Turning Japanese

Is the British economy turning Japanese? Since asking the question last year on Coffee House, the evidence has been piling up – and it makes for a cover story in this week’s magazine (which I have written with Mark Bathgate). The similarities are as follows:

1. Japan’s bust followed years of debt-fuelled growth which vain politicians saw as prosperity. 2. When the bust came, Japan’s government kept on spending. They did so in the name of Keynsian stimulus, thinking this would in itself kick start a recovery. All it achieved was to sink Japan deeper into debt. 3. Crucially, Japan didn’t do full disclosure on the collapsed banks. To fix the banks was, they figured, painful root canal surgery that this recession-struck country could do without. 4. They became “zombie” banks – i.e. they’d be dead if it wasn’t for taxpayer support. 5. Problem is, this is self-perpetuating. The longer they refuse to disclose their real losses, the harder they find it to raise capital. So to cover their losses, they have to keep making calls on the taxpayer – bailout after bailout.

So far, so British. This week’s stunning disclosure by Mervyn King that HBOS and Lloyds had borrowed £62 billion without telling anyone shows that British banks are still living in a secrets-and-lies situation. No wonder they can’t raise capital: people don’t want to sink their cash into a vortex. This is holding back the British recovery in three ways.

1. The mistrust dissuades people from investing in the banks. Banks don’t lend to each other – each suspecting the other of hiding toxic debt. Just like in the run-up to the American Great Depression, the banks start overcharging their current customers (i.e. mortgage-owners) to cover the losses of bad clients who wont repay loans.   2. This costs Britain billions. Our base rate is 0.5 percent and average mortgage rate is 4.3 percent. This gulf – worth about £50bn a year to the British economy – is the price we pay for a broken bank system. No wonder Europe has pulled into recovery: its base rate cuts actually work. That is to say, people’s mortgages are appreciably lower. Most on the continent pay under 2 percent interest (thereby releasing cash to pump into the economy and get the recovery started) 3. Small companies are not getting the credit they need – and business investment falls. It’s okay for listed companies, who can do rights issues etc. But not for banks. This is why MPC member Adam Posen said in his recent speech that Britain is suffering worrying similarities to Japan.

Not all crises are the same (see this excellent note by Carmen Reinhart). Japan tried the Keynsian stuff. It resulted in false dawns and more debt (now about 200 percent of GDP). Britain can avoid this, however. Whatthe next government can do is to end this secrecy, which is what the Scandinavians did. They sufferered their bank blow-up about the same time as the Japanese (overview here), but instead of hiding the loans they did what our government should do: brought in credible outside experts to audit all of the banks and give a full damage report. The Scandianavians realised early on that Brown-style concealment, this “oh, here’s a £62bn loan to the banks we didn’t tell you about last year” – is absolutely toxic. Not just for investment, but for the economy. In their lets-all-get-naked-in-a-sauna way, the Scandinavians revealed everything. Banks were forced to raise capital, but when investors felt they knew everything the money eventually came.

Doing this to Britain would reveal a very ugly picture – the IMF suggests around $600bn (i.e. about £360bn) of writedowns. But without it, banks won’t get work. Sure, we’ll have a few functioning ones – like HSBC. But when the world economy comes (as it did in the mid 90s for Japan), Britan will not be able to catch the wave because our banking system will still be broken.  Posen put it well in that speech to the Cass Business School:

“The UK has an uncomfortable parallel with the Japanese financial system when the Japanese economy began to recover in the mid-1990s and was unable to sustain it …. The closer one looks, the more worrisome this specific parallel becomes, given the concentration of the UK banking system in a few major, mostly still troubled, banks.”

Potential PM Cameron will only have one shot at fixing the banks: investors will want to see what type of a guy he is. That’s why Britain is at a crossroads – Japan on the left, and the Scandinavian example on the right. Right now, Britain is indeed in danger of turning Japanese. But if the Tories are smart, and bold, they can turn it back.

P.S. We toyed with putting this Darling illustration on the cover, but the idea of a sumo Chancellor squatting on our readers’ coffee tables did not appeal. The original attempt, by the wonderful Carla Millar, was to put a Union Jack on the cartoon used in the original cover to the 1980 Vapors single cover. It’s to the right – and fab. But we figured that there are only a handful of people sad enough to have recognised the reference.

P.P.S. Tom Pride makes an excellent point below: reading and listening to Liam Halligan has done much to persuade me of the need to fix the banks. We did a post-Budget panel together in April where he urged Cameron to show leadership on this. He’s been pretty much on his own, but events are proving him right.

P.P.P.S. An economics editor of a national newspaper emails to say he’s been banned from saying “Turning Japanese” because of these ridiculous lyrical conspiracy theories. I ask you. The song is about love. Missing your girlfriend. Not recognising yourself without her, because of the behavioral pattern changes.  There are some twisted minds out there.