At the end of last year there were many who feared that the crisis in East Asia could herald a global wave of deflation and ultimately depression.

Wall Street has seen record highs

There was even the mirage of a western stock market crash in late October. But those markets recovered and have scaled new heights ever since.

As a result there were some who argued the Asian crisis could not have come at a better time: just as it looked as though the United States in particular was beginning to risk some kind of inflationary boom, along came a useful influence to act as a depressant.

As a result it was not necessary to raise interest rates in the United States, and the steady boom continued in the English-speaking world while continental Europe maintained an equally steady economic recovery.

Japan proves the exception

Investors queue for cash after the collapse of Yamaichi Securities

All the signs of Japanese recovery that seemed to be apparent in nine months have petered out. A succession of reflationary packages have come to nothing, banks are in crisis and the financial system is unable to help revive the stagnant economy.

Nobody will borrow and few want to lend while consumers save as much as they can. Those who argue that the West is complacent have to use Japan rather than the financial crisis in East and Southeast Asia to support their arguments that the world could face disaster.

Japan dwarfs the economies of South Korea and Asean but is itself a victim of the fallout of their crisis.

Today it sells less to its neighbours, faces more competition from them and will lose some money as a result of its banks having made large loans to now bankrupt companies in the region.

Nightmare scenario

The disaster scenario is that this will cause a further downward twist in the Japanese deflationary spiral and trigger a major stock market collapse. That will ruin the banks because another large chunk of their assets will be wiped out.

What happens next is open to question. The world could survive a Japanese crash but maybe not if it triggers further reactions, first in China and the rest of the region and then in emerging economies around the world.

If that happens then the extraordinary valuations now seen in western stock markets will really appear extraordinary - and then there could be a global financial market collapse.

This outlook is not impossible but depends on many things going wrong together. There is a law of human nature which states that if anything can go wrong it will, but not one that insists that everything collapses together. Governments, even the Japanese, still have the time to make rational decisions.

Those decisions in Japan mean taking some risks - a major tax cut to revive consumer spending is one of them. Japan faces a problem here because its budget deficit is relatively large today and increasing it still further may seem dangerous.