Dogs and Demons

Gavan McCormack points out, «Japan is the worlds greatest savings country, but it is also the world's most profligate dissipater of its people's savings.» Despite five decades of continuous growth, making Japan the second-largest economy in the world, the nation is living beyond its means. After seeing the civil-engineering and monument frenzy sweeping Japan, we have a pretty good idea where the money is going. What remains to be seen is the results as they manifest themselves on the bottom line.

In 1990, a cartoon in a Japanese newspaper featured two couples, American and Japanese. The American man and wife, dressed in designer swimwear, were guzzling champagne as they sat in the whirlpool bath of their large, luxurious apartment. In the companion cartoon, a Japanese wife was hanging laundry out on a tiny veranda while her shirtsleeved husband read the newspaper in a cramped kitchen. Under the American couple the caption read «World's Largest Debtor Nation,» and under the Japanese «World's Largest Creditor Nation.»

Since then, the Americans have gone on living well, and the Japanese have gone on sacrificing, but by 1996 their country had become the world's largest debtor nation. Adding in so-called hidden debts buried in Ministry of Finance special accounts, Japan, with a national debt approaching 150 percent of GNP, has no relief in sight, as budgets, set by government ministries on automatic pilot, continue to climb. The Ministry of Finance's support for banks and industry through the manipulation of financial markets has had high costs. Interest rates of 1 percent or lower have dried up the pools of capital that make up the wealth of ordinary citizens: insurance companies, pension funds, the national health system, savings accounts, universities, and endowed foundations. The prognosis is for skyrocketing taxes and declining social services.

Besides the central government, local units across the nation, from heavily populated prefectures to tiny villages, are drowning in red ink. By 1998, thirty-one of Japan's forty-six prefectures were running deficits averaging 15 percent of their total budgets; six prefectures had reached the crisis level of 20 percent, at which point the central government had to step in and rescue them. Of these, Osaka Prefecture, reeling from a string of failed waterfront projects, is basically bankrupt, surviving on emergency cash infusions from the central government; its cumulative debt already topping ¥3.3 trillion, Osaka has been running annual losses of ¥200 billion per year since 1997. However, Osaka could still lose in the race to become the biggest prefectural bankruptcy, for the municipality of Tokyo also met disaster at the waterfront, and its shortfall for fiscal 2000 is three times larger than Osaka's, and growing.

Quantifying Japan's debt crisis is not easy, because its debts are so well disguised that nobody knows the exact figure. In a special pamphlet on the national debt, the Yomiuri Shimbun reported: «In addition to the general budget, there are 38 special accounts and the Zaito program, known as the 'second budget,' as well as debts of local governments. All of these are intertwined with one another, and have become a bloated monster.» Here is one estimate: In 1999, revenue shortfalls for the official «first budget» came to ¥31 trillion, an astonishing 37.9 percent of expenditures. Measured as a percentage of national product, Japan's deficit came to 10 percent of GDP, jumping right off the scale when compared with the OECD average of 1.2 percent; the nearest competitor for big-deficit spending among advanced industrial nations was France, at 2.4 percent of GDP Adding long-term bonds, by 1999 Japan's cumulative debt had risen to ¥395 trillion, amounting to 72 percent of GDP (the United States' gross federal debt, in contrast, comes to 64 percent of GDP). But this is not all. We need to take into account the shortfalls of municipal and prefectural governments, which come to ¥160 trillion. Add this to the national debt and the total jumps to ¥555 trillion, approximately 97 percent of GDP.

There is more. «Hidden debt» from the JNR Resolution Trust and Ministry of Finance budget manipulations; Zaito loans to bankrupt agencies such as the Forestry Agency, the Highway Public Corporation, and the Housing Public Agency; and additional trillions of yen in off-budget short-term «financing bills» brought the grand total to 118 percent of GDP, surpassing even the notoriously spendthrift Italy, and making Japan the most heavily indebted of the twenty OECD nations. And that was 1999. By 2002, cumulative debt will have reached possibly 150 percent of GDP. David L. Asher, of Oxford University, claims that Japan's real debt could be as high as $11 trillion, or 250 percent of GDP, after Zaito loans and unfunded pension liabilities are added.

Bad as they are, these figures do not take into account dubious reporting, such as the numbers game the Housing Public Agency plays with apartment sales, showing unsold units as sold in its official statistics. Turn over a stone among government agencies and strange things come crawling out. The Housing Public Agency's subsidiary, Japan Unified Housing Life (JUH), developed a large office tower in Shinjuku that opened in 1995. Given that this was a stagnant real-estate market, everyone was surprised to learn that the building was 95 percent leased-the tenants turned to be JUH itself and related companies, which occupied the building at nearly four times market rents. Nobody knows the degree to which the cooked books of tokushu hojin and koeki hojin could drive up Japan's true indebtedness.

Japan may have a high deficit but not to worry, economists advise us, because the Japanese are such high savers that they have stored away in the banks more than enough money to pay their debt. Japan's high savings rate is the glory of its economy. For decades, American households consistently saved at only about one-third of the Japanese rate, leading the economist Daniel Burstein to label the two nations «grasshoppers and bees.»

