Learning from the past: Japanese Financial Crisis 1980s-1990s

Camellia Nguyen
13 min readJun 4, 2017

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In the new era of globalization, the economy of every country in the world has a close connection to each other. Once a financial crisis occurs in one country, it could affect the continent, or even worse — the whole world. All economists are trying to find the answer for the next global financial crisis, through analyzing the current global economy situation, as well as the trends of it in the future. However, it’s important for us to understand and learn from the past. Taking an example from Japan’s economy recently, the Bank of Japan, decided to move their interest rate into negative territory. We cannot help ourselves from questioning what is happening to the world’s third largest economy when this has become a requirement? What happened to their country for the past few decades which leads them to this current situation? The answer is not too far away, but right in front of us, if we take a closer look into the past. The asset price bubble in 1980s has a strong impact on the growth of the Japanese economy from that period until now. From analyzing the financial crisis of Japan in the past, we may understand more about their current situation.

Shibuya Crossing — Photo by Camellia Nguyen

After World War II, Japan rapidly became the world’s second largest economy by the 1960s. People call that period of Japan is “Economic Miracle”. In the 1980s the Japanese economy boomed over many years as the role of “King of the Global Electronics Industry” (Colombo, 2012). The prices of domestic stocks and real estate became unimaginable high. By 1989, the Bank of Japan tried to control the inflation through its decision on tightening its monetary policy and sharply raising interest rates. This sharp policy caused the bursting of the bubble and the Japanese stock market crashed. Since this crash of the asset bubble, Japan experienced a period of deflation economic as the “Lost decade”. Until now, there is still no sign of growth, in the near future, for Japan economy.

Asset price bubble and financial crisis

An asset price bubble represents a mispricing of asset values relative to price that would be consistent with the existence of efficient markets (Malkiel, 2010). Taking an example from the first bubble in the history in the early 17th Century in Holland, named “Tulipmania”. In that period, a type of diseased tulips, emblazoned with distinctive patterns, became more prized than healthy ones in the Dutch Republic (Sooke, 2016). People were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs (Beattie, n.d.). However, the prices which people overpaid in the time of the bubble, did not reflect the true value of it. People began to realize they were trading their homes for just a bulb. That was when the crash happened. Most bulbs became almost worthless, selling for no more than the price of an onion and the investors suffered massive losses. No matter how much the Government involved themselves in controlling the situation, the crash of the price bubble still led to a severe decline of the economic activity, from which it took many years to recover (Malkiel, 2010). The Dutch were very hesitant about speculative investment for a long time after that event (Beattie, n.d.).

Sharp increases in asset prices have frequently led to crashes and subsequent sharp declines in economic activity (Malkiel, 2010). Therefore, financial crisis can lead to a series of impacts on the economy, such as large institution failures, substantial loss of income and socio-economic distress. Among the various types of asset bubbles, stock market and housing bubbles, are historically of major interest to the central bank (Douglas, George, A.G, & Malliaris, 2012). The housing and stock markets are interconnected in multiple ways, and both are leading indicators of the activities of the economy, therefore, changing in one activity can lead to the changing of the other activities as well as the entire economy.

Japan’s asset price bubble in 1980s and The Crash

Within less than forty years, the Japanese reconstructed everything from the rubble of the World War II and became the second largest economy in the world. That was the reason why people call that period in Japan’s history the “Economic Miracle”. The central government greatly increased the amount of investments to both private and public firms (Takada, 1999). Many of the wartime companies and most of the technology which used during the war was converted to peaceful economic development (Loukaki, 2014). Especially in the 1970s and 1980s, when they manufactured majority of the world’s consumer electronic products (Colombo, 2012). The economy, therefore, was led by the booming in export electronics, cars and other products, which grew further than import (Takada, 1999). The average annual GDP growth rate in “Economic miracle” period was about 6.10% with the highest peak at 12.88% in 1968 as showing in Figure1 below.

Figure 1 Japan’s GDP growth rate from 1960–1990. Source: (WorldBank, 2016)

As the result of the healthy trade surplus and the rapidly growth of the economy, the living standard of the Japanese was higher and higher, which encouraged households to save more cash in the banks (Colombo, 2012). When savings exceeded investment, banks started to lend out the money to investors. Due to the fast growth of the economy and the excess liquidity in the banking system, the Bank of Japan (BoJ) was overconfident in easing the monetary policy in the mid late 1980s. The asset prices of Japan were pushed to the unimaginable high levels, compared with previous, especially the prices of domestic stock and real estate.

