Attacking the GLOBAL Financial System?
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Introduction +

Introduction

Several scenarios are outlined below under which the  attack on the citizens of 80 countries in America on 11 September 2001 might be linked to (or be a diversion from, an alternative to, or have disrupted) a potentially crippling attack on the US / IMF dominated global financial system for which there is currently a brief window of opportunity.

Whilst an attack on the financial system will probably seem unlikely, it is unfortunately psychologically possible from the viewpoint of a particular group who: find their way of life threatened by that system; have predecessors (and some contemporaries) who suffered ambitions of grandeur; and currently seem to have their fingers on the trigger of a powerful 'bomb' which could be exploded inside US financial institutions from October 2001.  

A financial attack on America could be viewed as part of a contest for control of the global financial system which has been developing for decades, and as a corollary of the 1997 Asian financial crisis which was seen by many Asian nationalists as a US / Jewish inspired 'attack' on the Asian economic models.

It could result in relative economic and political gains by East Asia for reasons outlined below that few Western observers will be aware of (ie the coordination of economic transactions through social networks rather than through financial measures of value). 

The author had long had a vague expectation on the basis of study of the incompatibility of traditional Japanese and Western worldviews that Japan's elites (and perhaps others) could be arranging a quite-legal passive 'attack'  on the US economy (ie one achieved by doing nothing to solve problems in their own financial systems - which would wreak destruction of US asset values because of the latter's dependence on Japanese capital). 

The terrorist attack on America's financial and military HQ's just 3 weeks prior to a critical date stretched the bounds of coincidence in the author's mind, and raised the possibility (if Reserve Banks were crippled by terrorist attack) that a more ambitious goal than damaging the US economy might be feasible.

In a banking crisis Reserve Banks (especially the US Federal Reserve) provide the liquidity to prevent short term cash flow problems from escalating into failure of the financial system. If they were crippled by terrorist action, the possibly-soon-to-be-exploded financial 'bomb' could have the effect of destroying (not just asset values that would damage the US economically but) the financial systems that are the nervous system of Western democratic capitalism.

Such a move would be suicidal for those who have built the 'bomb' (which is consistent with a kamikaze tradition) because it requires also destroying their control over Japan's economy, but this would in the process destroy Japan's 'merchant soul'.

The result could be (not only an unprecedented level of human misery) but a huge shift in the balance of global political and economic power.  The latter goal may seem outrageous - but could well be feasible, and would be compatible with the type of thinking which is the basis of ancient East Asian 'Art of War' strategies. 

Thus a primary (though unlikely) scenario is developed below which recognizes that the US financial system tends to be dominated by Jewish influences, whose agenda includes provision of support for Israel, so that there is a plausible basis for cooperation amongst extremist groups in the Middle East and East Asia - and thus for a direct relationship between the September 11 terrorist attack and a potential attack on the US financial system.   

The motivation for attacking the financial system itself could be objection to the massive cultural adjustments required in Japan if it is to succeed economically under the current (US / IMF prescribed) global financial system. East Asian traditions make it feasible  to achieve strength in the 'real' economy, but quite difficult to succeed in the 'paper' economy (especially for Japan) . 

Under the primary scenario, efforts to further increase the security of the Reserve Banking systems against terrorist attack would be highly desirable. 

The primary scenario is unlikely partly because, from a Japanese / East Asian viewpoint, the US is already on a path to losing economic and military power.

However if, as is very likely, the timing of the attacks is a coincidence then the terrorists may go down in history as mounting the most spectacularly unsuccessful attack of all time in terms of achieving their presumed objectives (eg because it may have disrupted what might otherwise have been a more damaging 'passive' attack on the US economy, and have provided major opportunities to the US by uniting world leaders behind it).

Moreover, there are quite different possible relationships between  these phenomena which are mentioned in alternative scenarios. One of the most intriguing is the possibility that the financial 'bomb' might not be intended to be exploded but rather to be one of several tools to influence the behaviour of the US government as a 'new shogun'.

The author's basis for suggesting the primary scenario (and variations which have different implications) involves 30 years of strategic public policy research - with particular emphasis on a systems approach to administrative and economic development which provides a key to understanding the intellectual basis of East Asian economic models. 

Under any of the suggested scenarios there are many options for turning evil into good. There is also potential for further shocks.

25 September 2001 (and progressively modified)

Primary Scenario

1. Primary Scenario - The Asian Financial Crisis Phase 2?

There is a possible scenario under which the terrorist actions on 11 September 2001 might not be the only 'Attack on America' which is to occur. A game might be on to try to achieve a dramatic shift in global economic and political power by seriously damaging the financial system that is the 'nervous system' of Western democratic capitalism - and also perhaps seen as currently a massive threat to the status of traditional Japanese culture and elites, which radical nationalists in Japan have moved heaven and earth to defend against Western values for 150 years. 

Such an attack is feasible because Japan has planted a huge 'suicide-bomb' in the US financial system:

  • Japan has had a long term mercantilist policy goal of creating production capacity far in excess of domestic demand and recycling all foreign exchange earnings and much credit expansion into production capacity - which resulted in large current account surpluses that have been recycled into investments in $US assets (a process which is increasingly difficult to sustain). Features of this clearly deliberate process (see Why Japan cannot deregulate its financial system) include:
    • building production capabilities under bureaucratic supervision without regard to domestic demand or profitability;
    • financing this through the creation of credit by bureaucratically controlled financial institutions;
    • generating large current account surpluses, which the financial system recycles into: further investment in production; acquisition of $US financial assets; and public works - while ensuring that it does not flow through to consumer demand;
    • regulation to protect the financial system from market competition; and  
    • distortion of the Japanese economy in the 1980s and 1990s in order to ensure that the accumulation of $US assets could continue; 
  • Japan is apparently to go officially onto a new international accounting system on 30 September 2001 as part of a package of structural reform of its financial system - which is likely to show that almost all of its financial institutions (and perhaps also some companies) are technically insolvent as a result of accumulated bad debts - because, under Japanese culture, making paper profits was never their goal; and
  • this could prevent future Japanese capital inflow to the US - or lead to large Japanese capital outflow (eg see forecast of $1000bn withdrawal in Cornell A 'Japan braces for painful prescription', Australian Financial Review, 7/5/01).  Because of the US dependence on such capital to support asset values, and on ongoing flows to cover its current account deficit, the effect could be to drive up interest rates substantially (as occurred in 1987) and add a massive new shock to the US share-market and financial system.

Such a shock could wreak economic disaster - a disaster which would be far worse if the US was engaged on a difficult diplomatic and military operation, and if Reserve Banks were damaged by terrorist attacks.  

Reasons that a passive (or worse) 'attack' on the US financial system from Japan was plausible are outlined in Section 2 below, while preliminary (and mixed) reactions which have been obtained from persons with varying degrees of expertise are outlined in Section 3.

