Japan's bubble economy and its collapse

How did post-war Japan become an export power in trade conflict with the United States? {japan}

Japan's economy lay in ruins after the Second World War; in 1946 industrial production fell to 27.6 percent of its pre-war level. With the Cold War the United States switched from weakening Japan to rebuilding it as an anti-communist bulwark, and military orders for the Korean War in 1950 saved heavy industries on the verge of bankruptcy. Having regained its pre-war living standard by the mid-1950s, Japan enjoyed "high growth" from 1957 to 1973, with GNP rising by around 10 percent a year. Under the Bretton Woods system the yen was pegged at 360 to the dollar, which favoured exports. 1

The engine of growth was a web of banks and firms. The Bank of Japan lent to the city banks, which in turn lent to industrial groups beyond their ability to repay, a practice known as "over-loaning". The keiretsu, business groups that succeeded the pre-war zaibatsu, were each centred on a bank and held each other's shares, a cross-ownership that kept out hostile takeovers. High household savings flowed through the banks into corporate investment. Japan became the world's third-largest economy in 1968 and, overtaking the Soviet Union, the second-largest in the 1980s. 1 2

Once the United States ran a persistent trade deficit with Japan after 1965, friction erupted. Washington extracted "voluntary export restraints" from Japan on textiles (1972) and steel and colour televisions (1977), and in 1981 the Japanese car industry limited its exports to the United States. When the US trade deficit with Japan reached $50 billion in 1985, criticism widened to the closed character of Japan's investment, finance and service markets, and "Japan bashing" became a catchword in the United States. In April 1987 President Reagan imposed punitive tariffs of 100 percent on Japanese personal computers, colour televisions and other goods in response to alleged dumping. 3 4

What did the Plaza Accord promise, and how far did the yen rise? {usa} {japan} {germany} {france}

In the early 1980s the dollar was far too dear. The high interest rates of Federal Reserve Chairman Paul Volcker combined with the Reagan administration's budget deficits to push US rates up and draw the world's money into dollars; between 1980 and 1985 the dollar rose about 50 percent against the yen, mark, franc and pound. A dear dollar makes American goods expensive abroad and foreign goods cheap in America. Grain exporters, carmakers and manufacturers such as Caterpillar, IBM and Motorola demanded protection, and when Congress began to consider protectionist laws, James Baker, Treasury Secretary from January 1985, opened negotiations to adjust exchange rates. 5

On 22 September 1985 the finance ministers and central bank governors of the five countries of the G5, the United States, Japan, West Germany, France and Britain, met at the Plaza Hotel in New York; Finance Minister Noboru Takeshita represented Japan. The content had been fixed beforehand by officials, and the meeting itself took only about 20 minutes. The announcement said that "some further orderly appreciation of the main non-dollar currencies against the dollar is desirable" and that the participants stood ready to cooperate more closely to encourage this when doing so would be helpful. The language was cautious but the meaning was plain: the central banks would sell dollars together in the market to drive its price down. The Japanese government pledged to expand domestic demand, open its markets to foreign goods and liberalise its domestic capital markets. 6 5 7

The effect was larger than expected. In the 24 hours after the announcement the dollar fell from 235 yen by about 20 yen, and a year later it traded in the 150s. Takeshita's remark that "even 190 yen to the dollar would be fine" also encouraged speculative buying of yen. On 22 February 1987 six Western countries meeting at the French finance ministry in the Louvre Palace in Paris agreed to halt the dollar's excessive fall and stabilise rates around the prevailing level (the Louvre Accord); the rate then was around 150 yen. Yet the yen kept rising, to 128 at the end of 1987 and 121 in early 1988. 6 8 9 10

When the yen rises, the dollar price of the same Japanese product rises, so exporters must raise prices and sell less or accept lower profits. The Japanese economy, led by exports and investment for export, was hit at once: real growth fell from 5.2 percent in 1985 to 3.3 percent in 1986, and this "endaka recession" (the high-yen slump) became the starting point of the policies that followed. The US trade deficit with Japan barely shrank. Japanese firms defended their competitiveness by rationalisation and by moving production abroad, and Japan's trade surplus actually grew in 1986–88. A surge of Japanese firms moving factories to Southeast Asia to escape the strong yen also fuelled that region's rapid growth. 10 3 11 6

Why did the Bank of Japan cut rates, and where did the money go?

