WASHINGTON - The trade agreement reached last month by the United States and Japan averted a wider trade war between the world's two largest economies, which could have rattled global financial markets.
With the two nations experiencing almost stagnant economies, officials on both sides of the negotiating table knew they could not afford to risk piling on losses in their export businesses. Thnough Japan depends on trade more than the United States, the dangers of upsetting global currency and other markets were real.
Despite the agreement, Japan remains trapped in a deepening swamp of domestic problems that are proving too much for the weak and divided government to solve. The economy was almost flat during the first three months of the year, and no quick turnaround is in sight.
Japan's economy is laboring under the heavy weight of a banking crisis and credit crunch, which are turning out to be more burdensome than the savings and loan mess that crippled U.S. financial institutions in the late 1980s.
Officials in Japan's Finance Ministry have estimated that Japanese banks are carrying about $475 billion of problem loans on their books. That is probably a conservative calculation, and the actual amount could be far greater. As a result, banks are not offering credit to business, cutting off the fuel that enterprises count on to expand.
Japanese banks were big creditors during Japan's heady real estate days, when land prices soared. Now, with falling land prices bankrupting developers, the banks find themselves with sour loans and collateral they can't unload.
Unlike U.S. banks, Japanese institutions are also large direct investors in stocks - another market that has taken a beating. Since Jan. 1, Japanese stock prices have fallen 25% and left banks with mounting portfolio losses. Since peaking in December 1989, the Nikkei stock index has plunged 62%.
The possibility is growing that Japan will slip back into recession, and the government is bracing itself for possible bank failures, according to analysts at Paribas Capital Markets in London. They warn: "A major bank failure could have severe economic and financial consequences," with stock prices dropping further and possibly sparking a run on the banking system as frightened depositors withdraw funds.
Analysts say there is little Japan can do to bail itself out quickly. The Japanese public is no mood to approve a massive taxpayer bailout for the powerful banking sector, and the government is running budget deficits that make officials fearful of stepping up spending.
Interest rates are already low in Japan, so cheap credit does not offer a path toward stimulating growth. The Bank of Japan's discount rate for bank borrowings is only 1%, compared to 5.25% in the United States.
Interest rates are low because prices are actually falling in Japan. Its huge trade surplus has pushed up the yen in exchange markets, making imports cheaper. But the strong yen is slamming corporate profits, forcing the big exporters to move operations overseas and keep a lid on hiring at home.
Meanwhile, consumers are hindered from enjoying their buying power in a society that discourages leisure and keeps prices artificially high with supply networks rigged to keep out foreign goods. The Japanese are a nation of people with golf clubs and cars but few public links to which they could drive.
Mr. Davies is Washington bureau chief of Munifacts, an affiliate of the American Banker.