Just over a decade ago, Japan was considered a serious challenger to the US for global economic supremacy. The Japanese industrial juggernaut rolled its way across the globe throughout the 1980s, decimating whole sections of US and European industries and sparking a hysterical campaign in some quarters about the new "yellow peril".

Japanese banks and corporations, sitting atop a sea of credit, stoked the Nikkei Stock Average to a record high of 38,915 in 1989 and financed a tsunami of capital, which swept away trophies of US capitalism like the Rockefeller Center and Columbia Pictures.

In 1987, the total value of Japanese land was estimated at 4.1 times that of the US (which is 25 times the size of Japan) and the Imperial Palace grounds in Tokyo were theoretically worth as much as all of Canada. By 1988, the world's 10 largest banking organisations were headquartered in Japan.

Current Tokyo governor, Mr Shintaro Ishihara, summed up the feelings of many when, in 1989, he said that technology, manufacturing and economic power "were shifting from the West to the East".

Things look very different today. Like air leaking out of a huge balloon, the value of Japan's assets has been shrinking for a period longer than the past 10 years. Land prices in the country's major metropolitan areas have plummeted by more than 60 per cent since 1990, and the Nikkei Stock Average slumped to 9,504.41 on September 17th - its lowest level since the early 1980s.

Banks are weighed down with soured loans and investment portfolios linked to the shrinking stock and property market. Fresh debt bubbles up faster than the financial sector can write it off.

The economy has spent most of the decade on government life support, leaving future taxpayers saddled with the developed world's worst public debt - at 130 per cent of GNP. Unemployment has reached a post-second World War high of 5 per cent and Japan is the first peacetime economy since the Great Depression of the 1930s to be gripped by deflation after two straight years of decline.

Many blame a greedy financial sector, loosely supervised by the Ministry of Finance, for the collapse of what is called, with wearisome regularity, the "bubble years". Ordinary Japanese have been paying ever since in negative equity, declining wages and job restructurings. Hopes that the worst was over took another blow last month with the news that GDP for the April-June quarter fell 0.8 per cent - or an annualised 3.2 per cent.

Even before New York's twin towers collapsed on September 11th, recession was looming over Japan and few seem to know how to stop it, least of all the economic policymakers who have spent the past decade rummaging around in the Keynesian box of tools - apparently without much effect.

Interest rates are at zero but few are borrowing. A series of huge public works budgets have helped keep the economy ticking over at about 1 per cent a year but have failed to bring it back to health, while at the same time propping up the construction and farming industries. And with the US economy turning south, Japan's traditional route out of trouble - exports - is effectively blocked.

The puzzling thing for many observers is that many of the country's economic indices are strong. It is still a manufacturing powerhouse with a massive export surplus and stockpile of foreign reserves. And, unlike in the US, people still save in Japan - a country with the highest personal savings rate in the world. BusinessWeek magazine says that, with $2.2 trillion (€2.39 trillion) in deposits, Japan's postal system is "effectively the biggest bank on the planet".

Not surprisingly, economists have lined up to put the blame for this mess on consumers. If only they would loosen their grip on this huge pool of savings, Japan could spend its way out of recession, they say. But consumers are having none of it.

Already living in cramped housing stuffed full of appliances, most are wary of government assurances that pensions and welfare systems are secure. Few are willing to invest in a declining stock market and, with prices dropping 0.5 per cent last year, even keeping your money under the mattress brings a better return than the banks.

With a sclerotic ruling elite dominated by the Liberal Democratic Party (LDP) and basically unchanged since 1955, political will to take on the country's problems seemed largely absent until the election of Prime Minister Mr Junichiro Koizumi earlier this year.

Mr Koizumi represents the beginning of a consensus of sorts that Japan's problems, particularly the bad loans that riddle the financial system, require major surgery rather than a few aspirin. He has staked his political career on a pledge to clear up the estimated 30 trillion yen (€270 billion) to 100 trillion yen in bad loans, and a Thatcherite bout of public spending cuts and sell-offs of the "inefficient" public corporations that run airports, highways and post offices.

However, in a political system dominated by bureaucrats, Mr Koizumi does not wield the sort of power Mrs Thatcher had. Many doubt the ability of a man who rose unheralded through the ranks of the LDP to take on the kingpins that dominate the system, and there is much trepidation about the fallout from Mr Koizumi's reforms, should he, by some chance, succeed. Is Japan ready for the sort of problems another million or more unemployed will bring? And can the country pay for the welfare of its ageing workforce?

There is another school of analysis claiming, despite the problems, Japan's economy is fundamentally sound. Tokyo-based Irish economist Mr Eamonn Fingleton says Japanese manufacturers escaped the whirlwind visited on the financial sector.

"Japan is now exporting more capital in real terms than any nation since America's days of global economic dominance in the 1950s." Although he claims the country's leaders are loath to draw attention to Japan's performance for fear of fanning a protectionist backlash, figures show that "in the first nine years of the 1990s, Japan's net external assets jumped from $294 billion to $1.15 trillion. Meanwhile, the US's net external liabilities rocketed from $49 billion to $1.54 trillion."

It is an argument that looks weaker, however, as some of the country's largest manufacturing concerns including Fujitsu, Matsushita and Hitachi, as well as a host of smaller makers, struggle or go under - dragging with them the lives of many who put their faith in the country's ailing postwar system. Despite a decade of slump and misfires, the fear is that with another recession looming, the worst in Japan is yet to come.