The rate at which the Bank of Japan lends to the commercial banks is the official discount rate. When it falls, banks and firms can borrow cheaply and lending and investment rise. Starting on 30 January 1986 the BOJ cut the discount rate five times, from 5 percent to 2.5 percent on 23 February 1987, and held this record low until May 1989. Apart from the first cut, most were tied to international policy to stem the yen's rise and intervene in the currency market: the second and third were announced jointly with the United States, and the fourth and fifth followed joint statements of Japan and the US or of the G7. Hence the criticism that exchange-rate stability had been put ahead of the domestic economy. 10

Fiscal policy was loosened too. In April 1986 the Maekawa Report, drawn up by a private advisory body of Prime Minister Yasuhiro Nakasone, called the huge current-account surplus a "critical situation" and urged Japan to grow through domestic demand rather than exports, open its markets and liberalise finance. The government expanded public investment, and in the supplementary budget for fiscal 1988 Finance Minister Kiichi Miyazawa embarked on more public works. In the Structural Impediments Initiative of 1989–90 the United States again pressed Japan to invest more in public works, and the Kaifu cabinet drew up a ten-year public investment plan of 430 trillion yen. 12 13 11 14

Cheap money went into land and shares rather than factories. As financial liberalisation let large firms raise funds directly on the stock and bond markets, banks that had lost these customers lent aggressively against property to small firms and individuals. In 1987–88 even an ordinary salaryman could borrow up to 100 million yen for any purpose with his house as collateral. Firms used rising share prices to raise cheap money through "equity finance" such as convertible bonds and bonds with warrants, and spent much of it on zaitech ("financial technique"), that is, speculation in shares and real estate. Rising land prices raised the value of collateral, which allowed more borrowing to buy more land. 10 15

In the summer of 1987 the BOJ, worried by soaring asset prices, hinted at tightening. But when the New York stock market crashed in a single day on 19 October, "Black Monday", it postponed the increase, citing uncertainty in the world economy. Official prices were stable, because the strong yen had lowered the cost of imported raw materials and oil. With "statistical price stability" achieved it was hard to persuade the public of a sharp rate increase, and pressure from the Ministry of Finance and foreign authorities added to the delay. BOJ Deputy Governor Yasushi Mieno is said to have argued at the time for higher rates, warning that "dry firewood" was piling up. 10 16 17 15

How far did land and share prices swell?

What swelled first was Tokyo land. The average price per square metre of commercial land in Tokyo rose 42 percent in 1985 and another 122 percent in 1986 alone, to 4,211,000 yen. As land ran short, investors moved on to Kanagawa, Saitama and Chiba, and then to Osaka, Kyoto, Nagoya and Kobe. By 1991 commercial land prices in the six major cities were 302.9 percent above 1985. In 1989 land in Ginza cost 30 million yen a square metre, and it was even estimated that the 1.15 square kilometre grounds of the Imperial Palace in Tokyo were worth more than all the real estate in California. 10

Share prices followed. The Nikkei 225 index rose almost 45 percent in 1986 alone and reached its peak on 29 December 1989, 38,957.44 during the session and 38,915.87 at the close, more than 224 percent above 2 January 1985. Price-earnings ratios exceeded 80. Because firms held each other's shares, few shares were traded on the market, and rising land prices increased the book assets of land-owning companies and pushed their shares up. In 1989, 32 of the world's 50 largest companies by market capitalisation were Japanese. 10 13 18

The size of these numbers becomes clear only against production. According to the Marxist economist Makoto Itoh, the capital gains from rising land prices in 1988 alone came to 416 trillion yen, 1.21 times that year's GNP; in the United States, which had a similar land bubble, the figure was about 3 percent of GNP. The tax system aided speculation. Inheritance tax was high, but land was valued at about half its market price while debt was deducted at face value, so borrowing to buy land saved tax. The effective property tax fell to 0.06 percent of market value in the Greater Tokyo Area, so it paid to leave land idle and wait for its price to rise rather than to use it. 15 10

At the end of the bubble corruption came to light. The Recruit scandal of 1988, in which unlisted shares of a recruitment company had been given to politicians, implicated the entire cabinet, and Prime Minister Noboru Takeshita resigned in 1989. Bribery, insider trading, share manipulation and fraud, it emerged after the bubble burst, had pervaded society from officials to ordinary people. 10 19

How did the bubble burst?

