Peter Tasker on Kan

A change in leadership in Japan passes almost un-noticed these days, but the ascension of Naoto Kan to the role of prime minister could have a long-lasting impact on the strategic landscape.

Kan is the fifth Japanese prime minister in four years. He takes over from Yukio Hatoyama, who resigned after botching the sensitive issue of the relocation of the U.S. military base in Okinawa. Kan, a much wilier politician, will not revisit that particular tar baby of an issue. His pragmatism has already boosted support for the Democratic Party of Japan, which had plummeted thanks to Hatoyama’s Hamlet-like indecision.

Most likely the DPJ will chalk up a decent result in the July 11 Upper House election, and Kan will prove more durable and effective than his hapless predecessors. That is exactly the problem. For if Kan gets his policy priorities wrong, he will create huge frictions with the U.S. and endanger the relationship that has been crucial to regional security for the past half century.

The reason has nothing to do with security policy, on which he has said little, and everything to do with his “Kansian” economic policies. When the DPJ won power last autumn, its economic program consisted of increasing domestic demand through big child allowances. The party also favored a stronger yen, which would bump up the purchasing power of Japanese households.

What Kan is now proposing is almost the reverse. In his short tenure as minister of finance, he appears to have been “turned” by the powerful mandarins who run Japan’s economic policy and has morphed into a fiscal hawk. Now child allowances are likely to be capped at half the proposed amount. Worse, there is talk of doubling the consumption tax while cutting taxes on company profits. Younger lawmakers are also talking about engineering a depreciation in the yen–dollar rate to 120, even though tighter fiscal policy and aggressive monetary easing (also part of the Kan agenda) would deliver the weaker yen that Japanese exporters crave.

The debt hawks justify their position by citing the Greek crisis. In reality, there is no comparison between the two countries. Whereas half of Greek debt is held by foreigners, Japan is entirely self-financing. True, the ratings agencies have been uttering dark threats, but remember that they also rated subprime junk as triple A. The best barometer is the Japanese bond market itself, which has risen this year. Ten-year yields under 1.2 percent indicate that the Japanese government is the best credit the world has ever seen.

Japanese mercantilism is nothing new; what has changed is the global context. The credit crisis has highlighted the imbalances of savings and consumption that have been building for decades. If surplus countries like Japan and Germany squeeze consumption and depreciate their currencies, rebalancing will never happen. Debtor countries, like the U.S. and U.K., will have to carry on borrowing and spending.

Something has to give. If Middle America sees jobs being “exported” to uncooperative trading partners, it is not likely to support free trade. There is already a bull market in populism and economic nationalism—as can be gauged by the bitter public response to the transgressions of BP and Toyota. It could get much uglier. We’ve seen this movie before—eight decades ago, to be exact. It does not have a happy ending.

The situation is complicated by the shifting military relationship between the U.S. and Japan. During the Cold War, the bargain was simple: Japan got its security on the cheap, the U.S. got military bases strategically positioned on the Soviet Union’s eastern flank. This is why the trade frictions of the 1980s (remember U.S. congressmen -smashing a Toshiba stereo on the steps of the Capitol?) never threatened -strategic links.

In the 21st century, the logic of the alliance is fuzzier. The rise of China has Japan worried, and the U.S. wants to remain a player in Asia. But would the U.S. really be prepared to sacrifice its own relationship with China for Japan’s benefit? Would Japan really support the U.S. in a face-off with China over Taiwan?

In normal times, such doubts could be kicked into the long grass. But these are not normal times. With the “special relationship” between Britain and the U.S. in question, it would be more surprising if the U.S. Japan relationship survived this era of turmoil in its current shape. Japan’s conversion to Kansianism could set the scene for a fracture.

Tasker is a founding partner of Arcus Investments.