The fact that a long-planned passive financial 'attack' on the American economy may have been intended does not prove that this was directly linked with the terrorist attack - or even suggest who may have been responsible if there is such a link (as information about the possible passive financial 'attack' has been available to any Asia-and-finance-literate person for several years).   Moreover the fact that such a passive 'attack' may have been seen as desirable partly  reflects cultural features which have been obvious for decades, yet irresponsibly ignored though they cause substantial difficulties. 

However, because of the coincidence of a terrorist attack just before the passive 'attack' was likely, the primary scenario developed here involves recognizing that a more-than-passive attack might be plausible

  • there have always been radical nationalist elements in Japan, who might contemplate more than a passive attack and have not been far removed from centers of power - as also outline in Section 2 below
  • dislocating the global financial system might be expected to result in relative economic and political gains by East Asia because:
    • the traditional economic goal in East Asia is to achieve 'real', rather than 'paper', economic strength;
    • the financial system is much less important in the operation of those social-network-based economies than it is in America or Europe (a fact that few Western observers have the 'Asia literacy' to understand). There is, for example, no Chinese word for 'unprofitable' [1]; and
    • international arrangements have already been made at Japanese initiative for a social-network-based financial system through the Asian Monetary Fund. 
  • there are possible bases for cooperation between Islamic extremists and radical nationalists in Japan:
    • firstly the Jewish groups, who dominate the US financial system which in turn controls the IMF system that Japan's radical nationalists might with to see replaced by an 'Asian' monetary system, also have an agenda which involves support for Israel as a Jewish homeland; 
    • secondly extremists in Islam and Japan share a  commitment to pre-modern styles of civilization - that modernization on Western principles has impacted on (though those pre-modern styles are not identical). Moreover both styles involve social elites exerting control over society by influencing the way others think. In Islam's case this involves the role which Islamic scholars have in interpreting events because of the assumes unity of nature and the Divine - so that everything that happens is seen to be symbolic of God (see About Arabic Thought and Islamic Science). In Japan's case, elite Confucian bureaucracies, who have proved most capable of handling information through educational success, exert power by manipulating the flow of information (see East Asia in Competing Civilizations); 
    • thirdly there are similarities between the principles that might underpin financial systems that Japanese elites and Islamic bankers might support. Each: involves pre-capitalist traditions; has a problem with gaining profits from pure finance; and seeks to promote 'communitarian' benefits (see Islamic Banking and comments on the differences between Western and East Asian financial systems) [There are also critical incompatibilities between these systems related to: religious versus secular goals; whether power would reside in the state or in individuals; the universality (or otherwise) of intended beneficiaries; the attitude to racism; and the role of law and contract]. In developing Islamic Banking and proposals for an Asian Monetary Fund, the proponents would inevitably have become aware of each other's interests.   
  • while the author is not aware of any evidence of such cooperation or linkages, Osama bin Laden's video calling for jihad in late September 2001 implied - in the context of claiming that Muslim societies have suffered systematic injustice - that the atomic bomb attack on Japan which ended World War II should have been seen as a war crime (see 'This is America, full of fear', The Bulletin, 16/10/01) which is an agenda of Japan's radical nationalists. All similar references seemed to involve 'genuflecting' to groups with whom al Qaeda had been negotiating;
  • radical nationalists in Japan may be facing a very narrow 'window of opportunity' for achieving their long and deeply held goals - for reasons outlined in Section 4 below;
  • if a financial system attack is planned and is linked with the terrorist attack, then other prior or simultaneous terrorist action against the financial system would be almost certain by (say):
    • attacking Reserve Banks (and especially the US Federal reserve) in order to disable their key role in coping with such a financial shock - so that financial losses would be likely to lead to complete failure of the financial system; or
    • release of large numbers of dangerous computer viruses, to cripple business communications.
  • under the primary scenario the attacks on the World Trade Centre etc would best be seen as a diversion - designed to (a) make it very difficult to see the ultimate goal - which would have been very obvious if the US Federal Reserve (say) had been the first to be attacked and (b) ensure that the wrong types of persons would be managing the US response (ie military and Middle Eastern experts, rather than financial and East Asia experts). Perhaps good 'Art of War' tactics! 
    • However it is also noted that 12 aircraft may have been intended to be involved in the September 11 attacks according to one report - of which eight (with presumed-terrorist guest-pilots aboard) were prevented from takeoff by the decision to ground all aircraft (ref? eg ‘Suspicion Aroused on more flights’, Courier Mail, 20/9/01)). If this report is correct, the targets of the eight unsuccessful airliner-bombs are not known (though the following item suggests one way in which other planned targets might be deduced).  
  • the fact that someone appeared to use trading techniques to profit greatly from the terrorist attack (Economist, 'Terror on a shoestring', Australian, 25/9/01) suggests that either the terrorists or some of their associates had sound financial skills. 

Most commentators currently seem to believe that Japan's public, banking and corporate financial position is verging on crisis - yet no one seems to be drawing the conclusion for America which is open to Asia-literate observers. Bloomberg (and other) articles have recently been drawing attention to the likely withdrawal of Japanese capital from the US - but not to the panic that could occur sometime after 30 September if it is 'discovered' that unfortunately the new international accounting standards that are being adopted to expose losses show (as seems quite possible) that [1, 2]: 

  • virtually all Japan's financial institutions are technically insolvent because of the effect of massive accumulated and previously concealed losses. This situation would be the result of the fact (well known in Japan and East Asia - but to which Western observers tend to be blind) that achieving a paper profit was never the goal of those institutions in the first place.
  • it is beyond the ability of the Japanese Government to bail them out - because of its huge existing debts

Some options for defusing Japan's financial 'bomb' and the risks that this primary scenario portrays are suggested in Section 5 below, together with other scenarios in Section 6 which outlines different possible relationships between a potential passive financial 'attack' and the terrorist attack.  

Caution: It needs to be noted that scenarios such as are developed here are based on limited information - and that there are presumably many relevant factors unknown to this author.

Plausibility

2.  Why a Passive Financial System 'Attack' (or Worse) was Plausible  

A generally-hidden contest for control of economic and financial systems has been emerging for nearly 2 decades between the US-led Western economies and various groups in East Asia.  The cultural background to, and  the historical development of, this financial contest are summarized in Competing Civilizations which also presents a more general historical background.

Features of this contest that were discussed include the following:

  • the US pressure on Japan to revalue its currency in 1985 under the Plaza Accord - as a means to correct its large current account surplus with the US;
  • the withdrawal of capital from US bonds in 1987 - which threatened to a stockmarket collapse;
  • the Asian financial crisis in 1997;
  • Japan-led efforts to establish an alternative to the IMF (an Asian Monetary Fund) which would operate under 'Asian values' (ie coordination of economic activities by relationships amongst ethnic elites rather than by calculation of expected financial outcomes);
  • the re-emergence of financial difficulties like those at the time of the Asian financial crisis - and the virtual insolvency of Japan's financial institutions which appeared very difficult to resolve (see below).

