Flashback Friday | How the asset price bubble dragged Japan’s economy

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Japan’s stock market is booming.  The Japanese stock market index, Nikkei, has breached the 37,000-mark for the first time since 1990.

This marks the resurgence of Japan’s share market, long shunned by global investors for its meagre returns.

The Tokyo stock market gained 28.2 per cent in 2023, surpassing the S&P 500’s 26.28 per cent increase last year. 

Foreign investors continue to pour billions into the stock market, with the Nikkei rising by eight per cent in January. Two big factors have made the Tokyo Stock Exchange more attractive to foreign investors. 

The recent corporate governance reforms have prompted companies to increase returns to shareholders. In addition, a weak yen has improved profits and helped Japanese stocks become more valuable. 

No wonder, Warren Buffett, the greatest stock market trader alive, has been bullish about Japanese stocks. 

Nikkei’s 1989 record of 38.915 points is now in sight. 

The stock market gains signal that Japan’s three decades of economic stagnation may be nearing its end. 

Japan’s ‘lost decades’, which began in the 1990s and continues till date, have been signified by “one-per cent” growth and deflation. 

The country was once in the race to become a superpower, rivalling the economic might of the United States.  In fact, the 1980s, American corporations faced tough competition from cutting-edge tech brands from Japan. 

At the macro level, the US and Japan were locked in a tussle over trade.  By the mid-1980s, the East Asian country had become the biggest trading partner of the United States. As the trade deficit began widening, the US began imposing several tariffs to bridge the gap. 

Moreover, Japan became the biggest creditor of the US, further complicating the bilateral dynamics. 

It won’t be wrong to say that Japan of the 1980s closely mirrored present-day China. 

So, what went wrong in the Japanese economic miracle? 

It is generally believed that the asset price bubble of the 1980s shook the economy in the 1990s.  The “euphoria” of consistent long-term economic growth boosted asset prices in Japan. 

However, there was a major mismatch between the increase in asset prices and the actual economic fundamentals of the day. 

Analysts narrow down the asset price bubble to the period between 1987 and 1990, when three major factors typical of a bubble co-existed. Prof Shigenori Shiratsuka put them as following: marked increase in asset prices, an expansion in money supply and credit, and an overheating economy.

The Bank of Japan’s monetary easing — increased money supply and easy credit — played a big role in inflating the asset price bubble.  Between 1986 and 1987, the Bank of Japan cut the borrowing rate from 5 per cent to the post-war low of 2.5 per cent. 

External factors delayed a hike in the interest rates, especially the fear that a strong yen could hit Japan’s vibrant export market. 

By the time the central bank decided to hike rates in early 1989, the asset price bubble had grown too big to be ignored. 

The two-year-long rate hike cycle pricked the proverbial “bubble”, but not before prices peaked.  As per estimates, the stock prices peaked in December 1989, land prices in the big cities peaked in September 1990, while the nationwide land prices peaked exactly a year later. 

The central bank began to ease the monetary policy in mid-1991. But that failed to halt the contagion effect of the asset bubble burst. 

The stock market plunged 60 per cent from December 1989 to August 1992, while land prices dropped throughout the 1990s, falling 70 per cent by 2001. 

The immediate impact on Japan’s real economy lingered for at least a decade. Between 1992 and 2003, the economy barely grew by over one per cent, while output could never achieve its earlier potential. 

“Bubbles” are not a unique economic phenomena. Countries face them as part of the economic cycle. However, they mostly recover and grow. 

But, as recent history tells us, Japan has never been able to mount a comeback since the price bubble burst. The asset price bubble and its aftermath is now a case study in economic management. 

Of late, this crisis has re-entered the public sphere, as China’s struggles with its weakening property sector.  Many analysts believe that China is undergoing a ‘Japanification’, wherein demand collapses under the weight of deflation. 

Whether China’s ‘Japanification’ is a scare or an eventuality is still a matter of scholarly debates. Given China’s massive size and influence, any comparison with the much-smaller Japan seems unfair. 

But the island nation’s crisis continues to serve as a reminder to maintain a stable macroeconomic policy, with one eye on “economic euphoria”. 

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