Formation of the Bubble

Economists often argue that

post war times always bring

about an economic prosperity

on account of increased

consumer demand and

government spending. After

Japan’s defeat in the World

War II, it witnessed an era of

the “economic miracle” and

became one of the world’s

fastest growing, and biggest

economies of the world.

Riding on a high tide Japan

had managed to evade the

Arab Oil shock of the 1970’s

and in the early 80’s emerged

as an economic power

following which the

government sought to

liberalize the yen for world

trade and it appreciated

sharply against the dollar.

Japan has always had a high

savings rate among its

people and a trend that was

emerging in the late 1980’s

was of easy credit being

available to people to make

risky investments in real

estate driving property

prices to unsustainable

levels. This was particularly

worrisome because of the

involvement of the banking

sector in giving these loans.

Not only banks but Non-

Banks, which at the time

were borrowing from the

banks, were giving even

riskier loans. The artificial

demand inflation, toxic

loans, and an appreciating

1990’s: The Lost Decade of Japan By: Shreyans Gangwal

Balance – Sheet

Recession

Economist Richard Koo

analyzed the problem of

Japan as not completely

monetary, fiscal or

structural; rather a

balanced-sheet kind of a

recession. He said that a

crisis that generates losses in

financial assets/wealth

causes both firms and

households to place priority

on repairing their balance

sheets. The low interest rate

funding by the government

to undo the damage was

being used to get rid off the

debt on the balance sheets

rather than increased

spending and furthering the

debt and in such kind of

cases increased fiscal policy

measures to buy off debt

from companies and

households stands more

effective.

The drop in prices on Japan’s equity markets

combined with a sharp decline in land prices

generated losses of about ¥1,500 trillion ($14

trillion) or roughly three times Japan’s gross

domestic product at that time. Nikkei Index had

fallen by more than 50% in a year.

yen were

showing early signs of a real-

estate bubble. Government

responded in 1989 by raising

the interest rates from the

levels of 2.5% to 6% followed

by subsequent rise in 1990

due to the Oil Price’s

appreciation scare following

Iran’s invasion of Kuwait.

This was the beginning of the

bubble burst when property

prices plummeted. The Nikkei

index which had peaked to

the levels of 40,000 in 1989 fell

dramatically to over 50% in

one year & more than 78% by

the end of 2002. The crisis

began as a financial crisis and

ended up in the overall

slowdown of the Japanese

economy.

Causes

Initially the asset price bubble

was primarily fuelled by the

easy credit and rampant

crowd mentality to buy any

available land. This was the

time of the high tide.

Excessive savings of the

Japanese people, following

the regulatory policies, was a

cause of the increase in

purchases. The banking sector

was closely related and a

major problem was because of

the close ties between the

corporations and banks where

loan’s directly went into real

estate and the returns went

into the banks’ assets allowing

for more loans. This circular

trend had contributed to the

inflation of the bubble. Non-

banks which borrowed from

the banks had also started

giving risky loans and the

scheme had become so large

that customers were flocking

NB’s to snatch whatever land

was available. This recession

was triggered by the interest

rate hikes and was to over a

decade due to poor policy

measures by the government.

There were also the structural

problems in the economy.

Government had not opened

up the market and

deregulation wasn’t allowed

for a long time inhibiting

competitive market driving

forces. The policymakers time

and again misunderstood the

situation making the wrong

policy decisions.

Impact

Japanese Banks are allowed to

hold equities as a part of their

capital base. The stock market

which had peaked in 1989

(Nikkei Index was at all-time

high levels of 40,000) had

crashed to more than 78%

(8700 levels) by the end of

2002. The unrealized capital

gains of these stock holdings

had dropped from $355

billion to about $40 billion in

2002 reducing banks’ capital

reserves. Resident’s & land

values had fallen by about

20%. By the end of 1998,

government had invested

about ¥60 trillion yen, which

is about 12% of the GDP, to

support the banking system.

Out of the 21 major financial

institutions in Japan in 1990,

only 14 still existed in 2000-

the rest were either merged

into larger entities or simply

dissolved. The stock market

never regained the peak levels

from the 1980's, and

continued to decline until well

into the 2000's.

Government

Interventions

Till today people while

discussing the US sub-prime

crisis cite Japanese poor policy

decisions which caused the

recovery over a decade which

is still

arguable. The Japanese debt

as of June 2013 had touched

the levels of ¥1000 trillion yen.

Unlike the great depression,

wherein the economy had

crashed suddenly, this was

more of a gradual decline.

There were structural defects

in the system; government for

long had shielded the markets

against the natural order of

supply and demand and they

responded to inflation by

increasing the interest rates

drastically. In 1991, the

minister of finance had to

recognize the failure of about

10 small banks seeking major

banks to assume their

liabilities. There were fiscal

and monetary blunders. There

was a time when the

government had introduced

zero-interest rate policy to

further consumer demand

and end the recession and the

debt sheet climbed up levels

of 167% of the GDP. In 1995

some signs of recovery started

popping up and not

comprehending the delicate

state of the economy govt.

was back on fiscal

consolidation measures trying

to reduce their deficit and the

economy was thrown back

into recession again. (This was

the time of the Asian Crisis of

1997)

Recovery &

Lessons

The recovery which could

have been possible by 1995

was prolonged to over a

decade and still haunts the

Japanese economic growth. In

1990 there was great

expansion in the mining

industry and when the

artificial boom ended the GDP

growth rate, by industry

sector, was worst in the

mining industry, followed by

manufacturing, and then

wholesale and retail and

finally, the service industry

had experienced the smallest

contractions. When Japan had

announced an early financial

rescue package, it placed

stringent

conditions on the assistance

that banks were unwilling to

accept and the result was that

the banks ignored the package

and tried to bolster their

balance sheets by not lending.

This was seen as worsening

the economic conditions for

the country. Comparing it

with the current US debt crisis

this was different as the

defaults in Japan tended to be

on commercial property

rather than that on private

residences and unlike sub-

prime lending this was more

of relational lending to the

corporates where the loans

were extended without due

diligence. But what had

initially started off as a

banking crisis developed into

an economic stagnation

wherein the lower commercial

profits caused more loans

turning bad and the

depression coupled with poor

policy measures led to the loss

of a decade.

References

http://www.mo.t.u-tokyo.ac.jp/seika/files/WP04-08motohashi1.pdf

http://aparc.stanford.edu/research/2033/

http://fpc.state.gov/documents/organization/125542.pdf

http://mises.org/daily/1099