The author had long expected that Japan's elites could be planning a passive 'attack' on the US economy on the basis of:

  • the contest to be No 1 economically which was clearly Japan's aspiration in the 1980s - and which was frustrated by its subsequent financial problems;
  • the apparent inability of East Asian economic models and methods to permit economic success if this is defined in terms of financial outcomes; 
  • the large scale withdrawal of Japanese capital from US bonds in 1987 - which drove up interest rates and triggered a US share-market crash - which could be seen as an 'attack' on the US financial system that was frustrated by the US Fed's ability to provide liquidity to prevent the failure of financial institutions;
  • if Japan was now 'forced' to withdraw a vastly greater amount of capital from the US, because the adoption of  US-style accounting standards exposed Japan's financial institutions as insolvent, then Japan 's leaders  would be able to claim that this was merely the result of following  others' prescriptions,  and that everyone has known for years what was going to happen. Such an outcome  (which required Japan's leaders to do nothing more than fumble around and fail to take any action to avert the inevitable crisis) could have been an 'Art of War' classic - resulting in major strategic gains to which no one could have expressed any reasonable objection.
However, unfortunately, it is also POSSIBLE that an attack could be more than passive. For example:  
  • Japan has always had radical nationalist  elements - who endorse theories of racial superiority. These elements have been part of, and influential over, the Japanese establishment (bureaucracy, LDP, business, yakuza). It was, for example, reported in the 1980s that 30% of the output of Japanese universities concerned Japan's cultural uniqueness and superiority - though this was never presented in English (Dale P, The Myth of Japanese Uniqueness, 1986). The ultimate enemy of these extremists has been the United States because of, for example, (a) deep cultural objections (given ideologies based on cultural uniqueness and particularist ethics) to the West's emphasis on universal values, individualism, truth, law and democracy and (b) the insult by Commodore Perry in forcing Japan to open to Western commerce in the 1850s - which was compounded by  the defeat of Japan's  military in World War II;
  • the 'Tale of the 47 Ronin' was reportedly  still  Japan's most popular folk tale - and involves masterless samurai who disarmed suspicion of themselves by pretended dissolute living for decades in order to get an opportunity to complete their dead master's plan to murder his enemy (see Burnstein D. Yen: The Threat of Japan's Financial Empire, 1989);
  • ethics tend to be particularistic (ie involve obligations only to those with whom one has a relationship) rather than universal - and thus do not lead to a concern for outsiders. Thus:
  • deception of outsiders is the first and most important principle of the ancient 'Art of War' concepts of strategy which Japan inherited from China. Strategy traditionally make no distinction between military and economic affairs, seeks to erode an opponent's political and economic systems to advantage oneself, and operates in long term / big system ways which are quite foreign to Western observers. Japan's society and economy are based on profoundly different assumptions about the nature of knowledge; power; governance etc (eg see Asian model). For example, defusing suspicions by 'holding up a mirror' in which others (when they look at you) merely see a reflection of themselves is a traditional 'Art of War' strategy;
  • Japan has been pursuing a strongly mercantilist economic strategy during the 1990s - through building 'real' industrial capability which would be of military value - but not of much commercial value (so compounding its financial losses). Information about this is on Fingleton's web-site - which highlights the fact that every effort has been made to make the US believe that Japan is much weaker economically than it actually is - especially by highlighting its financial weaknesses (see Fingleton E., 'Is Japan faking it?', FR, 22/11/02). The US has become dependent on Japan for the supply of sophisticated engineering and electronic components for its military hardware. Japan 's leaders have also invested massively in apparently unproductive public works to stimulate its stagnant economy - and the resulting infrastructure may well have un-evaluated strategic value;
  • Japan 's leaders  (and  those in  other counties in East Asia) are likely to believe that their economies could operate reasonably successfully in the face of financial chaos (especially if those economies are  coordinated  through obligation and social hierarchy - rather than through financial returns) whereas the US / European economies would not be able to do so. [[This assumption may not be correct - but it is a view that is likely to be held by idealists]];

Reverting to the soul of a samurai?

  • there have been constant efforts by Japanese extremists to argue that Japan should shift from the 'soul of a merchant' which it adopted at the time of the Meiji restoration - back to  what they would prefer to think was its original 'soul of a samurai'. For those who support such a goal, creating chaos in Japan at the same time that the basis of Western economic strength was destroyed would merely be an opportunity to gain power;
  • it appears that Japan's current Prime Minister is:
    • from a mainstream Japanese political background (ie of a conservative family and nationalistic orientation) - despite which he is:
    • behaving in a most un-Japanese way by showing political leadership - a way which corresponds with what the US would like to see in Japan (ie a shift towards real democracy and structural reforms to government and the financial system). Japan, by contrast, likes to think that it reacts 'through its belly' rather than through its head (an assumption which indicates both who is likely to make decisions, and that they are likely to be based on gut instincts, rather than intellectual reasoning); 
    • likely soon to face financial chaos through forcing companies and financial institutions to go bankrupt to deal with bad debts (Walsh M. 'Koizumi and the kamikaze factor', Bulletin, 8/5/01), and appears to be intent on a hard-line austerity policy to respond to prospective failure (Cornell A. 'What recession? What tragedy?', Financial Review, 20/9/01). The absence of any apparent process by which Japan's financial problems can be overcome can also be noted (eg see Walsh M. 'Hell bento', The Bulletin, 17/7/01). Chaos would be blameable on the adoption of US policy prescriptions - and thus perhaps break the popular admiration of the US which was built in the post-war period;
    • promising 'structural reform with no sanctuaries (ie to break down Japan's established bureaucratic and political interests) - though without saying what would be built in its place (Sayle M. 'Japan's New Wave', Bulletin, 17/7/01).  Western observers presumably interpret this intent as moving towards more real democracy and deregulated finance - but, in a crisis, this could involve a reorganization into institutions which give Japan a 'samurai soul';
      • Ozawa (author of A Blueprint for a New Japan, 1994) was Japan's political kingmaker in the 1990s - and had a role in opening up of the rice market. He now sees the present government as being unable to implement reforms - and as falling back onto traditional established interests - bureaucracy, LDP and business. Japan has to move from a consensus approach to a radical leader to make the necessary changes. Japan's main challenge is not economic but the potential for military conflict in north Asia (Pearson B. 'Japan at the Crossroads', Financial Review, 19/3/02). [Note: the rice subsidy (which buys electoral support from rural interests) and the 'establishment' (LDP, business, bureaucracy) are the key elements of Japan's 'merchant soul' which would need to be removed by a radical leader to re-establish a 'samurai' soul]
    • believed by observers in China and Korea to be a 'a dangerous populist and nationalist leader using his charisma to steer Japan back towards imperialism and re-militarisation' (Cornell A., 'Koizumi swims in murky waters' , Financial Review, 20/8/01).(see Competing Civilizations)
    • a frequent visitor to the shrine which commemorates Japanese war criminals as heroes [1] - and a close associate of (and likely to be succeeded by) the grandson of a suspected war criminal [1]
  • militarists gained control in Japan in the 1930s when the political and administrative institutions of Japan's 'merchant soul' were discredited in the Great Depression. Merely creating chaos was  apparently  considered a useful strategy by  extremists at that time - because out of such chaos a new order could emerge.  

