– Wei Gu is a Reuters columnist. The opinions expressed are her own –

Everyone agrees that China’s economy must be rebalanced, but few have bothered to delve into the costs. Japan’s experience has shown that even well-meant changes could sow the seeds for a bubble.

China cannot stay with its current economic model forever. But as the economy has become extremely unbalanced, to some extent even more so than Japan’s in the 1980s, rocking the boat too much risks tipping it over. Instead of rushing into changes, it would be better to make reforms gradually.

Most observers believe an extremely loose monetary policy was the root cause of Japan’s bubble. But Tomo Kinoshita, an economist at Nomura, reckons that efforts to liberalise the economy, such as sharply revaluing the yen, developing a deeper bond market and deregulating interest rates were among the fundamental reasons behind the bubble.

The challenges facing China’s economy are similar to those seen in Japan in the 1980s. Foreigners are calling for a currency revaluation because the undervalued yuan gives China’s exports an extra boost. Capital markets need to play a bigger role because investment has been directed mostly by state-owned banks.

True, property price increases appear to be milder than in the Japan of the 1980s. Household loans only account for 30 percent of disposable incomes in China, versus about 90 percent in Japan in 1989, according to Nomura. But there are warning signs. New mortgages recently hit a record. And ratings agency Fitch has cited China’s property market as a cause for concern.

The Chinese stock market also looks less overvalued than Japan’s did. The ratio of Chinese stock prices to earnings is only a third of the peak levels reached in Japan. Stock market capitalization as a percentage of GDP is 62 percent, much lower than Japan’s 150 percent at end of 1989. But China is catching up fast, and the ChiNext market, China’s long-awaited Nasdaq-style market, debuted last week with a speculative surge.

Moreover, China has been more aggressive in terms of monetary easing as it tries to prop up the economy while waiting for exports to return. The broad money supply in China has been rising at almost 30 percent this year, twice as much as in Japan back in the 1980s. So if there is a bubble, it could grow bigger than the one in Japan.

Even much-needed efforts to liberalise and rebalance the economy may lead to asset price inflation. Similar to China, Japan’s banks were too big and small companies had trouble getting financing. So developing a corporate bond market and encouraging banks to lend more to small firms was seen as a healthy change.

But policymakers underestimated the negative impact on banks. After Japan developed a liquid corporate bond market, large corporations issued cheap equity-linked bonds to repay bank loans. Because Japanese financial institutions lacked other revenue sources, they targeted smaller corporations and consumers. Total bank loans made to small- and medium-sized companies and individuals rose to 71 percent of total loans in the late 1990s from 47 percent in the late 1980s.

Due to a lack of information on their new clients, the banks’ bad loans started to rise. Their lending standards deteriorated as they scrambled to make up for lost business. This could very well happen in China as the country encourages consumers to take on more debt to stimulate domestic demand.

Moreover, Kinoshita argues that in Japan interest rate deregulation “put a cat amongst the banking pigeons” because banks were forced to lend out more when their margins became compressed due to more competition. Pressure from the United States played a role, and the Japanese authorities were eager to internationalize the yen anyway. Letting banks set deposit and lending rates was one of the requirements for the yen’s internationalization.

The policy lesson for China is that when Beijing takes business away from banks, it needs to balance things out by allowing them to take on new business, such as securities underwriting and broking.

But that leads to the question of how to compensate securities firms for their lost business and prevent them from engaging in reckless behavior. This just underscores the complexity of China’s problems.

Most of the world believes that China risks moving too slowly, not too fast. President Barack Obama might give Chinese leaders another ear bashing during his upcoming trip to China. But without the right systems in place, big bang reforms could be disastrous. It is important that China, as well as the rest of the world, learns from Japan’s mistakes.

Al Breach was Russia economist with UBS and Goldman Sachs and is currently managing partner of TheBrowser.com. The views expressed are his own.

HOSTENTAL, Switzerland - How bad was Japan’s “lost decade”? As we look east for clues as to the possible fate of western economies, it is worth dwelling on what actually happened, and not just how it was reported.