What the experts overlooked in the «Large GNP, Large Savings» formula was that capital in Japan earns consistently low returns. For the past decade, Japanese government bonds have yielded between 0.2 and 3 percent, far below the United States' 5 to 8 percent. No feature of the Ministry of Finance's magic system charmed financial experts as much as this, for the sacrifice by the public for the good of the national economy seemed unbeatable. After the Bubble deflated, the Ministry of Finance, in an effort to prop up the stock market and the banks, lowered interest rates as far as they could go-the lowest levels in world banking since the early seventeenth century – which is to say, close to zero: in the latter half of the 1990s, interest rates on ordinary deposits earned their owners less than a quarter of 1 percent.

To get some idea of how such rates affect the lives of ordinary Japanese, consider the case of an average salaried employee. He retires with a lump-sum pension equal to about ¥20 million, half of which he will use to pay off his mortgage, leaving ¥10 million in the bank. At 0.25 percent, his deposit brings him about ¥25,000 in interest income; that's $200 a year. «It's not worth the effort of taking your money to a bank,» says Senba Osamu of Daiwa Securities. «In a year, you'll have earned just enough interest to buy yourself lunch.»

Large segments of the public have agreed with Senba, and banks report unprecedented use of safety-deposit boxes to store cash, while piggy-bank sales have risen at department stores. By 1996, the Seibu Ikebukuro Department Store stocked sixty-eight kinds of money boxes – for example, Рака Рака Kan, a container that clacks its lid when you pass, demanding to be fed ¥500,000 in 500-yen coins. A Seibu spokeswoman said, «There has been an increasing number of people who would rather use a Piggy bank at home than a bank after interest rates declined with the end of the Bubble economy boom.»

They knew much better uses for their money during the mercantile heyday of the seventeenth century, when Saikaku wrote his novels of city life in Kyoto and Osaka, lovingly counting out each kamme and momme (weights of gold and silver) that his protagonists made from lending at interest. A clever young man

was able to loan out his one kamme at twelve percent annual interest, and by redepositing his earnings for thirty years, he found himself in possession of a tidy fortune of twenty-nine kamme nine hundred and fifty-nine momme eight fun four tin and one mo. He then withdrew the money from the bank, put it into a chest, and eventually managed to loan it out himself. Before long he had one thousand kamme. From then on he made money more and more rapidly until by the time he died he had accumulated the grand sum of seven thousand kamme, and his name was even entered into the social registry of the thirty-six richest men in the Capital. The way this man took one shingle and two one-mon coins from his father and turned them into a millionaire's fortune should serve as an example, just like a mirror, of what a merchant can do in this world.

That was a charming fairy tale of the past. Today, nobody can dream of retiring and living on interest in Japan. «I look at my bank account,» says Ishigaki Hisashi, a retired auto engineer interviewed in The NewYork Times, «and you know, we get interest about twice a year – and I say, 'What on earth is this?' You can't say it's just interest, that it's just a small bit of money. We need it to live on. It's a matter of life and death.»

Until recently, many economists saw the sacrifice made by Ishigaki as admirable because low returns for savers meant «free money for industry.» The assumption was that an impoverished lifestyle for the people was somehow morally superior, and payouts to the public a waste of national resources. As we have seen, the idea derives from the poor people, strong state policy, a relic of military-style thinking that dates to the days of the samurai.

Oscar Wilde said that the mind of an antiquarian is similar to a junk shop in that «it is filled with dust and bric-a-brac, with everything priced above its proper value.» Japan is just such a shop. When everything is priced above its proper value, it takes more money to accomplish less; in other words, capital has lower productivity. Low capital productivity has surprising results, and one of them is that the Japanese, saving for fifty years at far higher rates than the Americans, now find themselves with proportionately lower savings.

Simple mathematics shows that it takes a very short time for interest gains to equalize the totals achieved by a high savings rate. Assuming an interest differential of 10 percent, Americans saving a third of what the Japanese save end up, after about two decades, with exactly the same amount in the bank! Another ten years, and the Americans now have double the amount of the Japanese. While this calculation is very simplistic – the interest gap is narrower for savings accounts and wider for pension funds-one can see how it was possible for Americans to go on guzzling champagne in the Jacuzzi and still come out ahead. There is nothing strange about this. It's merely the principle of compounded interest, an iron law of capital, but one the Ministry of Finance overlooked.

While bureaucrats borrow against the future to build more monuments, something more serious is taking place behind the scenes, which threatens the system more than all the combined waste and losses to date. The national debt, Zaito, and tokushu hojin are mere lizards compared with the real Godzillas: massive underfunded insurance, health, pension, and welfare bills.

The problem arises from simple demographics: Japan is rapidly becoming the world's oldest country. With a birthrate that has fallen to 1.4 (the lowest in the world and possibly headed to 1.1 by 2007), the number of young people is shrinking, while the number of old people is burgeoning. In 1997, Japan surpassed Sweden in having the largest percentage of people aged over sixty-five among advanced economies-more than 17 percent. By 2020, this percentage will have soared to 25 percent. (By comparison, the numbers for the United States, China, and Korea will be 15 percent, 9 percent, and 10 percent, respectively.)

An aging population translates into trouble for Japan's pension funds and health-insurance plans, which must rely on a shrinking pond of productive workers to support an expanding lake of old and sick retirees. The figures point to an ever-increasing burden for the working population: in 1960, there were eleven younger workers supporting each retired person; in 1996, there were four; in 2025, there will be only two.

