Turning Japanese

Japan's post-bubble policies produced a "lost decade." So why is President Obama emulating them?

The scenario was eerily familiar. A long real estate bubble that had expanded extra rapidly for the previous five years suddenly burst, and asset prices came crashing back down to earth. Banks and financial institutions were left holding piles of worthless paper, and the economy soon headed south. The national government responded to the crisis by encouraging more lending and spending previously unfathomable amounts of money on public works projects in an effort to stimulate consumer spending and restart growth.

But that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits.

The Japanese government’s easing of credit rates, instead of spurring real demand, created artificial demand. Federal loans and stimulus spending were not economically productive, and they vastly increased the nation’s debt and prolonged the economic malaise. Worse, businesses spent critical time on the sidelines, waiting for government bailouts and other centralized actions, instead of speedily consolidating their losses, clearing their balance sheets of bad investments, and reorganizing.

The United States in 2008–09, unfortunately, has started down the same path. Federal intervention and the expectation of additional government action are removing firms’ incentive to clean up their balance sheets by selling “toxic” assets. Why accept pennies on the dollar if a deep-pocketed new bidder (i.e., the state) looms large on the scene? The Japanese experience shows that when the government is an active participant in the market, many firms would rather accept state support than initiate the inevitable financial reckoning. Such a status quo does not provide a sustainable foundation for the economy. Instead, it restricts economic growth and creates a cycle of stagnation.

How Bubbles Form—and Burst

The Japanese asset bubble grew out of a long postwar economic boom that accelerated in the latter half of the 1980s, spurred in part by the central bank’s loosening of monetary policy. With access to easy credit, businesses sped up the country’s transformation into an economy based on technology, most prominently in the consumer electronics, telecommunications, and finance sectors.

The ensuing demand for new and better technology products, combined with increased living standards, fed an asset investment craze referred to as the Heisei boom, after the emperor who took the Japanese throne in 1989. The value of the yen increased during this time, due primarily to the 1985 Plaza Accord, an agreement reached at an international conference in New York that depreciated the dollar against the yen, and Tokyo became a major financial services center. The Japanese Stock Market grew enormously, with the Nikkei 225 (an index similar to the Dow Jones Industrial Average) more than tripling between 1985 and the end of 1989.

Times looked so good that U.S. bestseller lists were sprinkled with anxious tracts about Japan eclipsing the country that had defeated it militarily less than half a century before. But a more real threat was hiding in plain sight: Japanese asset prices, after rising precipitously, were about to come crashing down to earth.

The late-’80s Japanese bubble and the mid-’00s American bubble had similar causes that are worth pondering:

Overaggressive financial institutions and poor risk management that ignored traditional economic fundamentals. In both Japan and the U.S., excessively optimistic expectations led to bad investment decisions from Wall Street to Main Street and a pervasive culture of denial that there was any bubble at all.

Japanese asset inflation was fueled by a 51 percent average growth rate in housing prices and an 80 percent increase in average commercial property values between 1985 and 1991. This spike created an overconfident climate in which investors failed to adequately prepare for a correction. Since that peak, asset values in Japan have fallen by more than 40 percent as of 2008.

Japan was flush with capital in the 1980s, in part due to an export boom that started the decade before. The country was becoming an increasingly important player in the world financial system, and international investors came looking for a stake. In the preceding years, Japanese individuals and firms had built up a large pool of savings and begun investing those resources in real property. This rapid rate of investment pushed the value of land, buildings, and other capital investments higher, encouraging even more investment, and in turn speculation, based on the belief that values and returns would keep rising.

Riding this asset appreciation, Japanese banks borrowed nearly ¥200 trillion ($3.4 trillion in today’s dollars) from foreign markets. This sum sloshed throughout the Japanese economy. The lending was further fueled by tiny debt-to-equity requirements, a relatively recent development that encouraged financial institutions to heavily leverage their bets. By 1991 Japanese banks held reserves of only ¥3 trillion to cover the ¥450 trillion they had lent. Normally, such a lopsided portfolio would have triggered widespread concern. But the economic climate in Japan back then was often described as “euphoric.” Prudence was not in vogue.

