From Surge to Stagnation: A Japanese Story
For a country where deflation is a common term associated with its economy, there used to be a time when the Japanese economy actually experienced an unprecedented price surge. The scene is set in the late 1980s when the Japanese economy was experiencing an asset bubble — one of the largest in Asia. At the height of the bubble, the famous Japanese Stock Market index Nikkei 225, touched a historical all-time high of 38,957.44 in late December 1989. The Nikkei 225 did not reach 30,000 points again until 31 years later, in September 2021.
The Japanese economy came out of a recession in 1986, known as the ‘endaka recession’, which was related to the Plaza Accord where Japan and three major Western powers signed an agreement to depreciate the United States Dollar. Consequently, this led the Yen to appreciate more than intended, sending the export-oriented country into a recession.
This situation sparked a large policy shift in the Japanese economy to curb the appreciation of the Yen through aggressive fiscal and monetary easing in the economy. From January 1986 to February 1987, the Bank of Japan (BoJ) significantly cut interest rates from 5.0 percent to 2.5 percent and maintained the same until May 1989.
A point to note was that the BoJ shared concerns over the asset price bubble that was being formed. However, it took a wait-and-see approach despite commencing a tightening cycle, mainly owing to the Black Friday crash in the US that took place in October 1987, which sent ripples through world financial markets.
Nevertheless, during this period of financial, monetary and overall economic easing, Japanese assets commenced their trend of rapid appreciation, with significant increases in Japanese land prices supported by the idiosyncrasies in the Japanese Property Tax laws and Lease laws, and a shift towards accommodating banking trends during the period.
At the peak of the bubble economy, Tokyo real estate sold for as much as US$139,000 per square foot, which was nearly 350 times as much as the equivalent space in Manhattan, New York. By the same standards, the Imperial Palace in Tokyo was worth as much as the entire US state of California.
Figure 1. Tokyo Stock Price Index (TOPIX) and Urban Land Value Index, 1970–2010 (1980=100)
Further, substantially high land prices meant land constituted around 65 percent of Japan’s national wealth, compared to just 2.5 percent for the UK at the time. Overall, the accommodative financial system and record-breaking stock market activity created additional incentive to further enlarge the bubble.
Meanwhile, owing to the encouraging marketability of assets and speculation, market participants created alternative asset classes that had a growing demand mainly attributable to shifts in the demographics of the Japanese economy.
For example, golf club membership could potentially cost millions, and became a tradeable asset worth an c. US$ 200 billion market. With the appeal of exclusivity and luxury, demand for golf club memberships soared — with estimations of club memberships and being considered as a tradeable commodity — by 400 percent between 1982 and 1989, while further rising 190 percent in 1989 at the height of the bubble.
In May 1989, the BoJ finally commenced its tightening operations, increasing interest rates from 2.50 to 3.25 percent, a 75bps increase, and continued to increase rates till August 1990 when it reached 6.00 percent. However, real interest rates remained low during 1989, and land prices rose amidst the interest rate hikes until banks imposed strict restrictions on lending to real estate companies.
With gradual monetary tightening and land related laws rectified, the collapse of the asset price bubble was completely in motion and largely paved the way for what is known as the ‘lost decade’, a period of economic stagnation between 1991 to 2001, which extended until the beginning of 2021. Moreover, the lost decade is how the term ‘deflation’ started its close association with the Japanese economy.
Many would agree that Japanese Ministry of Finance and Bank of Japan (BOJ) policies that supported speculative credit creation lie at the root of the Japanese asset price bubble.
Parallels can be drawn to current day with all major economies around the word responding to covid-19 pandemic by easing monetary policy and using unconventional policy tools, which combined with various other factors have contributed to asset price booms across the world.
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