Towards the abyss

Three years ago, senior Japanese industrialists publicly warned that the country's deflationary recession threatened to drag Japan and the world into a 1930s-like depression. That was avoided thanks to a booming United States economy and huge fiscal spending. The latest data, showing Japan falling back towards recession, represents a huge wake-up call.

Fatigue rather than a sense of crisis typifies most observers' view of Japan. Warning lights have been flashing for six months due to falling industrial production, but that has turned into a general malaise.

The arrival of reformist Prime Minister Junichiro Koizumi suggested the Government would finally pursue radical reform rather than persist with its failed pork-barrel demand stimulus. Mr Koizumi has told the electorate to expect pain, and his spartan message has tapped a rich vein of support. However, concrete initiatives have proven thin on the ground.

Since taking office, Mr Koizumi has back-pedalled on measures designed to force banks into writing off bad debts. His privatisation of the postal savings bank remains an idea. This was perhaps inevitable with upper house parliamentary elections due next month. But with a deteriorating international environment, the need for action is acute.

Above all, the Bank of Japan (BOJ) needs to loosen the monetary reigns. Despite returning to a zero interest rate policy, analysts reckon monetary conditions have not been as tight in any major industrialised economy since the early years of the depression. The idea that the BOJ should pursue inflation targets by printing money needs to be re-visited.

That could result in a sharply devalued yen. For Asian economies - and China in particular - that is deeply worrying. It was the yen's decline against the US dollar that arguably triggered the 1997 Asian financial crisis.