Japan’s stock market bubble burst at the end of 1989, and house prices started to fall about a year later. Asset prices at the peak were wildly inflated. Stock prices were trading at ratios of well above 50 times boom-time earnings, while the total value of housing represented around 300 percent of GDP.

These bubbles had formed after decades of rapid growth and, critically, even more rapid credit expansion. Total bank credit to the private sector had risen to 200 percent of GDP, doubling over 20 years.

(more…)

The victorious Democratic Party of Japan did not put economic growth at the heart of its electoral sales pitch. The party's manifesto mentions "growth" only once. The word "support", by contrast, appears 19 times.

Even so, there are reasons for optimism that the DPJ's softer and more nurturing policies are just what the economy needs.

The global slump provided a painful reminder of the dangers of Japan's export-oriented growth strategy. Output has fallen even faster than in other rich countries, leaving national income at roughly the same level as in the early 1990s.

After two decades of stumbling between recessions, policy makers need to convince their citizens to spend some of their vast cash savings, which are now equal to 1.5 times GDP. Making the Japanese feel more secure may be the best way of doing this.

There is plenty in the DPJ's platform that looks encouraging. If Japan's new government can enact election pledges, Japanese citizens would have fewer reasons to hoard cash.

Parents would benefit from a generous child allowance. High-school education would be made free and university scholarships more plentiful. For the elderly, there would be a minimum guaranteed pension of at least 70,000 yen (about $750) a month. The unemployed would get 100,000 yen (about $1,100) a month during job training.

There are two problems, however. The first is how to pay for this largess. The party's belief that its $180 billion social agenda can be financed by cutting wasteful spending has left some economists unconvinced. A good deal of the fat in the budget was cut out when Junichiro Koizumi was prime minister from 2001 to 2006.

Canceling public works may be easy. But reducing the cost of Japan's powerful civil service by 20 percent is a tall order -- especially when combined with a drive to strip senior mandarins of much of their influence.

Meanwhile the DPJ seems reluctant to privatize the government's giant postal savings and insurance businesses. An IPO could provide a large injection of cash without the need to trim costs or raise taxes.

If the Japanese feel the new social programs are unsustainable, they may be more reluctant to spend. With national debt at over 200 percent of GDP, a degree of skepticism would be natural.

The second economic headwind for the DPJ is even harder to overcome. Shrinking pay checks will make it difficult to tempt the Japanese into the shops. This year wages have been falling at their fastest pace on record -- 7.1 percent in the year to June.

Beyond the cyclical downturn, deeper demographic forces are at work. As highly paid baby boomers retire, they are being replaced by cheaper youths, according to Edward Lincoln, an economics professor at New York University. This is ratcheting down wages.

A decline in the working age population will also make economic growth more of an uphill struggle. Overall the number of Japanese citizens has been falling since 2005. This makes Japan an unlikely engine of global growth even if the DPJ gets everything right.

Promising as some of its policies are, Japan's new government will face strong headwinds. But it is good news both for Japan and the world that the country now has a leadership that seems inclined to put the interests of consumers before exporters.

- Arudou Debito, is a columnist for the Japan Times, activist, blogger at debito.org, and Chair of the NPO Foreign Residents and Naturalized Citizens Association. The opinions expressed are his own -

Japan's famous mantra is that things don't change much or very quickly.  But I have a feeling that this approaching Lower House parliamentary election on August 30 just might prove that wrong.

But first some background.  Japan has been ruled essentially by one party since the end of World War II -- the Liberal Democrats (LDP).  That's longer than in any other liberal democracy, competing with other countries that have no other parties to choose from.

There are many theories as to why that happened.  Some might insist that risk-averse Japanese weren't ready to tamper with the status quo, when economic growth was running so smoothly between 1950 and 1990, and everyone was feeling prosperous.

But that theory breaks down when you realize that Japan is the only developed economy which actually SHRANK on average over the past twenty years.  If prosperity breeds contentment, two decades is enough time to voters make the elected feel their winter of discontent.

I believe there just hasn't been a viable opposition party until now.  The previous #2 party for most of the postwar era, the Socialists, were essentially a one-issue group, holding just enough seats to block any revisions to Japan's "Peace Constitution".  They succeeded.  Our peacetime constitution has never been amended.

