MW-22 -- Twenty-Year Lows -- Circle the Wagons!

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Issue No. 22
Tuesday, April 1, 2003

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Viewpoint: Twenty-Year Lows -- Circle the Wagons!

The Bottom Line:

o As pointed out in Money Watch #20, the Japanese government has
shifted into an "extraordinary measures" mode, ostensibly
because it is spooked by the prospect that the Iraq War could
hurt Japan's economy and cause unforeseen problems in Japan's
financial markets. Meanwhile, the government appears to be
just skating by yet another "March crisis."

o The new BOJ governor Fukui's idea of "more flexible" monetary
policy is more gobs of liquidity, increased buying of stocks
from the banks, and intervention in the foreign exchange
markets to brake the yen's appreciation against the dollar.
Essentially, the BOJ is becoming the new "PKO" for the stock
market, replacing the public pension funds, which are already
5 trillion yen in the hole on their stock investments.

o Such band-aid measures will doing nothing to change market
sentiment, nor support flagging business confidence or the
flagging economy -- they will offer no support for Japan from
the exogenous "shocks" from the Iraq War and increased
geopolitical tensions that put the Japanese government in the
"extraordinary measures" mode in the first place.

o Sadly, barring an unlikely dramatic and risky departure from
conventional economic and monetary policy, that is about all
that we can expect. The best Japan can hope for in the Iraq
War is a successful conclusion of the US's grand design for
the Middle East without any of the exogenous shocks that could
push Japan to the edge of another financial crisis, and with a
nice relief rally that would take some of the short-term
pressure off. In this regard, history is on Japan's side, at
least from the stock market perspective. In other words, war
has historically been good for stock prices.

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Twenty-Year Lows -- Circle the Wagons!

While already beaten down, Japan's stock market crashed to new 20-year
lows as the Iraq War began. Foreign selling, pension-fund selling as
corporations returned the portion of their pension funds managed on
behalf of the government's welfare pension system, and unloading of
cross-holdings by the banks meant that there were essentially no
buyers of Japanese stocks except the Bank of Japan. Indeed, the Bank
of Japan was essentially the only net buyer of Japanese equities
during the January-March period, purchasing a net 882.2 billion yen of
equities from the banks.

While Japan is more exposed to gyrations in oil prices than its Group
of Seven industrialized peers, the country appears to have plenty of
oil reserves. It also has many other factors to consider beyond the
narrow focus of the Iraq War. Yet the government appears to be spooked
by the prospect of a prolonged war in Iraq and mindful of elections in
April, resulting in a mindset among the ruling Liberal Democratic
Party that is more like an "extraordinary circumstances" mode. This
mindset was at least partially fostered by a government poll which
found that up to 80 percent of voters surveyed say they can't rule out
the possibility of Japan being attacked. The war in Iraq and growing
tensions with North Korea have contributed to increased uneasiness by
the Japanese voting public.

This "extraordinary circumstances" mindset is reflected in recent Bank
of Japan actions. The BOJ is concerned about unexpected events, such
as a sudden share-price decline or credit concerns due to uncertainty
about how the war on Iraq will proceed. While monetary policy
was "unchanged" following an extraordinary policy board meeting
last Tuesday, the policy board decided to:

o Endorse expansion of the BOJ's purchases of shares held by
commercial banks by 1 trillion yen from the current 2 trillion

o Continue pumping ample funds into the money market in the
months to come to prevent the war in Iraq from hurting the
economy. The balance of current accounts deposited at the BOJ
totaled 25.2 trillion yen late last week. Government payments
to the private sector for public works expenses and other
factors are set to bring about 6 trillion yen into the money
market. With the BOJ not likely to drain those funds at the
fiscal year-end, the balance of current accounts deposited at
the central bank will most likely exceed 30 trillion yen,
compared to 27.2 trillion yen at the end of last March.

o Intervene in the foreign exchange market, with total
intervention to weaken the yen reaching as much as 1 trillion
yen, versus intervention of about 500 billion yen in February,
according to reports.

Some experts continue to call for the government to inject public
funds to bolster the capital bases of commercial banks, and new BOJ
governor Toshihiko Fukui has apparently acknowledged the need for a
system for preventive public-fund injections into banks. But the
current perceived anxiety about the financial system is different from
a situation where a major commercial bank could go under at any time
and trigger panic among the public. The system is now equipped with a
safety net to protect depositors even if an abrupt bank failure should
occur. One should note that no panic took place when major banks
collapsed in the past, even though such a safety net was not fully in
place. In other words, the new twist is that financial authorities
should not use public funds to contain a financial system crisis, but
to pave the way for carrying out the full reimposition of a cap on
deposit refunds in the case of a bank failure.

Japan's seven major banking groups are expected to generate net losses
totaling about 4 trillion yen for the fiscal year that ended March 31,
compared to the 2 trillion yen of capital they have just procured. Yet
there are signs that Japan's banking overhaul is producing some
immunity to such "crises." In 1992, the "Street" believed that Japan's
major banks could not handle a Nikkei average below 18,000. Three
years ago, the danger line was believed to be 12,000. Last September,
the danger line had fallen to 8,000, but some analysts are now
suggesting the banks could hold up even with the Nikkei at 6,800.

Just before the secular peak in the Japanese market, Japan's banks
held 80 trillion yen in stocks, or about 15.7 percent of total market
capitalization. Over the past five years, they have unloaded some 18
trillion yen of cross-held stock, the bulk since 2001. In addition,
banks are expected to keep trimming their holdings even if the
regulatory requirement to get their holdings to within their
regulatory capital is delayed.

