By Kristen Jia and Anonymous
During the second half of the 1980s, Japan experienced a massive surge in both real estate and stock market prices. This speculative bubble eventually burst in the early 1990s, leading to a significant recession by 1992. It remains one of the largest asset bubbles in global history, and the effects of the economic downturn lasted for decades. The recovery process was slow, and the repercussions of the crash can still be seen in Japan’s economy today. What led to such huge inflation in the first place, and how did the policy actions of the Bank of Japan and the Japanese government contribute to the creation of the bubble?
Japan experienced several economic booms and bubbles in the post World War II period. The Iwato boom was driven by technologic innovation and ended up with the first oil crisis. During the Heisei boom, asset prices rose dramatically amid sustained growth and relatively stable inflation (Shigenori, 2005). Okinawa (2001) defines the bubble period as 1987–1990. An Associated Press report in The Los Angeles Times illustrated the scale of the surge: soaring real estate prices pushed Japan’s total land assets above its gross national product for the first time, and by that year Japan’s land was valued at 4.1 times the value of all land in the United States, up from 2.5 times in 1986. (Associated Press, 1988).
A. Emergence of the Bubble
Land speculation has long existed in Japan and other countries. However, the bubble during the Heisei period was significantly amplified by (a) expansionary monetary policy after the Plaza Accord, (b) excessive credit expansion during the financial liberation era, and (c) moral hazard arising from institutions being “too big to fail”. This blog post also discusses key political and financial contexts that reinforced these mechanisms: the low-interest-rate environment following the Plaza Accord and Japan’s keiretsu system.
a. Expansionary Monetary Policy and Speculative Activities
The low interest rate environment after the 1985 Plaza Accord facilitated corporate borrowing and speculative investment. On September 22, 1985, the Plaza Accord was signed by the G5 countries to depreciate the US dollar to reduce its trade deficit. This agreement caused the Japanese yen to appreciate sharply in value. Because a stronger currency makes exports more expensive for foreign buyers, this posed a significant threat to Japan’s export-oriented economy. Meanwhile, Japan’s flagship market share declined under pressure of upward oversea prices (Robert, 1986). In order to avoid recession and help Japanese companies survive the high yen, the BoJ started to continuously cut rates from 5% to 2.5% in early 1987 (Fries, 1993). Despite asset prices rising during this period, the BoJ did not tighten monetary policy and remained interest rate low for over 2 years.
A lower interest rate environment made borrowing cheaper, encouraging corporations to finance their activities through debt while also stimulating speculative activities. As the GNP growth sprang back to in 1987, companies switched their capital flows into the land market in central Tokyo. 60% of Tokyo land was owned by corporations with their surplus borrowed cash (Robert, 1986, p.2). This information asymmetry between BoJ’s interest rate adjustment and speculative behaviors of corporations transformed a speculative bubble into a powerful driver of land price inflation.
b. Overexpansion of Credit and Double Leveraging of Land
The overexpansion of credit broadened the range of corporations involved in speculative activities. After World War II, Japan’s Ministry of Finance had long been the primary authority overseeing the allocation of credit. Large corporations raised capital through bank loans and insurance companies within their industrial groups, known as keiretsu. These institutions dispensed large pools of private savings under direction of the Ministry of Finance, operating through the Bank of Japan (Robert, 1998). However, as corporations became much more profitable in the late 1970s due to its strong performance in the export market, they relied less on heavy borrowings to finance growth. To maintain the influence over credit allocation, the Ministry of Finance encouraged banks to spread their liberal lending activities to reach medium and small-size companies. This policy created a second tier of liquidity circulation but also opened up the opportunities for speculative activities by borrowed cash.
In the context of the loose credit condition in the 1980s, aggressive collateral lending policies in both land and stock markets led to “double leveraging”,which significantly amplified the bubble. In the land market, banks commonly lent against land as collateral, often providing loans at 80% or more of its fair market value. At the same time, in the stock market, big corporations held substantial shares of each other through keiretsu networks and those stock portfolios could be accepted as collateral for borrowing. On the one hand, as land prices continued to rise, the value of this collateral increased, enabling corporations to expand their borrowing capacity. On the other hand, leveraged money in land speculation also flowed into the equity market, where the rising share prices increased the collateral value of the corporate stock portfolio. Those mechanisms created a “double leveraging” effect: capital value reflected in both land prices and in share prices, the latter realized as cash through the liquidity that land speculation had created. As a result, the more capital acquired by corporations in the stock market, the more nonoperating investments were available to them, including more land. (Robert, 1998, p.4).
c. Moral Hazard and Weak Market Discipline
Japan’s financial bureaucracy, particularly the Ministry of Finance and the Bank of Japan, had historically prevented major banks from failing and intervened to stabilize financial markets during crises. During the real estate bubble, the banking sector was dominated by eight very large “city banks”, most of which were associated with keiretsu groups (Robert, 1998, p.3). Because financial institutions believed the government would ultimately protect the system from collapse, they faced limited downside risk when expanding credit. This expectation encouraged banks and corporations to engage in increasingly speculative borrowing and investment.