The American housing bubble was bigger, although values have yet to fall as much as those of Japanese real estate. Between 2000 and 2006, average home prices in the U.S. grew by 90 percent, and commercial property values rose at the same rate. Since the peak in July 2006, home prices nationwide have declined more than 30 percent, and certain regions have experienced even sharper drops. Prices were still falling as of press time.

After the twin shocks of the dot-com bubble bursting and the September 11 attacks, the Federal Reserve repeatedly slashed interest rates. And like Japan in the 1980s, the U.S. was seen as an attractive destination for international investment. With more investors using more money to chase high returns, Wall Street began aggressively “securitizing” home mortgages by bundling and reselling bits of loans and doing likewise with the insurance contracts underwriting them. New subprime mortgages became increasingly available to home buyers with spotty credit histories. Because of the risk, subprime loans brought a higher rate of return. But since they were bundled with safer loans, the entire packages received ratings from credit agencies that were higher than warranted.

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  • Fascitis Necrotizante||

  • Chad||

    My first three cents:

    1: Yes, we are going to experience something similar to Japan's lost decade. It is a direct consequence of our need to de-leverage and shift towards saving an appropriate fraction of our incomes. Nothing the government can or should do will prevent this.

    2: Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality. This idea is almost always false, as changes made by governments are almost always tiny relative to the economy. In the short term and individually, no single policy will have a measurable effect, and in any case, you don't know what would have happened without the policy. For example, did Japanese infrastructure spending prevent the Lost Decade? Obviously not. But did it make it slightly less bad or slightly worse than it otherwise would have been? Only God knows. Odds are, it made it slightly less painful...and at least the Japanese have incredible bridges, dams, roads, and trains that will last generations rather than the junk we tend to blow our money on.

    3: Long-term growth rates are going to be much lower than current projections. We should be budgeting for 1% growth, and considering anything else a bonus.

  • JLM||

    I'm glad I get to read this online before I get my print copy. Wait, what?

  • ||

    Randazzo seems to fall deeply into the "The government did X, then Y happened to the economy, therefore X causes Y" mentality.

    So if the economy does well, it isn't due to the Obamassiah's economic policies?

  • Xeones||

    So why is President Barack Obama emulating it?

    Because he really does believe that central authority drives all things. The man is a totalitarian, and to a totalitarian, having his hands all over an absolute ratfuck is better than sitting back and letting things stabilize on their own.

    Also: hi, Chad! This one's not your best. Maybe you could have tried harder?

  • Chad||

    So if the economy does well, it isn't due to the Obamassiah's economic policies?

    Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

    People who claim that they can discern the impact of policies by looking what happens to the economy after they are adopted are just plain wrong. Unfortunately, that includes, well, just about everyone, because people can ALWAYS find a policy change they don't like that occured just before the bust, or a policy change that they did like that occured just before the boom. They can then use false causalities to harden their beliefs.

    You will not find me making such claims. Instead, you will find me noting that our current economy is a function of a wide variety of factors, including hundreds of policy decisions made both here and abroad over many decades. The impacts of any recent policy changes are almost always minimal and lost in the noise.

    As another point. The Democrats and Republicans are arguing over about 2% of the GDP, as the rest of government spending is pretty much agreed upon. Do you honestly think that wild fluctuations in the world economy rest upon what the government does with that tiny fraction of our economy?

  • Fascitis Necrotizante||

    Chad just won't be happy until we're all doing cosplay while being tentacle raped on a bullet train. Deru kui wa utareru, says Hello Kitty via telescreen.

  • Spoonman||

    This idea is almost always false, as changes made by governments are almost always tiny relative to the economy.

    Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

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  • Chad||

    Um, government spending is what percentage of GDP this year again? That seems pretty huge relative to the economy.

    Federal spending is usually just a bit over 20% of GDP. State and local push total government spending to just over a third of GDP. My point is that of this 20%, only about 2% is actually disagreed upon the political mainstream. What we do with this 2% has virtually no impact on the world economy.

  • ||

    Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP. But we will never know, because we don't know what the GDP would have been with the status quo or any alternative policy choices.

    Odds are? Really? The "odds are" that the Obama Administration will create a "Five Year Plan" that will increase economic growth? When it is the market, individuals acting freely, that has produced the most wealth in the history of the world why would the odds favor central planning at this time? Because the administration is going to put the word "smart" in front of everything? Smart bureaucrats instead of the normal, self interested kind can handle it? All they needed was a Messiah to lead them?