But the Socialists imploded in 1995 when their leader made a Faustian bargain to take power briefly from the LDP.  Ineptitude and three decades of opposition politics soon tripped them up, and the LDP was back in power within a year.

Arising from the ashes, eventually, was the Democratic Party of Japan (DPJ), which eventually convinced enough voters that it wasn't going to similarly implode.  It's only taken 15 years and a lot of horse trading (and some years holding the basically powerless Upper House) before it proved itself a viable second party.

It really proved itself earlier this July, when it ambushed the LDP in the Tokyo Government elections.  For the first time in 40 years, Japan's largest city has the opposition in control.   This is riding the wave of a shambolic LDP, with three disastrous (and unelected) prime ministers after the famously-charismatic Koizumi.  The current PM, Aso, is essentially an oblivious political Brahmin, who has made it clear that his only claim to power is his personal sense of entitlement.  Tellingly, he has refused to give up the LDP leadership even after the July ambush, and is driving his party into the ground.

It is now clear how deep the rot runs.  A near-majority of people in the LDP hold "inherited seats", meaning they are sons, daughters, or blood relatives of former Dietmembers -- some for several unbroken generations.  This degree of cosy entitlement has only encouraged more elitism, rot, and preservation of a status quo that is long run out of excuses for Japan's relative lack of prosperity.  The LDP are the party resisting change, and the only weapon they have left in their arsenal is that you can't trust the opposition party because it's never held the reins.  But that fear by circular logic isn't selling this time.

I think, as do most people, that we will have a change of government, with the DPJ taking power in September.  Will it change anything, however?

It just might.  The DPJ Manifesto (They were the party that started this earlier this decade.  How revolutionary!  Making your policies clear to the voter!) is already out and it's saying some pretty ambitious things.  Paying families sizable amounts to support their children.  Making schools up to junior high free.  Making our toll highways free.  Breaking the stranglehold the bureaucrats have over our policymaking levers.  And quite a bit more that is ambitious if not a bit vague.  (But that's quite normal.)  According to my backdoor channels, there's even the promise of the DPJ facing up to the task of dealing with Japan's decreasing population by broaching that taboo topic (until after the election) -- loosening up the borders to let more immigration happen!  That would mean EVERYTHING changes!

Many of these may turn out to be merely political promises, of course.  But they're still better than anything the LDP has come up with, and the DPJ is setting the agenda for this election.  Being in control of the debate is a good thing.  And it has had the intended effect.  Although a month is a long time in politics, I think at this time the attitude is, "Well, why not give the DPJ a try?  Can they really do all that worse than the LDP are doing now?"

I am an American-born naturalized citizen of Japan.  Have been for nearly a decade now.  I've voted in several elections.  This is the one I'm most looking forward to.

– Eric Auchard is a Reuters columnist. The opinions expressed are his own –

The fate of Yahoo Inc has become intertwined in the public’s imagination with the success or failure of its dealings with Microsoft Corp in recent years.

That’s despite the fact that as much as 70 percent of the value investors put on Yahoo’s depressed shares are tied up in its international assets or cash holdings — factors that have nothing to do with Microsoft.

Yahoo’s operations trade for just $5 to $6 per share out of its current $15 share price, once you exclude its Asian investments and the value of its cash. Its hidden assets in Japan and Chinese affiliates — Yahoo Japan Corp and China’s Alibaba Group — alone are worth around $6 to $7 per share.

The trouble is that Yahoo needs to find a way to cash out of its increasingly rocky relationship with Alibaba Group, in which it holds a 39 percent stake after it pulled back from operating its own business in China in 2005.

Yahoo’s best chance here may come next year if Alibaba succeeds with a second IPO of its Taobao.com consumer ecommerce site, building on the success of the 2007 IPO of Alibaba.com, now valued at more than US$13 billion on the Hong Kong exchange.

Truth be told, Yahoo’s huge success in building the biggest U.S. Internet media destination never translated very well overseas, despite the early foray into Asia that left it with lucrative assets in Japan and China. These passive investments came to substitute for a global operating strategy.

