Japan experienced a period of boom in the early 1980s, which saw stocks and land prices appreciate immeasurably. Easy credit and rampant speculation, coupled with a lax central bank, contributed to skyrocketing asset prices. But from the late 1980s, prices started stagnating, and they eventually collapsed in 1992. This asset bubble burst paved the way for a period of economic stagnation and price deflation, leading to the 1990s being referred to as the ‘Lost Decade’ in Japan. It would take a very long time for prices to turn upwards and for the Japanese economy to get back on track. The event also transformed the Bank of Japan (BOJ), Japan’s central bank, into one of the most active interveners in the economy.
Japan was a booming economy in the 1980s, averaging about 4% growth every year. The country had, in the 1960s and 1970s, expanded its export economy, but in the 1980s, it was both domestic and international demand that fuelled its growth. Unemployment was at record lows, and there was easy access to credit. Japan had conducted huge post-war technological research, and this led to the creation of quality high-tech gadgets for consumer and corporate use. These products were demanded both locally and abroad, and the huge money supply saw the Japanese people continually desire to improve the quality of their modern lifestyles. Furthermore, a favourable monetary environment ensured that the boom was overextended. A weak local currency and low rates made Japan an investment and consumption haven. Domestically, land and stock prices were also rising rapidly; and internationally, Japan had grown to be the largest creditor nation in the world.
Then, in 1985, in the midst of the economic boom, Japan, alongside other G5 nations, entered into an agreement dubbed ‘The Plaza Accord’. It was an accord championed by the United States to resolve its trade imbalance with fellow G5 nations, and it would eventually have negative impacts on Japan. It led to an almost immediate revaluation of the Japanese yen, which sharply appreciated in the last quarter of 1985. There was an immediate threat to the Japanese economy, and the Bank of Japan embarked on a monetary policy plan to devalue the yen.
The BOJ cut and maintained low rates, sparking a boom in speculation by both consumers and companies. There were concerns about inflation, but the ‘Black Monday’ crash of 1987 that happened in the US made the BOJ postpone plans of hiking rates. Companies continued to take advantage of easy credit to finance huge capital investments as well as investing in the lucrative stock market. Land and real estate prices rose by over 167% between 1985 and 1990, and stock prices doubled between 1987 and 1989. The BOJ belatedly saw the threat of runaway prices and started to take measures.
How the Bubble Burst
The BOJ started to hike interest rates sharply from the last quarter of 1989. Stock prices that had already peaked in late 1989 were the first to suffer. By early 1992, the Nikkei index had plunged by 50% to below 20,000 points, from a peak of just below 40,000 in late 1989. Land and real estate prices had started to decline in 1991, but at a slower pace. The BOJ continued to hike rates because of the resilience of real estate prices, even as stock prices suffered immensely.
What Happened After the Crash?
The asset price bubble had devastating effects on the Japanese economy. In 1991 alone, the rate of business bankruptcies rose by over 66%, and while unemployment remained relatively low, wages of workers decreased massively. There was also evidence of waste all over with unfinished factories, real estate projects, and other heavy capital investments. But much worse, the bubble burst and ushered in the ‘Lost Decade’.
The Lost decade was a period of economic stagnation that was witnessed in Japan from 1991 to 2001. Asset prices declined throughout this period. The Nikkei index, which had already tumbled by over 50% in 1992 from the peaks of 1989, extended its decline to around 10,000 points in 2001. Land and real estate prices continued the downward spiral and had plunged over 70% by 2001. The economy averaged a GDP growth rate of about 1% during those years, way below the average of other developed nations. Yet, after that ‘Lost Decade’, the economy still did not experience any meaningful reprieve.
The Nikkei index continued its decline and printed a low below 8,000 points in August 2003. A brief period of recovery was then cut short by the 2008 global financial crisis, whose impact drove the Nikkei to lows of below 7,500 points in March 2009. The benchmark index only ever climbed past the 20,000-point level in 2015, and to date, it has never reclaimed the bubble highs of 1989. It was not really a ‘Lost Decade’, but more of ‘The Lost 3 Decades’.
What Caused the Japan Asset Bubble?
Multiple factors catalysed the Japanese asset bubble. But a majority of the blame falls on the Bank of Japan, both for its action and inaction during the bubble as well as the aftermath. When the Japanese yen appreciated in mid-1985, the BOJ cut rates too much and for far too long. This led to the availability of easy money and the resulting bubble on asset prices. And when the bank was concerned about high asset prices, the reaction was hard and fast. The bank hiked rates aggressively from 1989, and it did not relent even as stock prices suffered. In just two years, rates were raised 5 times. By the time the central bank wanted to correct its mistakes by cutting rates in 1991, Japan was already dealing with both a credit crisis and a liquidity trap. It became hard to secure credit, and even with low rates set by BOJ, investors and households still had no confidence in spending or investing in the country.
Bank deregulation is also considered as another related cause for the asset bubble. In the early 1980s, the process of deregulating banks from the tight control of the Ministry of Finance started. Previously assured of high-profit margins and protection against bankruptcy, Japanese banks now had to quickly ‘innovate’ in order to guarantee survival. To make matters worse, they also lost major corporate clients who had huge cash reserves of their own as well as access to other cheaper financing options home and abroad.
The banks remained with a risky market for borrowers that included land and property developers as well as other small and medium enterprises. The banks lent too much to these risky businesses and other projects during the booming 1980s. In particular, land became much-sought-after collateral for loans, and this drove their prices even further up. The lending continued based on these new land or real estate project valuations. This made the banks vulnerable when the bubble burst. The huge debt load exposed the bank’s carelessness and contributed to the credit crunch and liquidity trap during the ‘Lost Decades’.
The 1992 Japanese asset bubble burst is a great economic reference period for the country to this date. In particular, it provides great lessons for the Bank of Japan on how it is important to respond to liquidity and inflation crises swiftly, carefully, and proactively. The BOJ failed to act quickly when banks were staring at danger during the 1990s. Their inaction failed in inspiring confidence in the Japanese economy, with both households and companies failing to spend and invest in the country.
For banks, the major lesson is the importance of properly assessing the creditworthiness of diverse groups of borrowers. Banks were unable to properly value projects and accepted overvalued assets as collateral. Before the bubble years, Japanese banks mainly lent to corporations, who were largely safe borrowers. Their greed during the bubble years exposed their recklessness as most of their loans were given to risky borrowers, and their capital was tied to a collapsing stock market.
There were also lessons learned from how big brokerage companies conducted their businesses. They marketed ‘safe’ investment schemes to various top companies. The companies then went ahead to commit massive funds in top brokerage houses, money that was available at any given time to be invested in the lucrative stock market. Having practically lost a lot of money during the bubble burst, companies scaled down their investing as well as spending in the Japanese economy even as low rates persisted.
The Japanese asset bubble era, its burst, and its aftermath will always be viewed as a potent warning of how mismanagement of an economy can be devastating for many years. To this date, the Japanese economy still feels the effects of the bubble era, with stocks yet to reach the highs of 1989. Japan will be keen not to repeat the mistakes that led to the ‘Lost Decades’, and the Bank of Japan will always be active in monitoring the financial system so as not to be caught off-guard again.