  • Chad||

    When it is the market, individuals acting freely, that has produced the most wealth in the history of the world

    If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth", you might have a point. Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

    Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

  • EJM||

    But as Anthony Randazzo, Mike Flynn, and Adam B. Summers write in our July issue, that stimulus did not save the Japanese economy in the 1990s; far from it. The ensuing period came to be known as the Lost Decade, characterized by multiple recessions, an annual average growth rate of less than 1 percent, and a two-decade decline in stock prices and corporate profits. So why is President Barack Obama emulating it?

    Unfortunately, Japan is the Lance White of industrialized East Asian democracies; by extension, South Korea is the Jim Rockford.

    That said, Nouriel Roubini is apparently bullish on the Korean economy.

  • Kris||

    We are Japan.

    If we're lucky.

    Really, really lucky.

  • Spoonman||

    Your point would be even stronger if we hadn't borrowed ourselves into oblivion in order to purchase all this "wealth".

    The market didn't do that.

    Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

  • ||

    What's funny is that Lance became Rockford when he got his own private investigator series.

  • Chad||

    Spoonman | June 2, 2009, 10:11am | #

    The market didn't do that.


    There is far more private debt in this country than public debt. What are you talking about?

    Also, re: your size point, 2% of government spending is still huge compared to any other body which can make a decision in the national economy.

    Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

    Let me repeat:

    Before ANY boom or bust you can find a:) policies that were adopted that fit your ideology and b:) policies that were adopted that contradict your ideology

    Most people then pick-and-choose whichever policy and economic cycle combination fits their beliefs, and assert causality. This is childish logic.

  • Spoonman||

    There is far more private debt in this country than public debt. What are you talking about?

    The Federal Reserve's ability to affect interest rates, and their use of that power to encourage borrowing.

    Irrelevant. 2% of US GDP, or few tens of a percent of world GDP, simply doesn't matter. The world economy does what it does despite our petty political fights. Anyone who pretends otherwise is simply seeking illogical justifications for their ideologies.

    So you've said. Proof?

  • phalkor||

    doing cosplay while being tentacle raped on a bullet train

    What's funny is that this would probably be a sign of economic recovery. Well, or the coming of Robo-Aids; your pick.

  • squarooticus||

    Chad, what you seem to be arguing is that what will happen will happen, regardless of which of the two major political parties in the US controls the government. For once, I agree.

    We were set upon this course decades ago, with the outcome inevitable. I suspect Obama will speed the demise along a tiny bit, but even if Dole were elected in 1996, or Gore in 2000, or McCain in 2008, the ultimate outcome was pre-determined by government policy made long ago: you know, the government policy that comprises the other 28% of GDP that the two political parties functionally agree on.

    What I'm saying is that focusing on some silly battle between the two major parties is silly, because they are virtually identical in terms of what policies they support, differing only on a small margin. What is needed is for the other 28% of GDP to be reevaluated. Of course the government will not do this voluntarily, because government is a ratchet on revenue and power: thankfully, our debtors will force us to do this, either nicely (by asking) or not nicely (by destroying the market for our debt). One way or the other, however, this reevaluation is coming.

    We'll be lucky if the US goes through only two lost decades. *Lucky*.

    In a similar sense, even the warnings of those of us who predicted this are irrelevant: I suspect I've helped some people on a small margin avoid financial ruin when the day of reckoning comes for the dollar, but I have no illusions that my advocacy has had any substantive effect on the overall political composition of the country or will in any substantive way impact the final destruction of the dollar, the (hopefully final) discrediting of central banking, or the lower rates of growth of government during the coming retrenchment and rebalancing of the world economy. These things will happen the way they will happen because the numbers don't allow them to work out any other way: we are armed only with a coffee mug against a rising tide.

  • ||

    Odds are, Obama's policies will make things slightly better than they otherwise would have been, perhaps 2-3% larger GDP.

    Funny, that's not what the CBO said. Their take, as I recall, was that the stimulus package would be a net negative in the long run.

    The world economy does what it does despite our petty political fights.

    To me, this sounds like a reason for the Almighty State to back off and do very little. To Chad, it is a reason for the Almighty State to grow, expand, borrow, and spend like crazy.