  • There is uncertainty about whether Japan has broken with its militarist past or, mired in economic stagnation, is slowly reverting to ultra-nationalist ideology stressing national superiority. Japan's PM failed to comment of photos of emaciated POWs in Australia, yet bowed deeply before 'heroic spirits' at Yasukuni Shrine. Japan's previous PM labelled it as the 'country of the gods with the Emperor at its centre' - and exclusivist / racist formulation of Japan's national identity (Victoria B. 'Right face! The return of wartime ghosts',  FR,  9/8/02)

  • Japan is rethinking the purely defensive ideas that underpinned its post-war foreign policy (Pearson B 'Japan yearns for self-defence' FR, 7/4/03)

  • Japan wants right to take pre-emptive military action against nations wishing to attack it (Person B 'Japan wants pre-emptive policy', FR, 22/5/03)

  • there is increasing support for changing the constitution which renounces war [1]

  • Japan is undergoing a military transformation [1];

  • there is an external perception in late 2006 that Japan is sliding into a nationalist style like that in the 1930s [1].

None of the above is proof that the radical nationalist elements (which most countries have in one way of another - though few are like Japan's) have been able to have any practical influence on events. 

Furthermore there are many reasons that persons holding to a traditional 'East Asian' viewpoint would be able to convince themselves that the USA's (West's) current economic and military strength represents a 'paper tiger' that can't last long, so that (except for reasons like those suggested in Section 4), there would be no need for risky action. Those reasons might include: 

  • the USA (like Australia) has a huge foreign debt - which is balanced by similar foreign asset holdings in North Asia, reflecting the difference between cultural preferences for consumption or savings. While financial systems in (say) Japan and China are plagued by unresolved bad debts, these obligations can never cause real problems because they are to owed to loyal domestic lenders, while the USA's debts are owed to foreigners;
  • the US-dominated global financial system is unstable;
  • financial outcomes are 'rigged' in the US just as in Asia's non-transparent accounting - noting (a) some evidence of distortion of corporate accounts by managements and tame auditors; (b) the role of the IMF / FED in boosting liquidity to protect investors (c) the US's ability to borrow and issue currency more readily than other countries might because US dollars are the world's reserve currency;
  • a great deal of the world's manufacturing has shifted to Asia over the past 20-30 years;  
  • there is vastly less emphasis on institutional capital in the USA (where corporate management and civil services are displaced by the dictates of shareholders and politicians). East Asia relies on the traditions of Confucian bureaucracies involving educated elites who closely study the lessons of history;
  • the West is subject to the dictates of consumers and voters - who express short term selfish goals and have no strategic wisdom; 
  • Western societies are no longer united. For example, in the US the majority have now shifted from reliance on mainstream to 'ethnic' sources of information [1]
  • East Asian human capital would be held to be stronger - because of the emphasis on rote learning (which transmits the wisdom of masters) and the effect of intense educational competition on the overall culture; 
  • Western thinking styles are precise which results in the pursuit of narrow goals in a rational way - where a vague style of thinking is held to be more appropriate to the true complexities of reality. For example, traditional East Asian wisdom is conveyed through ambiguous fortune telling - which provides insights into the dilemmas of life (in the manner of lateral thinking) - as compared with the clear moral precepts derived from Western faith and rationality;
  • 1000 years of history suggest that the strategy to conquer strong foreigners is to serve them - and then be the one, rather than the foreign master, who survives;
  • Western leaders and analysts are unaware of these styles of thinking.  
Other's Views

3.  Other's Views on the Primary Scenario

Reactions have been obtained to the above scenario from persons with varying degrees of expertise including:

  • an ex Asia specialist with Australian Department of Foreign Affair's (who has written extensively on  Confucianism  and been applauded  in Asia for his views) suggested that Japan (like China) is currently likely to be happy to continue to exploit US demand to build their (mercantilist) economic strength for another few years;
  • an International Professor of Political Science at a major US university (with a prior Japan specialization) suggested that the scenario was implausible and that, at present, Japan simply wants to keep out of everyone's way - though he acknowledged the risk of a withdrawal of Japanese capital and the concerns which some observers have about the goals of Japan's current political establishment; 
  • a former finance executive with a chartered accounting background who did an MBA thesis on a comparison of Japan to Australia over the last 50 years - who suggested that "nothing mentioned (was) inconsistent with what I know. On top of which as I have no problem with the thesis that the Japanese banking and insurance system suddenly found to be insolvent as a result of the write down of inter group loans and investments within their keiretsu structures (as a result of newly implemented IMF approved accounting rules) would have to recapitalise by withdrawing huge lines of short term credit extended to both America and Australia, resulting in massive collapses of all types of assets values".

Also Francis Fukuyama's restated views about The End of History can be interpreted as an emphatic rejection of the primary scenario [1]. He suggested that there is now no alternative to Western-style democratic capitalism. However his analysis neglected to mention that Japan (and others in East Asia who have adopted variations on the Japanese economic model) could not succeed economically under the present (US supported) global financial system (as outlined above and in Competing Civilizations).
Window of Opportunity

4.  Window of Opportunity?

Radical nationalists in Japan MIGHT have seen 2001 as their best and last chance to achieve deeply held goals for Japan to be a 'non-capitalist market economy' (ie one where economic transactions are coordinated by social relations - with the political elites at the top - rather than by money), and being 'Great Japan' with a unique and important role in world affairs, because:

  • Japan's ultra-nationalists have long had aspirations for Japan to be 'No 1'. To be No 1, a strategy could be: to play, with respect to China (who is expected to be a future superpower) something like the role which the New York Jews have played with respect to the USA - ie to be the ones with strategic control of the financial system (though a financial system run differently on 'Asian values'). This role might currently be available to some Japanese elites, but is much less likely to be possible in another 5 years when the abilities of China's own elites have increased in this area; and
  • due to the massive asset bubble that has been created in the US (a bubble which it may be noted was partly funded via the Yen-carry trade using zero-interest credit created in Japan), the US is currently more exposed to a financial collapse than it has ever been in the past, or will ever be again - because the Federal Reserve has apparently realized the problem and has been moving to slowly deflate the bubble without causing disaster;
  • Japan is likely to undergo a large cultural change over the next 5 years as a result of the structural reform which has been devised to meet US and IMF goals. If that reform takes effect then Japan's aspirations about being a non-capitalist market economy  will be steadily eroded - as Japanese people learn-by-doing to behave differently (which is the goal of the structural reforms) and it becomes impossible to restore the traditional practices which give power to the radical nationalists.