Nowhere is the problem so severe as the national health-insurance plan, where, on top of the demographic undertow, a tide of rising medical costs is dragging funds underwater. By 1999, 85 percent of Japan's 1,800 health-insurance societies had fallen into arrears, forcing them to take the radical step of halting payments for elderly policyholders because they simply could not afford to pay them.

In 1996, when the national health program reached the point where collapse was imminent, the Ministry of Health and Welfare began raising contributions and lowering benefits. Holders of employee health-insurance plans now pay 20 percent of their medical costs (versus 10 percent before), and health premiums have risen from 8.2 to 8.6 percent. In addition, the ministry is levying a ¥15 surcharge on each daily dosage of medicine, which translates into approximately a 30 percent tax on medicine.

Even this isn't enough to save the system. In raising premiums by a few tenths of a percentile, the Ministry of Health and Welfare has taken its first baby step. As one popular daily newspaper has observed, these measures amount to no more than «throwing water on a red-hot stone.» During the coming decades, the share of the health bill that a salaried worker will have to bear is projected to rise to 2.5 times the present level. Even so, to fund the health costs forecast for the next decades, premiums will have to increase three times, to about 24 percent of salary by the year 2025.

An aging population is nobody's fault. If anything, it is the result of one of Japan's great modern successes – the lowering of the birthrate. In less extreme forms, an aging population is a fate that lies in store for all industrialized nations. Japan's real problem is its failure to plan for this inevitable fate. With a high GNP and a household savings rate of 13 to 14 percent (two and a half times the American rate), Japan has the wherewithal to amass pools of capital with which to support its aging population. Or so everyone believed.

Nothing comes for free – everything has its price, as the collapse of the Japanese insurance industry illustrates. Japanese households have turned to life insurance as a way of avoiding steep inheritance taxes, among the highest in the world. Indeed, the tax system essentially forces people to buy life insurance, which accounts for about 20 percent of household savings. And, as we have seen, MOF requires insurance companies to buy low-interest government bonds and invest in the stock market whenever the exchange begins to drop. After years of investing in stocks and bonds that produce no yield, insurance companies are showing zero, or even negative, returns.

Even this would not be so serious – just a case of running in place – but, in addition, life insurers are exposed to trillions of yen of bad loans extended during the Bubble. In the latter part of the 1990s, the eight biggest insurers wrote off trillions of yen in bad loans, but this is only a fraction of the real exposure, since tobashi techniques obscure most of the bad debt. The Ministry of Finance did its best to hide the damage (no insurance company had gone bankrupt since the war), but in April 1997, MOF could no longer cover for Nissan Mutual Life Insurance, which went belly-up with losses of ¥252 billion. Others followed. By October 2000, Chiyoda Mutual Life Insurance and Kyoei Life Insurance, Japan's eleventh and twelfth largest life insurers, had both collapsed, with combined liabilities of a whopping ¥7.4 trillion, in Japan's biggest corporate bankruptcies ever, with further bankruptcies and consolidations in sight. Reliable information about pension funds and insurance is sparse-so far, only a vague silhouette of the Godzillas looming over Japan in the coming twenty-five years is visible in the mist. At Nissan Mutual Life, for example, MOF knew that Nissan was bankrupt in 1995 but allowed the company to continue in business without publishing any report of its losses for two more years.

Extremely low interest rates have also heavily affected the nation's pension funds. In 1991, pension funds in the United States made a whopping 28 percent return on their investments; Japanese pension funds gained only 1 percent. By 1998, Japanese pension funds had made the lowest returns of pension funds worldwide, declining at a rate of minus 3.2 percent, while U.S. funds garnered 14.6 percent. The year before, the rate for the United States was a hefty 18 percent. Rates of return like these, compounded annually on immense pools of money, make a difference of literally trillions of dollars to public savings.

When Japan founded its national pension-fund system in 1952, planners set 6 percent as the minimum annual rate of return for employee savings plans. Pensions have not met this goal since 1991. One survey, in September 1996, showed that only 4 percent of corporate pension funds had sufficient reserves to make payments to pensioners, and since then the situation has deteriorated further. Dozens of pension funds are outright bankrupt, with assets worth less than the cumulative money paid in by participating workers. The number of pension funds in arrears has become such an embarrassment that the Labor Ministry lowered the minimum rate of return to 3 percent in 1995, and then to only 1 percent in 1997. Meanwhile, since 1998 a record number of companies have resigned from the national pension system – more than 800,000 companies simply don't pay premiums for their employees, even though they are legally required to do so.

As in the case of health insurance, the pension system cannot survive without lowering benefits and raising taxes. Pension premiums are rising rapidly, growing from 14.5 percent of salary in 1994 to 17.4 percent in 1997, and reports say they may even reach 30 percent by 2020. In addition, in 1994 the government raised the minimum age for beneficiaries from sixty to sixty-five. As many Japanese firms and government agencies mandate retirement at age fifty-five, this leaves workers with a ten-year gap after retirement before they can receive their pensions.

