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.
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 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.
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.
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.
- 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.
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