Bursting the Japanese Economic Bubble


After World War II the much vaunted Japanese Imperial Army was humiliated by the Allied Powers led by the United States of America. The Americans occupied Japan but they did not conquer the Land of the Rising Sun; instead the U.S. government taught the struggling government that democracy is much better than the antiquated monarchical system. Instead of wallowing in self-pity the Japanese began to adopt democratic principles and created a free market that would compete with the rest of the world. A few decades after the war, Japan transformed itself into one of the most formidable economies not only in Asia, but the world. Yet in the decade of the 90s the country of the flaming red sun became the victim of its own success. Since that time onwards the current history of Japan can be understood in the way the government, private enterprise and its people tried to turn things around after the economic slump of the 1990s.

Background

Japan was always a major player in the Asian region. This is the reason why the Japanese Imperial Army joined Hitler’s Nazis – so that it can increase its strength in the said region. This is important to understand why the Japanese will never be satisfied with a mediocre performance. There is something within Japanese culture that pushes its people to strive for excellence. This drive together with other factors will help catapult Japan into the elite club of highly industrialized nations in the world.

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But the path towards economic power was not a smooth one. Japan had to undergo centuries of political instability that would cause a lot of bloodshed and disunity (Hyma & Stanton, 2000). Considering the fact that Japan is composed of many islands, it is safe to argue that regional leaders vie for control within their own territories and nation building is farthest from their mind. All of that changed when a powerful family began to consolidate power and established one of the most enduring dynasties in human history. The Yamato dynasty is so resilient that the sitting Japanese emperor is descended from this royal line.

Post-War Years

For the Japanese people, Japan’s defeat in World War II can be viewed as a blessing in disguise. There is no way to lessen the impact of the atomic bombs released over Hiroshima and Nagasaki but in the overall picture, the defeat freed the people from the narrow-mindedness of the imperial court. While the United States was there to act as the patient tutor and guide when it comes to teaching democratic ideals, the presence of U.S. forces in Japan created fundamental and radical changes in Japanese policies.

As mentioned earlier, prior to the advent of World War II, money and technological breakthroughs were focused on building the empire of the rising sun. This means that upgrading the army and then diverting funds to provide for its upkeep. The rest of the Japanese population continued to live an agrarian lifestyle while the elite continued with their self-improvement. When the United States occupied post-war Japan the Japanese could no longer build another mighty army and so all resources were being used for nation building (Hyma & Stanton, 2000). The democratic system that was installed encourages everyone to participate and so after only a few decades after being hammered to submission by invading forces, Japan began to rise from the ash heap of defeat to forge a new economy.

Rapid Industrialization

There is no need to get into details. The whole world is witness to the rapid growth of the Japanese economy. In the post-war years the West belittled what the Japanese companies can achieve in the long run. After all the best and the brightest engineers and scientists are in the West and not in Asia. But the Japanese people were challenged by that assumption and with the help of their government began a campaign that would shock the world. The result was the flooding of the international market with brads such as Honda, Sony, Hitachi, Toshiba, Suzuki, Mitsubishi, Nissan, Mazda and many more Japanese sounding brand names.

Gary Hamel said that in the 1970s Volkswagen executives came to visit Japan and had a close-up view of Honda and their first attempt to manufacture Japanese cars. The executives came home with the conclusion that German engineers were one of the best in the world and that Japan had created a car that is not up to their lofty standards (Hamel, 1994). But this did not discourage the Japanese and they embarked on a quest to prove their detractors wrong. They began to establish an export-driven economy that would make this Asian nation one of the most amazing success stories of all time. In 1986 Japan surpassed the United States in per-capita GNP in 1986 (Ito, 1992). But the United States already made preparations to reverse the trend.