It is also noted that:

  • the aspirations of Japan's nationalists to be No 1 were clearly manifest in the 1980s - and frustrated in the 1990s despite which the subject has not really been mentioned and Japan seems content - which suggests that those who have traditionally fermented discontent have a plan; and (again) that
  • Japan's extremists would probably believe that their economy (and China's - being ideally coordinated through social relationships rather than through money) would be able to function effectively through a financial system disaster, whereas most others would not be able to do so;
  • an international framework for a social-relationship-based financial system has been established over recent years through Japan-led developments leading to an Asian Monetary Fund.

However, even if Japan's elites intended that a passive 'attack' would seriously damage the US economy to achieve major strategic economic gains for the cause of a non-capitalist market economy, this does not prove (or even necessarily imply) their association with the terrorist attack.  Furthermore, noting the age-old adage that "the love of money is the root of all evil", there could be virtue in seeking an alternative in which money (a tool) is not treated as a god. 
Response

5.  Responding to the Primary Scenario

If the primary scenario outlined above were real, then appropriate emergency responses could include:

  • ensuring the security of Reserve Banks (especially the US Federal reserve) whose role includes providing liquidity to prevent short term cash flow problems in banking institutions from leading to a banking system failure;
  • an urgent international meeting on the Japanese financial system to find solutions for Japan's financial institutions - and thus prevent any financial 'bomb' from being exploded in America (see notes below).  

These proposals would still leave: Japan with major (and perhaps unmanageable) challenges in dealing with its public debts and banking system losses: America with a financial 'gun at its head';  and everyone with a need to resolve the complex cultural incompatibilities that were outlined in Section 2. 

Notes: on defusing Japan's 'financial bomb': 

  • Japan's Prime Minister indicated that the US crisis would force a rethink of tough economic restructuring plans (though it would not excuse a delay in making those reforms).  A proposed limit on new debt may have to be reconsidered. Though Japan has huge debts, pursuing fiscal reform could turn recession into depression. The crisis has also allowed Japan to take a more supportive approach to its banks - with a plan now rapidly emerging for a debt reconstruction agency to buy bad debts off the banks (Cornell A. 'Japan forced to rethink reforms', Financial Review, 26/9/01); and
  • President Bush reportedly asked Japan's Prime Minister to concentrate on his country's bad debts (which could amount to half of Japan's GDP) (Cornell A. 'Fix your economy US tells Japan', Financial Review, 27/9/01)
  • Japan's banks and regulators have appeared unable to perceive the level of losses they are facing. For example, 
    • when Mycal Corp, Japan's fourth largest retailer, collapsed with debts of $29.7bn - the biggest default in Japan's history - it had not even been on anyone's doubtful lists. Japan's Financial Services Agency and the government panels charged with cleaning up the decade old financial mess have a myopic approach to such matters (Cornell A. 'Mycal's crash a blunder by banks', Financial Review,  8/10/01)
  • As Japan's government considers again delaying reform of the banking system, credit rating agency Moody's has warned that the banking disaster is now so entrenched that it is beyond the banks themselves to remedy it (Cornell A. 'Japanese financial woes beyond control of banks', Financial Review, 7/11/01)
  • Japanese banks wrote off 3tr yen in the September half year - four times what the market had been expecting (Cornell A. 'Japanese banks wake up to bad loan calamity', Financial review, 27/11/01)
  • Japan's restructuring of the private sector through cutting credit to non-performing companies is likely to further increase Japan's record unemployment. Japan's only solution is to ensure that investment is made in profitable companies (Lunn S. 'It may be time to Japanic', Australian,  8-9/12/01)
  • Japan holds $US403bn foreign exchange - double what it held 7 years ago - and needs to find ways to bring this down or risk losses if $US falls (Mori Y. 'Japan's paradox: too many greenbacks', Financial Review, 13/12/01)
  • The credit ratings of Japan's steel companies have been severely downgraded by international credit rating agencies to speculative grade - though their positions are not as bad as those of Japanese retailers and construction firms. The Mycal case showed that Japan's domestic ratings agencies make large allowances for the value of established business relationships - but that these may not hold together (Cornell A 'rating sound severe alarm for Japan's grants', Financial Review, 10/12/01)
  • Japan's government is facing a $US1tr bailout of its banking sector - or a default could melt-down Asia's financial systems (and be disastrous for Australia). American Enterprise Institute has suggested that Japan's banks have $US1tr negative net worth. The government has apparently set aside much less than could be required. Japan's total public debt might need to increase 15% - which would deflate the yen. Japan's deflation is now a threat to the global economy (Phaceas J. 'Japan warned of $2tn bailout', Australian, 7/1/01)
  • At the World Economic Forum - it was widely admitted that almost all Japanese Banks and many life offices are technically insolvent. The US is nervous because of the $300bn in bonds and Treasury securities that these institutions hold that might be sold in recapitalising them (Gottleibsen R. 'Japan's crisis at centre stage', Australia, 8/2/02)
  • A plan to ease Japan's bank's problems by buying some of their shares has been proposed ('Japan may buy bank's stocks for stability', Australian, 11/2/02)
  • On 1 April 2002, guarantees on bank deposits will expire, leaving investors savings at the mercy of Japan's banks - which have enormous bad debts. 20% of Japan's GDP will be unprotected. Up to half its banks could disappear if left to market forces. 15-20% of loans might be in default, while deflation reduces the profitability of good borrowers. A major economic shock is expected - though some believe that injection of government funds may ease this. If government's official projections are realised, the effects will be bad but manageable. But many worry that the solution will just be a patch-up job because funds provided to bail out the banks are inadequate (Pearson B. Japan: heading for a disaster',  Financial Review,  12/2/02)
  • Major bank failures are expected in Japan in March 2002 (Pearson B. 'Bank fears cast cloud over Japan',  Financial Review,  26/2/02)
  • A rescue of Japanese banks is  likely by seeking injection of private capital is likely to be attempted (according to a Japanese business leader). Government agencies have not been cooperating with recent attempts to solve this problem, because doing so would involve admitting that their own attempts several years ago had failed (Gottleibsen R. 'Japan bank rescue on says Toyota chief',  Australian, 4/3/02) 
  • There is a debate in Japan about changing the way in which its economy works as a 'nation created by ties of blood and the desperate and mostly secret strategies devised in the postwar years to achieve national survival. This, which saw Japan's economy operate like one large family, where individuals were subordinated to national goals, is the opposite of the way economists view an economy. It worked brilliantly for 40 years - but has contradictions (Pearson B. 'Traditions dragging down Japan',  Financial Review,  22/4/02) [Comment: The opportunity for change could well be one that Japan will say 'no' to]
  • reform of Japan's banking system could cripple its recovery. The Japanese government is backtracking from reform - by exempting some accounts from the phase out of deposit insurance. An insurance cap was imposed in April 2002 - and raised the risk of capital flight. About $2.8tr could be unprotected by deposit insurance (Martin N 'Japanese bank rally hangs in the balance',  FR,  6/8/01)
  • Institute of International Monetary Affairs says Japanese banks have written off $120bn in non-performing loans, and have been told to remaining NPLs by 50% by March 2003 - and a further 30% a year later. With high public debts, and near-zero interest rates there is no scope to stimulate the economy. The Reserve bank has a very accommodating policy but money supply is not increasing as banks are not lending. (Chong F 'Painful surgery the only hope for ailing Japan',  A,  23/8/02)

