The strength and direction of the U.S. economy may depend increasingly this year on Japan, which remains mired in recession.
"As the world's second-largest economy, Japan matters in all sorts of ways," said Edward Yardeni, chief economist at Deutsche Bank Securities in New York.
Unless Japan pulls out of the severe recession of the past year, risks will increase that the United States could eventually slide into a downturn itself, he said in a recent report to clients.
That would probably mean heightened credit risks, a worrisome prospect for bankers and investors in bank stocks.
On the other hand, a Japanese recovery would boost worldwide demand, particularly for commodities. This would help other economies and reduce the risk of deflation.
Japan's new fiscal year, featuring a new round of tax cuts, began last Thursday, prompting economists to take a fresh look at business conditions there.
Recently, some observers have detected what they believe are fledgling signs of recovery in Japan, such as a drop in the rate of business failures, after bankruptcies last year hit their highest level since World War II.
That development probably reflects the enormous amount of stimulus from the Japanese government and central bank, but Mr. Yardeni and some others doubt that it also signals a recovery.
"Government spending is the only current source of economic strength" in Japan, according to economist and money manager A. Gary Shilling, who heads his own firm in Springfield, N.J.
"The drop in bankruptcies means very stimulative monetary and fiscal policies have eased the pain," Mr. Yardeni said, "but the real issue is economic restructuring, which Japan has only just begun. The same is true in Asia generally."
"Bankruptcies have declined in recent months, but that is because the government has basically been writing checks to bail out small to medium- sized companies," said Sung Won Sohn, chief economist at Wells Fargo & Co.
"Without that, the bankruptcy rate would be skyrocketing at this point."
Despite fast money supply growth and interest rates near zero, the Japanese economy shrank 3% last year, according to the most recent data. Japan's industrial production dropped an unexpected 0.6% in February.
Meanwhile, as unemployment has risen, consumer spending has plunged. Household consumption fell 5.7% in February from the previous month-and 4.7% from a year earlier-to the lowest level in 13 years.
The figures suggest Japan may be in a "liquidity trap," Mr. Yardeni said. "Not only are the banks not lending enough to revive economic growth, but consumers are holding rather than spending the economy's liquidity."
Mr. Sohn, who visited Japan last month, said people's confidence is extraordinarily low, with a general feeling among the public that the best and perhaps only option is to save, not spend.
At the same time, banks remain "extremely gun shy" about lending. "I am still expecting the Japanese economy to contract further in 1999 as a whole," he said.
That is disappointing news far beyond Japan, since its business activity accounts for 70% of the East Asian regional economy.
If Japan remains in a rut, Mr. Yardeni said, another round of regional currency and economic problems could begin this year.