Additionally, the keiretsu network also raised concerns about market discipline. Because banks and affiliated companies were closely connected through cross-shareholding and long-term relationships, lenders had weaker incentives to monitor risk. As a result, banks were more willing to continue extending credit even when borrowers’ financial conditions deteriorated.
B.The Burst
Japan finally started to tighten monetary policy in May 1989 from the concerning asset price inflation levels, bringing the rate up to 3.25% after maintaining it at 2.5% for 2 years. They continued to raise rates for four more rounds up to 6% in 1990 (Fries, 1993). Finally, the economy started to contract, officially entering a recession in early 1992.
C. Consequences in Japan’s Economy
Following the burst of the bubble, Japan experienced a period of economic stagnation in the 1990s now known as the “Lost Decade”. During this time, Japan’s GDP growth averaged only 1.3%, which was the lowest of all the G7 nations. The period is a good example of a liquidity trap, where Japan’s monetary policy became ineffective. To stimulate the economy, the BoJ set interest rates to 0%, but businesses and households were still unwilling to invest because of slow technological advancement and low expectations for future rates of return (Yoshino & Taghizadeh Hesary, 2015). And once the rate hit the zero lower bound, the BoJ could no longer use it to effectively target inflation.
Additionally, it created issues in Japan’s banking system. Banks started to fail very soon after the crash, with a total of 181 going bankrupt in the 1990s. Those that survived were forced to lend out less credit to meet the strict capital requirements under Basel I. This resulted in a credit crunch where small and medium-sized businesses struggled to raise funds to grow their business, further contributing to the stagnating economy. The severity of this crisis was acknowledged by Japan when in 1992, the Finance Minister announced Tsutomu Hata emergency financial packages to stabilize the markets. The government had believed that Japan’s “real” economy of manufacturing and exports was immune to money games in the stock and land markets (Sterngold, 1992). But this position changed when Hata admitted that Japanese financial institutions were facing their “most severe situation since the Second World War”. Many people now also refer to this era as the “Lost Decades” because the trend of low inflation and stagnant growth did not end with the 1990s. It continued for nearly 30 years, only reversing during the COVID-19 pandemic, where inflation was experienced worldwide, highlighting the severity of its impact on Japan’s economy.
References
Cutts, R. L. (1990, May 1). Power from the Ground Up: Japan’s Land Bubble. Harvard Business Review. https://hbr.org/1990/05/power-from-the-ground-up-japans-land-bubble
Fries, S. M. (1993). Japanese Banks and the Asset Price “Bubble.” IMF Working Papers, 93(85), https://doi.org/10.5089/9781451954302.001
Hoshi, T., & Kashyap, A. K. (2004). Japan’s Financial Crisis and Economic Stagnation. Journal of Economic Perspectives, 18(1), 3–26. https://doi.org/10.1257/089533004773563412
Shiratsuka, Shigenori. (2003). The asset price bubble in Japan in the 1980s: lessons for financial and macroeconomic stability. RePEc: Research Papers in Economics, 21, 42–62.
Sterngold, J. (1992, August 20). Wake-Up Call in Tokyo; After 2 Years of a Stumbling Stock Market, Official Japan Says It May Have a Problem. The New York Times. https://www.nytimes.com/1992/08/20/business/wake-up-call-tokyo-after-2-years-stumbling-stock-market-official-japan-says-it.html
Yoshino, N., & Taghizadeh Hesary, F. (2015). Japan’s Lost Decade: Lessons for Other Economies. ADBI Working Paper, 521. http://adb.org/sites/default/files/publication/159841/adbi-wp521.pdf
Associated Press. (1988, December 21). Japan’s assets surpass its GNP.Los Angeles Times. https://www.latimes.com/archives/la-xpm-1988-12-21-fi-619-story.html
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