Private industry faces an exposure to unfunded pensions that could develop into one huge flat tire for Japan's manufacturing businesses; for some companies, the cost of funding pension shortfalls is approaching half of their net profits. According to a survey carried out at the end of 1999, 70 percent of Japanese companies did not have enough money set aside to cover their pension obligations. In fiscal 2000, MOF changed its accounting rules to better reflect pension liabilities (previously completely unreported), but the new rules left plenty of «cosmetic accounting» techniques in place to veil the true extent of the danger. Only a handful of large companies have divulged their pension shortfalls, but the numbers for the few that have are sobering: in spring 2000, Mitsubishi Electric announced that it owed ¥540 billion; Honda Motors and Toyota Motors were short ¥510 billion and ¥600 billion, respectively; Sony needed to make up ¥225 billion. While nobody knows the true number, the aggregate shortfall for companies on a national basis is estimated to reach tens or even hundreds of trillions of yen. Given corporate unwillingness to admit embarrassing facts and the worsening economic situation in the late 1990s, the true situation is probably much worse. To get a sense of scale, the World Monetary Fund estimated Japan's pension liabilities in 1997 at roughly 100 percent of GNR As Jane Austen said, «An annuity is a very serious business.» Life will not be easy for Japan's future pensioners.

A favorite mantra of economics experts is to say that Japan's debt is of less concern than that of other countries because it owes this debt mostly to its own people. While this is true, the fact remains that the Japanese people must repay the debt through taxes, and the burden will be crushing. By 2005, according to Gavan McCormack, government debt will run about «¥1,400 trillion, ¥11 million per head (say, two years' salary for an average worker). To repay such a sum with interest would call for a tax of ¥1.7 million per year every year for sixty years from every working citizen.»

As McCormack points out, Japan can dispose of its debt in three possible ways: increase GNP (rapidly), tax, or inflate. An explosive growth in GNP is unlikely. So the next alternative is taxes, and over the next twenty-five years taxes could skyrocket to the point where they surpass notorious situations such as Sweden's. Withholdings that in 1997 took a bite of about 36 percent out of the average taxpayer's income are estimated to soar to more than 63 percent by the year 2020 – and these tax increases do not take into account the burgeoning national debt.

The consumption (sales) tax rose from 3 to 5 percent in 1997 – and there is strong pressure to raise it to 10 percent or more once the economy recovers. Indirect taxes, such as road tolls, surcharges such as the Ministry of Health and Welfares tax on medicine, and a myriad of fees levied by other distressed agencies will also double and triple. Meanwhile, the level of services will decline, pension payouts will drop, and patients will be called upon to bear a larger share of medical costs. Add the rising consumption tax, and by 2025 the average Japanese citizen could end up paying up to 80 percent of his income to the government.

Obviously, this isn't going to happen – such high taxes would strain taxpayers to the breaking point. Hence it would seem that «printing money» (having the government buy bonds or deposit money in banks), thereby causing inflation, would be the obvious next step. But this, too. Taggart Murphy points out, may not work, since it would undermine the value of government bonds; at the same time, banks, grown cautious after the Bubble, might not turn around and lend the money to the public. We're back to the Mole Game: Cut down on government spending, and millions of people (including politicians) will be out of work. Raise taxes too high, and even the long-suffering Japanese public will rise up in anger. Print money, and government bonds lose their value. So what to do? Nobody knows.

All this comes of supporting an artificial regime so long that everyone's livelihood depends on it. So elaborate is this structure that to change any part of it threatens the whole; hence it is nearly impossible to make serious reforms. Facing a similar situation, Abraham Lincoln recounted the following story:

Two boys out in Illinois took a short cut across an orchard. When they were in the middle of the field they saw a vicious dog bounding toward them. One of the boys was sly enough to climb a tree, but the other ran around the tree, with the dog following. He kept running until, by making smaller circles than it was possible for his pursuer to make, he gained upon the dog sufficiently to grasp his tail. He held on to the tail with a desperate grip until nearly exhausted, when he called to the boy up the tree to come down and help.

«What for?» said the boy.

«I want you to help me let this dog go.»

Some believe that the Japanese save according to «Confucian ethics.» Others point to the fact that high land prices force people to save, since they have no alternative if they wish to own a home. In any case, Japan's stock of savings is not nearly as secure as it looks, for mice have gotten into the storehouse. Behind the scenes, personal and corporate debt is gnawing away at Japan's savings.

Surprisingly, and this runs contrary to the common wisdom about Japan, the Japanese people have an avid aptitude for debt. Credit-card use quadrupled from the mid-1980s to the mid-1990s. Of course, expanded use of credit cards is not what it seems on the surface, for the anti-consumer nature of credit in Japan means that most cards are highly restricted and do not provide much credit as we usually understand it: most people must pay their cards monthly in full. Even so, the public has developed its own form of tobashi, whereby borrowers withdraw money on one card to pay for another. «Buy now, pay later,» with installment purchases and long-term lease arrangements, have led to the growth of giant leasing and consumer-credit companies. Installment buying is so popular in Japan that by the mid-1990s the Japanese were carrying more consumer debt per capita than Americans.

While the public pays for its debt with usurious interest rates, industry has access to free money. Stocks and bonds pay negligible returns, and banks would never foreclose on businesses in their keiretsu grouping. In a world where banks hand out money for free, it would be easy to predict that companies might begin to pile up debt. That they did. Today (and for most of the postwar era), corporate debt in Japan has exceeded equity by an average of 4 to 1 (compared with 1.5 times to 1 in the United States). Allowing companies to leverage themselves far beyond what was considered safe in the West was one of Japan's most successful stratagems. It worked well in the high-growth era, but when exports reached a plateau and growth slowed in the 1990s, these companies found themselves saddled with huge surplus capacity. Suddenly they began to feel the heavy weight of debt on their shoulders.

