Who blew the bubble in Japan?

When the price of various assets in an economy rises above their actual value due to speculator activities and then, after their price reaches a peak level, starts to drop significantly, it is called a bubble economy (Japanese: バブル景気).

Real estate and stock speculations were very popular which started to blow the so-called bubble

The process is similar to a rapidly expanding and popping bubble, hence the name. The economic boom happened between 1986 and 1991 in Japan.

In 1985 the so-called Plaza agreement was signed by the G5 nations including Japan, West-Germany, United Kingdom, France and the United States. According to this accord the dollar was devaluated against the Japanese yen and the German Deutsche Mark.

After signing the agreement, the Prime Minister of Japan, Yasuhiro Nakasone (中曽根康弘) started to support the private sector and took steps to accelerate domestic demand. In addition in order to avoid market recession he maintained a cheep money policy (cheap money fuels markets), which made it easy for citizens and corporations to access loans and mortgages. As a result of another act Japanese corporate taxes were decreased from 42 percent to 30 percent, income taxes from 70 to 40 percent and commodity taxes were also repealed.

On one hand national tax income dropped, but on the other hand higher classes became wealthier and they started to invest in real estate and stocks as well. Japanese corporations making use of their monetary management techniques started to profit on their investments.

In addition, by deregulating the Japanese markets and prioritizing several government corporations more and more speculators started to get in business. Real estate and stock speculations were very popular which started to blow the so-called bubble. This was mainly, because everybody was told or at least believed, if he or she invests in real estate, there should be no loss.

Usually investors bought properties solely for selling it, without any other purpose. Real estate prices were skyrocketing in Japan those days. For example it was said that for the price of the 23rd district of Tokyo the whole United States could have been bought. ( Banks were giving out loans while taking real estate collaterals )

Japanese people prefer to own their own properties, as such citizens, who were afraid of additional price rises started to purchase houses. Naturally the increase demand on the Japanese real estate market generated new (higher) prices. On the other hand there were many people who just simply gave up and stopped saving their money, saying that it will be impossible to buy their own real estate. These people went on luxury vacations or purchased expensive vehicles. Interestingly collecting antiques was also extremely popular those days in Japan.

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From 1986 the Japanese hyper-economy started to expand its boundaries and M&A tendencies initiated by Japanese companies appeared in Europe and in the United States. The whole world was surprised when Mitsubishi purchased New York’s symbol, the Rockefeller Center.

Problems in a bubble economy

The main problem of such an economy is that companies instead of income gain (using their assets to conduct business activities), operate with capital gain, which is a result of a sudden rise in their asset prices. Plus many companies start to focus on their monetary strategies instead of their business activities.

When prices stabilize on a relatively high value and stop increasing, there is only one way to go, which is downhill. It can be regarded as a card game where the one, who has a specific card at the end of the game, looses. Whoever is about to loose, tries to minimize its loss.

This all leads to a significant price drop on the stock and real estate markets, which is followed by a deep economical recession.

When the bubble bursts

The Bank of Japan(日銀) in 1989 changed its mind and increased the official discount rate from 2.5% to 3.25% (which was gradually decreasing until 1989). In 1990 the Japanese Government introduced a new regulatory system (総量規制), which controlled the amount of money banks could give out as loans. The growth of real estate loans could not exceed the total loan growth. However they intended to regulate the abnormal price changes on the market, the economy reacted differently.

The Nikkei Stock Average(日経平均) reached its peak in 1989 at 38915 yen. It dropped to 20000 yen in 1990.

Real estate prices in Japan started fall as well, which caused several significant side effects, because these properties were used as collaterals for mortgages. Japanese banks had to face massive amount of bad debts and their performance dropped significantly from 1990.

The Japanese government started to act in order to save the Japanese financial institutions from bankruptcy. From 1995 they started to revise bad debts and strictly enforce regulations on easy money loans. In the same time they made actions to restore poorly performing financial instructions.

In the following years main Japanese banks, such as Hokkaido Takushoku Bank(北海道拓殖銀行), Long Term Credit Bank of Japan(日本長期信用銀行), The Nippon Credit Bank Limited(日本債権信用銀行) and Yamaichi Securities(山一證券)faced bankruptcy. Financial institution that cooperated with these entities also suffered huge losses or defaulted.

Banks became reluctant to lend and withdrew huge amount of loan credit, which triggered continuous economical drawbacks.

The bubble economy phenomenon in Japan, which was caused by excessive lending, made many Japanese people loose their faith in the current financial systems. Chronic economical regression after the bubble is still a serious problem in Japan.

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Source: http://kezai.net/jpn/bubble

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