What Was The Japanese Asset Price Bubble? The "Japan Lost Decade" In A Nutshell

The Japanese asset price bubble resulted in greatly inflated real estate and stock market prices between 1986 and 1991 which resulted in the largest Japan financial bubble, which also caused a decade of economic stagnation for the Japanese economy.

Aspect	Explanation
Definition of the Bubble Economy	The Bubble Economy, often referred to as the “Japanese Asset Price Bubble,” was a period of excessive speculation and soaring asset prices in Japan, particularly in real estate and stocks. It is characterized by a frenzy of buying and investing, leading to inflated asset values far beyond their intrinsic worth.
Key Concepts	Several key concepts are associated with the Japanese Asset Price Bubble: 1. Speculative Bubble: A speculative bubble occurs when the prices of assets, such as real estate and stocks, rise rapidly and significantly, driven by investor speculation rather than fundamental economic factors. 2. Real Estate Mania: One of the defining features of the Japanese Bubble Economy was the soaring real estate prices in major cities like Tokyo. Land prices reached astronomical levels, with the grounds of the Imperial Palace in Tokyo being valued higher than some real estate markets in the United States. 3. Stock Market Boom: The Tokyo Stock Exchange experienced a tremendous surge in stock prices during this period. The Nikkei 225 stock index reached its all-time high in December 1989. 4. Land Price Bubble: The bubble extended to land prices, with urban land in Tokyo and other major cities becoming exceptionally expensive. People and companies invested heavily in land, expecting prices to keep rising. 5. Asset Overvaluation: The bubble was marked by significant overvaluation of assets. People bought assets with the expectation of profiting from further price increases rather than their intrinsic value. 6. Excessive Debt: Many individuals and companies took on massive amounts of debt to finance their speculative investments, contributing to the fragility of the economy when the bubble burst. 7. Asset Price Collapse: The bubble burst in the early 1990s, leading to a dramatic collapse in asset prices. Real estate and stock values plummeted, resulting in massive losses for investors.
Characteristics	The Japanese Asset Price Bubble exhibited the following characteristics: – Rapid Asset Price Growth: Asset prices, particularly in real estate and stocks, experienced unprecedented growth over a short period. – Excessive Investment: Investors, including individuals, corporations, and financial institutions, poured money into assets, often using borrowed funds. – Credit Expansion: Banks and financial institutions played a significant role in fueling the bubble by providing easy credit to investors and businesses. – Economic Boom: The bubble coincided with a period of strong economic growth in Japan, driven in part by the wealth effect from rising asset prices. – Asset Deflation: When the bubble burst, asset prices deflated rapidly, leading to a prolonged period of economic stagnation and deflation. – Banking Crisis: The bursting of the bubble exposed weaknesses in Japan’s banking sector, as many banks had significant non-performing loans on their books.
Implications	The bursting of the Japanese Asset Price Bubble had several significant implications: 1. Economic Downturn: Japan entered a prolonged period of economic stagnation and deflation that lasted for more than a decade, known as the “Lost Decade.” 2. Banking Crisis: The bubble’s collapse led to a banking crisis as financial institutions struggled with non-performing loans. 3. Corporate Failures: Many companies, especially those heavily invested in speculative assets, faced financial distress and bankruptcy. 4. Policy Responses: The Japanese government implemented various policy measures to address the crisis, including fiscal stimulus and monetary easing. 5. Long-Term Effects: The Japanese economy experienced a prolonged period of slow growth, which had lasting effects on the country’s economic landscape.

Table of Contents

Understanding the Japanese asset price bubble

During the late 1980s, the Japanese economy was booming as a result of exuberance in equity markets and skyrocketing real estate prices.

Indeed, the ground beneath the imperial palace was once said to be more valuable than the entire state of California.

Nationalist sentiment was also high. Japanese citizens had never been more wealthy and the country boasted some of the largest banks and corporations in the world.

Many believed Japan would become an economic powerhouse with no possibility of failure.

With land and stock prices tripling during the 1980s, Japanese firms relied heavily on traditional bank loans as opposed to issuing stock or bonds to raise capital.

