(FORTUNE Magazine) – When it comes to economics, the award for the biggest liar on the planet ought to go to Japan's Ministry of Finance. For more than five years the MOF's bureaucrats have blandly insisted that the economy would soon be back on its feet, only to see it fall on its face time and time again. More recently, the MOF told U.S. Treasury Secretary Robert Rubin that sharp increases this year in Japan's trade surplus were a temporary side effect of recovery, to be followed soon by a strong pickup in Japan's domestic demand. Exporting our way out of a slump? No way. Not us.

The numbers tell a different story. Just-released statistics show that Japan's GDP actually shrank 2.9% in the second quarter this year, its worst showing in 23 years. The only sector that did well was exports, which grew 6.4%, and Japan's overall current account zoomed--up from about 1.3% of GDP earlier this year to close to 2.6% in August, a level Washington considers alarming.

It didn't take a crystal ball to see this coming. Last April, Prime Minister Ryutaro Hashimoto declared war on Japan's huge budget deficit by raising income and sales taxes while cutting government spending. That helped suffocate growth at home, as did the continuing shakeout in industries like finance and construction. At the same time, Japan's export powerhouses like Sony and Honda are soaring on the strength of a weak yen and their own restructuring efforts. "These guys at the Ministry of Finance will fool, lie, do anything until they are proven wrong, and then they just say 'sorry,'" says Richard Koo, an economist at Nomura Research Institute. "They told Rubin that the increase in the trade deficit was just temporary, but that makes no sense at all."

They definitely owe Rubin an explanation. Back in late 1995 the MOF promised to do the right thing--stimulate domestic demand, deregulate, and stabilize Japan's troubled banks--in exchange for the U.S. Treasury's help in managing the volatile and overvalued yen. Since then there has been some deregulation at the margin and the promise of more, but the tax increases and budget cuts earlier this year left U.S. Treasury officials shaking their heads.

The Clinton administration and the governments of other large industrialized nations in the G-7 want Tokyo to finally do its part to help the world economy. That calls for deregulating, stoking consumer demand, and soaking up more of the rest of the world's output. Few doubt that such a program is the best strategy for Japan, as well. Japan's budget deficit--7% of GDP--is less threatening than it appears because of the nation's record-low interest rates and status as the world's No. 1 creditor.

So what is Rubin to do? His deputy, Lawrence Summers, fired a shot across the MOF's bow when he told the Financial Times that he was "concerned" that Japan "achieve the domestic demand-led growth to which it's committed and avoid export-led growth that has been a hallmark of many Japanese recoveries." Diplomatically put--but currency traders read Summers' comments, probably correctly, as a threat to resume the Clinton administration's stealth campaign to drive up the yen, which had been the single most effective source of pressure on Tokyo until Rubin's deal in 1995. Rubin is unlikely to push up the yen today, because Wall Street could get nervous about the flight of Japanese funds from the U.S.

At the late-September G-7 meeting in Hong Kong, Rubin will undoubtedly ask Japan's Minister of Finance, Hiroshi Mitsuzuka, to prime the pump at home, and Mitsuzuka will do his best to say no. Prime Minister Hashimoto has staked enormous political capital on the fiscal rectitude campaign. And Japan has already set interest rates at record lows, to no avail. Rubin has few options indeed.

Had Japan's bureaucrats been less timid, their economy would have suffered a quicker, sharper recession years ago. Instead, only now does Japan seem to be experiencing the domestic contraction that has to precede a serious restructuring of the economy. The result: The sustained economic growth that Rubin--and everyone else--so fervently desires still hasn't begun. In the meantime, manufacturers around the world should watch out: Japanese exporters like Toyota and Canon will continue to come on strong. And that's no lie.

--Edward W. Desmond