A Glimpse of the Past (Part II) Japanese Asset Price Bubble
Asset Price bubbles have been blotting financial history for quite some time now. Economic bubbles should be monitored as their burst can lead to decline in income levels, institutional failures and distress in socio-economic welfare. Some of the first occurrences of economic bubbles date back to the 17th and 18th century in instances like the tulipmania of Holland in 1634- 38 where the price of tulip bulbs skyrocketed to 60 fold only to picket down abruptly.
Post the first World War, Japan was termed the “Asian Miracle” for its booming post-war economy. With the annual average growth rate of 6.10%, signs of success were all around but between 1990–2000, growth stooped to an all-time low of 0.97% With public debt shooting off the roof and inflation going negative. This was later termed as Japan’s Lost Decade which many scholars agree was due to banking crisis caused by economic bubbles mostly in real estate.
The Japanese bubble was the biggest boom of the late twentieth century. The hike in land prices were 550% during a period of 10 years. Between 1981–91, land prices in Japan came to be valued at 20% of the world’s wealth. This later dropped to about 70% by 2002.
In the pre-boom era, banks in Japan gave out a huge no. of loans using land as collateral, investing trust in the post-war thinking that land prices would never fall. Bubbles in both real estate and equity markets increased liquidity and allowed banks to continue dispensing “easy credit”. The US “Twin Deficits” also boosted the credit expansion in Japan.1 1 (Annual Report on Japan’s Economy and Public Finance, 2001)
Beginning of the Bubble
Most Economists date the beginning of the bubble to September 1985 when Japan and other countries signed the Plaza Accord. The Accord entailed the depreciation of the US dollar to the yen and hoped to increase the US exports by making them cheaper. But the Accord also made purchase of foreign assets easier for Japan which then went on to buy the Rockefeller Centre in New York to golf courses in Hawaii and California.
After the Accord, Japan pursued expansionary fiscal measures to counter recession doubts brought about by the sharp appreciation of the yen. At the same time, strong yen created optimistic economy and this fueled by abundant liquidity led to the price bubble. A 10,000 yen note dropped in Tokyo’s Ginza district was worth less than the tiny piece of land that it covered. The stories around Japan at the boom phase were ridiculous with some saying that $500 coffee was bought by housewives in Nara and topped off with gold dust!
Most economists believe that the bubble was the result of a structural deregulation of banks. The Ministry of Finance had held the banks on a tight leash prior to the bubble giving them little incentive to innovate. The protectionist shield by the Finance Ministry had its benefits too as banks were assured of adequate profit margin and were safe from bankruptcy.
Journey from the boom to the bust period.
From the peak of 38,916, the Nikkei Stock average fell to 63% during the 1990s.
Japan had a budget surplus of 2.4% in 1991. By 1998 this had become a 10% budget deficit and the country’s national debt to GDP ratio had reached 100%. As the size of the budget deficit grew, the government cut back on the stimulus measures.
Fiscal Policy post the Bubble Burst
The government implemented no less than ten separate fiscal stimulus packages during the 1990s, totaling more than ¥100 trillion. The Japanese government introduced a total of nine fiscal stimulus packages in the 1990s — in 1992, two in 1993, one in 1994 and another two in 1995. The economy showed signs of revival in 1996.The stimulus package between the years (1992- 2000) was Y130 trillion and stimulus between years 2001–08 it was Y57 trillion.
Between the period of 1990–95, the rate of growth of real GDP for Japan was at an average of 1.5% annually. This was one-third of the pace of growth it had witnessed in last five years. Expenditure by the government went up by 5%of the total GDP and 2% hike again by the end of the decade. In 1994, the government implemented a sizable tax reduction. IT was cut down by 5.9 trillion yen in hopes that revenue would be compensated with higher VAT.
Kiichi Miyazawa, Prime Minister of Japan from 1991 to 1993, followed a Keynesian policy. Public investment was the means to boost economy. Major highways and bridges had already been completed and hence investment in new infrastructure did not help the economy due to a fall in the multiplier for public investment. Public investment produced low stimulative effects on the GDP because of ineffective distribution. The core portion of public investment had been in the countryside and research shows that such investment had a much smaller impact on rural 4 (Trading Economics, 2010) Marginal productivity of Public and Private Investment 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Private Capital Public capital areas than on urban areas. Public investment in the agriculture sector has been much less fruitful than in the industrial and service sectors (Yoshino and Sakakibara 2002).
The multiplier of public investment as a result of bias in rural and agricultural bias in allocating public investment this dropped sharply from 2.5 to 1.Hence, public investments only raised the budget deficits and could not stabilize the economy. Such miscalculation resulted in declining returns from public and private investment.The marginal productivity of public capital was high during the high-growth period (1955–1969) but declined from 1970 onward.
Japanese government initiated the counter-cyclical Keynesian policy. The government increased its spending and cut taxes but this only resulted in a huge fiscal deficit. The Japanese government’s first reaction was to reduce interest rates to 0% to boost economic growth, but this had no effect on either asset prices or economic activity. Private borrowing and spending had taken a hit. So the government then decided to pump trillions of yen into new highways, bridges and other big ticket infrastructure projects. (Yoshino & Taghizadeh-Hesary, 2015)
In 1995–1996, the government injected 680 billion yen to deal with jusen, specialized, nonbank housing loan companies. Jusen were less strictly regulated, and thus more aggressive in their lending to real estate-related small businesses than larger commercial banks during the bubble period. It was a politically unpopular move and government received flak for bailing out nonbank financial institutions. Government started looking for other means of bail-outs than using public money.6 Also most of the infrastructure expenditure was politically motivated and hence often a waste. Low efforts made to increase direct benefit transfer to the masses.
Fiscal Stimulus By the Government
In April 1997, the government lauded its efforts in recovering the economy and in the same month raised consumption tax from 3% to 5%. The Japanese Prime Minister Junichiro Koizumi implemented measures in the year 2001 which included privatization of postal services and ending constructions of highways.
The ZIPR (Zero Interest Rate Policy) was pushed forward by the Government gave the indication to the corporate that nothing had changed realized that it had to reconsider the policy of forbearance towards banks and asked them to stop spending money on a lost cause and write off default loans towards insolvent non-financial companies. The government infused capital into financial institutions and ability to postpone the recognition of losses, ultimately turning them into zombie banks.
Japan lost an entire decade because the Bank of Japan and the Finance Ministry did not act swiftly even after realizing that the banks were in grave trouble. The reform measures started pretty late.
There were systemic delays in policy decisions depending on the land myth believing that land prices would never decline. Also the crisis was slow to develop and growth expectations were too high. Also there was a lack of legal framework to resolve distress banking. The fiscal response could have be better planned. Flaws in the mix and implementation of such policies slowed their impact and pushed Japan in deep recession for the years to come.
Bibliography
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