Japan Beware

Et tu Tokyo? If Washington is counting on Japan to act as last-resort buyer of US dollar bonds, it may have to think again. Masaharu Nakagawa, finance chief of the Democratic Party of Japan (DPJ), told the BBC that his country should not purchase any more US debt unless issued in yen as "Samurai" bonds, akin to "Carter bonds" in 1978.

This is the sort of petulance that tends to emerge in the late phase of slumps (1840s, early 1930s) when mass lay-offs provoke a populist backlash and hotheads run away with the agenda. Mr Nakagawa later played down the comments, calling them private thoughts, but the genie is out of the bottle.

We have come to assume that Japan under the Liberal Democratic Party (LDP) will always cleave to America, if only to safeguard US protection against Chinese naval expansion. Backed by Washington after the war as a rural counterweight to the urban left, the LDP has held an almost unbroken grip on power since 1955.

But crashes have a habit of bringing regime change. Brian Reading, a Japan veteran at Lombard Street Research, predicts a "seismic shock" over the next four months as voters rebel.

"With unemployment heading for 5 million by end-year, something must happen," he said.

The tremors from Japan follow near-weekly fulminations from Beijing, which suspects that Washington is engineering a stealth default on America's debt by the trickery of quantitative easing. This was put bluntly in February by Luo Ping, head of China's banking commission: "We hate you guys. Once you start issuing $1 trillion-$2 trillion, we know the dollar is going to depreciate." Premier Wen Jiabao picked up the theme more politely, asking whether the "massive amount of capital" lent to the US was still safe. Since then the People's Bank has floated ideas for a world currency.

China and Japan together hold 23pc of America's $6,369bn federal debt. This has caused alarm on the US talk radio circuit, but fears of imminent "dollardämmerung" and a collapse of American economic power may prove far off the mark. Who ultimately holds a gun to the head of whom?

If Asia's leaders give free rein to frustrations and crater the US bond market, they will ensure their own political destruction. Japan already risks descent into demographic death, deflation, and debt atrophy (its public debt is nearing 200pc of GDP). China's regime depends on perma-boom for post-Maoist legitimacy. Could it survive the wrath of jobless graduates and rural migrants if it provokes America into erecting trade barriers, killing the globalisation goose that lays the golden egg?

American can if necessary retreat into its vast home market and rebuild its industrial base, well-armed with 12 aircraft carrier battle groups.

The last 12 months should be lesson enough that Asia cannot yet stand on its own two feet. Its mercantilist export model remains a "high-beta" play on the West, to use trader parlance.

Japan's industrial output has fallen 34pc. China's exports are down 23pc.

Ray Maurer, from Qatar's QNB Capital, said China may be too busy closing factories it should never have built to challenge US primacy over coming years.

"China is not going to be a juggernaut until it creates a viable economy based on home consumption. It's just a tiger, living a myth," he said.

Lombard's Charles Dumas says the "super-savers" (China, Japan, Germany) have warped their own economies by relying on exports and, therefore, on perpetual debt build-up by the West.

"Their currencies are due to decline against the dollar as weak US recovery throws a few scraps from its table, over which the world's exporters will have to scrabble, cutting their prices and currencies in the process. The US is not, and is not about to become, Argentina or Zimbabwe," he said.

Let us not forget how we got here. Japan amassed a quarter trillion dollars of US bonds from January 2003 to March 2004 in a frantic effort to drive down the yen and stave off deflation. It has not yet won that battle. Producer prices fell to minus 3.8pc in April, a 22-year low.

China's holdings of US bonds are a consequence of its own policy of holding down the yuan to boost exports. Beijing may rage about America's "helicopter" stimulus, but what would have happened to the factories of Guangdong if the Fed had not taken emergency action or if the US Treasury had allowed the banks to collapse? China wants it both ways.

The world economy has long been running on fumes. The debt appetite of the Anglo-sphere and Club Med kept demand afloat, concealing excess capacity. The deformed interplay of Asia's Confucian model and Western consumption ran unchecked, until the imbalances blew up.

Yet it is easier to blame Uncle Sam, subprime, and friendless bankers. A folk tale has captured political discourse everywhere, from Beijing, to Tokyo, Moscow, and Berlin. If they are foolish enough to act on this self-serving illusion, they will pay the higher price.
www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/5339435/Asia-will-author-its-own-destruction-if-it-triggers-a-crisis-over-US-bonds.html

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Last updated 22/05/2009

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