In 1989 things changed. In April a 3 percent consumption tax was introduced for the first time, and when unemployment fell to 2.2 percent and labour shortages pushed manufacturing wages up 6.5 percent, the BOJ began raising rates in May to forestall inflation. Yasushi Mieno, who became governor on 17 December 1989, pressed the increases on: in five steps over fifteen months from May 1989 the discount rate rose from 2.5 percent to 6 percent in August 1990. At a time when land prices kept salarymen from buying a house in Tokyo, the press hailed him as the "Onihei of Heisei", after a famous Edo-period enforcer, for fighting speculation. 10 20 21 17 15

Shares fell first. The Nikkei opened 1990 at 38,921 on 4 January and fell to 21,902 on 5 December, losing more than 43 percent in a year, and in August 1992 it fell as low as 14,309. On 27 March 1990 a circular "On Restraining Land-Related Lending" went out to all financial institutions in the name of Masaaki Tsuchida, director of the Banking Bureau of the Ministry of Finance. This "total volume restriction" held the growth of real estate lending below the growth of total lending. The finance minister at the time was Ryutaro Hashimoto. The restriction was lifted only on 20 December 1991. 10 22

The restriction had holes. Housing loan companies (jūsen) and agricultural co-operative lenders were left out, so co-operative money kept flowing through the jūsen into real estate, which later swelled the jūsen bad-loan problem. Meanwhile banks issued loan certificates and then refused to lend, or cut off loans halfway through construction; what would later be called "credit crunch" and "loan recall" happened all at once across the country. Land prices began to fall sharply in Tokyo in 1991, by the end of the year most urban land prices were falling, and the collapse of the bubble was officially recognised in early 1992. 22 10

At the time some criticised these measures for coming too late, but few for being too harsh; leading newspapers wrote "Crush the land-price bubble completely" and "Don't loosen the reins on land-price policy". Yet the rate increases and the lending restriction brought on a far sharper downturn than expected, and Mieno was later criticised for overdoing the attack on the bubble and then easing too late and too little, ushering in deflation and the "lost decade". 22 17

Why were the bad loans not cleaned up for more than a decade?

During the bubble the banks had lent against land. When land prices halved, selling the collateral no longer recovered the loans, and loans with little prospect of repayment, bad loans, piled up on the banks' books. Corporate balance sheets, the statements setting assets against liabilities, were wrecked too: asset prices had collapsed while debts remained, so many firms held back investment to bring down their debt ratios. Makoto Itoh called this a "complex depression" in which a slump in the "stock" of assets combined with a slump in the "flow" of income and output. As collateral values melted, firms could hardly expand either with their own funds or by borrowing on mortgage, employment conditions worsened, and in 1993 real wages actually fell. 10 15

The banks had reasons to defer their losses. The Bank for International Settlements capital rules of 1988 required banks to hold capital of at least 8 percent of their assets, and Japanese banks were allowed to count 45 percent of the "latent gains" on their shareholdings, the gap between book and market value, as capital. As share prices fell these latent gains melted away and capital ratios dropped. Since recognising losses would leave them short of capital, the banks kept insolvent borrowers alive by rolling over their loans. Firms unable to cover even their interest from current profits but kept afloat by bank credit came to be called "zombie companies"; they were criticised for cutting the profits of sound firms and depressing job creation, productivity and investment. 15 10 18

The government responded with stimulus. It raised spending sharply in 1993 and announced package after package thereafter. But people uneasy about the future saved rather than spent, tax revenue shrank and the deficit grew. The first injection of public money went to the jūsen. In 1996 the Hashimoto cabinet introduced a bill to cover with taxes 685 billion yen of the jūsen companies' 6.4 trillion yen of losses, the part that the parent banks, other banks and agricultural co-operative lenders could not bear. The bill provoked fierce criticism in what was called the "jūsen Diet", and members of the opposition New Frontier Party picketed the committee room, but it passed. 10 23

How did the financial crisis of 1997–98 break out?