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Emergence of the Japanese Bubble

There is a saying that goes something like this: adversity will make one strong, but success can easily destroy a person. The wisdom of this phrase is demonstrated in the familiar tale of rags to riches to rags. It can also be seen in the lives of struggling actors, businessmen, athletes etc., who had to go to great lengths and to pay their dues just so they can reach their goals but once they reach the top they begin to self-destruct. It is interesting to note that the same can be applied not only to individuals but even to nations. The same can be said of Japan but the explanation as to how this economic giant faltered in the 1990s is more complicated than the analogy given above.

Throughout the decade of the 80s their economy grew at a rate that was even faster than most of the industrialized countries that were located in the Western hemisphere (Karan, 2005). In other words the Japanese bubble economy began to emerge. The “bubble economy” was defined as the, “…extreme increase in asset prices based on expectations of future price increases, unsupported by economic fundamentals and typically followed by a reversal in expectations and collapse in prices” (Bergsten & Noland, 1993). The Japanese bubble would continue to expand until it was exposed in the early 1990s.

The Bubble Economy

As mentioned above, the decade of the 80s gave Japan the most impressive growth spurt in its entire history. This of course has a downside. “Concomitant with this spurt in growth was an extraordinary rise in stock and land prices. Japan was beset by a speculative mania” (Karan, 2005). This was made clear in the latter part of the 90s but before that time it was difficult to predict that a serious economic downturn was in the offing. The emergence of the Japanese economic bubble can be attributed to at least three major developments:

  1. The appreciation of the Japanese yen in the middle of the 1980s;
  2. The resulting negative impact to Japanese exports;
  3. The monetary policies put in place to stimulate growth and help save troubled corporations.

It all began with the significant appreciation of the yen in the 1980s that coincided with the creation of monetary policies that would strengthen the capabilities of Japanese corporations (Hornick, 1997). Economists and various financial experts would love to compartmentalize the events that happened during the decade of the 80s. This allows for easy study but real life does not follow such rules. Thus, one can see a complex interaction between the rise of the yen and the monetary policies put in place to ensure growth. But the proponent of this study will try to explain it as simply as possible.

First, the yen greatly appreciated against the U.S. dollar. This was a direct result of the so-called Plaza Accord. This was the result of a secret meeting – between finance ministers and central bank governors from five industrialized countries or G-5 – held at the Plaza Hotel in New York City, on September 22, 1985 (Taniguchi, 1999). The goal of the meeting was to devalue the US dollar since it was considered as overvalued and harming US exports. As a direct result of the Plaza Accord the Japanese yen appreciated from a level of 237 yen per US$ to 141 yen per US$ (Taniguchi, 1999). This Plaza Accord also succeeded in narrowing the budget deficit between Japan and the United States.

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While the above-mentioned events limited the exporting capability of many Japanese corporations there were unexpected results. With the revaluation of the yen, the Japanese people realized that they can now buy more especially when it comes to purchasing land and stocks. As a result, “The additional liquidity … found its way into the demand for shares and real estate, so that these prices rose” (Siebert, 2002). In fact, in the middle of the 90s the Nikkei index was expected to increase from 39,000 yen in 1989 to 80,000 yen (Taniguchi, 1999). No one knew what was coming.

A destructive pattern was set. As more and more people began investing in the stock market and driving up the prices of shares, the increase in liquidity also pushed land prices to historic highs. Appreciation of land values created another problem. Those who have small parcels of lands found themselves sitting on a piece of property that can fetch millions of dollars in value. These land owners went to the banks to take out loans and used their property as collateral. As banks encouraged these types of loans time came that the Japanese banks began to have an increase on collateral loans. Assuming that the prices of stocks and prices of land are accurate then the banks are sitting on top a treasure trove of high value properties. For the sake of comparison, in the late 1980s, the land under the Imperial Palace in Tokyo was worth as much as “…all the land in California, or all the land in Canada, or all the land, houses, and factories in Australia” (Bergsten & Noland, 1993). But these were all driven by speculation and the real values are much lower than that.