Figure 2 Japan Nikkei 225 Stock Market Index
Source: (TradingEconomic, 2016)

According to Figure2, Japan’s Nikkei stock index reached the peak at 39,000 in 1989, triple the amount in 1985. No matter how high the price of stocks would raise, investors could still loan the money from banks with low interest rates and invest in stock market, which kept pushing the prices even higher. The real estate prices were even more dramatically boomed. Land prices in Tokyo’s prime neighborhoods rose to levels that made them 350 times more expensive than comparable land in Manhattan, New York (Colombo, 2012). 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 wealth and about double the total value of the world’s stock markets (Malkiel, 2010). In 1989, the Japanese Government were officially concerned with the asset price bubble, which was growing dramatically within the country. The Bank of Japan finally decided to tighten the monetary policy and raise the interest rates. However, it was too late. Instead of controlling the inflation, they made the economy of Japan crash heavily, starting with the bursting of the stock market’s bubble. Following the bursting of the stock market, the real estate bubble popped, causing the heaviest financial crisis in Japan’s history.

The impacts of the Japan’s financial crisis on the economy

  • Businesses and Corporates

First of all, falling of stock prices left the speculators stranded (Gordon, 2003). According to Figure2, the Nikkei stock index from the highest peak in 1989 dropped to 20,000 in 1990 and finally hit 15,000 by 1992, producing a loss of $2 trillion (Colombo, 2012). Firms which borrowed the money from the banks to invest in the stock market and real estate, could not afford to pay back their loans. The average debt left by bankrupt companies nearly quadrupled between 1990 and 1992 (Alexander, 2000). The impact did not stop at that. Because the debtors could not pay back their loans, the banks and the insurance companies were left full of bad debt (Colombo, 2012). However, the Japanese banks continued to extend credit to some insolvent borrowers. The reason was because, if all the firms went bankrupt, the banks could not keep their minimum capital level standards which was one of the regulation that banks had to comply (Cabalerro, Hoshi, & Kashyap, 2008). Those insolvent companies were too debt-ridden to do anything else but trying to survive on the bail-out funds. They depressed the market prices with their low-quality products, raised the market wages to hang on to the workers. In addition, because of the bursting in the asset prices, the asset values in the balance sheets of those corporations became nearly nothing in compared with their liabilities. The combination of low product quality, high prices, low profits products and unhealthy balance sheets of the corporates, chased the foreign investors away. Japan’s companies, therefore, could not compete with other new productivity firms from other Asian countries such as China, South Korea (Colombo, 2012). The Japanese products became less competitive overseas also led their export in to a recession.

  • Households

In the 1980s, many Japanese homebuyers felt comfortable about taking on huge debt to keep on buying lands and houses with the expectation of rising real estate in the future. The bursting of the asset price bubble, therefore, pushed a lot of Japanese into debt and misery until now. For example, on New York Times (2015) mentioned the case of Mr. Nakashima who still owes the bank $300,000 from his loan 30 years ago. When Japan’s property market collapsed, the price of his house dropped dramatically and until now is only worth half of what he paid. Not only suffering from debt, a lot of Japanese also lost their jobs after the financial crisis due to the lay-off policies of firms or because of the firms went bankrupt.

Figure 3 Japan Unemployment Rate
Source (WorldBank, 2016)

According to Figure3, unemployment rates in Japan increased rapidly, from 2% in 1990 exceeded 4% in 1998 and kept increasing after that. The number of personal bankruptcies exceeded 100,000 in 1998 (Setaishi, 1998). As an obvious result, consumer confidence was also affected. Japanese people showed little interested in spending and preferred to save, which led to the low aggregate demand of the economy. When no one wanted to buy, the prices of products in Japan kept falling. This hurts corporate revenue heavily, because they could not cover their fixed costs which was even heavier due to the costs of warehousing unsold items.