Judging by history, one could even argue that the Japanese show a cultural bent toward wild, heedless borrowing. Perhaps it was a result of the traditional intense love of the moment. It is remarkable how many Kabuki and puppet-theater plays revolve around debt, or around the misuse of money entrusted to the hero or heroine. (In contrast, Chinese theater is obsessed with injustice and law courts – the misuse of power rather than the misuse of money.) One of the most famous moments in Japanese puppet theater is the scene known as Fuingiri, "Breaking Open the Seal," in the play Meido no Hikyaku. An Osaka shop clerk, Chubei, driven by his love for the courtesan Umekawa, breaks open the seal on a packet of gold coins consigned to him by his master. He knows the punishment will be death, but he can't stop himself. Debt owed by daimyo lords to moneylenders in Osaka brought down the Tokugawa Shogunate in 1868. Debt was the very key to Japan's pre-Bubble financial system, with its cycle of assets-debt-assets. And spiraling debt and misuse of funds intended for other purposes is the hallmark of the bureaucrats who run agencies such as the tokushu hojin. In the corporate sector, a giant millstone of debt hangs around the neck of Japanese industry. In short, the Japanese are anything but natural savers. On the other hand, who is? It is human nature to borrow-and here is where the bureaucrats guiding Japan's financial system made a mistake that has had serious consequences for society. They punished noncorporate borrowers with usurious interest rates.

In Japan, lenders can legally charge interest of 40 percent, the sort of rate for which Dante confined usurers to the third ring of the Seventh Circle of Hell. While corporations enjoy access to capital at near-zero interest rates, private individuals have no alternative but to turn to sarakin, «consumer loan companies,» a nice name for loan sharks, who lend at official rates ranging from 30 to 40 percent, with actual rates sometimes reaching 100 percent. Failure to repay earns a visit from a crew of gangsters. The Ministry of Finance smiles on this system, because it believes such high rates dampen consumer borrowing. But despite MOF's best intentions, nothing will stop needy people from borrowing money. What consigning the consumer-loan business to gangsters did achieve was to drown millions of people in usurious debt. Saikaku remarks, «Of all the frightening things you can imagine, surely there is nothing as horrifying as having one's fortune ruined and being hounded by creditors. Nothing else even comes close.»

Sarakin are the hopeless debtor's last resort, yet it is estimated that in the late 1990s borrowers from loan sharks amounted to 12 million people (one in eight adults). In fact, the only part of the Japanese banking system to grow appreciably during the 1990s was this one, with assets leaping 25 percent in some years. Of Japan's 12 million «deep debtors,» 1.5 to 2 million are «heavy debtors» with no chance of repaying loans. Bankruptcy is not an alternative for most of them because it carries heavy social disapproval. Also, says Utsunomiya Kenji, Japan's leading bankruptcy attorney, «They haven't declared bankruptcy only because they don't know how.» For most of them, however, the real reason for not declaring bankruptcy is the fear of gangsters. Just as the Yakuza (organized crime) plays a role in Japan's financial system at the high end, by fixing shareholder meetings so that nobody asks questions, it plays an even larger role at the lower end, as loan harvesters. No legal bankruptcy proceeding will prevent a group of burly crew-cut men from threatening your in-laws, pounding on your door at night, and calling you at your place of work twenty-five times a day. As a result, tens of thousands of people disappear each year in a process known as yonige, «Midnight Run.» They discard their homes, change their identities, and move to another city, all to hide from the enforcers of Japan's consumer loans.

Traditionally, people must clear all debts by the end of the year, so New Year's Eve is the premier time for yonige. The 80,000 people who fled in the night in 1996 had nearly doubled by 1999, to 130,000, while estimated sarakin debts quadrupled, from about $45 billion to $200 billion. So popular is the Midnight Run that it has spawned a new business, benriyasan («Mr. Convenient»), facilitators who help families flee their homes and who take care of their possessions while they are on the run. In 1999, Japanese television featured a new drama, The Midnight Run Shop, whose hero devises schemes for people to evade gangster loan enforcers. It's a Mission: Impossible for debtors, with each episode featuring a new clever escape: a disc jockey goes on the lam during a live show; a florist evaporates during a wedding.

Sarakin loans are not the only means by which Japan's financial system beggars the public. The nation has no lender-liability laws, leaving the public at the mercy of scam artists who prey on credulous old people and heavy debtors. Most notorious of the scams is so-called variable life insurance. In the late 1980s and early 1990s, banks and insurance companies colluded in selling these policies to homeowners, claiming that they would guard against high inheritance taxes. A homeowner would mortgage his house and invest the proceeds in an insurance policy but was not told the meaning of the word «variable»; namely, that payouts were not guaranteed. When investments made on their policies went south with the collapse of the Bubble, owners of variable insurance found that they owed more on their houses than their policies were worth.

