Japan could have bought California?
One of the largest booms and busts of the late twentieth century involved real estate and stock markets. From 1955 to 1990, the value of Japanese real estate increased more than 75 times. By 1990, the total value of all Japanese property was estimated at nearly $20 trillion- equal to more than 20 percent of the entire world’s stock markets. America is twenty five times bigger than Japan in terms of physical acreage, and yet Japan’s property in 1990 was appraised to be worth five times as much as all American property. Theoretically, the Japanese could have bought all the property in America by selling off metropolitan Tokyo. Just selling the Imperial Palace and its grounds at their appraised value would have raised enough cash to buy all of California.
o The stock market countered by rising like a helium balloon on a windless day. Stock prices increased 100 fold from 1955 to 1990. At their peek, in December 1989, Japanese stocks had a total market value of about $4 trillion, almost 1.5 times the value of all U.S equities and close to 45 percent of the world’s equity market capitalization. Firm-Foundation investors were aghast at such figures. They read with dismay that Japanese stocks sold at more than 60 times earnings, almost 5 times book value, and more than 200 times dividends. In contrast, U.S stocks sold about 15 times earnings, and London equities sold at 12 times earnings. The high prices of Japanese stocks were even more dramatic on a company by company comparison. The value of NTT Corporation, Japan’s telephone giant which was privatized during the boom, exceeded the value of AT&T, IBM, Exxon, General Electric, and General Motors put together.
o Supporters of the stock market had answers to all the logical objections that could be raised. Were price-to-earnings ratios in the stratosphere? “No” said the salespeople at Kabuto-cho (Japan’s Wall Street). “Japanese earnings are understated relative to U/S earnings because depreciation charges are overstated and earnings do not include the earnings of partially owned by affiliated firms.” Price earnings multiples adjusted for these effects would be much lower. Were yields, at well under ½ of 1 percent, unconscionably low? The answer was that this simply reflected the low interest rates at the time in Japan. Was it dangerous that stock prices were five times the value of assets? Not at all. The book values did not reflect the dramatic appreciation of the land owned by Japanese companies. And the high value of Japanese land was “explained” by both the density of Japanese population and the various regulations and tax laws restricting the use of habitable land.
o In fact, none of the “explanations” could hold water. Even when earnings were adjusted, the multiples were still far higher than in other countries and extraordinarily inflated relative to Japan’s own history. Moreover, Japanese profitability had been declining, and the strong yen was bound to make to make it more difficult for Japan to export. Although land was scarce in Japan, it’s manufacturers, such as its auto makers, were finding abundant land for new plants at attractive prices in foreign lands. And rental income had been rising far more slowly than land values, indicating a falling rate of return on real estate. Finally, the low interest rates that had been underpinning the market had already begun to rise in 1989.
o Much to the distress of those speculators who had concluded that the fundamental laws of financial gravity were not applicable to Japan, Newton arrived there in 1990. Interestingly, it was the government itself that dropped the apple. The Bank of Japan saw the ugly specter of a general inflation stirring amid the borrowing frenzy and the liquidity boom underwriting the rise in land and stock prices. And so the central bank restricted credit and engineered a rise in interest rates. The hope was that further rises in property prices would be choked off and the stock market might be eased downward.
o The stock market was not eased down; instead it collapsed. The fall was almost as extreme as the U/S stock market crash from the end of 1929 to mid 1932. The Japanese (Nikkei) stock market index reached a high of almost 40,000 on the last day of the 1980s. By mid august 1992, the index had declined to 14,309 which is a drop of about 63 percent. In contrast, the Dow Jones Industrial Average fell 66 percent from December 1929 to its low in the summer of 1932 (although the decline was over 80 percent from the September 1929 level.) The chart below shows quite dramatically the rise in stock prices during the mid and late 1980s represented a change in valuation relationships. The fall in sotck prices from 1990 on simply reflected a return to the price to book value relationships that were typical in the early 1980s. The air also rushed out of the real estate balloon during the early 1990s. Various measures of land prices and property values indicate roughly as severe as that of the stock market. The bursting of the bubble destroyed the myth that Japan was different and that its asset prices would always rise. The financial laws of gravity know no graphic boundaries.
- I came across those excertps while reading: A Random Walk Down Wall Street by Burton Malkiel