  • Economy

According to the expenditure method base on the academic theory in calculating the GDP of a country (Investopedia, 2016), there are 4 components: the consumer spending ©, business investment (I), government spending (G) and the net exports (Net Ex). With the declining prices of goods and services, the consumers postpone spending with the expectation that goods will become cheaper (Farrel, 2016). Both foreign investors and domestic investors found their opportunities outside the country as mentioned before. The component “C” and “I”, therefore, could not help much in this situation of Japan’s economy. The Japan’s trading was even worse when their import exceeded export, which causes trade deficit. The only hope to save the growth of the GDP was through the Government spending. The Japan’s government injected nearly JPY 100 trillion of public funds to the Deposit Insurance Corporation of Japan from 1997 to 1999 for financial support for banks (Fuji & Kawai, 2010). Over $10 trillion was pumped into expensive public works projects, construction projects from 1999 to 2001 (Fackler, 2009). A legacy of trillion of dollars was spent to lift the economy from deflation. However, it just sank Japan more deeply into debt, leaving an enormous tax burden for future generations.

Figure 4 Japan GDP Growth Rate 1990- 2014
Source: (WorldBank, 2016)

According to Figure4, the GDP growth rate dropped dramatically from above positive 5% in 1990 to negative 2% in 1998. Some temporary improvement in the economic outlook can be seen in 1999 and 2000 but then it dropped to nearly negative 6% in 2009 and since then has not increased higher than positive 2%. The Japanese economy plunged into recession for decades.

The recurrence of financial crisis in Japan

Instead of preventing the recurrence of financial crisis, Japan government is trying to create inflation by any means, to save their economy from more than 2 decades of deflation. According to “Abenomics” strategy of Japan’s Prime Minister Shinzo Abe, the unprecedented monetary easing and government spending would tackle deflation and buy time to implement much-needed structural reforms (Sharp, 2016). Starting with the fiscal stimulus in 2013, Japan’s government focused on building critical infrastructure projects, with a total investment of $210 billion. Following this was the monetary policy which injected liquidity into the economy (McBride, 2016). The newest action taken from BoJ was the announcement of moving their interest rates into negative territory in the beginning of 2016. The idea is to encourage banks to put their money to more productive use, lending it to households and businesses and getting them to spend it, thereby stimulating the economy (Johnathan, 2016). The BOJ now expects to meet its 2% inflation target around the first half of fiscal year 2017/18 (David, 2016). The whole world is questioning the effectiveness of negative interest rates as well as “Abenomics”. What would happen if the inflation exceeded their expectation and led to financial crisis? The economy of Japan has been deep in deflation for a long time, but that does not mean inflation and/or financial crisis cannot return. Who can guarantee that the commercial banks won’t try to secure their situations, by lending out the money to each other or create fake capitals to borrow the money? A negative return on parking funds with the central bank might encourage banks to invest in riskier assets to secure a return, potentially driving new asset bubbles (Farrel, 2016). If that happened, Japan might have to face a further pain from another financial crisis. While the negative interest rates are meant to encourage banks to lend out their money and the people borrow more to spend more, if the financial crisis occurred, the Bank of Japan could not just increase the interest rates. Once again, the Japanese would suffer from accumulated debts. To prevent the worst situation from happening, the Japanese government should consider a way to check the lending out from the banks. The requirements to apply for loans should be revised and the banks need to be selective on choosing the borrowers. It’s still too soon to make any judgment on the methods taken from the Japanese government to stimulate their economy. However, they can see that the impacts of the first financial crisis still remain until now. The Japan economy as well as the Japanese population cannot handle another crisis.

Conclusions

In this research, I analyzed the financial crisis that occurred from the asset price bubble in Japan 1980s and found that it exerted a strong impact on the Japan’s economy since that period. They have been through deflation for the past 2 decades and still have no sign of economic revival until now. I also found that instead of preventing the recurrence of crisis, the Japanese government is trying their best to raise the inflation. Because of the slow reaction of the government in 1980s, the inflation was raised to its peak rate. The decision of Japan’s government at that time just to control the inflation resulted in breaking the bubble, but not solving the problem. Therefore, the Japanese government has to consider carefully of what action they should take this time. It is harder every time for Japan to recover and revive growth without getting into another financial crisis. We cannot know if the methods they are using now to kick up the growth of the economy are right or wrong. Only time will reveal the answer.

Camellia Nguyen

References

Economics
Japan
Finance
Macroeconomics
Research

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Camellia Nguyen

Written by Camellia Nguyen

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Phuong-Mip-Camellia Studying Master of International Business at International College of Management Sydney

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