Tazaki Aiko, age sixty-two, was a typical victim. The law prohibits banks from selling insurance, but they got around it as follows: In 1989, a salesman from Mitsubishi Bank began paying Tazaki visits, warning her about the high inheritance tax her family would face. Soon she received a call from someone at Meiji Life Insurance (one of the Mitsubishi keiretsu group of companies), offering her a variable insurance policy Tazaki bought, and seven years later she faced eviction from her home.

Altogether, insurers issued 1.2 million such policies, leading to the public's loss of trillions of yen. In many cases, bankers and insurance-company salesmen were present together at the time the contract was signed. Victims have filed hundreds of lawsuits, and some of the plaintiffs have committed suicide. «Suicide is a tempting idea, because the longer you live the larger your debts grow. That is the nature of the insurance,» says Oishi Satoru, the secretary for a plaintiffs' group. Yet to date, despite the damage done to the public, neither MOF nor the courts have punished a single bank or insurance official.

A system that favors gangster-ridden loan sharks as the established means of consumer credit, allows banks and insurance companies to practice financial scams with impunity, rewards savers with near-zero interest rates, and punishes debtors with interest rates of 40 percent and higher – it doesn't take an expert economist to predict what this will do to public savings over time.

Nor is the damage limited to individuals. When economists measure «public savings,» they tend to concentrate on how much individual savers put in the banks, and overlook endowed trusts and charitable foundations. Japan s Ministry of Finance, intent on ensuring that labor and money go straight to manufacturing corporations, has discouraged charitable giving and volunteerism. Almost no tax deductions are allowed on charitable gifts, and severe hurdles have made establishing nonprofit foundations extremely difficult.

Yet trusts and foundations represent national wealth in a very real sense. In the United States, by 1998 there were more than 1.5 million nonprofit foundations with annual revenues of $621 billion, accounting for more than 6 percent of the GDP. Nonprofit organizations are so important that they make up their own sector of the economy, known as the «independent sector,» which employs 10.2 million workers. Assets from these foundations are the fuel used to fire start-up companies and boost the capitalization of the stock market. The proceeds fund schools, hospitals, libraries, and myriad other institutions. The IRS grants about $12 billion in tax exemptions to foundations annually, and an additional $18 billion to individuals as charitable contributions-a total of $30 billion. That $30 billion makes up part of America's overall savings, even if it does not belong to individuals or companies.

In Japan, charitable giving is negligible. It stems from the lack of a philanthropic tradition, an undeveloped legal structure to regulate the work of nonprofit organizations, and tax disincentives. Only in 1998 did the government pass a law making civic groups eligible for nonprofit status, but the law provided no tax benefits either to the organizations themselves or to the people giving to them. For the foreseeable future, the lion's share of nonprofit endowment will continue to lie in tokushu hojin and koeki hojin established as amakudari nests for retired bureaucrats and feeding off government money. They are parasites on the national wealth, not contributors to it.

Canny fund managers in the United States have multiplied their funds' assets at fantastic rates. Yale University's assets rose from $3.9 billion in 1996 to $7.2 billion in 1998, while Harvard's rose from $9.1 to $13.3 billion during the same period, the two universities enjoying three-year returns on investments of 84.6 percent and 94.9 percent, respectively. Although these years were a bumper season for the stock market, and endowments do far less well in slow periods, foundation endowments grew tremendously during the 1990s. Meanwhile, Japan's foundations, their money invested in bank accounts earning no interest and in stocks making no yields, withered on the vine. By 1997, the assets of the twenty largest U.S. foundations came to twenty-two times the assets of Japan's twenty largest.

The difference between the United States and Japan is further underscored by the existence of something like the American Cancer Society, which in 1998 had more than two million volunteers, dispensed more than $100 million for research, and had assets of $1.1 billion. There is no private organization in Japan that functions on a scale remotely like this. By the beginning of the twenty-first century, total assets of American nonprofit groups could be estimated as approaching $2 trillion – a hoard of savings that Japan couldn't begin to match. And the difference lies not only in dollars in the bank but in a legal infrastructure and the expertise of millions of people in managing such funds.

It's difficult to compare university-endowment growths, since Japanese university endowments are one of the nation's great secrets – a textbook case of how hard it is to find accurate information in Japan. In the summer of 2000, an extensive search of Web and newspaper databases and more than a dozen e-mails to Web masters and college offices at Tokyo, Keio, Waseda, and Doshisha universities drew a complete blank. However, even without hard figures to go by, any visitor to a Japanese college can see visible evidence – in substandard libraries and run-down facilities – of the beggaring of the universities as a result of low capital returns. In 1995, in the wake of the subway poisonings by the fanatical religious group Aum Shinrikyo, commentators marveled that Aum was able to recruit elite scientists from leading universities, and its facilities were much better. Trying to explain a piece of Aum machinery before a television audience, a professor would say, «Well, the one at my university is ten years old, and not nearly as sophisticated as Aum's, but you can get the idea.»

