Nazis, Debt Cloud Japanese Stagflation Debate: William Pesek

Commentary by William Pesek
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Aug. 6 (Bloomberg) -- Japan's ``next'' prime minister, Taro Aso, has made a name for himself with unfortunate comments. His latest ones are real standouts.

Aso, the newly appointed Liberal Democratic Party secretary- general and the man widely touted as next prime minister, made remarks likening the main opposition to Nazis. Offended leaders of the Democratic Party of Japan are asking for a retraction.

Why does this matter to investors? At a time when Japan's economy risks stagflation, leaders are distracted by petty bickering, name-calling and score-settling. It's hardly good news for the remaining Japan bulls out there.

The irony is that the 67-year-old Aso, a former foreign minister, was tapped by Prime Minister Yasuo Fukuda to stabilize his government's support rate. Doing so is necessary if Fukuda is to win backing for economic-stimulus efforts to keep Japan's longest recovery since World War II from ending in recession.

You have to wonder how Fukuda, 72, is feeling about that decision just a few days after reshuffling his Cabinet.

For journalists who love gaffe-prone politicians, Aso is a dream. In 2001, he said he would like Japan to become a nation where ``rich Jews'' want to live. More recently, Aso made jokes about Alzheimer's disease. In 2006, Aso said Taiwan garnered benefits from Japan's colonization efforts. It achieved something remarkable: He brought Taiwan and China together on an issue. Both governments denounced the statement.

Immediate Problem

Aso is already taking some wind out of Fukuda's sails; his notoriety was supposed to help fill them. Investors hoping Japan would be immune to global credit-market woes are being forced to reconsider things, and politics are a key reason why.

The arm of government matters more in Asia's biggest economy than in most developed ones. While banks reduced bad debt and many companies restructured in the early 2000s amid deflation, politicians haven't done their part to boost Japan's competitiveness. As global growth wanes, that will become painfully clear to those betting on a resurgent Japan.

The real question is what latitude Japan has to cushion its economy from global events.

The nation remains reliant on ultra-low rates, massive government borrowings and exports. Waning global growth is making it more likely Japan will slide into recession, Aso said yesterday. Not a deep recession, perhaps, yet Kaoru Yosano's first act as new minister for economic and fiscal policy was to warn of a ``downturn.''

Diminishing Returns

After reshuffling his Cabinet last week, Fukuda is under pressure to help consumers as food and energy costs rise. With the Bank of Japan's benchmark rate at 0.5 percent, there's little ammunition on the monetary front. Fiscal options are limited, too; Japan has the largest public debt in the developed world.

Efforts to boost growth are suffering from a case of diminishing returns. They aren't instilling in executives or consumers a belief that growth will accelerate. It's also important to show investors that policy makers have a plan to improve competitiveness and deal with an aging population.

Given Japan's record, today's trends aren't conducive to the fiscal belt-tightening Fukuda's 11-month-old government pledged.

``Japan is facing risks from cost-push stagflation because of external factors,'' Finance Minister Bunmei Ibuki said yesterday. ``Overseas economies, especially the U.S., are facing a similar situation and I'm concerned that this will create difficulties for exporters.''

Budget Balancing

The government claims it hasn't yet decided to allocate funds for a stimulus package. With Ibuki saying it may be difficult to achieve the government's goal of balancing the budget by 2011, there can be little doubt one is in the works.

That's a short-term fix, though. Japan's finances aren't doing the nation's growth prospects any favors. Neither are politics. Expect infighting over Aso's Nazi comment to distract Fukuda's government indefinitely when it needs to be working with opposition leaders to stimulate the economy.

The thing is, Japan finally has the functioning two-party system for which many observers have long waited. The Democratic Party of Japan last year won control of parliament's upper house, offering Japan something closer to the democratic process its constitution intended. The result has been political paralysis.

Moody's Investors Service in June raised the country's sovereign long-term credit rating one notch to Aa3 from A1. Analysts at Moody's cited ``expectations of continued fiscal restraint and consolidation,'' and they may regret it. When it comes to making the most of an economic recovery, Japan's current crop of leaders deserves scant credit.

Opposition leaders have done little more than stand in the way of ideas put forth by the ruling Liberal Democratic Party. That's presumably what Aso meant by his ill-conceived Nazi comment -- that the party would govern in an authoritarian manner if it took power, firmly resisting change.

Aso forgets that his own party is as resistant to change as any. Six years after recovering from its bad-loan crisis, Japan still hasn't figured out how to grow without free money, massive debt sales and an undervalued currency. Here, less hyperbole about Nazis and more focus on debt and stagflation would help.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net