The Ryutaro Hashimoto cabinet hurried to restore the public finances. In April 1997 it raised the consumption tax from 3 to 5 percent, ended a special income-tax reduction and raised patients' share of medical costs from 10 to 20 percent. Consumption froze again. The Asian monetary and financial crises under way at the same time added to Japan's difficulties in turn. On 3 November 1997 the mid-sized broker Sanyo Securities filed for reorganisation, and the next day about one billion yen of unsecured short-term (call) money lent to it went unpaid, freezing the call market where banks lend each other overnight funds. 15 24 25 26

Within the next two weeks large institutions fell one after another. On 17 November 1997 the Hokkaido Takushoku Bank (Takugin), Hokkaido's only city bank, announced that it could no longer fund itself and would transfer its business to the North Pacific Bank (Hokuyo). It was the first, and is still the only, failure of a city bank since the war. Anxious at being the smallest city bank, Takugin had expanded lending aggressively during the bubble, and by March 1997 its bad loans reached 13.4 percent of total lending. On 24 November Yamaichi Securities, one of the four largest brokers, resolved to close itself down voluntarily: it had hidden off-book debts, incurred by compensating clients for losses, of 158.3 billion yen in Japan and 106.5 billion yen abroad. Tokuyo City Bank failed the same month. 26 25 15 10

In March 1998 and March 1999 the government injected a total of 9.3 trillion yen of public funds into the major banks. When the LDP lost the House of Councillors election of 1998, Hashimoto resigned and Keizō Obuchi became prime minister. In the "financial Diet" that autumn the governing parties in effect swallowed the opposition's financial revitalisation bill whole, and the Financial Revitalisation Act (12 October) and the Early Strengthening Act (16 October) were passed. On 23 October 1998 the Long-Term Credit Bank of Japan (LTCB) was placed under special public management, that is, temporarily nationalised, and in December the Nippon Credit Bank followed. Some 7.9 trillion yen of public money went into the LTCB, of which about 3.6 trillion yen became a confirmed loss; the bank was sold to an investment group led by the American fund Ripplewood and renamed Shinsei Bank in 2000. 10 24 27 28

The Obuchi government raised public spending, cut income tax and handed shopping coupons to 35 million people to revive consumption. This policy of issuing more government bonds to build infrastructure became known as "Obuchinomics". It briefly slowed the downturn but did not turn it round, and public debt swelled. Through the crisis the banks merged again and again until they formed four national banking groups. Many small borrowers cut off from credit turned to loan sharks (sarakin). 29 18

Did zero interest rates and quantitative easing stop deflation?

Under deflation, a steady fall in prices, cash gains value as time passes. Firms cut wages, research and investment and prefer to sit on cash. A central bank normally cuts rates to encourage investment and consumption, but while prices fall even a nominal rate of 0 percent leaves a positive real rate equal to the fall in prices. Because rates cannot easily be pushed below zero, monetary policy loses its force; this is called the zero lower bound. Japan's interest rates stayed below 1 percent from 1994. 18

In February 1999 the BOJ decided to guide the overnight interbank rate (the uncollateralised overnight call rate) to a record low of 0.15 percent; Governor Masaru Hayami's remark that "even zero is fine" gave the "zero interest rate policy" its name. When the American information-technology boom seemed to revive the economy, on 11 August 2000 the BOJ overrode the government's request for a delay and ended zero rates by seven votes to two. A worldwide downturn arrived at the end of that year; the BOJ cut rates again in February 2001 and on 19 March began quantitative easing, which replaced the interest-rate target with a target for the current-account balances that banks hold at the BOJ and raised them. Quantitative easing ended on 9 March 2006, once consumer prices had risen year on year for four months in a row. 30 31 10

Hayami resisted politicians' demands for easing, arguing that "inflation is no solution to economic problems" and that structural reform to reduce regulation and monopoly had to come first. The 2000 exit was later criticised as a signal that the BOJ was not committed to ending deflation, which entrenched deflationary expectations. The clean-up of bad loans gathered pace under the cabinet of Junichiro Koizumi. The "Takenaka Plan" of the economist Heizō Takenaka, financial services minister from 2002, forced strict scrutiny of bank accounts; in May 2003, when auditors refused to approve Resona Bank's accounts, the government put in a $17 billion bailout. The Nikkei reached its post-bubble low of 7,862 on 11 March 2003. 32 30 33 10