One of the myths of the financial world is that the United States is a model of laissez-faire capitalism and Japan is highly, even overly regulated. Nothing could be further from the truth. In the United States, regulations elaborated and enforced by legions of busy lawyers hem in transactions on every side, with rules punishing insider trading and mandating disclosure, liability laws protecting investors, and myriad other devices functioning to make the market more transparent and efficient (and at the same time, of course, enriching the lawyers). It is Japan that is unregulated. Where the Federal Reserve has between 7,000 and 8,000 banking inspectors, the Ministry of Finance had only 400 to 600, and, according to Richard Koo, a senior economist at the Nomura Research Institute, «Of that, only 200 are considered any good.» Lack of financial supervision became such a scandal that the Diet removed this function from the Ministry of Finance in the late 1990s, creating a new Financial Supervisory Agency (to become the Financial Services Agency in January 2001). The new agency, however, has only 310 inspectors, most of whom hail from its inept predecessors. The U.S. Securities and Exchange Commission employs 3,000 inspectors, versus about 200 in Tokyo and Osaka, whose work is mostly perfunctory. In Japan's financial world, gangster payoffs, insider trading, juggled books, defrauding of old people by insurance companies and banks, under-the-table payments to bureaucrats, usurious interest, special accounts for officials and politicians at securities houses – anything goes. It's wild and woolly out there.

In place of regulation, the Ministry of Finance has drawn rigid boundaries around Japan's financial world in an attempt to limit its range. Rather than clean the sharks out of the lagoon, the ministry chose a smaller lagoon. Circling round and round inside their little universe, MOF officials neglected to learn the new techniques of wealth creation that are redefining finance elsewhere in the world.

MOF is dragging its feet in legalizing derivatives, and the red tape for granting stock options to employees of start-up firms is so lengthy that so far only a handful of companies have applied for permits to do so. In any case, it takes an average of thirty years to list on the Tokyo Stock Exchange, so stock options are not much of an incentive. Pension-fund management, at the leading edge of financial sophistication outside Japan, is only in its most primitive stages, and MOF is still in a position to order managers to buy nonproductive stocks and low-yield government bonds. With rules of disclosure nearly nonexistent, investors lack confidence in listed firms and, as a result, the over-the-counter market languished.

To put it simply, Japan failed to develop mature financial markets – and the expertise that goes along with them. This means that money does not make money. Another way of putting it is that Japan has very low productivity of capital. It is one of the oddest paradoxes of modern Japan that in a nation seen worldwide as a paradigm of «capitalism,» the bureaucrats in charge basically distrust money This may result from the fact that in the early postwar years Japan's bureaucrats found keiretsu banks effective (and controllable), and in time the Ministry of Finance became addicted to a system. One might say that MOF's love of the system is far greater than its interest in financial health.

Japan's low capital productivity begs another comparison with ancient Sparta. Plutarch writes that Lycurgus, the founder of Sparta, ordained that Spartans must use iron money. Given that iron was of so little value and yet so heavy, the best people could do was lay up stocks of it in their closets. After a while, they ceased to have much interest in acquiring wealth and instead devoted themselves to military glory. Plutarch points out that «being iron, it was scarcely portable, neither, if they should take the means to export it, would it pass amongst the other Greeks, who ridiculed it... For the rich had no advantage here over the poor, as their wealth and abundance had no road to come abroad by but were shut up at home doing nothing.»

Japan has stored up a huge pile of savings, but the money is iron, shut up at home doing nothing, and the nation is paying the price, with the Tokyo Stock Exchange stagnant for a full decade, a crumbling welfare system, and securities firms that lack the expertise to compete abroad. In this there is a valuable lesson in what really constitutes culture and tradition. Entrenched Asian elites are very fond of appealing to hallowed «Asian values» as a means of clinging to power. MOF's distrust of the free use and flow of money would seem to have all the sanction of Japan's tradition of control by elite officials. On the other hand, it's important to realize that for all its bureaucratic background, Japan also has a freewheeling mercantile history. Distrust of the free flow of money is actually something new, an aspect of Japanese tradition that was relatively minor until after World War II.

When the U.S. Occupation confiscated the zaibatsu assets from their owner families, the bureaucracy as we now know it took control of the government. Salaried officials feared the robber-baron capitalists of prewar times and used every means m their power to rob them of the power of their money. That was how the present system got going. Today, the reason MOF fears the free flow of money boils down to a simple question of control. Money is power, and the ability to decide how money is used and invested is what keeps Japan's bureaucrats firmly in control. That said, the oddest part of the equation is the amazing disdain the bureaucracy shows for money. The figures for debt, bad loans, failed stock markets, and so forth are staggering enough to keep the leaders of most other countries lying awake at night in terror. Yet Japan's government agencies seem curiously unconcerned. Like spoiled society girls who grew up on ample trust funds, Japan's officials have never really had to learn what money is. When they needed it, there was always more from Daddy.

Edo townspeople knew better than to distrust and disdain money. The novelist Saikaku warned:

Year after year the loss and senseless waste pile ever higher one atop the other: the blossoms of a merchant's flowering talents fall, his brocade robes are replaced by ones of paper, and finally, in the same way the seasons turn one to another, he is reduced to a faceless beggar. Consider all this and it should become apparent that for the merchant, in all his varied activities, there is simply no room for lack of heed.

Michael Phillips, an adviser to start-up companies in California, wrote a classic little volume in 1977 entitled The Seven Laws of Money. The Second Law was «Money has its own rules,» which meant that no amount of goodwill or cleverness gets you beyond the simple laws of supply and demand, income and outgo, profit and loss, compound interest, and so forth. He writes: «The rules of money are probably Ben Franklin-type rules, such as never squander, don't be a spendthrift, be very careful, you have to account for what you're doing, you must keep track of it, and you can never ignore what happens to money.» Yet for a while it became fashionable to believe in a mysterious new Japanese system that somehow transcended the Second Law. As Alan Blinder put it, «The amazing Japanese economy poses another challenge-one that has been barely noticed. I refer to Japan's challenge to received economic doctrine. Stated briefly and far too boldly, the Japanese have succeeded by doing everything wrong (according to standard economic theory). That should make economic theorists squirm.»