  • Japan may be running out of options in relation to its public sector debt and bad debt problems. Writing off debts would increase unemployment into double figures and slow growth 1-2% (Pearson B 'Japan finally comes to the crunch', FR, 17/9/02)

  • the bank of Japan is to pump trillions of yen into the banking sector (Pearson B. 'Japan prepares rescue operation for troubled banks',  FR,  27/9/02)

  • In Sept 2002, Japanese government ejected those who have slowed reform of its financial system, and gave control to Tanaka with mission to impose shock therapy to rid banks of bad loans - which are seen as either a cause or a consequence of Japan's decade long stagnation and a precondition for recovery. (Pearson B 'Japan braced for shock therapy', FR, 14/10/02 )

  • Japan's new Financial Services and Economics minister is expected to just let firms fail (with massive layoffs) as the only way to resolve Japan's bad loans ('Japan fears zombies', A, 14/10/02)

It appears that the size of the financial 'bomb' that could be exploded in the US financial system was being increased rapidly, noting:

  • Japan is in severe trouble. GDP is shrinking. Unemployment is high. Japan is the world's most indebted country and its current account surplus will disappear next year. Bond yields have failed to follow established theory - and the bond market bubble in Japan is now as dangerous as the equity bubble was in 1989. Spreads between poor and good quality bonds have narrowed. Most surprising however is the currency market where the yen remains strong - despite the tendency for Japanese banks to invest in US treasury bonds. In October, their buying was huge ($80bn). This appears to be based on a passive version of the 'yen carry trade' - ie such foreign assets would strengthen if the yen weakens. Overall foreign holdings of the Japanese banks has grown 42% over the last year (Cornell A. 'Anomalies abound as Japan deteriorates', Financial Review, 19/11/01)
  • Japan's banks must clear the results of 1980s bad debts. Everyone now knows this - but despite record write-offs the volume of bad debts climbed almost 50% last year (Lunn S. 'Japan faces a fate worse than debt', Australian,  27/5/02)

Ultimately the only way to deal with this situation is likely to involve efforts to develop a new global financial system and to accelerate the development of disadvantaged groups worldwide as a key part of the war against terrorism (as suggested in the Competing Civilizations). 

Such steps might, with a huge amount of work, produce good out of evil. 
Alternative Scenarios

6.  Alternative Scenarios 

A second interpretation could be that a 'passive' attack on the financial system could be intended at some future date (eg through being forced to dramatically increase interest rates to slow a by-then rapidly growing economy - a step which could reverse the 'Yen carry trade'). This could create a liquidity crisis that could be catastrophic if reserve banks were simultaneously incapacitated by terrorist attacks - whose linkage to the passive financial attack would be less obvious because the history of terrorist action would have been established.

A third (psychologically implausible) interpretation of the link between a suspected passive financial 'attack' and the 9-1-1 terrorist attack is possible. Could it be that some US or allied interests had anticipated the passive financial 'attack' outlined above and feared it could destroy their economic, military or political positions, and so sought to either render a financial attack impossible or distract attention from financial problems? After all, if this author can see the possibility plainly surely others could do so. 

Aside: There are a large number of conspiracy theories that have emerged in relation to the events of September 11 - from groups with different theories about what happened and why (Hau J. 'Hooked on paranoia',  Financial Review,  27-28/4/02). Many of those theories would be compatible with this second scenario.

A fourth interpretation is that a Japanese 'bomb' in the US financial system might not be intended to be exploded - but to be an ongoing threat to US administrations to provide political influence.

This scenario has emerged (and been added in March 2003) as a result of considering the US administration's strategies for dealing with 'terrorists with weapons of mass destruction' (see The Second Failure of Globalization?). The latter suggests that causing stresses that force others to make global multi-lateral machinery (eg the UN) work (which others would oppose vigorously if the US itself advocated this), may well be the hidden intent of the unilateral action proposed to replace Iraq's regime.  For reasons suggested below, this suggests a plausible scenario under which Japan may be encouraging US administrations to play the role of new Shogun.

A 'New Shogun' Scenario

History: Shogun (ie 'barbarian quelling generalissimo') was the title of the de-facto ruler of Japan from 1192 to 1867. It was first used for military commanders commissioned in the 8th century to suppress Anui tribes in northern Japan. In 1192, after winning military hegemony over Japan, Minamoto Yoritomo was appointed shogun by the Emperor to legitimize his conquests. As the military class acquired increased power, the shogun (whose office was hereditary) became the actual ruler of Japan - although the Emperor retained formal sovereignty. In 1603, after the chaos associated with disintegration of the then shogun's house, the shogunate was re-established by the Tokugawa family. In the 19th century, the shogun's usurpation of Imperial powers was contentious, and the Tokugawa shogan yielded the administration to the Emperor in 1867 (Encyclopaedia Britannica, 1985)

The latter event, the Meiji restoration, was the start of Japan's economic modernization and its acquisition of the 'soul of a merchant' to displace the earlier 'soul of a samurai'.

It needs also to be recognized that Japan's society work on principles that are radically different to those of Western societies (see Asian literacy). In particular, the most powerful are never visible (ie 'the oyabun does not dance on stage'). Power resides with elite bureaucracies who provide nominal 'rulers' (shoguns, emperors, elected politicians) with advice and encourage them to amuse themselves as long as they do not interfere with government.