The rise in the prices of stocks and real estate did not come naturally. The price hikes were the direct result of monetary policies designed to counter the effects of the rising yen and lower exports. In 1988 the Central Bank of Japan revealed their strategy in stimulating economic growth that will counteract the impact of the Plaza Accord:

“We intended first to boost both the stock and the property markets. Supported by this safety net – rising markets – export oriented industries were supposed to reshape themselves so they could adapt to a domestic-led economy. This step then was supposed to bring enormous growth of assets over every economic sector. This wealth-effect would in turn touch off personal consumption and residential investment, followed by an increase of investment in plant and equipment. In the end, loosened monetary policy would boost real economic growth” (Taniguchi, 1999).

The plan was simple to understand. The government approved the lowering of the interest rates. This triggered the flow of money to the stock market and subsequently to the corporations that needed it most. Then these export-oriented industries will then turn around and use the new infusion of cash to invest in factories and equipment. But it seems that no one knew the implications of such moves in the long run, considering the unique characteristics of the Japanese economy.

It did not take long before Japanese banks and corporations began to exploit the new set of circumstances as well as the loopholes in the Japanese economy. The most important loophole is called the mochiai or mutual stock sharing (Taniguchi, 1999). In other countries in order to have more investors the company will sell more stocks. But in the process the value of the stock decreases. Not so in Japan because the triumvirate of banks, bureaucrats, and corporations established a system of mutual stock sharing. In this way, a company can have banks purchase their newly issued stocks while keeping their stock prices high. As a result more money is available for these corporations to invest and expand. The close relationship between bank, government and businesses eradicated the checks and balances common in other industrialized countries such as the United States. In the long run this practice caught up with the Japanese economy, especially so when the investors found out about it and lost their confidence.

Aside from the mochiai there is another problem with the Japanese economy when it comes to opaque accounting standards and practices. This was made evident by the way the government and the banks tried to conceal the problem of bad loans to the public. “When the problem of non-performing loans emerged in the early 1990s, both banks and the government tried to conceal the fragility of the balance sheets, thereby aggravating the economic setback” (Karan, 2005). This is the reason why Japan remained in economic doldrums for a very long time.

Moreover, it has to be pointed out that during this period there were only a few accountants in Japan. There were only, “…12,000 certified public accountants to audit 3,422 public companies, an average of 3.5 auditors for each business” (Karan, 2005). It does not require a rocket scientist to realize that three people sifting through a ton of accounting data will never be able to produce exemplary work. There were so many loose ends providing so many people the ability to hide, steal, and cheat. While Japanese corporations are actually losing money, the outsiders, specifically the investors knew nothing about it. When it was found out investor confidence was shaken to the core.

Overheated Economy

Experts are beginning to get worried with high-speed growth. Conventional wisdom dictates that a bullish economy will soon be followed by a decline as a corrective measure that will stabilize the economy. But before everyone realized the real extent of the problem Japan continued to dazzle the world with its purported potential for growth. The following will show why investors did not hesitate to invest in Japan and exacerbate an already overheated economy.

First of all, before an investor would pour in money into a company it will look at many indicators. One of which is the capability of the said corporation to undergo expansion and growth. When one would look at the state of the Japanese industries in the years prior to 1989 they will find out that, “Japanese plant and equipment investment amounted to U.S. $1, 551 billion, exceeding West Germany’s 1989 GNP of U.S. $1,194 billion” (Taniguchi, 1999). It is not hard to make the necessary computations that will reveal the extent of their supply capability and therefore it is not hard to make the decision to buy Japanese stocks. But at this point only a few outside Japan knew about the mutual stock sharing scheme that artificially created an environment that attracted more money.

Aside from the healthy façade of Japanese corporations, investors found it hard to resist putting more money on this economy because a significant number of Japanese banks are valued higher than those found in Europe and America. As of September 1991, 17 out of the world’s top 33 banks are owned by the Japanese (Taniguchi, 1999). In contrast – based on the data shown below – there is only one U.S. bank that made the list of heavy hitters. This can partially explain why the world thought that Japan would continue to be an economic miracle in the 1990s. But they were greatly mistaken because they thought that Japan operated under the same strict banking guidelines as the banks that can be found in highly industrialized countries.

