Japan As Argentina

It may seem outrageous to compare the gathering crisis in Japan to the chaos of Mexico in the '80s or Argentina today. Japan is so much more modern, wealthy and, one would think, stable. Yet serious analysts are starting to draw just such comparisons. Here's how the Third World-crisis scenario might play out in Japan.

It begins with foreign hedge-fund managers losing what little confidence they have left in Japan Inc. Spooked, say, by a downturn in Japan's trade surplus, they might issue "sell" orders on billions in Japanese stocks and bonds and yen. Such a rush for the door, warns Takeshi Kimura, head of the international accounting firm KPMG in Tokyo, could be enough to upset the precarious equilibrium in an economy burdened by massive debts. The money flow out of Japan would accelerate the weakening of the yen, increasing the cost of imports and reversing the deflation that has ravaged Japan of late.

The endgame could leave Japan in new, perhaps even more dire straits. Exports would fall even faster, but with rising prices at home--creating a condition of stagflation roughly akin to Argentina's before the recent devaluation. "This is the pattern often seen when a developing nation's economy implodes," Kimura wrote in a recent KPMG newsletter.

Japan is no developing economy, to be sure. Yet it has assumed that role of late, threatening the global financial system like a moody emerging market. Its currency is unstable. Its banks are undercapitalized. Its neighbors are nervous that what ails Tokyo might jump borders. Japan and Argentina share another trait, too, one that spells headaches for the International Monetary Fund: stubbornness. Just as Argentina clung to the untenable (the peso's hard peg to the U.S. dollar), Japan still hopes against all logic for an economic soft landing. "Japan is stuck in a place where there is no solution," says one construction-industry analyst in Tokyo. "We need a crisis of control. We need the IMF to set policy. We need gaiatsu [foreign pressure] to reorganize our national economy."

Japan and Argentina aren't clones--far from it. But rejecting their similarities out of hand--as the IMF's own No. 2 man in Asia did last week in Tokyo, declaring: "I don't think there is any comparison"--blurs the big picture. Take debt. Argentina crumbled under massive foreign borrowing, whereas Japan, in contrast, remains a huge international creditor. Tokyo's debt woes emanate from several dozen huge companies that together owe enough to bring down their banks. Despite its purely domestic nature, Japan's bad debts, by some estimates, now exceed 60 percent of the GDP, compared to about 52 percent of GDP in Argentina. And while Argentina's crisis has not destabilized its neighbors, Japan's larger debt bomb could prove much more dangerous.

Researcher John Makin of the American Enterprise Institute predicted earlier this month that Japan will fail to disarm the bomb in time. Tokyo, he forecasts, will dally until several major banks fail abruptly, forcing the government to spend up to $1 trillion bailing out the financial system--enough to sink the yen and collapse Japan's bond market. "Japan's deflation and debt crisis," he argues, "now constitute systemic risk to the global economy."

As in Argentina, average folks would be the biggest losers in any crisis. Traditionally strong savers, Japanese households keep much of their net worth in yen-denominated bank accounts. Depreciation already has cut the value of their savings by 10 percent in dollar terms since September. If enough of them opt to shelter assets elsewhere, Tokyo might look a lot like Buenos Aires when locals began queuing outside banks to withdraw all the money they could. That risk, albeit slight, will intensify after March 31, the day Japan is set to stop insuring bank deposits larger than 10 million yen. Makin predicts "the inevitable outcome" will be the "the failure of the banking system." He also warns that, as in Latin America and Russia before, credit-ratings agencies won't raise a red flag about Japan because they're afraid to hasten the coming crisis.

Nobody expects riots or bloodshed of the kind that has engulfed Argentina in recent weeks. But capital flight, Kimura's doomsday scenario, could be mere months away. The decisive factor: Prime Minister Junichiro Koizumi's ability to reform Japan's financial system and revive the world's second largest economy. On Jan. 4 he pledged "to use every available means to prevent a financial crisis." Should he fail, the damage might prove Argentine in magnitude--or even worse.