Will "Convoy Capitalism" Sink Japan?

• Author: Katz, Richard

Zero interest rates may be causing more harm than good.

When the Bank of Japan (BOJ) decided in September to end its zero interest-rate policy, it came under enormous public pressure from the Ministry of Finance (MOF) and the ruling Liberal-Democratic Party (LDP). This dispute was not about the difference between zero percent and the recently raised 0.25 percent overnight loans. What is really at stake is whether Japan will finally rid itself of its notorious "convoy capitalism" or whether the BOJ will be forced to keep pumping out nearly cost-free loans to keep "zombie" banks and borrowers alive.

What is convoy capitalism? Just as no ship in a convoy can go faster than the slowest boat, Japan's economy bleeds the most efficient companies to support the dying ones. In the past, this was done mostly in covert fashion. The high prices that Toyota pays for glass, steel, and electricity are disguised subsidies for Japan's inefficient sectors. But in recent years the cost of keeping the convoy intact -- by preserving the survival of the least fit -- has become so high that the transfer of resources from the fittest companies to the weakest has come into public view. The government has transferred hundreds of billions of dollars to Japan's banks to prop up their weakest borrowers. The funds have come from individual and business taxpayers and savers, who have received virtually no interest, even on long-term deposits.

The recent saga of the Sogo department store chain epitomizes the syndrome. The banks and the government agreed to forgive an astonishing US$6 billion worth of Sogo debt to keep the company solvent. For the sake of one firm, the banks were prepared to eat up one-twelfth of the US$72 billion capital injection that Tokyo pumped into the major banks last spring. Only a loud public uproar over a direct transfer of funds from the Deposit Insurance Corp. to Sogo forced a retreat. Sogo ended up failing with US$ 18 billion in liabilities, one of the largest non-bank failures in Japanese history.

Since Sogo's failure, two giant life insurance firms have failed, one with US$40 billion in liabilities. A number of large construction firms have avoided bankruptcy only because of debt forgiveness by the banks, totaling about US$ 18 billion.

No wonder so many banking experts now believe that the banks will have to return to the public trough for more capital within a year or two.

Near-zero interest rates have become an essential component of...