But that’s changing now, as Yahoo once again has begun investing in international operations it can fully control.

In its latest such push, Yahoo said on Tuesday that it would buy Maktoob.com, the largest Internet media site for the Arab world, with an estimated 16.5 million users. Terms were not disclosed.

Yahoo’s international stronghold is Asia, where it had 172 million unique users in the month of June, according to industry estimates. It is the top player in Japan through its stake in Softbank-controlled Yahoo Japan, and is dominant in Taiwan and Hong Kong as well.

In India, Yahoo has the most visited home page and is the most popular provider of e-mail, instant messaging and online news to consumers. In a country mad on the sport, Yahoo operates the most popular site for cricket fans. Yahoo had 23 million unique monthly users in India in June, according to market researcher comScore.

But Yahoo stock gets little to no stock market credit for these international operations. Converting market share into meaningful financial results will take years. First, Yahoo must develop its patchwork of leading properties in places like the Philippines and Vietnam and Latin America into a global franchise. And it’s hard to see how Yahoo can regain lost ground in Europe’s more developed Internet markets.

Until now, the trap for Yahoo has been that much of its international value remains latent, locked up in investments in Japan and China rather than in operating businesses it controls. That is changing, slowly.

This leaves Yahoo at the mercy of an eventual rebound in U.S. advertising markets. For the foreseeable future, any significant rebound in Yahoo’s share price depends on conjecture over the still unknown potential of getting into bed with Microsoft.

– At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article, with the exception of a token Yahoo share. He may be an owner indirectly as an investor in a fund. –

- Danny Sriskandarajah is Director of the Royal Commonwealth Society. The opinions expressed are his own -

In recent years the Commonwealth has become an easily derided organisation. From its inception as a clever way of easing de-colonisation to the heady 1970s and 1980s when the association showed a radical dynamism on issues like Apartheid, the international association has shown itself to be unique and useful.

However, today, the Commonwealth risks being drowned out in a more crowded field of international organisations, many with a clearer sense of purpose, more collective will and better resources.

Before the 2002 Commonwealth Heads of Government Meeting (CHOGM), in Durban, South Africa, Tony Blair reportedly said he would rather be at home watching football than meeting his fellow heads of state. A candid indictment of how irrelevant the Commonwealth has become?

Polling done in seven member countries to mark the launch of a public conversation on the future of the Commonwealth shows some worrying signs. Globally, only a third of people polled could name any activity carried out by the association and only about a third of people in Australia, Canada and Great Britain would be sorry if their country withdrew altogether.

No international organisation has a pre-destined right to exist and these poll results should be a wake up call to ask whether and how this association will be relevant in the 21st century.

This year the Commonwealth is 60 years old, and some have said that the association risks easing into a low-key retirement. Yet the organisation contains some of the worlds most developed and dynamic countries: two members of the G8; two members of the G8 plus 5; five members of the G20 and one member of OPEC. Outside Japan and the USA, the cutting edge countries in information technology and e-commerce are all Commonwealth members. The booming economy of India, the world’s largest democracy, is a founding member.

The Commonwealth will never become a trading bloc, like NAFTA or the EU. But the common cultures, legal systems and regulatory frameworks across so many Commonwealth countries are a great incentive for trade and cooperation between them. The Commonwealth itself accounts for some 30 percent of world trade.

Much more should also be made of the incredible people-to-people links that exist between Commonwealth countries. Buttressing the inter-governmental Commonwealth is an unparalleled network of civil society organisations and business networks that promote the exchange of ideas, people and much more. Organisations like the OECD or APEC cannot boast such a hinterland.

On issues like climate change, the Commonwealth could offer a unique informal space for dialogue between countries that might otherwise be at loggerheads in negotiations over binding commitments. Indeed, past leaders frequently say the true value of the Commonwealth lies in the opportunity for a unique informal dialogue that happens at Commonwealth leaders’ retreats.

Access to international markets presents great opportunities for poorer countries to trade their way out of poverty. If all Commonwealth countries, from giants like Canada to minnows like Tuvalu, agreed to take a decisive and common stance on trade issues, the Commonwealth voice could be a powerful force to kick-start the stalled Doha Development Round.

