Japanese asset price bubble
After the September 1985 Plaza Accord, the yen's appreciation hit the export sector hard. The government attempted to offset the stronger yen by drastically easing monetary policy between January 1986 and February 1987. During this period, the Bank of Japan (BOJ) cut the discount rate in half from 5 percent to 2.5 percent. Following the economic stimulus, asset prices in the real estate and stock markets inflated, creating one of the biggest financial bubbles in history. The government responded by tightening monetary policy, raising rates five times, to 6 percent in 1989 and 1990. After these increases, the market collapsed.
The late 1980s boom was artificial, caused by the Bank of Japan's expansionary monetary policy. The 1985 discount-rate reduction began the central bank-induced boom. Following this reduction, the Bank of Japan expanded the money stock by an average of 10.5 percent per year from 1986 until 1990, while the price-level remained stable.
The boom of the late 1980s encouraged consumers to spend and companies to invest as never before. From 1987 to 1990, private consumption increased an average of 5.6 percent per year while at the same time gross fixed capital formation increased by 10.63 percent per year. The economy was both consuming and investing more in the late 1980s because the central bank was distorting the interest-rate price signals from consumers to producers. This can only be sustained in the short run while the central bank pursues ever increasing rates of monetary inflation. When the central bank stopped the monetary expansion, the stock market dropped, investment dropped, and recession followedâ€”as Austrian business cycle theory predicts.
Japan lowered its interest rates between 1986 and 1987 to 2.5%, a historical low? Japanâ€™s central bank took on a loose monetary policy partially at the behest of the US government which convened the G7 at the Louvre Accord in 1987 in order to stabilize international currency markets and halt the slide of the US dollar.
Japanâ€™s gross consumer debt increased seven-fold from 9 trillion yen in 1979 to 67 trillion in 1991 (2). Per capita consumer debt reached $2985 in Japan, just below the $2915 of the US (2). Between 1985 and 1990, Japanese industrial companies raised some 85 trillion yen ($638 billion) through the stock market, at what were essentially free financing levels, fueling the biggest spending spree since 1945. In terms of the stock and real estate markets, the numbers were even more staggering. At the height of the bubble the stock marketâ€™s capitalization made up 42% of the entire global marketâ€™s capitalization, when in 1980 it had made up a comparatively meager 15%; Japanâ€™s market worth had increased to 151% of GNP, from 29% in 1980 (8).
 The Crisis
The Nikkei stock market index fell more than 60 percentâ€”from a high of 40,000 at the end of 1989 to under 15,000 by 1992. It rose somewhat during the mid-1990s on hopes that the economy would soon recover, but as the economic outlook continued to worsen, share prices again fell. The Nikkei fell below 12,000 by March 2001. Real estate prices also plummeted during the recessionâ€”by 80 percent from 1991 to 1998.
The unemployment rate rose from 2.1 percent in 1991 to 4.7 percent at the end of 2000. Although the unemployment rate may seem low by international standards, the rise to 4.7 percent is significant in Japan, given the cultural and historical precedent of lifetime employment and given that it was never above 2.8 percent in the 1980s. The official unemployment rate is also biased downward because the Japanese government offers "employment adjustment subsidies" to companies that maintain employees as "window sitters".
Between 1992 and 1995, Japan tried six spending programs totaling 65.5 trillion yen and cut income tax rates during 1994. In January 1998, Japan temporarily cut taxes again by 2 trillion yen. Then, in April of that year, the government unveiled a fiscal stimulus package worth more than 16.7 trillion yen, almost half of which was for public works. Again, in November 1998, another fiscal stimulus package worth 23.9 trillion yen was announced. A year later (November 1999), yet another fiscal stimulus package of 18 trillion yen was tried. Finally, in October 2000, Japan announced yet another fiscal stimulus package of 11 trillion yen. Overall during the 1990s, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen, and each failed to cure the recession. What the spending programs have done, however, is put Japan's government in poor fiscal shape. The "on-budget" government spending has caused public debt to exceed 100 percent of GDP (highest in the G7), and even more debt is apparent when the "off-budget" sector is included.