The economy recovered slowly in the 2000s, but the losses were large. Between 1991 and 2003 GDP grew by only 1.14 percent a year, and GDP in 2017 was only 2.6 percent higher than in 1997, so the "lost decade" stretched into the "lost twenty years". Stimulus after stimulus, with a deficit every year from 1991, left public debt at about 240 percent of GDP by 2013, the highest in the world. The yen carry trade, borrowing ultra-cheap yen to invest in higher-yielding assets abroad, also grew in this period. 18 10

How did working people's lives change?

In the 1970s and 1980s the symbol of Japan's large firms was "lifetime employment". As the slump dragged on, firms restructured through downsizing and outsourcing, and lifetime employment was shaken. Because case law made it hard to dismiss regular employees, firms protected existing staff and sharply cut the hiring of new graduates instead. Those who graduated roughly between 1993 and 2004 are called the "employment ice age generation", estimated at about 17 million people. Unemployment among those aged 15 to 24 reached 8.7 to 10.1 percent in 1999–2005, and new job openings in manufacturing fell by more than half, from 138,000 in 1992 to 61,000 in 2002. 10 34

Non-regular employment filled the gap. The share of non-regular workers, part-timers, casual workers, dispatched and contract employees, among those employed first passed 20 percent in 1990 and then held steady for a while, but after the Asian financial crisis of the late 1990s it climbed steeply, passing 25 percent in 1999 and 30 percent in 2003. The Ministry of Health, Labour and Welfare's 2010 White Paper on the Labour Economy named as causes a strong drive to hold down labour costs by using relatively low-paid workers, and the deregulation of temporary staffing. Revisions of the Worker Dispatching Act in 2003 and 2004, pushed by Takenaka, greatly widened the scope of dispatched work. Korea's non-regular employment grew in the same years after its own currency crisis, a story told elsewhere. 35 33

Wages stagnated. Real wages fell about 13 percent from their 1997 peak by 2013, a decline that stood out internationally, and in 2010 household income was back at its 1987 level. Makoto Itoh pointed out that while big business introduced microelectronics (ME) information technology, "rationalised" labour management and increased the share of female non-regular workers, real wages were held down and the international competitiveness and finances of big firms actually improved. In his view, in a company-centred society the more workers cooperated to raise profits, the more the trade surplus grew and the yen rose, squeezing the firms again. 18 15

How do economists explain the bubble and the long slump? {japan}

The first question is whether the Plaza Accord was the cause. Many in Japan see it as the starting point of the "lost thirty years": pushing up the yen by coordinated intervention cost Japanese goods their competitiveness, and behind it lay American alarm that Japan's GDP might overtake America's, along with long-standing trade friction. When the US-China trade war began in 2018, China's state news agency Xinhua wrote that the economic stagnation of a Japan that had "bowed to the United States in the Plaza Accord" should not be forgotten. There are opposing views. The economist Jeffrey Frankel points out that between the yen's rise in 1985–86 and the recession of the 1990s came the bubble years of 1987–89, when the yen was no longer being pushed up, and that the rising mark caused neither a bubble nor a recession in Germany. Richard Werner holds that external pressures such as the Plaza Accord and the Ministry of Finance's calls for lower rates cannot explain what the Bank of Japan did. 6 5 10

The second is monetary policy error: the BOJ kept rates too low for too long and raised them too late, creating the bubble, then tightened too hard and eased too late after it burst. Werner goes further, arguing that the BOJ inflated lending through "window guidance", the loan-growth quotas it set for each bank, and that this was driven not by Governor Satoshi Sumita but by Deputy Governor Mieno and Toshihiko Fukui, head of the banking department. Paul Krugman saw Japan as an example of a "liquidity trap", where rates near zero leave monetary policy powerless, while Scott Sumner argued that monetary policy was too tight and prolonged the pain. 10 18 36 17