This was at least partly enabled by the aging Japanese population, which had some of the highest personal savings rates of any developed nation.

This particular demographic trait caused banks and corporations to enter into dubious relationships where there was an implicit guarantee of a taxpayer bailout of bank deposits. For corporations, this caused a moral hazard problem.

That is, they were happy to increase their level of operating risk because they did not have to bear the full cost of something going wrong.

Lending standards started to decline as a result, with the whole Japanese economy enveloped in an atmosphere of so-called “crony capitalism”.

The Japanese asset price bubble bursts

The Nikkei stock market index reached a peak of 38,916 on December 29, 1989. The bubble burst soon after as the Bank of Japan raised bank lending rates to try to keep inflation and speculation in check.

What followed was a spectacular fall from grace, with the market losing more than $2 trillion in value over the next twelve months.

In the decade that followed, Japanese society was in disarray. Land values plummeted as economic growth ground to a halt.

Corporations refused to invest and consumers refused to spend, despite generous government spending and relaxed monetary policy.

This resulted in a liquidity trap scenario, where consumers and investors preferred to sit on cash with the belief that goods and services would become cheaper in the near future.

In 1993, the Liberal Democratic Party lost control of power for the first time since 1955. Divorce rates and instances of suicide increased as many individuals struggled to cope with the new normal.

The period between 1991 and 2001 is often referred to as the Lost Decade. Annual GDP growth during this period was a paltry 1.14%, well below that of other developed nations. Real estate prices decreased by a staggering 70% over a similar period.

What caused the Japanese asset price bubble?

There are two generally accepted though alternate views regarding the cause of the Japanese asset price bubble. Let’s take a look at them below.

Bank deregulation

Historically, Japanese banks were tightly regulated by the Ministry of Finance.

Regulation meant there was little incentive to change the status quo, and many institutions were happy to operate under this regime because they were assured of reasonable profits and were protected against bankruptcy.

However, deregulation started to occur in the early 1980s. Competition increased, with many corporate clients moving away from bank finance toward other options including corporate bond issuance and international markets.

To fill the void, Japanese banks lent money to small and medium enterprises and borrowers in land and property investment.

Both categories were higher risk than corporate borrowers, and, in any case, the banks lacked the necessary experience to evaluate projects or judge their creditworthiness.

When the economy was booming, Japanese banks lent out more money than they should have. These loans became a sizeable mountain of debt when the bubble burst.

Easy money

The more popular view suggests that easy money caused the asset price bubble.

In 1985, the Plaza Accord was signed between Japan, the United Kingdom, France, West Germany, and the United States.

The agreement, which was created to address trade imbalances between the countries, caused the yen to appreciate significantly.

This caused a sharp appreciation in the yen as investor speculation reached unprecedented levels.

Many blame the Bank of Japan for making matters worse since the traditional Japanese policy response to yen appreciation is expansionary.

With inflation remaining near zero, the bank could not find a worthwhile reason to tighten money and end the asset price increases citizens were no doubt enjoying.

Monetary expansion explains why the bubble continued for years, even as the growth in broad money accelerated to more than 10% between 1987 and 1989.

This growth rate was much higher than the 4% growth rate of the economy itself over the same period.

Key takeaways:

The Japanese asset price bubble resulted in greatly inflated real estate and stock market prices between 1986 and 1991. During the late 1980s, the Japanese economy was booming as a result of exuberance in equity markets and skyrocketing real estate prices.
The Nikkei stock market index reached a peak of 38,916 on December 29, 1989. The bubble burst soon after as the Bank of Japan raised bank lending rates to try to keep inflation and speculation in check. The economy lost over $2 trillion in value over the next twelve months.
The Japanese asset price bubble was primarily caused by bank deregulation and expansionary monetary policy. Japanese banks who had lost their corporate clients instead lent to riskier small and medium enterprises. The 1985 Plaza Accord trade agreement also caused a sharp appreciation in the yen, which caused massive speculation that the Bank of Japan was happy to ride for years.