0230 GMT March 23, 2018
By Sadrodin Moosavi
Bubble Period: Late 1980’s
The Japanese economy experienced a bubble period in late 1980’s. Professor Watanabe analyzed the formation of this bubble economy and shed light on various aspects of this new phenomenon in Japanese economy.
A bubble develops when a rise in asset prices cannot be explained by any basic economic factors (also known as the 'fundamentals'). In 1988-89, Japanese stock and land values rose sharply. This did not necessarily 'reflect productive investment, rather it was largely due to excess speculation. In these situations, higher stock values induce more speculative investment into stock and land, causing their values to rise even more. A long-drawn large increase in values that stimulates economic activity and asset buying.
The Formation of the Japanese Bubble
1) The 1985 Plaza Accord
In order to explain the rise of the bubble economy, we have to start with the Plaza Accord in 1985, she said. The Plaza Accord was a meeting between the finance ministers and central banks’ governors of five developed nations (US, Japan, UK, Germany and France). They agreed that the US dollar at that time was overvalued, and that corrective measures were needed, in particular intervention in the foreign exchange market in order to weaken the US dollar by strengthening the yen and the Deutschmark.
At that time, the US was suffering from the so-called 'twin-deficits' (a public finance budget deficit and a trade deficit). In order to maintain balance ('balance-of-payments'), the US had to attract 'financial capital' from abroad. So, she had adopted a high interest rate policy. From 1979, there was an appreciation of the interest rate and in consequence, the value of the dollar surged.
It was clear that there existed a circulus vitiosus (vicious circle) and that the fragility of the American economy threatened to destabilize the global economy. Therefore, the agreement to weaken the US dollar at the Plaza Accord was an attempt to solve this problem.
However, a high dollar value made US goods and services internationally uncompetitive, which led to the trade deficit (from 1982, the US had a balance-of-payments deficit). In order to pay for the trade deficit, the US had to attract more and more money from abroad.
2) Appreciation of the yen
After the Plaza Accord, the Japanese government began to sell dollars on the foreign exchange market, which led to a fall in the value in the dollar, and a corresponding rise in the yen. In around 2 years, the yen exchange rate rose from 237 yen = 1 dollar, to 120 yen = 1 dollar. The exchange rate switched from a weak yen – strong dollar, to a strong yen – weak dollar rate.
3) 'High-yen recession' (1986-87)
This was in accordance with the objectives of the Plaza Accord, but would have consequences for the Japanese economy. Japan fell into recession, called the 'High-yen recession'. Business profits worsened, and economic growth fell from 5.2% in 1985, to 2.6% in 1986. Since Japan depended on export of industrial goods such as automobiles or machinery, the high yen was a direct hit on the economy.
The Japanese government implemented a loose monetary policy to beat the 'High-yen recession'. Usually, a policy to increase growth would be a mix of both fiscal (government spending) and monetary policies. However, at that time, the government had tried to balance the budget, so more emphasis was placed on monetary policy to stimulate the economy.
International factors also influenced the decision to adopt an easy monetary policy. Some of these factors explained by Professor Watanabe are as follows:
1) The American economy was suffering from twin deficits. In order to provide the space for the US to cut interest rates, Japan had to cut its domestic interest rate by even more.
2) The Louvre Accord of 1987, the G7 (G5 plus Italy and Canada) agreed on a coordinated strategy to lower interest rates, and that Japan and Germany in particular would raise domestic demand. Japan promised to raise domestic demand in order to reduce the excess volume of exports, and restore its trade balance, she said.
The background to this situation was that, despite the weak dollar strategy agreed at the Plaza Accord, the US trade deficit stubbornly persisted (the sharp fall in the dollar’s value discouraged capital from flowing into the US. Since this capital was used to finance the trade deficit, reduced capital inflows made it difficult to restore the balance of payments), said the professor.
Watanabe added, for this reason, Japan and Germany were requested to reduce their exports to the US by increasing domestic demand in their respective countries.
3) In October 1987 the one-day stock market crash known as Black Monday in the New York Stock Exchange threatened the stability of the dollar. In order to avoid a large fall in the value of the dollar, Japan was forced to adopt a low-interest rate policy, she said.
Professor Watanabe said, Japan was already recovering from the 'High-yen recession' by this point, so continuing this loose monetary policy was probably no longer beneficial. However, the above international factors took precedence over domestic concerns, so Japan continued to maintain this policy.
The Rise of the Bubble
Asked to explain the reasons for the emergence of the asset bubble, Watanabe said, the low-interest rate policy caused the money supply in the economy to expand, creating an excess amount of liquidity in the economy. This excess money was invested in the asset market (stock market, real estate), causing the values of these assets to rise.
Looking at the event retrospectively, it is easy to see that an asset bubble had developed. However, at the time, policymakers had not realized what was happening. Rather, they saw the rise in asset values as an indication of strong economic growth and a reflection of the strength of the Japanese economy internationally, Professor Watanabe said looking at the issue on the hindside.
Japan had escaped the previous recession and was enjoying economic growth led by domestic demand. The increase in demand was mainly an increase in business investment and domestic consumption, as well as strong exports. These positive economic conditions allowed the merits of a high yen to have a ripple effect, or an 'asset effect' in the economy, she said.
An 'asset effect' is when consistently rising asset values gives the owner of those assets a feel-good effect which encourages him to consume more (although in reality, the owner doesn’t realize these gains unless he sells the assets). Indeed, many Japanese people engaged in conspicuous consumption at this time (such as expensive cars, brand-name clothing, foreign travel, golf, expensive art, etc.), the Professor said.
To be sure, land values (particularly in Tokyo and Osaka) had increased at a rate that was abnormal, although there was an increased demand for office space among other things, so some thought that it was reasonable.
The issue was not properly grasped at the time. Hence Watanabe said, “This is why it was quite difficult to judge at the time, whether or not a bubble economy had emerged.” She added, “However, this indecisiveness would allow speculative behaviour by firms and individuals to become embedded in the economy, which would cause serious problems later.”
However, on the hindside, Professor Watanabe enumerated a number of reasons for the asset bubble or bubble economy. Some of these reasons are:
1) Corporate 'Speculative Investment
When a manufacturing firm uses its reserves not to invest to increase productive capacity by buying equipment, technology, etc., but uses its reserves to invest in property or shares, or other financial assets, it partially leads to bubble economy. This behaviour was partly responsible for the rising values of these assets, but also because new laws liberalized the financial sector allowed new financial products to be sold, Watanabe said.
2) Loans by financial institutions to real estate and small & medium enterprises
The lending patterns of financial institutions (banks) also changed during this time. Until the rapid growth period, the large city banks had been traditionally granting loans to large manufacturing firms, she said, in the 1980’s, however, there was a 'detachment' of large firms away from the banks, with lending to these firms falling markedly.