Through the Commonwealth Conversation, the largest ever public consultation about the future of the Commonwealth, the Royal Commonwealth Society hopes to help the Commonwealth recapture its relevance. As it stands the organisation is not articulating its strengths, aims or ideals.

This sixtieth anniversary presents a crossroads for the organisation. It can retire from the international stage it has served so well in its first 60 years or it could reinvigorate itself with renewed purpose to face the challenges of the 21st century. We should remind ourselves of the Commonwealth’s potential, and fully utilise this network to our advantage. Whether it is through promoting shared values or an agenda to tackle shared challenges, the Commonwealth needs to show it can make a real difference on key issues.

– James Saft is a Reuters columnist. The opinions expressed are his own –

Sure, seeing your economy shrink at a 15 percent annual clip is depressing, quite literally, but if you believe in even a tepid global economic recovery in the second half, then Japan is actually attractive.

There is no way to sugar coat the first quarter Japanese gross domestic product figures released on Wednesday: they are breathtakingly bad viewed from virtually any angle.

The economy shrank by a record four percent in the quarter, or an annualized fall of 15.2 percent, leaving the economy no bigger in real terms than it was in 2003. Net exports fell sharply, by themselves pushing GDP 1.4 percent lower and, perhaps even worse, capital spending shrank by more than ten percent and private consumption fell by 1.1 percent.

What’s more, stocks of inventory remain high when compared to sales, so there is plenty left to sell without placing new orders.

But just as global trade, and with it Japan’s economy, had an extended and sudden plunge in the wake of last year’s panic, there are signs already of an improvement.

Industrial production in March in Japan actually rose from the month before, up 1.6 percent, a rise echoed softly in the Reuters Tankan survey of confidence among manufacturers which showed less gloom than the month before.

A recovery will require a substantial recovery in exports, industrial output and household spending, according to Julian Jessop, chief international economist at Capital Economics in London.

“The strong rebound in the survey evidence confirms that this is realistic,” Jessop wrote in a note to clients. “The extent of the previous declines in exports and investment also leaves plenty of room for a decent bounce.”

That decent bounce could result in a nice return on Japanese shares, which have rallied in sympathy with global stocks.

Significantly, Tokyo shares actually rallied after the GDP news even despite a rise in the yen which crimped the competitiveness of exporters. And measured on a price-to-book value basis, Japanese shares, especially smaller cap issues, are among the world’s cheapest, implying decent potential for gains if the economy as a whole surprises.

Japanese shares as a whole are trading on a one year prospective price-earnings ratio of about 30.

LEVERAGED TO CHINA AND U.S.

Japan’s economy is very highly leveraged to global trade, making this perhaps the key call in any bet on a recovery there. Japan’s position is better than it might seem because those things which it does still successfully export are of high quality and technical specification and less vulnerable to cheaper substitutes from China or elsewhere.

A Barclays Capital composite leading indictor for Japanese exports, which tends to be three to five months ahead, has recently turned positive after a sustained and precipitous drop.

The index includes U.S. stock prices, commodity prices, new orders in the U.S. in both transport machinery and information technology, Chinese auto production and the relationship between U.S. inventories and sales.

Efforts by China to jump start auto sales seem to have worked particularly well, recording an 18.5 percent gain in April from the year before. Similarly, there is a reasonably good chance we are in the midst of a U.S. recovery of some sort, though the risks are it is short lived or chronically feeble.

As this happens look for a rebound in exports and production in Japan and even, at some point, in actual investment. This leaves us with the 20-year running sore that is Japanese domestic consumption.

The fear, and it is not a small one, is that employment and income suffer after a downturn of depression size and that already falling consumption retracts further. The gap between Japan’s output and its capacity is eight or nine percent now, making the risk of deflation, and with it the possibility of a negative spiral in spending, quite high.

Balancing that is the fact that Japan’s healthy savings rate gives its consumers an option less available to their U.S. peers when income falls, they can make up some of the shortfall by simply saving less.

Further, Japan is feeling the impact of a substantial fiscal stimulus, with at least some of the tax cuts finding their way into shopkeepers’ hands. Japan also has front loaded infrastructure spending.

