of a team of analysts slumped at their desks after working three days flat is common. At best, the workers manage to sneak out for an hour's catnap at a capsule hotel or a shower at the gym.

Given the working conditions, one might expect Japanese bankers to be zombies when finally they escape from the office. In fact, the bars of Roppongi and Marunouchi buzz when the bankers break out. After work in Tokyo, I used to go back to my hotel - always the Park Hyatt in Shinjuku - for a swim in the pool on the 47th floor. Then I'd head out to join workers from the local offices of Merrill Lynch and Citigroup, Mitsubishi UFJ and Sumitomo Mitsui, for dinner and drinks.. There'd be long, boozy conversations about Japanese literature and film, and mammoth drinking sessions followed by tear-stained karaoke. One night, a Mizuho banker, hearing that I had never seen kabuki, immediately booked us tickets to Kabuki-za in Ginza. I lasted two and a half hours, standing, before retiring to a nearby bar.

They were good times to be a banker in Tokyo and to raise money there. Although the economy continued to decline during the last decade, Japanese banks used the fact that they (mostly) managed to avoid significant sub-prime exposure to re-establish themselves as leading financial players.

During the credit crisis, the country's banks cashed in on the capital weakness of their US rivals. Mitsubishi UFJ paid $9bn for 21 per cent of Morgan Stanley. Sumitomo Mitsui bought a Japanese subsidiary of Citigroup. Nomura acquired Lehman Brothers' Asian operations and its equities and investment banking interests in Europe, the Middle East and Africa (but today many question the wisdom of this move). Where Japanese banks were previously almost entirely absent from the European markets, Daiwa, Mitsubishi UFJ and, particularly, Nomura are now making a name in niche areas such as convertible bonds and equity derivatives trading.

Wilderness years

It is too soon to say whether the tragic events of 11 March and subsequent days will derail the renaissance of the Japanese banks. What is certain is that the fragile recovery that gathered pace in Japan over the past three years is seriously at risk. In the wake of the earthquake and tsunami, and the subsequent nuclear crisis, the Bank of Japan (BOJ) implemented emergency measures to control the rise of the yen and stimulate liquidity. The Nikkei plunged more than 16 per cent on 14 and 15 March, the steepest two-day fall since 1987. Shares in Tokyo Electric Power Company, the firm that owns the stricken Fukushima nuclear reactor, traded off by almost a half. Toyota and Nissan fell by 15 per cent over the two days; both companies have closed most of their Japanese plants.

An enormous injection of liquidity from the BOJ came in the form of ¥15trn (£114bn) pumped into the money markets on 14 March, a further ¥8trn (£61bn) the following day and a ¥5trn (£38bn) increase in the country's existing asset purchase scheme - a legacy from the 2008 credit crisis - while rates were kept at a record low of between 0 and 0.1 per cent. It was the largest ever liquidity stimulus carried out by the central bank. As an initial move to control the rise of the yen, it seems to have worked.

The yen rose over 20 per cent after the 1995 Kobe earthquake, and it will be critical to prevent a similar rise if Japan is not to suffer further economic woes following the Sendai disaster. The yen has been rising as companies liquidate offshore holdings in order to pay for reconstruction following the earthquake, and at one point overnight on 14 March the currency crept close to its postwar high against the dollar. Japan is still an export-driven economy and a strong yen makes exports prohibitively expensive for the country's trading partners. The yen's climb against the dollar even before the catastrophe - up 14 per cent in the past 12 months - has made things tough for Japan's already stretched manufacturers, particularly given that their major competitors, the Chinese, exert much more control over their currency's exchange rate.

The BOJ made comforting noises in the immediate aftermath of the quake. In a terse press release, the bank said that it expected the Japanese economy "to return to a moderate recovery path". Such optimism may prove ill founded. Estimates of the cost of the disaster to the economy are between ¥14trn and ¥15trn - that is to say, at least 3 per cent of GDP - as rolling power cuts and disruptions to transport systems prevent people getting to work. The previously bustling agricultural and fishing industries of Miyagi Prefecture have been wiped out. Clearly any major nuclear incident would have an economic as well as a human cost.