Indicators that the US administration may now have been encouraged to play the role of Japan's shogun include:

  • the US's 'war against terror' corresponds to the traditional ('barbarian suppressing') role of a shogun;
  • if the 'hidden agenda' of a war to disarm Iraq is to force the global multilateral institutions (eg UN) to be more effective, then the methods that that the US administration is using would correspond to Japanese leadership styles - under which the 'oyabun' creates chaos and it is left to his social subordinates to sort this out. Change in Japan, it has often been noted, always occurs through crisis. The traditional Western leader, by contrast, would seek to define how order could be achieved.
  • likewise if the war in Iraq is a true (dis) information war - and it appears that this could be the base - then it is likely again that the US is gaining advice from Japanese strategists;
  • Japan provided the largest contribution to the cost of the 1991 Gulf War, which would have ensured that its voice was influential. Those and similar payments perhaps allowed the US to be seen in the role of mercenary;
  • Japan will have a huge leverage against the US (encouraging its administration to listen to suggestions) because of the 'bomb' that has been planted within its financial system in the form of (a) the potential insolvency of Japanese financial institutions whose large holdings of US assets would have the potential to collapse the US financial system if they were 'forced' to be sold and (b) the greater ability of East Asia's economic systems to operate independently of an effective financial system; 
  • traditional Japanese ideologies have been presented as a foundation for future US policies (eg a disbelief in further progress / history has been associated with the inevitable global dominance of US ideologies of liberal capitalism and democracy [1], while Japan's highly centralized social hierarchy and Western concepts of a rule of law have been equated in promoting 'high trust' societies). The implications of such arguments for a Japanese audience (ie implying common cause with the US) should also be noted);
  • China's ascendancy poses a huge threat to Japan (because of events in World War II), which can be neutralized if the US administration becomes its shogun for a time;
  • proposals to internationalize Japan's culture were announced in the late 1980s - and 'internationalization' can have several meanings;
  • it appears that Japan's leaders are seeking ways to move Japan back to the 'soul of a samurai' and may be doing so under a US umbrella. For example:
    • Japan has indicated that it might take pre-emptive military action against North Korea if threatened;
    • Japan may acquire missile technology from the US [1];
    • the US has suggested that it might move its forces out of South Korea because the latter does not want them [1] (a move which would increase pressure for increased Japanese military capability).
  • the role of shogun was hereditary;
  • there are indications (Michael Lind, 'Deep in the Heart of Darkness Washington Monthly, 1/2/03) that the tradition southern-confederate character of Texas (which President Bush II, its one-time governor, was said to reflect) was very similar to Queensland in Australia (ie highly conservative, a hierarchical agrarian social order, one-party dictatorship, minimal corporate-friendly state-corporatist government, primitive extractive economy, low wages and low taxes seen as basis for economic advantages, national government seen as enemy). While political and economic influence in Texas from the dark side of Japan is beyond this author's knowledge (and references only to minor oil investments can be located), similar regional characteristics led [based on the author's own observations] to a high level of Japanese investment in Queensland that was (almost-invisibly) facilitated by a Japanese business-man who thus wielded immense political influence in the 1980s, and who appeared to be a front for one of Japan's top-level and ultra-nationalist fixers (a suspected World War II war criminal).
  • the latter individual reportedly was the largest private financial contributor to the UN and financed establishment the US-Japan Foundation in 1980 as a means of influence building (Kaplan and Dubro, Yakuza)
  • Japan is reportedly providing strong diplomatic support to the US in the UN (Sheridan G 'NATO, UN suffer France's mass destruction, Australian,  15-16/3/03)
  • Japan seems to be taking the lead role in organizing the financing and implementation of reconstruction activities following US military efforts (eg in Afghanistan). Handling such practical matters, while the US is a mere 'warrior', would give Japan the real power under Japan's perceptions.

It needs to be emphasized that this scenario is based purely on circumstantial indicators, and a particular interpretation of the 'hidden agenda' of some events.

Furthermore the fact that it is essentially impossible for Japan to succeed economically under the current (US sponsored) global financial system - because as outlined above, Japan's economy is coordinated primarily through social relationships and financial outcomes are of limited relevance - suggests that Japan would not wish a US administration to remain as 'shogun' indefinitely.

A plausible strategy for Japan to achieve its long held vision of being No 1, would involve (a) encouraging the US to pacify the world and suppress potential challengers (b) create in Japan the key practical capabilities that such an empire relies upon and (c) wait for the friction due to the US's role as 'enforcer' to lead to pressure for its removal and (d) inherit the empire. Achieving Peace!

In this third scenario complicity by radical Japanese nationalists in the September 11 events would be conceivable but not likely.

A fifth possible relationship between any planned passive financial 'attack' on the US and the terrorist attack (which is the scenario the author believes most likely) is that it was pure coincidence.  

In this scenario, it can only be said that the terrorists have mounted an attack that should probably go down in history as the least successful of all time, in terms of achieving its presumed objectives. 

Terrorism has a long tradition in history. In revolution it has three main purposes - (a) to radicalize the masses by it provoking those attacked to respond in kind (b) to wear down the will of the existing order and (c) to impose discipline on the masses after the revolution. Bin Laden appears to have miscalculated almost everything. His objective was to radicalize the Islamic masses. But by attacking the US he provoked only anger and resolution - and raised preventing Islamic destruction to the top of US priorities. He was wrong about fighting in Afghanistan - because he failed to note that the Taliban had grown unpopular, and that while the Afghan people have a history of repelling invaders, they will also side with them when convenient. In geopolitical terms he failed to take account of the fact that almost all other major countries had problems with Islamic extremism - and would thus side with the US.  For some weeks it looked as if he might gain support in the Islamic world - but the leaders in those countries saw radical Islam as a threat to themselves. (Rees Mogg W. 'The walls come tumbling down',  Australian,  1-2/12/01)

The terrorist attacks appear to have encouraged many Muslim communities to improve their relationships with the West - because of concern to avoid a real clash of civilizations [1]

This attack handed a massive strategic opportunity to the US in terms of (a) mobilizing its people (b) building an unprecedented international coalition of support (c) allowing economic risks that had built up to be discretely defused and (d) providing a framework in which reform of the global order could both consolidate the position of US-favoured democratic capitalist models, and remove the breeding grounds of terrorism.
Financial Deregulation?

Outline of  Why Japan Cannot Deregulate Its Financial System
(Mikuni, Akio, JPRI Working Paper No. 68: June 2000)

Can Japan join the global economy and, if so, at what cost to itself and others (eg US). Japan is a net exporter of both goods and capital - due to historical reasons and bureaucratic imperatives. This has been sustained despite growing market pressure because

  • its governing bureaucracy has an economic policy of maximizing production far in excess of domestic demand. When, production outstrips demand this shows up on national accounts as a current account surplus. Japan's producers and financiers base decisions not on profit maximization but on their roles in this national policy. In turn, their viability is guaranteed by government - and all business transactions are ultimately carried for the government.
  • Japan's manufacturers can sell the dollar proceeds of their exports to their financiers for yen. But authorities ensure that financial institutions do not have to sell their dollar holdings for yen. As long as the dollar proceeds of Japan's exports are held in Japanese entities, the exchange rate is prevented from rising to destroy export competitiveness. Meanwhile, exporters pay workers / suppliers in yen while continuing unlimited expansion of production.

The yen/dollar exchange rate at 100 yen per dollar is too strong in light of a purchasing power parity (around 160 to 180). But given Japan's chronic current account surplus and net creditor position (133 tr in 1998) it is too low. Meanwhile, total indebtedness of Japan's governments has doubled from 60 to 120 percent of GDP. Yet Japan has very low interest rates on the bonds that finance this.

