News that Japan is officially in recession, as its economy contracts for the second quarter in a row, comes at the end of a week in which there has been mounting concern that its financial woes could spill over into another Asian economic crisis with potentially grave worldwide consequences.
While the evidence of recession is the worst since 1974-5, this week the yen is trading at its lowest levels for eight years. There are fears that if it falls much further South Korea's recovery, and therefore its social and political stability, would be jeopardised. Most important for the region, would be any shift by the Chinese government from its firm commitment to maintain its existing exchange rate with the US dollar. If that happened there would be a spiralling impact in Asia, Latin America and throughout the international economy.
Such scenarios may appear alarmist given the basic strengths of the Japanese economy with its massive reserves held in US bonds, its high savings ratios and its domination of so many high technology export sectors. But while a declining yen may boost Japanese exports, it may not have much effect on corporate profitability and therefore on the business confidence that is necessary to turn its out of recession.
Central to the present crisis is the Japanese financial system and the government's failure to tackle the legacy of bad debts arising from the downfall of its bubble economy at the end of the 1980s. Despite the collapse of several major finance houses last winter, the matter remains unresolved. It serves to illustrate a wider problem, the systematic shortfall of political will among the Japanese cabinet and bureaucracy to address the difficulties in the financial and fiscal systems.
This is partly, no doubt, a political matter, as elections to the Upper House of the legislature loom; yesterday an opposition motion of no confidence in the government over its handling of the economy was defeated. The government says it is ready to implement another stimulative package, following the substantial one put in place last April. But the latest crisis also exposes a deeper structural problem - the lack of a political centre in the Japanese system of government capable of responding urgently and effectively to a possible runaway loss of market confidence. In addition, its department of finance is notoriously orthodox and slow to accept political direction.
There are suspicions that the American authorities are deliberately holding back from organising a concerted effort to prop up the yen in an effort to stimulate a change of behaviour in Tokyo. It is only when a serious problem confronts them that the Japanese governmental system responds to change, they argue. But it is hardly good policy to play such fast and loose games when there are grave regional and global interests at stake. President Clinton will no doubt come under pressure during his visit to China next week to take action to avoid another currency meltdown in the Asian region. The affair underlines even more clearly than before how integrated the international economy has become. There can be no doubt that when Japan sneezes we all catch pneumonia.