Japan's Abundant Savings Myth
Japan's so-called excess savings have long been considered a strength
of Japan's economy, and a huge cookie jar for Japanese politicians to
dip into whenever they needed funds for the Fiscal Investment and Loan
Program and to prop up financial markets, teetering financial
institutions, or inefficient industries. In fact, Japan's savings have
peaked and are beginning to enter a period of rapid decline.

In aggregate, Japan's household savings rate is already down from 14
percent in the early 1990s to 10 percent by the end of that decade,
and to 6.9 percent in 2001. Recently, the rate is more like 4.3
percent. Normally, savings rates increase during recessions, but in
Japan's case, the Heisei Malaise has pushed Japanese households way
beyond the point of merely being cautious about spending. Senior
citizens own most of Japan's personal financial assets, and the aging
society as well as growing unemployment among older workers is causing
them to dip into their savings.

In addition, there is reduced incentive to save and growing preference
for durables as interest rates are at rock-bottom levels while faith
in the nation's financial institutions is at an all-time low. Also,
incomes are declining faster than Japanese savers can downsize their

Consequently, financial assets held by households at the end of last
year slipped 1.3 percent from the previous year to 1,396.01 trillion
yen, posting the sharpest decline ever. Despite the fact that 56
percent of these personal financial assets are in cash and bank
deposits, stock market losses continue to erode the value of these
savings. The year 2002 saw the first and second straight quarters in
which the figure was below 1,400 trillion yen, and there have been six
consecutive quarters of year-on-year declines. In addition, individual
pension funds continue to pile up losses. For example, the Government
Pension Investment Fund (GPIF) lost 2.15 trillion yen on its pension
investments in 2002, and the fund now has cumulative losses of 5
trillion yen.

Financial assets are not the only source of personal wealth that is
shrinking. Land prices in Japan fell for both residential and
commercial areas in the year to January 1, 2003, the 12th straight
year of declines. Residential land prices fell an average of 5.8
percent, a decline larger than the previous year's 5.2 percent, while
residential land prices in the Tokyo, Osaka and Nagoya metropolitan
areas fell 6.5 percent, the same margin as the previous year.
Commercial land prices fell by an average of 8.0 percent as falls in
land prices in areas outside major urban centers more than offset
rises in some busy urban districts. While the margin of decline was
smaller than the 8.3 percent of the previous year, 12 years of
consecutive declines have brought the average price of commercial land
to a level roughly equivalent to that of the late 1970s.

Incremental Flows Go Offshore
In addition, households are converting increasing amounts of their
savings into foreign currency assets, with such deposits surging 19.3
percent while investment in foreign securities soared 52.1 percent in
2002. Surveys of individual investors indicate strong allergies toward
domestic stocks and keeping one's money in a domestic bank. In total,
individuals own some 15 trillion yen in offshore assets. Since 1990,
cumulative net investment outflows into foreign bonds and stocks from
Japan have totaled 108 trillion yen.

Last week, the Welfare and Labor Ministry announced its 2003
allocations for the GPIF. While the GPIF has 162 trillion yen in
assets, only a small slice of this is currently managed in risk
assets. In fiscal 2003, the fund will be raising its risk asset
exposure by 12.1 trillion yen to a total 32 trillion yen. However,
only 1.7 trillion yen of this will be going into domestic equities,
while 1.6 trillion yen will be invested in foreign stocks.

BOJ as Equity Buyer of Last Resort -- A Bad Precedent?
Over the last five years, the constant and substantial purchases of
Japanese government bonds (JGBs) by the BOJ have been one factor
behind plunging bond yields. These purchases have helped to prevent
any upticks in interest rates due to "crowding out" fears, where the
government's growing and substantial need to issue more JGBs begins to
compete with the private sector and crowd out private sector issuers.
Growing purchases of JGBs by the BOJ have in fact helped to support
the banks.

Now, as seen in the first quarter of 2003, it seems that the BOJ has
become the buyer of last resort for stocks held by the banks as well,
replacing the public pension funds in government-sponsored
price-keeping operations (PKOs). As the government has now overcome
opposition from the central bank for such purchases, the government
will be tempted to prod the BOJ into even more purchases whenever the
stock market threatens to significantly fall to new lows.

This decision to have the BOJ purchase more stock was made while the
government was in "extraordinary circumstances" mode. Such band-aid
measures without commensurate action by the government are a bad
precedent. That is indeed the point that former BOJ governor Masaru
Hayami had been trying to make all along. The BOJ is edging ever
further out on the limb of unchartered monetary policy, but the bank's
actions so far have not been matched with equally bold government
action. On their own, the BOJ purchases of stocks are doing nothing to
change market sentiment and will do nothing to support flagging
business confidence or the flagging economy.

Money Watch's own straw poll of visitors asking what they think is
needed to fix Japan produced the following: a) Clean up bad debts: 50
percent; b) Devalue the yen, adopt inflation targeting, have the BOJ
buy assets, nationalize the banks and clean up bad debts: 20 percent.
In other words, even the casual observer has a pretty clear idea of
what is needed -- a concentrated, integrated program to clean up
Japan's mountain of bad debts. Yet this is exactly what the Japanese
government and the banks are finding most difficult to do. When the
government or the BOJ does act, it is only to bring more band aids,
ostensibly to overcome whatever short-term crisis that exists at the
time. This is not strategic policy making, it is "brush fire"

-- Darrel Whitten

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Four Seasons Hotel, Tokyo
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- Fusion of the brand and business strategy
- Brand management in crisis and recession
- Delivering global brands in foreign markets
- B2B targeted versus consumer sector branding
- Global and local case studies of failure and success

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Written by Darrel Whitten

Edited by J@pan Inc staff (


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