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
Japans defeat in the World
War II, it witnessed an era of
the economic miracle and
became one of the worlds
fastest growing, and biggest
economies of the world.
Riding on a high tide Japan
had managed to evade the
Arab Oil shock of the 1970s
and in the early 80s 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 1980s
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
1990s: 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 Japans equity markets
combined with a sharp decline in land prices
generated losses of about 1,500 trillion ($14
trillion) or roughly three times Japans 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 Prices
appreciation scare following
Irans 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
loans 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
NBs 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 wasnt 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. Residents & 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