As with all such spending, the impact of this is transient and, with the possibility of an election soon, there is no guarantee that further extra budgets will be forthcoming.

It won’t be glamorous, in part because the engine of growth will be elsewhere, but between now and the end of the year a rebound could be surprising and, depression-era style economic statistics notwithstanding, surprisingly profitable.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

– James Saft is a Reuters columnist. The opinions expressed are his own –

With the U.S., Japan and Britain — nearly 40 percent of the global economy — facing the threat of deflation, it’s going to be just too easy for one, two or all three of them to get the policy response horribly wrong.

The global economy is so connected, and our experience with similar situations so limited that the scope for error is huge.

Think of it as having three pilots flying a jet plane, one each operating a wing and the third managing the tail.

Oh yeah, and they all work for different airlines.

Though there will be much talk of international coordination in the next year, and though the central banks and governments of the world will likely be rowing in the same direction, their ability to gauge the effects of monetary policy and government spending on their own economies will be pretty limited, and even more so on the whole.

Failure when fighting a global recession, a global balance sheet adjustment, a global banking recapitalization, debt deflation and very possibly actual deflation can take many forms.

“It’s very hard to calibrate and it’s awfully easy to overshoot or undershoot, both of which would be disastrous,” said Lena Komileva, London-based strategist at Tullett Prebon.

Under clubbing the response to falling prices means you could slip into a self-reinforcing deflation, making your debts, be they consumer, housing or government, heavier and setting up a cycle where businesses and consumers defer consumption and investment.

Over-reacting risks fomenting a new bout of inflation and potentially causing a new bubble. (Who knows what that would be — dirt, water, baseball cards?)

And remember too, when deflation was last an issue on this scale globally during the 1930s, the global economy was nowhere as near as integrated.

As for now, the signs are clear: deflation is a growing threat in much of the world’s economy, though still to be sure not the central forecast.

U.S. producer prices dropped by 2.8 percent in October, the largest decline on record. Core intermediate goods and core crude goods prices, which show inflation at earlier stages in the production cycle, fell by a big 1.7 and a staggering 17 percent, respectively.

Consumer prices, which are usually sticky on the way down, fell at a record rate in October, down one percent and even falling by 0.1 percent in the month when plunging food and energy prices are excluded. That will kill corporate profits and shows a business community racing with consumers to see who can capitulate fastest.

HERE, THERE AND EVERYWHERE

Inflation is falling rapidly in Britain too, with overall consumer price inflation down 0.2 percent in October, the first monthly fall since the annual January sales and the first in October since 2001, just after 9/11.

Japan meanwhile has slipped back into recession, domestic demand is weakening, wages are falling and deflation may develop some time next year, a scenario Barclays Capital rates as a 40 percent chance.

Even China, where inflation has tumbled to 4.0 percent in October from a 12-year peak of 8.7 percent in February, has moved its focus to averting deflation.

Be in no doubt, central banks have the tools to fight deflation; while interest rates can only be cut so much, officials can step up the quantitative easing now happening, they can commit to hold rates at zero for an extended period of time, they can drive down their own currency by purchasing foreign bonds or finally, simply print money and drop it from the famous helicopters.

The issue is not the tools, but the speed of the printing presses or size of the bond purchases needed to get the right result, especially when it is interacting with what will be huge tax cuts and deficit spending.

A mix of monetary and fiscal policy will work, but it’s got to be the right mix and it has to be reasonably well coordinated internationally.

None of this is without risk. Remember the last deflation scare in the U.S. in the early part of this decade, which in retrospect caused the monetary bubble which was nursemaid to the housing bubble.

Print money or borrow excessively and you could lose the confidence of the currency market and experience a run, which certainly will help to fight deflation but is no-one’s idea of good policy.

In theory the amount the state will need to borrow will be in part offset by the amount individuals save, or more to the point pay down in debt and decline to invest privately. That theory will be put to the test by the number of governments who are going to be selling a very large number of bonds, which will after all have to be paid back.

Next year is looking as if it will be as unconventional as it is scary.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund –

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