japan-lost-decade

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.

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.

Related Financial Bubbles

Tulip Mania

tulip-mania
Tulip mania was a period during the 17th century where contract prices for tulip bulbs reached extremely high levels before crashing in 1637. The causes of tulip mania have perhaps been distorted over the centuries, with many assuming it was one of the first examples of a market bubble bursting. However, the proliferation of once rare tulip bulbs probably lead to them becoming less desirable. Tulip mania remains a popular term to describe markets where high prices are associated with low value or low utility items, including baseball cards, Beanie Babies, and NFTs.

South Sea Bubble

south-sea-bubble
The South Sea Bubble describes the financial collapse of the South Sea Company in 1720, which was formed to supply slaves to Spanish America and reduce Britain’s national debt. Investors saw the potential for the South Sea Company to collect interest on the loan in addition to collecting profits from its gold, silver, and slave interests. Positive sentiment was also driven by the actions of the government. Lucrative trade profits never materialized, which caused the share price to become dangerously overvalued. Instead, the South Sea Company operated more like a bank and less like a shipping business. Capital invested from waves of new investors was redistributed to older investors in an early Ponzi scheme. The share price crashed in December 1720, with many South Sea Company directors impeached or imprisoned.

Mississippi Bubble

mississippi-bubble
The Mississippi bubble occurred when a fraudulent fiat banking system was unleashed in a French economy on the verge of bankruptcy. Scottish banker John Law proposed that the French transition from gold and silver-based currency to paper currency. Law theorized that he could sell shares in the Mississippi Company to pay off French national debt. When the company secured total control of European trade and tax collection, investor speculation increased to unsustainable levels. The company share price reached its peak in January 1720 as more and more speculative investors entered the fray. Law continued to issue banknotes to fund share purchases, which inevitably caused hyperinflation. Less than twelve months later, shares in the Mississippi Company declined by 1900% and Law had to flee France in disgrace.

Stock Market Crash of 1929

stock-market-crash-of-1929
The Stock Market Crash of 1929 was a major American stock market crash in October 1929 that precipitated the beginning of the Great Depression. Black Friday, Black Monday, and Black Tuesday are terms used to describe the calamitous fall of the Dow Jones Industrial Average over three days. The index would slide further in the following years and would not recapture its pre-crash value until November 1954. The Stock Market Crash of 1929 was caused by complacency during the economic prosperity of the 1920s with many new investors buying stocks on margin. Government mismanagement and company share prices that did not reflect their true value were also contributing factors.

Japanese Lost Decade

japan-lost-decade
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.

Dot-com Bubble

dot-com-bubble
The dot-com bubble describes a rapid rise in technology stock equity valuations during the bull market of the late 1990s. The stock market bubble was caused by rampant speculation of internet-related companies. At the height of the dot-com bubble, instances of private investors quitting their day jobs to trade on the financial market were common. Thousands of companies held profitable IPOs despite earning no profit or even revenue in some cases. The dot-com bubble began to burst after interest rates were raised five times between 1999 and 2000. Wall Street analysts, perhaps seeing the writing on the wall, advised investors to lower their exposure to dot-com stocks. The NASDAQ peaked in March 2000 and had lost 80% of its value by October 2002.

Global Financial Crisis

global-financial-crisis
The global financial crisis (GFC) refers to a period of extreme stress in global financial markets and banking systems between 2007 and 2009. The global financial crisis was precipitated by changes to legislation in the 1970s. The changes created the subprime mortgage industry and forced banks to loosen their lending criteria for lower-income borrowers. When the subprime market collapsed in 2008, one-fifth of homes in the United States had been purchased with subprime loans. Bear Stearns and Lehman Brothers collapsed because of their excessive exposure to toxic debt, while consumers were left with mortgages far exceeding the value of their homes. In the aftermath of the GFC, interest rates were reduced to near zero and there was sweeping financial reform.

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