  • Colonel_Angus||

    "McMansions, SUVs, cheap Chinese crap" Chav sure does like typing this. I think it's his catchphrase. Suck a fat one, you twat.

  • ||

    Japan's shinkansen bullet trains will be used by today's children's children. Your SUV will be obsolete by next summer, when gas is $4.50 again. Libertarians just can't seem to grasp the difference, or that free markets overwhelmingly favor short-term consumption.

    Oh, sure, since a few governmentally controlled infrastructure investments are good then 3 or 4 trillion a year must be great?!
    My SUV? Bullet trains? You don't even realize that there will be very few children of the children of the Japanese to ride those trains.

    Spending more than you have is a Leftard practice, not a Libertarian one. You are claiming that there is either "Five Year Plans" or "short-term consumption" and never the twain shall meet. Fiscal Responsibility doesn't include pissing away more money than you have times ten. Or perhaps the government would limit what I can consume based upon their superior wisdom? Based upon "need"? You know the mantra

    From each according to his ability and to each according to his need?

  • Jordan||

    Two word re: Japan and bullet trains: population density. And credit-default swaps are not market inventions.

  • ||

    I think the case for not spending the money on infrastruture would be stronger if we didn't have bridges collapsing, or a highway system that gets a "D". If I remember correctly we need to spend 2-3 Trillion just to get our current system back in shape.

    See once you build stuff you have to maintain it. Moreover, you need to set aside more money to build it again once you can't repair it anymore.

    CA is a great example, we built highways, and universities etc, now everything is falling apart becuase we didn't spend the money to maintain it.

    Americans have been living beyond their means for a long time, and it's going to suck now trying to pay everything down, and fix everything that's broken.

  • Jordan||

    With the amount of money government at all levels currently takes in, they could afford to fix every piece of infrastructure several times over. Cut spending and leave us alone.

  • ||

    I suppose that's true. If we didn't spend any money on SS, or Medicare for a couple of years we could fix everything. But that seems unlikely.

    Besides the military nothing else even comes close.

  • bt6||

    "If you count massive amounts of McMansions, SUVs, cheap Chinese crap, and credit default swaps as "wealth","

    McMansion = home that someone owns, rather than living in a government housing project. Owning a home is wealth.

    SUV = car that someone owns, rather than standing in a blizzard hoping that the bus gets there before someone steals the food from the bags you're carrying. Owning an SUV is wealth.

    Cheap Chinese crap = things that people buy, rather than doing without. Owning things is wealth.

    Default credit swaps = a government-created fiasco. This is not wealth.

  • janejim||

    Banks have huge debts, but they're getting a helping hand from the federal government. If you have overwhelming debt--perhaps from bad investments, or maybe a job loss, a medical crisis or just plain overspending--you're probably on your own. Check the website http://obamadebthelp2009.blogspot.com
    to see if they can help. I am glad I did read it before I talk to my CC company and it helped - Jane Jim, California

  • Marian Kechlibar||

    Kroneborge: you are SO RIGHT about the need to maintain infrastructure once it is built.

    In my opinion, this is one thing that separates reasonable transport management from idiotic one.

    From this point of view, Germans, Danes, Swiss or Japanese have reasonable, rational transport management.

    My own country (Czechia) is a fencesitter, swaying dangerously to the idiotic half.

    From what I have heard of California, it is way beyond the fence.

  • Ogden Homes||

    That's sick. Didn't economists study Japan's problem back in the 90's? History repeats itself. But sometimes we can learn from past mistakes can't we.

    I read something that more than 25% of mortgages are upside down. That will take years to recover.

  • dan22||

    10. Japan's Government Bond Market Implodes- The Japanese government and economy got used to record low interest rate. But the combination of government debt reaching 230% of GDP and the ageing population cashing in via the pension funds on the government bonds cause a total implosion. In only 2 month the yield on 30 year government bond went up to 4% causing a panic selling and forcing the government to finally cut the deficit. The deficit cut where not enough, and Bank of Japan did what it knew best- printed money. Only this time, to there big surprise it resulted in inflation, and just ordinary inflation-hyperinflation. The markets discovered that they where worried about the wrong country. Japan became the first modern country in 21st century move towards hyperinflation

    http://israelfinancialexpert.b.....redictions 2010

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