Don't bank on Utopian balance

NOW

Many will recall the 1960s and 1970s, when Britain seemed doomed by balance of payments problems. Nerves were stretched each month by fears that a big trade deficit might mean a run on the pound, higher interest rates, even an emergency budget. If only we could crack the balance of payments problem, they said, all would be well.

But I am of course playing a little economic joke. Utopia is in fact Japan - the industrial world's most troubled economy of the last 10 years.

Japanese industry can sell to the outside world but seems incapable of tackling its daunting domestic problems. A couple of weeks ago, business forecasts seemed to provide a ray of light. The recession may be ending and the decline of the last three quarters 'bottoming out', according to economics minister Heizo Takenaka and non-politicians too.

But Takenaka had to back-pedal last week, as figures showed services output dropping 4.5% on the month, the biggest fall since 1989. True, exports are rising yet again. But a rising current account surplus is liable to strengthen the yen. And just as a falling currency can, as the saying is, import inflation, so a strengthening currency can import deflation, already Japan's perennial problem.

Imports still cheaper in yen terms can make prices fall even faster, causing already reluctant consumers to postpone purchases. Ominously, the Japanese savings rate is on the rise.

However, it is the banks that are the biggest threat to financial stability - along with the major life insurance companies. Three of the latter have had their bonds downgraded to junk status. And even government bonds, though above that category, now have a status below Botswana because of the huge levels of official debt.

The date to watch is 31 March, when the banks, many of them insolvent in reality, have to put a market value on their absurdly large holdings of equities (which would not be allowed in other countries). To make matters worse, that is also the date when the government withdraws its guarantees for time deposits held in banks by businesses.

If that rule is adhered to, there may be runs on the banks. A survey has shown firms already moving their cash. The whole banking sector is riddled with bad debts that are not properly acknowledged, let alone accounted for. Estimates of the real figures range from £225bn to £1,000bn.

Meanwhile business failures rocket, loading even more bad debts onto banks. Unemployment mounts and government action - such as recently backing a rescue of a major retailer - looks whimsical and ineffective. So drastic is the banks' position that nothing short of nationalising them - an improbable move - is likely to restore stability.

There lingers an optimistic belief that Japan's problems are so alarming that the government will have no choice but to introduce bold reforms whoever gets hurt. But a country that has dodged urgent reforms for a decade, and where the electorate slavishly elects the same party to power, whatever the crisis, is unlikely to change.

An immediate fear for the outside world is that a tide of red ink on March 31 could force Japanese businesses and investors to repatriate their overseas assets. That could devastate US Treasuries and send US interest rates soaring.

We should know by April 1 - appropriately.