Table 1. The World’s Top 33 Banks (Taniguchi, 1999)

Ranking Deposits in million US Dollars
  1. Dai-Ichi Kangyo Bank
  2. Mitsui Taiyo Kobe Bank
  3. Sumitomo Bank
  4. Mitsubishi Bank
  5. Sanwa Bank
  6. Fuji Bamik
  7. Bank Nationale de Paris
  8. Deutsche Bank
  9. Credit Lyonnais
  10. Industrial Bank of Japan
  11. Credit Agricole
  12. Mitsubishi Trust Bank
  13. Barclays Bank Plc
  14. National Westminster Bank Plc
  15. Sumitomo Trust Bank
  16. Norin Chuo Kinko Bank
  17. Tokai Bank
  18. Mitsui Trust Bank
  19. Dresdner Bank
  20. Long Term Credit Bank of Japan
  21. Tokyo Bank
  22. Yasuda Trust Bank
  23. Union Bank of Switzerland
  24. Societe Generale
  25. Daiwa Bank
  26. Commerzbank
  27. Hongkong and Shanghai Banking Corp.
  28. Swiss Bank Corp.
  29. Bayerische Vereinsbank
  30. Westdeutsche Landesbank Girozentrale
  31. Toyo Trust Bank
  32. Banca Nazionale del Lavoro
  33. Citibank
339,684
330,799
318,282
310,331
300,739
299,686
246,019
241,610
241,002
240,288
224,199
214,036
212,713
204,157
199,007
196,683
192,353
185,053
174,441
171,610
168,423
156,337
149,697
147,626
146,484
134,663
133,580
129,660
129,184
125,810
125,406
112,987
112,586

It is one thing to describe a phenomenon and then form opinion regarding what is happening. It is also another to show a person something that is tangible to base his or her decision by. At the end of the 1980s, investors can only see one thing and that is the dominance of Japanese banks in international finance and it would be foolish not to invest in Japan. Unknown to many the much vaunted Japanese economy has been showing cracks and it is about to collapse under a massive weight that could no longer be supported by Japanese fiscal policies.

Bursting the Bubble

There is also another popular expression that can be said very quickly and yet carries with it great wisdom – it is too good to be true. This simply means that if something is too attractive, too easy to get, then it maybe because there are hidden risks involved. This was the case with the Japanese bubble economy. The high prices of stocks and real estate were not all glitter and gold. Underneath the façade is a complex web of policies and Japanese-styled business ethics that spelled the doom for the economy. When the year 1990 was just around the corner, the policy makers were in a state of heightened vigilance and they tried to fix the complex web of problems. But even before 1989 came to a close, the bubble began to burst. Between December 1989 to August of 1992 the stock market tumbled to more than 63 percent while land values began to decline steeply. The worst is yet to come. After the bubble burst, Japan’s economy grew at an average rate of only 1.5 percent for many years (Karan, 2005). And the economy did not recover as quickly.

Conclusion

After the post-war years the Japanese people did not wallow in self-pity. Within Japanese society emerged the formidable troika of bureaucrats, giant corporations, and banks. These three worked hand-in-hand using non-conventional business practices to create super brands such as Nissan, Honda, and Toshiba. From mediocre products the Japanese industries began to produce world-class cars, machines and electronic gizmos that changed the consuming habits of the human race. Thus, the nation’s economy saw unprecedented growth in the decade of the 1980s.

While Japan grew at an astonishing rate in 80s the United States economy began to falter. The huge trade deficit between the United States and Japan was a cause for alarm. Thus, in late 1985, a secret meeting was conducted to create a strategy that will help the U.S. strengthened its economy. One of the major implications of these new developments is the significant rise in the value of the yen. This in turn led to more spending power and the Japanese people wisely invested in stocks and real estate. Little did they know that their prudent actions would lead to the Japanese economic bubble. While the consumers had more cash to spend the same could not be said of the ailing Japanese corporations. Thus, the bureaucrats stepped in to stem the tide and created a way for the said corporations regain lost footing.