The question of whether there really are «laws of money» is one of the most hotly debated topics among economists today. Karel van Wolferen warns against taking this view too far. He says:

That [there are laws of money] is what neoclassical economists, in other words, the vast majority of contemporary mainstream economists, are telling themselves and want everyone to believe. Keynes never thought so. And it fits in with American ideology, which is rarely recognized as an ideology. What Alan Blinder is referring to is perfectly accurate: Japan is definitely a challenge to received economic doctrine. Blinder once pointed out to me that the reason why this doctrine has become one, and why it is now rarely challenged, is because it had been made to fit the Anglo-American experience amazingly well. The reason why money does not have its own rules, like physics, is because there is an important political dimension to it. This notion is anathema to mainstream economists, which is why you get so much certainty where none is warranted.

There is no doubt that countries can structure the means of production and the use of capital in many different ways depending on their political structures, with «Russian communism,» «Japanese capitalism,» and «Anglo-American capitalism» being only three of numerous varieties. In that sense, van Wolferen is correct in reminding us that economics does not have ironclad laws of cause and effect, like physics. By Western standards, Japan's banks are almost all bankrupt-yet they continue to function. Many other aspects of Japan's unique form of credit-ordering also baffle outside economists-and, most remarkably, despite the Bubble and all the pain it has engendered, the whole system is basically still intact, ready for the next period of economic expansion.

However, the meltdown in Russia and a decade of doldrums in Japan suggest that while cultural factors can make some difference, certain underlying rules of money do exist and will in time assert themselves. The interesting lesson to be learned from Japan is that the effects of an economy's defying «laws of economics» will not necessarily show themselves as classical theorists would predict. Instead, they go underground, re-emerging in surprising forms elsewhere. At a bank in Tokyo, you can make 10 plus 10 equal 30 if you like – but somewhere far away, at a pension fund in Osaka, for example, it may be that 10 plus 10 will now equal only 15. Or even farther away, implications of this equation may require that a stretch of seashore in Hokkaido must be cemented over.

The Ministry of Finance did not get away with ignoring all the classical rules, for the bankruptcy of pension funds, insurance companies, and banks, the stagnant stock market, six years of zero-to-negative growth, and millions of people in debt to loan sharks are cold, hard facts that cannot be ignored. The argument over whether there are laws of money has to do partly with what sacrifices you are willing to take to maintain an «unscientific» system. Japan is willing to drive its national debt to stratospheric levels, flatten its mountains and rivers, and bleed its savers dry in order to support its system. So the system endures.

Back in the seventeenth century, when Saikaku penned his racy stories of townspeople in the cities of Osaka and Kyoto, shopkeepers knew differently. In Saikaku s world, people had to repay debts, money earned interest, quick-thinking businessmen prospered, while their competitors went bankrupt. Even staid Confucianists understood these things. In 1813, the Confucian scholar Kaiho Seiryo wrote: «Everything under heaven and earth is a commodity. And it is a law of nature that commodities produce new commodities. From paddies is produced rice, and from gold is produced interest, and there is no difference between them. For the forests to produce timber, the sea to produce salt and fish, and for gold and rice to produce interest is a law of the universe.» Saikaku's sharp-witted shopkeepers and Confucian academicians alike would find today's so-called Japanese Model – where debts don't matter, money earns no interest, and no established company ever fails – absolutely incomprehensible.

This brings us to one of the most profound implications of the Bubble and Japan's financial troubles as the nation enters the twenty-first century: the source of these troubles does not lie in the economy or even in financial weakness per se. I'm definitely not predicting the collapse of Japan industrially – or even financially (although the strain is terrific). Neoclassical Western economists are very wrong if they believe that Japan is about to crumble. The entire system can continue for two reasons: strong resources, and what one could call «the sacrifice.»

As for resources, Japan has piled up tremendous industrial capacity as well as savings in the bank-and these can support the status quo for years or possibly decades to come. «The sacrifice» refers to the fact that a nonclassical economic system can indeed be sustained, but, when the system strays very far from reality, at an ever-increasing sacrifice. The question is: What is a nation willing to sacrifice? In Japan's case, the answer is: everything.

The process of propping up the system that created Japan's Bubble wreaks untold havoc on society. These days the trend among the more penetrating writers, both Japanese and foreign, is to analyze Japan's financial problems in political terms. I, on the other hand, see them as part of a «cultural trauma.» We are probably all talking about the same thing. Japan's financial system has fallen far, but it has a long way to go before real value asserts itself. In the meantime, the distortions of the financial markets will continue to manifest themselves as distortions in society and as depredations on the environment.

«There is a solid bottom everywhere,» Thoreau writes. «We read that the traveler asked the boy if the swamp before him had a hard bottom. The boy replied that it had. But presently the traveler's horse sank in up to the girths, and he observed to the boy, 'I thought you said that this bog had a hard bottom.' 'So it has,' answered the latter, 'but you have not got half way to it yet.»