It is hard not to see parallels between this disaster and the one in 1995. In the days following Kobe, the Nikkei fell 8 per cent, staged a brief recovery, then dropped by more than 25 per cent in the subsequent six months. Back then, the quake felt like a metaphor. The fabric of the Japanese economy was altering profoundly, and Kobe was merely one of a number of problems weighing on the Nikkei. After reaching a high in June 1994, the Japanese stock index had begun to trade off as the size of the country's real-estate bubble became clear: at one point the land beneath the Imperial Palace in Tokyo was worth more than all of the real estate in California. Furthermore, the banks had begun to show the state of their problem loan books and needed major recapitalisation. Although the Lost Decade officially began in 1991, to many, 1995 and Kobe marked the start of Japan's years in the wilderness.

This time, the Nikkei has remained stagnant, rather than fallen, but there is a similar sense that the quake is merely another nail in the coffin of the Japanese economy. The hugely unpopular government of Naoto Kan is under pressure to get spiralling government borrowing under control - at 200 per cent, Japan's debt-to-GDP ratio is the highest in the world - but the rebuilding of the country will demand that this figure rise further.

Japan is unique in the global economy, in that the bulk of its debt is owed to thrifty domestic savers rather than other governments or foreign banks, and this has allowed it to maintain its inflated ratio for some time. However, the demographics work against the government here. Placing national debt with local individual, small-scale investors was a sensible strategy when there was a flourishing class of young professionals to shoulder the burden. Now Japan is a nation moving towards retirement, with one of the lowest birth rates in the world, and these domestic debt holders will need to sell their government bonds to fund their twilight years. More immediately, the other large holders of government bonds - Japanese insurance companies - will have to liquidate these to fund their liabilities relating to the disaster.

Terminal decline

China overtook Japan as the world's second-largest economy last year and it is hard not to feel that the decline may be terminal. One of the first moves that the Japanese financial authorities made after the 11 March disaster was to ban naked short-selling. The minister for the economy, Kaoru Yosano, said at a press conference on 13 March that "we can't tolerate any moves by speculators trying to profit from the earthquake". Yet the vultures won't be held off for ever. Japan used to be a safe haven for investors; soon it could be the next Greece. On 15 March, Japanese five-year credit default swaps rose to a record 122 basis points as investors rushed to minimise their exposure to risk.

A severe Japanese debt crisis would have far-reaching consequences. Although Japan's economy is waning, it is still a leading player in the global financial markets. Much is made of China's holding of US bonds, but Japan isn't far behind. Tokyo bought $260bn of US government debt in the past five years, over 60 per cent of this coming last year alone.

On 14 March, the global markets still seemed to be operating rationally, and only those companies directly exposed to the disaster were trading off. By 15 March, a rout was under way. Asian stocks fell across the board, hitting Taiwan, Hong Kong and Korea particularly hard. European markets followed suit and US futures fell to their lowest level in three months. Crude oil prices fell 1.3 per cent. Chillingly, even gold was sold off, a palpable sign of fear as investors liquidated their portfolios to raise cash. Panic is gripping the global markets and all eyes are on Japan.

It is tough to write about matters financial when the human cost of the disaster is so horribly apparent, but perhaps less so in Japan's case than others. Its postwar economic success story is fundamental to the nation's conception of itself, and the bankers I met in Tokyo always spoke of the boom years of the 1980s with a kind of wistful reverence - even those who could hardly remember them. The Lost Decade has in fact lasted almost 20 years now, and, sad to say, the Sendai earthquake could merely mark a dramatic coda to the myth of the Japanese economic recovery.

Alex Preston writes the New Statesman's City and Finance column

This article first appeared in the 21 March 2011 issue of the New Statesman, The drowned world