But the chain reaction of events created a complex web of activities that added pressure to the overheated economy. Stock prices continued to rise and land prices continue to soar because everyone thought that the economic miracle will continue for a very long time. But reality sets in and everyone heavily invested in Japan Inc. lost a lot of money. A closer inspection revealed that the high value of stocks and real estate created problems to the economy. This was not evident at first because since World War II Japan was in an uphill battle with other Western economic superpowers. Their products were ridiculed and considered inferior by those produced by German and American technology. So when the trade deficit between the U.S. and Japan showed great disparity in favor of the Asian economic powerhouse, the Japanese people and the Japanese government were in uncharted territory.

For many decades they desired to be the best but it can be argued that even the Japanese did not anticipate that they could be as successful at such level and able to do so at a relatively short period of time. Therefore, no one knew what to do when the rest of the world conspired to temper their rapid economic growth by increasing the value of the yen. This was supposed to limit the growth of the export industry. Whoever planned the Plaza Accord was right on target. The export-oriented industries in Japan reeled from the impact of the revaluation of the yen. But the government intervened to save these ailing corporations. One has to be reminded here that there is a special type of relationship that exists between the government, the blue chip corporations and the banking sector. These three worked together to bring about a change in the economy but they did not anticipate that their plans would backfire.

At the forefront, the most visible players are the consumers, the Japanese people, bureaucrats and the Japanese corporations. But behind all these is another major culprit, the banks. These banks (see Table 1) were as much to blame as the bureaucrats and the corporations who continued to rely on ineffective policies. With the unconventional method of cross-sharing of stocks the banks continued to increase its value by acquiring high-priced stocks and high value collateral in the form of expensive pieces of real estate. But as it turns out, the real value of the stocks are way lower than the purchase price and the real value of the real estate was also way lower than what it was perceived to be.

It is understandable why the government wanted to assist the corporations. These are the corporations that made Japan great. What is difficult to understand is the willingness of the government to hurt investors and the public in order to accomplish its mission of helping the said firms. Moreover, it must be understood that the lack of Certified Public Accountants made it very difficult to create a stable system of checks and balances. So, investors from outside Japan wrongly assumed that there world-class accounting systems are in place to reveal the true financial state of the corporations. But as it turned out the accountants are extremely loyal to the corporate and the banking sector to make public what they know about the truth behind the hype and overpriced stocks.

When the rest of the world found out about these anomalous practices combined with disastrous fiscal policies, the Japanese economic bubble burst and surprisingly there was nothing in there but air. But the main reason why their economy was in the doldrums for a very long time is not because the Nikkei stock index took a dive in the 90s. The main reason for the slow recovery is the fact that the whole world discovered that accounting practices in Japan could no longer be trusted. The Japanese together with the aforementioned troika of bureaucrats, giant corporations, and banks, need to work very hard to convince investors that they are doing everything in their power to overhaul an ineffective and disastrous system.

References

Bergsten,C. & M. Noland. (1993). Reconcilable Differences?: United States-Japan Economic Conflict. Washington, D.C.: Institute for International Economics.

Hamel, Gary. (1994). Competing for the Future. MA: Harvard Business School Press.

Hornick, R. (1997). “The Myth of the Miracle.” TIME Magazine [online]. Web.

Hyma, A. & M. Stanton. (2000). Stream of Civilization. Illinois: Christian Liberty Press.

Ito, T. (1992). The Japanese Economy. MA: Massachusetts Institute of Technology Press.

Karan, P. (2005). Japan in the 21st Century. Kentucky: The University Press of Kentucky.

Ramo, J. (1999). “Get Rich Quick.” TIME Magazine [online]. Web.

Siebert, H. (2002). The World Economy. 2nd ed. New York: Routledge.

Taniguchi, T. (1999). Japan’s banks and the “bubble economy” of the late 1980s. In W.M. Tsutsui(ed.) Banking in Japan. New York: Routledge.

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