Boom and collapse: how the Japanese asset market collapsed in the lost decade

In the 1980s, the Japanese economy was the envy of the rest of the world, with average annual growth (measured by GDP) of 3.89%. The United States, by comparison, grew 3.07 percent.

From the book Devil takes the last word by Edward Chancellor, who takes stock of the major financial speculations and bubbles, stock prices in Japan in the 1980s rose more than three times faster than corporate profits. Around 1990, the Japanese real estate market was on fire, valued at over 2,000 billion yen, or about four times the value of real estate in the United States.

The price-to-earnings ratio (P / E) – a company’s share price relative to its earnings per share – was over 60 at the peak of the market in 1989. A high price-to-earnings ratio could signify that a company’s stock is overvalued. or that investors expect high growth in the future.

However, it was all too good to last. The bubble was going to explode. The country was quickly embroiled in one of its oldest economic crises – a 10-year slowdown that came to be known as the lost decade.

The beginning of fate

According to several economists, the bubble began around September 1985, when Japan and four other countries – France, Germany, the United Kingdom and the United States – signed the Plaza Accord to manipulate exchange rates. by the depreciation of the US dollar against the Japanese dollar. German yen and deutsche mark. In other words, the intention was to minimize the current account deficit of the United States, which hovered around 3% of GDP, while overcoming the negative growth rate in Japan and European countries.

What happened instead was that the value of the yen and the deutsche rose dramatically against the dollar. The yen soared as speculators bought the Japanese currency and sold US dollars.

As the yen appreciated, Japanese companies suffered heavy export losses as they had to sell their products in the United States at higher prices than before to make a profit.

This affected the economy, the main driver of its economic growth being its export surplus. GDP fell from 6.3% in 1985 to 2.8% the following year, leading to a recession.

The accelerator

In view of the loss of exports, the Japanese government decided to feed the demand for domestic products and services within the country.

To curb further appreciation, the Bank of Japan reduced discount rates (repo rates) to increase cash flow and market activity. The haircut fell from 5 percent in January 1986 to 2.5 percent until 1987. During this phase, the bank lent more money, so that more people could afford loans. low rate. The regulations were bad, leading to bad debts.

In May 1989, the bank rate was raised to 3.25%, the bank calling it a preventive measure against inflation. However, the economy continued to expand. The discount rate was raised again by 0.5% each in October and December of the same year, and twice as much in 1990 during March (1%) and August (0.75 %).

The money supply grew despite the hike in the bank rate and peaked around the second quarter of 1990. The last lightning strike for the asset-inflated bubble economy was on December 29, 1989, when the Nikkei stock index hit a record high of 38,916.

It wasn’t long before everything deteriorated, with the stock market losing nearly $ 2 trillion at the end of 1990. All that was left was ridiculously high house and stock prices.

The results

Following the stock market crash, land prices fell in 1991. This fall in asset prices seemed to have serious consequences for the Japanese economy. Urban land prices have fallen 1.7 percent from their peak in 1992, with six major cities most affected. Prices for commercial, industrial and residential land fell 15.2%, 13% and 17.9%, respectively.

As asset prices continued to decline, real income and household consumption fell sharply. Financial institutions suffered heavy losses due to the accumulation of non-performing loans. Most banks had sanctioned large loans backed by real estate, but with falling land prices, the value of assets held by banks as collateral fell.

The painful phase of low GDP growth and economic stagnation, dubbed the lost decade, continued until the 2000s. Whatever stimulus strategy or policy proposed by the government, the economy remained cold. People had lost faith in the banks, viewed them as unstable and therefore chose to keep their money locked away at home.

Policies were finally revised in the 2000s, with the government deciding to bail out banks with taxpayer money to clear accumulated debt and increase the money supply.

The causes

While there is unanimity among economists and historians on the catalysts that caused the lost decade, the causes are still a matter of debate. Most of them agree on one of these factors – record interest rates fueling the stock market, real estate speculation causing valuations to explode and general complacency. Japan was found guilty of considering itself invincible because of its strong position in international financial markets and also because of the takeovers of foreign companies by Japanese firms.

According to Nobel laureate Paul Krugman, Japan found itself caught in a liquidity trap where consumers kept their savings over fears the economy would go from bad to worse. Such a feeling has led to an overall decline in the productive capacity of the economy.

Other researchers have looked at how a collapse in land and stock prices reduced overall household wealth and disposable income, which could have increased demand.

A 2017 research paper attributes Japan’s economic woes to a “vertical investment economy,” blaming it on an aging population coupled with a slowdown in the country’s innovation ecosystem.

Lessons learned

  • The Bank of Japan did not act in time to nip the crisis in the bud. He should have closely watched the currency’s position vis-à-vis other major currencies during the appreciation process and also during the fall in the discount rate.
  • Don’t underestimate or forget how far people can stretch the markets. Plus, there’s almost always a price to pay for overconfidence.
  • Spending may not be the key to building public confidence. Japan has invested a lot in development projects, but this has hardly convinced people to put their money in the bank.
  • Valuations are important, but don’t necessarily work as a timing tool. The market is defined by volatility and therefore does not depend entirely on mathematics. Back it up with your common sense and intuition.
  • Don’t make decisions based on “certainty”. Many were certain that Japan was overtaking the United States as the largest economy, but as the yen continued to appreciate, the whole game shifted.
  • Try not to invest your entire corpus in a single asset class. Japanese government bonds gave annual returns of over 6.1% from 1990 to 2015, moving faster than the stock market.

About Vicki Davis

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