World deflation - led by Japan Japan The complacent optimism of capitalist consensus is fast disappearing. At the beginning of this year, the general view about the world economy was that US growth would slow gradually to about 3% from 5%, Japan would pick up a little to about 2% and Europe would trundle along at about 2.5%. The US central bank, the Federal Reserve, would cut interest rates to ensure that any slowdown would not mean a loss of investor confidence or consumer demand. Well, January seems like eons ago in global economics. After a non-stop spate of warnings about lower profits from the main US corporations and the release of economic data each day that showed a weakening economy, US stock prices have plummeted. Michale Roberts analyses how all this is affected by the growing problem of deflation in Japan. The complacent optimism of capitalist consensus is fast disappearing. At the beginning of this year, the general view about the world economy was that US growth would slow gradually to about 3% from 5%, Japan would pick up a little to about 2% and Europe would trundle along at about 2.5%. The US central bank, the Federal Reserve, would cut interest rates to ensure that any slowdown would not mean a loss of investor confidence or consumer demand.Harold Wilson once said that a week was a long time in politics. Well, January seems like eons ago in global economics. After a non-stop spate of warnings about lower profits from the main US corporations and the release of economic data each day that showed a weakening economy, US stock prices have plummeted. And it's not just been the so-called hi-tech stocks, but also all the mainstream company stocks as well.The 60% drop in the value of share prices in the last year has meant that American households have lost $3trn in financial wealth from their peak at the beginning of 2000. At that time, nearly one-third of all household assets (including property) were held in shares. Americans still have a lot more in the value of shares than they had five years ago, but the shock on the psychology of middle-class households is palpable. They are going to save more and spend less. As a result, the US economy is going to slide even further.And US companies are also suffering. According to the latest figures provided by the Federal Reserve, corporate profits are now falling at annualised rate of 26%. Although they are cutting back on investment spending, the drop in profits means that companies have less profit to reinvest. So they are borrowing even more. US companies have never been more in debt and have never spent so much more than they can raise in revenues. Their cash deficit has now reached over 5% of GDP. Companies are going to have to cut back even more on investment and production in order to narrow that borrowing gap and many will go bust. That means lower investment and economic recession on the way.The coming slump in the US is already mirrored across the Pacific in Japan, which has been stagnating since its stock market collapsed at the end of 1980s. The bursting of that bubble has continued taking out Japan's stockbrokers and banks by the dozen and bringing down the likes of Barings in the infamous 'Nick Leeson' rogue trader scandal. Now the Tokyo stock market is at a 16-year low. It's the future for Wall Street.A stagnant and deflating economy, the stench of scandal and corruption, a plunging yen and Nikkei - it's all doom and gloom in Japan. Prime minister Yoshiro Mori's short reign as Japan's political leader will probably be over by the time you read this. And it is getting closer to the end game for those he represents - the ruling Liberal Democrats. They are just like the Italy's old Christian Democrats were back in the mid-1990s. The people who run the Liberal Democrats were collaborators with Japanese military machine during the Second World War, but were reinvented and rehabilitated by the Americans afterwards in order to keep Japan safe from 'communism'. And, along with the American military, they helped to impose near slave labour conditions for Japanese workers and the atomisation of the trade unions.Now they are engulfed in scandal after scandal and seem brain-dead when it comes to solutions for Japan's economic malaise. Under the Mori administration, we've had former construction minister, Eiichi Nakao forced to resign after being accused of accepting bribes to handing construction contracts. Then Kimitaka Kuze, a top banking regulator, resigned after not declaring alleged donations from various financial institutions he was supposed to be regulating. Then Mori's own cabinet secretary, Hidenao Nakagawa was found to have close connections with an extremist crime syndicate and was accused of leaking details of a drug investigation to his mistress. More recently, the Minister of Economic Affairs, Fukushiro Nukaga, had to resign after being accused of taking a bribe from insurance company KSD, a beneficiary of government subsidies. And when foreign ministry official, Katsutoshi Matsuo was fired for embezzling government funds to buy racehorses named after his mistress, it badly Indeed, one of the reasons Mr Mori has survived as long as he has, despite having the lowest popularity rating ever for a PM, is because the LDP does not know who to replace him with. And the leading candidates in the LDP's factions are not sure they want to take up the poisoned chalice and take the bad medicine of heavy defeat in the upcoming Upper House elections this summer.What's wrong with Japan? Everybody knows about Japan's huge public sector debt accumulated over the last decade or so, as gross national product has stagnated and deficit after deficit has been run up as the politicians tried to spend their way out of the economic stall. And whoever takes over from Mr Mori will no doubt deliver yet another 'supplementary fiscal package' to try and kick-start the economy before the elections.But just as a junkie gets less and less 'high' from each new 'fix', so each new fiscal package has had less effect on stimulating the economy than the last. The only result has been that Japan now has the largest gross public debt to GDP ratio of any country in the OECD, currently at 130%. The past response of Japan's politicians has been to point out that, when public assets are taken into account, net public debt is only 60% of GDP. But that assumes that these assets are worth anything. As they are mostly the product of loans by public agencies to 'pork barrel' projects favoured by leading politicos over the last 20 years, the value of much of these assets is likely to turn out to be fictitious. Indeed, if you add in local government debt and the huge liabilities of state pension funds (not backed sufficient revenue flows over the next 20 years), then the public sector debt ratio is more like 250% of GDP. Even finance minister Kiichi Miyazawa has now admitted that Japan's fiscaAnd it's not just public sector assets that are bogus. Japan's banks have lent money in a big way to Japanese companies and, by most realistic reckonings, there is now something like Y60trn ($50bn) of non-performing loans on their books. The long economic stagnation has mainly crippled Japan's small and medium-sized companies. Their average net debt to equity ratio is 165% while the large company ratio is about 93%. The banks are being squeezed in all directions with huge bad debts and falling share prices that have turned their profits on equity holdings into lossesEasy money, fiscal stimulation and stock market support funding - it's the same old formula from the political mafia. It hasn't worked before and it won't work now. Japan remains locked into a downward deflationary spiral of falling prices, stock markets and currency. And it's a prospect not just for Japan, but also for the OECD economies. The US is heading towards a Japanese-style bust at the rate of knots. The Asian 'tigers' are being dragged down by the US slowdown and Japanese stagnation. Latin America is also heading downwards. Argentina is struggling to meet its commitments to the IMF without being forced to devalue its currency. Mexico is beginning to lose out because its major export market, the US, is slowing down. And Brazil will face problems if the other Latin American economies head into recession. In Europe, Turkey is already a busted flush and going into slump and Poland is also failing fast. European leaders seem to be maintaining their complacency. European growth is still trundling along at about 2.5%. But it won't last if the rest of the world collapses. This year, Italy and Britain go to the polls. Next year, Germany and France do. Just as President Bush and PM Mori are finding it difficult to keep capitalism on track now, so will Messrs Blair, Berlusconi, Schroeder and Jospin find it increasingly tough over the next year.