To understand low interest rates despite high fiscal deficits and weak currency despite trade surpluses,  it is necessary to explain how Japan's political economy functions. As the economic system does not rest on profitability or efficiency as defined by Western economists, it cannot allow profit-seeking players into its economy. Japanese producers and financiers know that market forces are controlled by the bureaucracy in their favor. Government socializes credit risk and market risks to provide friendly managerial environments. This requires isolating the domestic economy from outside forces (an unstated goal of Japan's policy makers). However it creates a big public relations problem.

Now foreigners are allowed into limited and much-hyped areas of the economy (eg luxuries such as coffee, hamburgers, and handbags, or troubled firms like Nissan and failed banks). But real foreign participation is not compatible with bureaucratic control, and is covertly resisted.

In Western countries limits to a bank's lending capacity are set by the availability of deposits and the interbank and capital markets. In Japan, banks create deposits by allocating loans to accommodate the funding requirements of borrowers. They do not wait for deposits to accumulate before lending. The Bank of Japan (BOJ) provides them with any liquidity needed to bridge the asset/liability gap. This is why in Japan banks (not capital markets) provide most external corporate financing. The Provisional Law on the Control of Interest exempts banks from anti-trust law. And most household savings take the form of bank deposits. This system separates borrowers' profitability from returns to savers. Savers and borrowers cannot be allowed to compete for higher returns or lower borrowing costs. They accept whatever is offered. Profitable borrowers are not allowed to grow faster than unprofitable ones.

Markets exist in Japan, but only to create the illusion that Japan is a market economy. In actual fact, most markets are tightly controlled by monetary authorities and the financial institutions they control. Thus, financial markets involve small easily-manipulated floats. And withholding taxes and inefficient and risky delivery and settlement systems, discourage outside participation.

Aggregate capital spending is decided by government (eg MITI). Each key industry started life as a consortium led by MITI, thus freeing lenders from credit risk. When capacity expansion plans are completed, domestic demand is inadequate to ensure full capacity utilization - because expansion was undertaken without regard for demand. Thus external markets are vital to full capacity utilization.

Capital outlays and the trade surplus account for large and stable proportions of GDP. Exports and capital spending drove the Japanese economy; export earnings led to capital spending which led to more exports. Domestic demand played no essential role in this cycle.

The Japanese government has often been confused when western counterparts demand an easing of domestic credit to reduce the current account surplus. That makes sense where easier credit results in higher consumer spending and higher imports. But in Japan, extra credit simply goes to export manufacturers and their financiers, thus increasing exports. Government officials do not explain to foreigners how the Japanese system works. Instead, they cave into foreign pressures - so Japan amassed an enormous net creditor position.

Japan's elite knows that a strong dollar is essential in prevent challenges to its power to determine economic outcomes. It is now threatened by Japan's current account surpluses. As Japan learned in World War I and the Korean War, large current account surpluses can pose problems. If not spent on imports (threatening domestic producers), or converted into yen (threatening export competitiveness by producing a stronger currency), they must be held as foreign currency. However, allocating domestic money to hold foreign assets subjects the economy to deflationary pressures.

In the prewar period and during the two decades after WWII, imports of advanced capital goods helped reduce the trade surplus. Since 1970, Japan has produced most capital goods for itself. And , the largest deficit nation, the US, produces nothing Japan needs in sufficient quantities to reverse the trade imbalance. Thus, Japan has had trade surpluses with the U.S. for 30 years. Most of these have been invested in dollar instruments that produce income to expand current account surpluses even faster. The U.S. and other Asian countries are now dependent on Japanese components, so any rise in global economic activity increases demand for Japanese goods. Any reduction in Japan's current account surplus would lead to a sharp / catastrophic rise in the yen's value.

When the floating exchange regime began in 1973, it was hope that a stronger yen would reduce trade imbalances. But with the US unwilling or unable to shrink its deficits, trade imbalances can only be reduced if surplus countries take the initiative. Japan would have to close factories and lay off workers ie end its policy of maximizing production. Such steps are politically impossible. In the early 1990s committees sponsored by the MOF and MITI recommended that exchange rates not be used to reduce payment imbalances, and that Japan should continue to accumulate net claims on the rest of the world - as capital for a capital-hungry world.

The strong dollar policy announced by Rubin in 1995 was a tacit acceptance of the Japanese position. Joint interventions to reduce the yen and strengthen the dollar in August 1995 cemented the policy. This has brought the global financial system into uncharted territory, with the US -- the largest economy and provider of the closest thing to a universal currency-- running a large current account deficit that  will not shrink under any economic scenario except for a sharp and catastrophic US recession.

Given Japan's willingness to hold its surpluses in dollars, the US can experience a "deficit without tears".  Since Japan's dollar holdings remain in the U.S. banking system, they continue to provide the US with credit to enable it to grow and expand the deficit yet further. Imports of goods help stabilize prices while higher growth rates in consumer spending provide more sales and revenues, resulting in higher profits. Higher current account deficits by definition suck capital into the United States, thus automatically creating more credit to fuel the stock market.

In theory, these imbalances will continue forever. But to recycle those surpluses instead of converting them into yen or into imports, Japan must fund them. Unless the Bank of Japan can create credit to fund the growing external assets position, Japan will be faced with the choice of a tightening monetary regime as more domestic money is drained into funding the external position, or converting some of the external assets to yen. As there is virtually no supply of yen outside Japan, the yen/dollar rate would soar, making it impossible for Japanese companies to export.

In the 1980s, the government promoted "excessive" lending by banks to fund Japan's external asset position. As deposits in Japan are a function of the volume of loans, not the reverse - a huge bubble in bank lending was possible because the authorities engineered a concomitant real estate bubble. As banks lend on the basis of collateral not cash flow, astronomical real estate prices allowed lending far in excess of underlying economic activities. Landowners sold their properties at bubble prices. As such people are wealthy they did not spend their funds but kept them as immobile deposits, which the banks used to help fund the permanent external assets.

At the end of the bubble in the early 1990s and the end of the government's ability to prop up real estate prices, Japan has had to use massive public works spending to stimulate the stagnant economy and to create the deposits needed to fund its external position. Efficient investment in public works would have translated into increased wages and stimulated the economy. But this would not provide the purposeless and immobile deposits needed to fund the external assets. Thus the government spent construction funds inefficiently, including transfers to construction companies that they could not spend at once and kept as bank deposits. These deposits were used to fund the external position. However, just as it turned out to be impossible to engineer infinite increases in real estate prices, the government now seems to be bumping up against limits in its ability to flood the economy with fiscal spending.

If the day comes when the government can no longer sustain fiscal deficits (eg if the Government Bond market collapses, bringing on a sharp and catastrophic rise in interest rates) the bureaucracy will be unable to support all those dependent on it. Following the collapse of bureaucratic control, the socialization of market and credit risk will end, followed by wide price fluctuations and a wave of corporate bankruptcies. This will lead to the reduction or reversal of Japan's current account surplus and the US economic expansion it helps finance. This will signal Japan's integration with the global economy - but the price for Tokyo and Washington will be high.