This cycle of assets-debt-assets is the background for the madness that seized Japan during the Bubble. It explains why IBJ lent Madame Nui money to buy IBJ's own bonds in a deal that cost her $30 million the moment she signed the contract. IBJ knew well why she wanted those bonds. She took her bondholdings to other banks, which were glad to lend her more billions because she had such blue-chip collateral.
This system flies in the face of Western economic theory, but it worked brilliantly in Japan for the first years after World War II, allowing Japan to pull itself up by its own bootstraps. Karel van Wolferen calls the system «credit ordering,» and it is important to remember that it really did achieve great success, turning Japan in a few decades into the world's second-largest industrial power. Since then the South Koreans have copied Japan's credit ordering and so to a greater or lesser extent have most of the so-called Asian Tigers.
This new paradigm of capitalism once appeared to have triumphed over old-fashioned Western values such as the law of supply and demand. There was just one little flaw. As Nigel Holloway and Robert Zielinski wrote back in 1991, «The competitive advantages that Japanese companies gain from their stock market depend on a single factor: share prices must go up.» The Ministry of Finance patched together an intricate machine to support this market: stocks that yielded no dividends, real estate that produced no cash flow, debts that companies never needed to repay, and balance sheets that legally hid losses and liabilities. In this market, no Japanese company could ever go wrong. It was the envy of the developed world.
It was a powerhouse, but it also was a Ponzi scheme. Ponzi schemes work well as long as money keeps flowing in; when the flow stops or slows down, trouble ensues. During the period of high growth that lasted until the late 1980s, Japan's financial system seemed invincible. The economy grew at an annual rate of 4 to 6 percent for so long that everyone took it for granted that this would continue indefinitely. When, in the early 1990s, it slowed to 1 percent or less, the system began to fall apart.
The aim of the contraption the Ministry of Finance had rigged up for Japan's financial world was peace or, rather, stasis. No bank could ever fail; no investor could ever lose by playing the stock market. Everywhere, cartels and monopolies ruled, guided by the firm hand of bureaucrats. This desire for peace, for no surprises, is such a strong factor in traditional Japanese culture that the Law of No Surprises comes first in my personal Ten Laws of Japanese Life. There is no better paradigm for this than the tea ceremony, where detailed rules determine in advance every slight turn of the wrist, the placement of every object, and virtually every spoken word. No society has ever gone to such extreme lengths to rein in spontaneity. In the industrial arena, employees rarely change companies; small start-ups do not challenge established large firms. Concrete slabs armor river-banks and seacoasts to guard against any unwelcome surprises from nature.
The Law of No Surprises means that people find it difficult to let go of failed policies and cut their losses-a process that we will see at work in many fields in Japan. The inability to cut losses is what underlay the Daiwa Bank scandal of July 1995, when the U.S. Federal Reserve discovered that Daiwa had hidden $1.1 billion of trading losses from federal authorities, and also the Sumitomo Trading scandal of October 1996, in which a copper trader for Sumitomo Trading in Great Britain ran up $2.6 billion in secret losses. Both cases involved a spiraling series of bad trades that lasted years-in the case of Daiwa, for more than a decade. Neither the traders nor their parent companies were able to call a halt at an early stage.
Traditionalists hold the hallowed word Wa (peace, or harmony) as Japan's ultimate ideal, even going so far as to use Wa as an alternate name for Japan itself. The nation's first constitution, promulgated by Prince Shotoku in 604, began with the words «Harmony [Wa] is to be valued, and an avoidance of wanton opposition to be honored.» To update this to the twentieth century, read «market forces» for «wanton opposition.» There is a hankering after a peaceful golden age, when everyone knew his place and all human relations worked like clockwork-the quiet harmony of the feudal era. In the words o^ the seventeenth-century novelist Ihara Saikaku, Japan is the land of peace, with «the spring breezes stilled and not a rippl upon the four seas.»
The trouble is that the world does in fact change, and as it does, inflexible systems grow increasingly removed from reality. Small losses accumulate into torrents of red ink, as Daiwa Bank and Sumitomo Trading discovered. A beautiful stock exchange, lovingly engineered with a thousand clever devices so that prices will always rise, results in the biggest banking fiasco the world has ever seen. With a twist: in banking fiascos elsewhere, banks typically go under; in Japan, with a few exceptions, the government cannot allow that-so the nation has paid the price in other ways.
There is a moral to the story, and it strikes at the root of authoritarian societies everywhere. The Soviet Union under Brezhnev, Japan under its bureaucracy-each is an example of a society that believed it had achieved eternal balance: central planners had everything under their control. Change, and all the social chaos to which it gives rise, had been banished. But alas, we can never banish change. Machiavelli writes: «If a man behaves with patience and circumspection and the time and circumstances are such that this method is called for, he will prosper; but if time and circumstances change he will be ruined because he does not change his policy... Thus a man who is circumspect, when circumstances demand impetuous behavior, is unequal to the task, and so he comes to grief.»
One aspect of Japan's failure to keep in touch with reality was that the Ministry of Finance and Japan's banks and brokerage firms failed to acquire the technology used in financial markets elsewhere. This may be one of the most surprising aspects of the Bubble, for it runs against the common wisdom about Japan's alleged gift for high technology.
If debts need never be repaid and stocks produce no yields, what is the measuring rod of value? There was none, aside from Madame Nui's toad. In the 1980s Japan's securities houses, dominated by Nomura, towered over all competitors and many believed them to be practically invincible. But traders at Nomura and other brokerage houses did not learn the mathematical tools that Wall Street brokers developed in the 1980s, and that led to the complex computer trading and new financial instruments that dominate the market today. Since 1991, they have seen one long series of retrenchments, with Nomura consistently losing money, or barely scraping by in the United States and Great Britain. Daiwa cut its foreign branches from thirty to eighteen in 1999; Nikko reduced its overseas operations; and Nomura is closing foreign desks. By January 1998, Japanese securities firms had fallen completely out of the ranking for the world's top-ten bond dealers. Nomura made it only to No. 13; the other firms did not get into even the top twenty. And by then foreign brokerage houses were handling almost 40 percent of all trades on the TSE. In the fall of 1997, Yamaichi Securities, one of the Big Four brokerages, declared bankruptcy when more than $2 billion in losses surfaced in hidden offshore accounts. And then there were three. «Just as the U.S. brokers toppled England's largest securities firms, the same thing is happening here in Japan,» said Saito Atsushi, Nomura's executive managing director.