The third is the "balance sheet recession" theory of Richard Koo, an economist at the Nomura Research Institute. When land and share prices collapsed, many firms found their debts exceeding their assets, and even with rates near zero they used their earnings to pay down debt instead of borrowing to invest. According to Koo, corporate demand for funds turned negative in 1995 and net repayment continued for ten years until 2005, and from 1998 the corporate sector became a net saver rather than a borrower: firms aimed to minimise debt rather than maximise profit. With no one willing to borrow, monetary policy is ineffective, and only government borrowing and spending can fill the hole in demand. Koo believes that massive fiscal stimulus spared Japan a collapse like the American Great Depression. This connects with the Keynesian prescription of filling the gap in effective demand with public spending. Krugman agreed with the diagnosis but left room for monetary policy, arguing that a promise of inflation would lower real interest rates and reduce saving. 37 18 38

The fourth looks to the real economy and institutions. Fumio Hayashi and Edward Prescott attributed Japan's poor performance in the 1990s not to a credit crunch but to slower productivity growth: the investment firms wanted to make was mostly financed, so the problem was a low desire to invest. Jennifer Amyx argued that Japanese experts were not ignorant of the causes but lacked the institutional flexibility to push through policies, such as bank bailouts, that would cause short-term harm. 18

What did Marxists and the Japanese Communist Party say? {japan}

Makoto Itoh, a Marxist economist of the school of Kōzō Uno, analysed the 1990s depression as follows. The general logic of credit swelling into speculation and bursting, as in Hyman Minsky's financial instability hypothesis, cannot fully explain the scale and course of Japan's crisis; one must also examine the fiscal and monetary policies to expand domestic demand after the Plaza Accord and the roles of the BOJ and the government. When interest rates fall, the prices of "fictitious capital" such as shares and land rise accordingly. The capital gains from these swollen asset prices, and the domestic demand they led, were largely fictitious, different in character from the growth of domestic demand in the high-growth era, when real wages rose roughly in line with productivity. Capital gains, he added, are not confined to the surplus value produced by society's surplus labour in that year, and conversely the collapse of asset prices is a destruction of fictitious asset values, so the theory of surplus value should not be applied too directly to such gains and losses. 15 39

Itoh criticised the neoliberal policies pushed through during the depression: liberalisation of finance to match the global financial "big bang", deregulation of labour law and employment relations, and mass taxation such as the 1997 consumption tax increase. He saw the policy failure of 1997 as deepening working people's anxiety about the future, and argued that the vicious circle of insecure employment and deflation could be broken only by restoring a secure sense of the future so as to revive consumer demand from below. 15

In The Economics of Global Turbulence (1998) the American Marxist economic historian Robert Brenner placed Japan's bubble within a "long downturn" of advanced capitalism as a whole. In his account the G7 manufacturing rate of profit in 1970–90 was on average 40 percent lower than in 1950–70, because low-cost producers in Germany and Japan entering the American market created worldwide overcapacity. The Plaza Accord pushed up the yen and the mark so that Japanese and German manufacturing bore the lion's share of adjustment, and Japan eased that pressure with a loose monetary policy that produced the bubble. The "reverse Plaza Accord" of the mid-1990s, when the Clinton administration let the dollar rise, was a bailout of Japanese manufacturing, but it failed, Brenner argued, because Japanese factories that had moved to China and East Asia to escape the strong yen had made overproduction worse. Within the same Marxist camp, a review in the British journal International Socialism criticised Brenner for ignoring the effect of arms spending concentrated in the US and Britain on German and Japanese competitiveness, and argued that the downward pressure on profit rates from a rising organic composition of capital also had to be considered. 40 41

The Japanese Communist Party says it has opposed the government's policy of settling bank failures at the public's expense. In July 2002, when an amendment allowing public funds to buy up bank shares held by non-financial companies passed a House of Representatives committee, the JCP member Kenshō Sasaki called it a new bank-support measure that increased the risk to taxpayers and said that "a policy of propping up share prices with public funds, without reviving the real economy and improving corporate performance, is fundamentally wrong". In 2008 he summed up that since the jūsen settlement of 1996 more than 46 trillion yen of public funds had gone into financial institutions, leaving taxpayers with more than 10 trillion yen of losses and breeding the dependent attitude that "even if you fail, taxes will save you in the end"; 12.4 trillion yen of capital had been injected into the banks, yet their lending to small and medium firms had fallen by 84 trillion yen. 42 43 44