Outlook: Japan's crisis demands international action

It could only happen in Japan. Far from causing another precipitous plunge in the Tokyo stock market, the first ever post war collapse of a major Japanese commercial bank was greeted with unrestrained glee yesterday, with the Nikkei rebounding a full 8 per cent. While this might seem a curiously perverse reaction to a cataclysmic event, it is not altogether without reason. If the Japanese authorities are prepared for the first time to allow a big bank to go the wall, then that means they have an underlying confidence in the system, they believe that even if this bankruptcy is followed in short order by others, the damage to Japan's economy would be limited.

Furthermore, the insolvency seemed to be dealt with in a thoroughly business like and calming manner. The Bank of Japan stands ready to provide loans that will enable depositors in Hokkaido Takushoku Bank to get their money back, while the Bank's non performing loans are to be taken over by the Deposit Insurance Corporation, a Government backed fund that will work the loans out over a period of time. All very satisfactory.

The trouble is that from a Western point of view it is hard to see how anything has really changed. Is this not just more smoke and mirrors from the Japanese authorities? Finally a Japanese bank has been prepared to admit what everyone has known for years, that it is insolvent. We have now entered the next stage of this great Japanese illusion, that it is possible to have a painless insolvency.

While the process of bankruptcy is confined to just a few players, it may just about be possible to pull off this slight of hand. But if there is a more serious spill over into the Japanese financial system, then the illusion becomes much more difficult to maintain. At this stage, the Japanese authorities can get away with the pretence that no public money is being applied to the bail out. That would plainly not be possible if the process began to snow ball. The chances of this happening are not as remote as might be hoped. Any use of Government money could prove unacceptable to the Japanese electorate.

Without much more positive action by the Japanese Government than we have seen so far to stimulate the Japanese economy there is no reason to suppose that the present bounce in the Nikkei is any more than temporary (for the reverse view on this see Hamish McRae on page 23). Psychologically, the Japanese Government is already in that phase of thinking where the last thing it wants to do is provide a new fiscal stimulus. It is in rebuild the public finances mode, not slash taxes frame of mind. That in turn is going to put further pressure on Japan's beleaguered banks. The ruling LDP party has proposed some use of public money to recapitalise the banking sector through the issue of a new class of preference share, but the timing of this assistance is in the lap of the gods. It could be years away. The need is more urgent.

If the Nikkei sinks below the 15,000 level, then the system moves into melt down territory. Holdings of Japanese equities provide an important part of the reserves of all Japanese banks. At 15,000 and below, liabilities begin seriously to exceed legal reserve limits, there would be a loss of confidence, and the cost of propping up the banks might become prohibitive. Already there is worrying evidence of this spectre in the rising cost of the "Japan premium", the premium over the norm which Japanese banks have to pay for international money.

So are there no solutions? There are two possible avenues of escape, both hinted at by Larry Summers, the US Deputy Treasury Secretary, during trade talks in Japan over the past few days. The first is the possibility of an international lifeboat for the region's ailing banking system. If this were seriously to be offered, there would have to be a quid pro quo, which would be measures to restimulate the Japanese economy and strengthen the yen. Neither of these two options would have seemed possible even three months ago, but the political will may now be there.

It is a measure of the seriousness of the region's economic plight that Mr Summers now gains a hearing for measures like these. The addition of Korea to the region's list of casualties has underlined the extreme dangers of the present crisis. Even Korea has entered the game of competitive devaluation. With economic growth across the region in full retreat, deflation and protectionism may not be far behind. Certainly some form of coordinated international action has become a matter of urgency. It is still all too easy to think of the financial crisis of the Far East as somebody else's problem. Perhaps unfortunately, the world just isn't like that any more. The Far East's difficulties are all too quickly likely to become our own.