Yelling at Japan Jude Wanniski June 16, 1998

As we contemplate the continuing economic/financial crisis besetting Asia, make sure you keep in mind the fact that Japan has not done anything this past year to contribute to the crisis -- which is primarily the handiwork of the Fed and the boys at the U.S. Treasury and IMF. Japan could, though, help all concerned by getting its economy on a better track than it has been on this past decade. The best recent piece in the popular press about the crisis appeared Friday in a Wall Street Journal editorial, “The Yen Dilemma.” With everyone and his brother yelling at Japan to DO SOMETHING to get its economy in motion, the Journal at least began to yell at Fed Chairman Alan Greenspan for bearing some responsibility for the “weakness” of the yen: “In theory, after all, the weak yen may be a sign that the Fed is too tight. Indeed, this may not be mere theory, with the dollar also strong against the mark, gold below $300 and no sign of domestic inflation.” The Journal went on to “suggest” that “the world’s primary currency carries international responsibilities,” and while it was nice for Greenspan to hint the Fed will not tighten, “the more pertinent issue is whether it should ease to help Japan and the rest of Asia.” The editorial had no visible effect on Bernard Wysocki Jr., who wrote the Journal’s front-page “Outlook” column Monday morning. The “simple proxy for the whole mess” is “the sinking Japanese yen.” As with otherwise intelligent people who make the same mistake, it never occurs to Wysocki that if the yen has been fairly stable against gold for 18 months while the dollar has rocketed up relative to gold, it makes no sense to say the dollar is stable and the yen weak. Treasury Secretary Bob Rubin, who makes the same mistake, is practically yelling at Japan to grow faster.

It is, of course, true we all would like Japan’s economy to grow again. If the Fed would add liquidity to the banking system sufficient to push gold to $330, the yen would strengthen in the process relative to the dollar, to ¥125, with gold constant at ¥41,000. How would that help Japan? By ending deflationary dollar pressures on commodities throughout the world, including Asia. Would this be bad for the United States? In a zero-sum game, one might make that calculation, as it would put an end to the going-out-of-business sales that temporarily provide us with cheap imports. In his Joint Economic Committee testimony, which I watched on C-SPAN this weekend, it was encouraging to hear Greenspan say that while the Fed only has responsibility for the U.S. economy, it must take into account the feedback effects on our economy of our policy actions. This seems to be a window through which liquidity could be pushed.

Japan’s problems did not start with the Fed dollar deflation and they cannot be fixed simply by monetary ease at the Fed. Japan has been in a slow growth mode for a decade, when it first bowed to Keynesian pressures from the Bush/Brady Treasury department to save less and spend more. How? Japan responded by raising taxes on the people so the government could finance its spending. The demand for yen plummeted 26% from February 1989 to March 1990, when it hit its low of ¥61,756 in gold. In an extended paper we published August 31, 1995, “Japan’s Ailing Economy: A Critical Diagnosis,” we pointed out that the Nikkei crash from 38,915.9 that began on January 4, 1990, was in response to a doubling of the holding period on real property -- to ten years from five -- required to get a preferential treatment on capital gains. The “bubble” that people talk about was the result of the surplus liquidity that appeared with the 1988-89 tax increases, liquidity the Bank of Japan did not mop up. The liquidity moved into property and became capitalized into the Nikkei, as there is a minimal capgains tax on equities traded on the stock exchange. In 1990, the Nikkei lost 26% in four months, recovered a bit, and then went into new slides as the government raised taxes again and again.

In the course of 16 months from April 18, 1991, to August 18, 1992, the Nikkei index lost 47%. The Bank of Japan accelerated its treadmill, draining liquidity to depress short-term interest rates when it should have been adding fresh yen to liquify the banking system; at the end of the 16-month period the gold price was at ¥40,000... Again, monetary policy was not the sole culprit for this decline. The Bank of Japan was attempting to offset with lower interest rates an economy further weakened by new taxes on land. The Japanese government imposed a national sales tax -- starting at 0.2% in 1992 and rising to 0.3% thereafter -- on the assessed value of all land holdings on individuals and corporations. The tax rate was 1.4% for so-called “idle land.” The government also inaugurated an additional 10% long-term capital gains tax on land sales by individuals and corporations after a five-year holding period. And it levied a so-called “super short-term capital gains tax of 30% on land sold within two years of purchase. For a company, this meant short-term land sales were taxed at a 67.5% rate (including the usual corporate income tax of 37.5%). Of course, with land prices continuing to slide, there were no capital gains to be had here, except for gains investors had made but not realized, prior to the “bubble” experience. 

With all the yelling at Japan in recent weeks, we have been unable to persuade anyone in a position to influence the Japanese government that it should recommend elimination of the capital gains tax on real property. I actually put a copy of our 1995 paper in the hand of Deputy Treasury Secretary Larry Summers last year, having requested a meeting to warn of the problems ahead. (A shortened version was published by Barron’s on September 18, 1995, “What Ails Japan?” which can be found via Dow Jones news retrieval.) At least Summers, as does the Journal, recommends “tax cuts” for Japan. Neither he nor the WSJ have bought the argument we have been making these past several years that the problem lies in the capital gains tax. In the United States, more of household wealth is in the form of financial assets than real property. In Japan, where 130 million people live on a plot of land no bigger than California, most of the wealth is held in real property. As long as the capital gains tax remains confiscatory on real property, individuals or corporations are loath to sell it, and the government gets no revenue from that source. This is the peculiar cancer eating away at Japan, which easily can be cured if it were understood. Abolishing the useless tax would wipe out something like a hundred trillion yen of tax liabilities. My guess is that the Nikkei quickly would rise from the 14000 level to the 20000 level.

The financial crisis would be over for Japan and at least bring instant relief to the rest of Asia. We still would face the problem at home of a Republican Congress that wants to hoard the budget surplus instead of improving the tax structure. And we still would have a Federal Reserve that insists the economy is doing beautifully, and would be inflationary if the dollar deflation were ended by adding the liquidity clearly being demanded. It’s not as if we did not know what are the problems that have cropped up in the process of getting the growth we have. A little nudge here, a little shove there, and the bull market could resume until the next set of problems arise. If you know anyone in Tokyo, give them a holler. Just don’t yell.