The Keynesian policy solution when the economy is in a liquidity trap is to have the government lend directly to businesses instead of creating liquidity in the banking system. Japan has the Fiscal Investment and Loan Programme (FILP), an off-budget branch of the Japanese government worth about 70 percent of the spending in the general-account budget. FILP gets most of its money from the post office savings accounts. Once they collect the money, the funds are allocated to borrowers through the Ministry of Finance Trust Fund Bureau and the bureau's various agencies. Much of this money was not allocated according to market-based consumer preferences, but to the most politically connected businessmen. Also, because the loans are often highly risky, Japan's fiscal condition deteriorates further. Once FILP and other "off-budget" debts are included, Japan's debt is estimated to exceed 200 percent of GDP in 2001.
Almost half of the $16.7 trillion in the April 1998 fiscal stimulus package was for public works. Then, in November 1998, $66.4 billion of the $196 billion stimulus package was spent on public works. Overall, between 1991 and 2000, the construction industry received orders from the government valued at 59,054.7 billion yenâ€”this sum is 30.12 percent of the total value of all construction industry orders for that period.
The political voice of the agricultural lobby is enhanced by Japan's electoral system, which, by failing to take account of the massive postwar shift of the population to the urban areas, makes votes in the sparsely populated rural areas worth more than those in the urban areas. This has resulted in a wide array of import quotas and price-support programs. Barriers to price adjustment, such as these, harm the market's ability to adjust to consumer demands and correct itself out of the recession.
The central bank has tried to reinflate, which has only further distorted the interest-rate price signals, slowing the market's ability to correct. Despite the massive interest-rate cuts, broader monetary aggregates have not responded because of the poor condition of the Japanese banking industry. For example, when the BOJ increased the monetary base 10 percent from mid-1997 to mid 1998, M2 + CDs increased only 3.5 percent. The asset contraction that the Japanese banks have experienced on their balance sheets has not only hindered attempts of the BOJ to reinflate but also has interfered with their ability to serve as financial intermediaries.
The collapse in real estate prices and the economic slowdown that has put many borrowers out of business have left Japanese banks with a huge overhang of problem loans. Japan's financial institutions are estimated by the Financial Services Agency to have 31.8 trillion yen in problem loans, and even this estimate is widely believed to underestimate the extent of the problem. In addition to these problems, banks that invested in the real estate boom have seen values fall 80 percent from 1991 to 1998. Banks invested in the stock market have seen the Nikkei average drop from 40,000 yen in 1989 to under 12,000 yen by March 2001. Because of the increase in bad loans with poor collateral and the fall in other asset values, increased funds injected from the BOJ or additional deposits from savers have been used to hold as cash reserves against bad loans, instead of being used to extend loans to worthy borrowers.
The government's answers to the problems in the banking industry were bailout funds and nationalization. In late 1998, a $514 billion bailout fund was set up, with $214 billion designated to buy stock in troubled banks, and $154 billion to nationalize, restructure, and liquidate failed banks.
The Japanese government has gone to great lengths to prevent the liquidation of the boom's malinvestments. Japan set up a 20-trillion-yen credit guarantee fund to ease credit availability for companies. The Economist Intelligence Unit profile indicates "funds disbursed under the programme are often going to companies that are not creditworthy and that would otherwise go bankrupt".
The government has also worked to prop up the stock market by purchasing shares when the Nikkei stock average drops below 12,000, to maintain Japanese banks' capital adequacy ratios as defined by the Bank for International Settlements. Banks are allowed to count up to 45 percent of unrealized profits on share holdings toward their tier-two capital; these ratios are in jeopardy whenever the Nikkei falls below 13,000 (EIU 2001). Artificially holding up stock prices hinders market forces from reasserting themselves, further delaying capital reallocation and economic recovery.
- Benjamin Powell. "Explaining Japan's Recession", Mises Daily, November 19, 2002. Referenced 2011-06-18.
- Benjamin Weingarten. "The Cause of Japanâ€™s Boom and The Reasons for Its Prolonged Bust" (pdf), Mises Institute Working Papers, Japanese Politics, 12/29/2008. Referenced 2011-06-22.
- Interview with Hiroyuki Okon, Winter 1997
- The Rise and Fall of the Japanese Miracle by Jeffrey M. Herbener, September 1999
- Japan Can't Inflate Away Its Woes by Jeffrey M. Herbener, October 1999
- Apoplithorismosphobia (pdf) by Mark Thornton, 2003, on the measures taken after the crisis
- The Japanese Bubble Economy by Mark Thornton, May 2004