Financial Times, 18 May 1994

By Barry Riley

Global investors have punted heavily in Japanese equities in recent months, and the tactical shift has been nicely rewarded in the short term. So far this year the FT-Actuaries World Index is showing a gain of about 3 per cent in dollars, but the sub-index for Japan is up 20 per cent. Foreigners bought Japanese stocks worth $33.5bn net in the first three months of 1994, contributing substantially to the rally in the Tokyo market and also to the strength of the yen. Meanwhile the Japanese were net sellers of foreign securities, to the tune of about $9bn (mainly reflecting a $13bn sell-off of bonds in March).

Whether these speculative portfolio movements have done anything to cure Japan's economic woes is a moot point, however. Real GDP has been more or less unchanged for two years now. With consumer prices up just 0.8 per cent year-on-year, Japan teeters on the edge of deflation: indeed, on the basis of wholesale prices falling at nearly 3 per cent a year, it is already there. The capital flows are serving to aggravate the problem of an over-valued yen, adding to the impact of the obstinately durable $130bn current account surplus. Moreover the purchases of equities by foreigners are essentially being mopped up by banks and are not contributing to liquidity growth which might stimulate demand in the broader economy.

Some of these issues are addressed in an in-depth study from Jardine Fleming's Tokyo economist Richard Werner, who has conducted an extensive analysis of liquidity in Japan. He has constructed several indices of liquidity which suggest that the recent slight upturn in the conventional monetary indicators may be misleading; the M2 plus certificates of deposit aggregate, shrinking in 1993, has recently been growing at about 2 per cent, but liquidity on most of JF's definitions remains flat.

During the 1980s private liquidity in Japan was growing at around 12 per cent a year while nominal GDP was rising at only about 5.5 per cent: the excess fuelled the great asset price bubble. By 1991 some 40 per cent of outstanding bank credit was directed to speculative areas such as property and finance. If only half of these are eventually paid back the bad debts would be 20 per cent of outstanding loans. Many financial institutions have become technically insolvent.

Shell-shocked banks cannot be substantial sources of new credit in these circumstances. Spending packages by the government have had little effect because they have been offset by bond issues which have drained liquidity out of the economy again.

Only if the Bank of Japan prints money can the economy grow - but the BoJ is terrified of creating inflation and/or another asset price bubble.

As for the foreign portfolio inflows, much of the supply of stock will have come from banks seeking to book profits to strengthen their balance sheets. There are no significant new issues of the kind which pumped huge amounts of liquidity into the US corporate sector.