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Japan and China Brace for New Banking Crises
Global Intelligence Update
Red Alert
August 19, 1998
According to Agence France Presse, Taku Yamasaki, a senior official of the Japanese ruling
Liberal Democratic Party, told Indonesia's President on Tuesday that Japan's economy would
face its "most serious crisis" within a week. The story was also carried by the
Japanese Kyodo and Jiji news services. While Yamasaki did not specify what crisis was
brewing, he is quoted as having said that "I contacted very important persons in the
Japanese government, and they said that they decided not to let ailing major banks go
bankrupt to avoid negatively influencing the economic situation in the world, especially
in Asia." An obvious inference to be drawn is that some major Japanese banks will be
facing a major cash flow problem next week and may be unable to meet obligations. If this
is the case, the Japanese government is sending out a signal in financially devastated
Indonesia, telling the rest of Asia that the Japanese government is prepared to bail out
the banks, preventing bankruptcy.
Yamasaki's reassurance in anticipation of a crisis that has not yet surfaced is more
chilling than calming. Clearly, senior officials in the Japanese government are aware of
an impending crisis of substantial proportions, such as the bankruptcy of some of Japan's
major banking institutions, and are trying to soften the shock. This is not the usual
Japanese style. Denial until the last possible moment has been the normal operating
procedure in Japan. Yamasaki appears to be trying to do damage control in the ASEAN
countries, attempting to reassure them and to limit the effects of the crisis. As economic
crises have become the norm in Japan, Yamasaki's unusual warning indicates that Japan is
facing a new crisis of truly impressive magnitude.
Perhaps part of Japan's concerns were events in China. On Monday, China's Ministry of
Finance announced that they were issuing 270 million yuan (about $32 billion at the
official rate) worth of special, 30-year, yuan- denominated bonds, carrying an annual
coupon of 7.2 percent. The purpose of these bonds was to supply capital to the Industrial
and Commercial Bank of China, the Agricultural Bank of China, the Construction Bank of
China, and the Bank of China. The bonds were not to be sold to the general public. Wang
Wuhong, a Finance Ministry spokesman, pointed out that the Ministry could not guarantee
that the bond issue will enable the four banks to meet the eight percent capital adequacy
ratio set by the International Bank of Settlements. According to Agence France Presse,
these banks had capital bases of four to five percent and at least 25 percent of their
loans were non-performing. The banks are also being pressured by the government to write
off bad loans, which involves foreclosure and other aggressive collection efforts. As in
other Asian countries, this action is difficult to execute because of political and social
implications.
At the same time, the People's Bank of China issued a circular urging all banks to
separate themselves from non-financial entities they owned. This is a crucial step in
saving the banking system, since there is a tendency to support unprofitable linked
businesses with favorable loans that are not economically justified. This linkage between
banks and non-financial businesses has been a key element in the Asian meltdown, since
banks' irrational lending practices have undermined their stability. Of course, this
circular comes about five years too late. With a conservative count of 25 percent
non-performing loans, the damage has already been done.
Not surprisingly, China's Xinhua News Agency reported that Beijing banks reported a 121.7
percent rise in sales of foreign currencies in the first half of this year. Thus, we have
the key elements of the Asian economic crisis now clearly in view in China. First, Chinese
banks cannot meet the minimal IBS standards, even with massive infusions of capital.
Second, their non-performing loans stand at 25 percent. Third, the government is trying,
far too late, to get banks to sell off capital-draining assets.
Fourth, the government is trying to get banks to write off bad loans.
Finally, the price of the yuan is kept stable while the public is buying foreign currency.
The Japanese and the Chinese are tied together now. If the Chinese were to devalue
suddenly, economies throughout Asia, including Japan, would be devastated. If the Japanese
weakened any further, the Chinese would be forced to devalue. China has been warning Japan
about this for the past few weeks. The Japanese can hear the creaking sounds of China
buckling under the strain. The Chinese see an uncontrolled plummet in Japan's economy, and
are scrambling to do damage control, albeit too little and much too late.
We believe that the next two weeks will be critical in the Asian crisis.
Japanese banks seem about to break. The Japanese government is going to forced to save
them. They will need to borrow money on the international market to do so. That means that
they will need to strengthen the yen. Of course, strengthening the yen involves selling
dollars, which undermines their ability to borrow money. The pressure on China will
increase. China is trying to get its house in order, hoping to stabilize its banks in
anticipation of the crunch. Of course, their own banking crisis is far greater than a $30
billion bond issue can handle.
A question arises: the Chinese have been defending the yuan with currency controls. If
Japan is facing its "most serious crisis" yet next week, is there any way they
can navigate through the treacherous waters without imposing some sort of currency
controls of their own? Given the magnitude of their problems and their unwillingness to
impose genuine, wrenching controls, we are beginning to wonder if there is any way out,
short of such controls. And with the two largest Asian economies having controlled
currencies, what other Asian countries would follow suit? We note that Yamasaki was in
Indonesia when he made his dire prediction. Even if the Japanese decide not to impose
currency controls, the mere threat should achieve what Japan wants most-an American
solution. The U.S. is committed to the current monetary arrangements. If Yamasaki's crisis
is as serious as he is implying, the threat may not be as farfetched in a week as it seems
today.
That is speculation. What is not speculation is that the Japanese are worried about
something, or at least want the world to think they are worried. We think it is a
combination of a Chinese banking crisis and Japanese bank bankruptcies, converging on each
other. And that is a radical event requiring radical solutions that leave Japan's internal
social and political arrangements intact. We are open to other suggestions, but Japan does
not seem to have many options.
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