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Monday, April 21, 2003

JAPANESE PERSPECTIVES

Evasive accounting will darken already cloudy economic outlook


Now that the war in Iraq has completed a crucial phase, a major source of uncertainty for the world economy appears to have been eliminated. However, the global economic outlook still remains cloudy, as illustrated by the fall in share prices that occurred when Baghdad fell into the hands of the U.S.-led forces. This cloudiness is being caused by such factors as the daunting task of rebuilding Iraq, the lingering risk of terrorism, and the outbreak of severe acute respiratory syndrome (SARS), all of which are exerting heavy downward pressure on the major economies.

The fiscal and external deficits of the United States are each forecast to break $500 billion. The recent weakness of the U.S. dollar in this time of crisis is symbolic of the gap between its unrivaled military strength as the world's hyperpower and the current condition of its economy.

In Europe, meanwhile, the rift the Iraq issue is causing among the major powers remains unhealed, and the fundamentals of the region's key economies remain shaky. European share prices have fallen roughly 45 percent over the past year -- much faster than the 25 percent the American and Japanese markets have dropped.

The Japanese government has little room to work with in macroeconomic terms, with fiscal debt mounting and interest rates already down to zero. The only way to pull the economy out of its slump is to pursue structural reforms that will help individual firms and the public sector adapt to the changing global environment and regain inter-regional competitiveness. In this sense, I feel obligated to point out the stupidity of two arguments that have recently been made.

The first argument calls for upvaluating the Chinese yuan, based on the belief that China is the root of the world's global deflationary woes. While such calls would be understandable coming from the United States, which has huge external deficits, Japan enjoys a huge current account surplus and continues to post surpluses vis-a-vis both China and Hong Kong.

While it is true China has a large trade surplus, its capital account is being strictly controlled. What China should do then is liberalize its capital account. But given the expanding income gap between the rich and the poor in China, capital account liberalization would lead to a fall in the value of the yuan because the wealthy are creating strong demand for foreign currency.

Although China's foreign currency reserves have topped $250 billion, the nation remains saddled with external debt -- a situation different from Japan the net creditor. China is therefore being cautious about capital account liberalization. Japan may be tempted to support its fragile economy by increasing exports, but the logical step would be to call for revaluation of the yen, not the yuan.

The second argument deals with demands from some members of the Liberal Democratic Party to let companies avoid using the mark-to-market accounting method. They say that both listed and unlisted firms should be able to choose between appraising their securities holdings at current market value or at book value, the price set at the time of purchase. This argument was born from a sense of crisis that, as Tokyo share prices continue to plumb post-Bubble lows, appraisal losses on corporate stockholdings will push more companies into the red, kicking the economy deeper into darkness. What they do not understand is that such a near-sighted approach has no chance of succeeding in today's globalized economic environment.

Corporate earnings reports are supposed to mirror the performance of each firm. Only when such reports are compiled under a common set of rules will fund holders be able to make fair comparisons of their investment targets. If Japan alone is allowed to take those special steps, foreign capital -- and domestic investors as well -- will shy away from Japanese stock markets.

Furthermore, the market itself will view companies that opt for book value with skepticism: they will think they are not fit enough to withstand mark-to-market accounting. Shares of such firms will thus face even more selling pressure, which will put more downward pressure on the economy.

The mission of our political leaders is to create an environment in which structural reforms can be accelerated. A proposal that enables companies to avoid mark-to-market accounting runs counter to such efforts and will only impact the stock market in a negative way, and its proponents will lose credibility in the eyes of global financial players. I strongly urge them to bear that in mind.

Teruhiko Mano is an adviser to Tokyo Research International Ltd.


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