The Japanese Asset Bubble


Apurva Dhamankar

11/9/20224 min read

In the years following the Second World War, the country of Japan experienced many significant changes, most of which were influenced by the Western Allies. Under the United States (US) Marshall Plan, America provided aid to the Japanese economy and allowed Japan to begin exporting its manufactured products to the US.

It wasn't long until the Japanese industry adopted a manufacturing strategy that allowed them to flourish. They gained an edge by taking the electronics products, improvising them, and reselling them back to the Western Allies for a cheaper price.

Japan rose from the ashes to become the world's second-largest economy, beating Germany, France, and Russia. During this golden run, the Japanese economy was growing at a super-fast pace of 10% per annum in the 1960s.

During the first five years of the 1980s, the US dollar appreciated by 50%, which made exports expensive and imports cheaper, and for the first time since the end of World War I, the US went into debt to the rest of the world.

In 1985, the US, France, Germany, the UK, and Japan purposefully decided to depreciate the dollar at the meeting in the Hotel Plaza in New York known as the "Plaza Accord." This made the Japanese Yen drastically appreciate against the US dollar, from 357.35 Yen in 1971 to 261.63 Yen today. Although this appreciation made the common man wealthy, it caused a stain on the exports—after all, 40% of Japan's exports were made to the United States.

Let us understand it by an example, if you were selling electronics from Japan to the US in 1985 for 500 Yen (Exchange rate @261 Yen/$) it would cost $1.92 but within four years Yen appreciated (Exchange rate @126 Yen/$) costing 3.96$ for the same 500 Yen, meaning in four years the cost increased by 100%.

Because of this appreciation, Japanese exports became extremely costly and, hence, out of competition. Therefore, to deal with the situation, avoid the risk of a crisis, and make up for these losses, the government and the central bank of Japan came up with a monetary policy whereby they decreased the lending rate of interest from 5% to 2.5%. The government significantly increased public spending, and banks started giving loans very leniently so that more loans could be availed to grow their businesses.

This is where the infamous asset price bubble started: people took loans to buy land, so there were more buyers in the market. This led to an appreciation in the land price, and then buyers pledged this land to get more loans.

In 1985, a square meter of land cost 0.5 million yen, but in just 6 years, the same land shot up four times to 2 million yen, and the same happened with the stock market, which shot up from 10,000 points to 40,000 points in just 5 years.

According to the International Monetary Fund (IMF), in 1989, the Japanese index was trading at a price-earnings (PE) ratio of 60. The company's debt kept on growing while its competitiveness was deteriorating, inflation was skyrocketing, and the housing market was already inaccessible to young people. So, to control this, the banks increased the lending rates to 6% in 1990, and this broke the virtuous cycle. Due to high-interest rates, people suddenly stopped borrowing. This saw a drastic drop in buyers, and the demand for land fell, which led to a fall in land prices.

The banks that had given loans as collateral saw their value plummet, meaning that for a loan of 20 lakh yen, the banks only had collateral worth 10 lakh yen, which was disastrous for their balance sheet. The banks then started selling collateral properties, which increased the supply of land and decreased the price of land further. Because of this, the banks started selling more land, and this cycle spiraled into an economic disaster whereby the land and stock prices started tumbling.

As a result, the non-performing assets (NPA) in Japan increased from 2 trillion yen to 13 trillion yen in just three years.

Also, the Japanese didn't invite any foreign investment due to their Keiretsu model, under which different companies, including manufacturers, supply chain partners, distributors, and financiers, made up the keiretsu and all had a small equity stake in each other and made contracts of 20 to 30 years.

This stopped any young company from getting contracts with bigger giants because they had already signed a long-term contract with their keiretsu partners despite offering a 20% to 30% reduction in the cost of production. Similarly, if any foreign company competes with a Japanese company, the banks in Japan would favor the latter because both are keiretsu partners. Also, the government policies in Japan made it very difficult for foreign companies to make a profit, and this stifled innovation.

Also, the Japanese policies were never built for foreign investment. Since the Foreign Direct Investment in Japan was very low as compared to other similar countries, the demand for Yen and investment in the Japanese market fell drastically. This was another reason for their currency failure and depreciation.

These were the major reasons why the Japanese lost despite having the fastest-growing economy in the post-war period, and yet after 30 years they have still not reached their 1985 levels.

Thank you.


Mayank Minda,

Kautilya, IBS Mumbai

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