By Mark J. Ravina, University of Texas at Austin
The bursting of Japan’s asset bubble coincided with two other events that raised questions about the country’s place in the world: death of the emperor and the end of the Cold War. Combined, those events spawned an existential crisis in Japan. And those rumblings of discontent continue decades later.
Japan’s Economy of the Late 1980s
The reasons for how and why the bubble got so big are complex but essentially it happened because the Japanese economy didn’t look like a bubble. The long-term Nikkei stock index had grown by about 12% a year from about 1950 to 1990. There was a surge in stock prices in the late 1980s, but it wasn’t unprecedented.
In percentage terms, the late 1980s rally was little different from some previous ones in the late 1950s, early 1960s, early 1970s, typically followed by short- or medium-term corrections that didn’t hurt careful investors.
Moreover, Japanese regulators thought external forces would prompt a correction. When Black Monday occurred in the United States on October 22, 1987, US stocks fell by almost 25% in a single day. That broke a five-year rally and prompted a massive correction around the world.
So, even though Japanese regulators had started to worry about an overheated economy, they thought maybe Black Monday will cool off our markets, too.
Financial Deregulation
Another reason why the bubble got so big was financial deregulation. Under pressure from the United States, Japan deregulated its financial markets and opened them to foreign competition. That led to a flurry of ill-advised lending and liquidity.
Until then, Japanese banking had been highly regulated, with a strict distinction between ordinary commercial banking and investment banking. It was all very similar to US regulation because it was based on US regulation.
Conventional Japanese banking was overregulated, stodgy, and boring, and it was unlikely to provoke an asset bubble.
This article comes directly from content in the video series The Rise of Modern Japan. Watch it now, on Wondrium.
Japanese Bank Loans
In the 1950s, ’60s, and ’70s, Japanese companies were highly dependent on bank loans, much more so than their US or European counterparts. But in the 1980s, they began exploring alternatives to standard commercial loans.
Deregulation meant there were new alternatives to raising capital. There were now Japanese and foreign financial companies eager to help issue bonds or sell stock. With these new competitors, old-school Japanese banks had to scramble to compete.
In their search for business, bankers lent to some businesses that they would previously have rejected as too risky. But now, they needed the customers, and even if the borrowers’ business plans seemed shaky, the client seemed to have great collateral assets—lots of valuable real estate holdings.
However, land prices were inflated. So, when the real estate bubble burst, all of those Japanese bank loans to shaky businesses went bad, and the banks’ balance sheets suddenly turned red. Furthermore, the bankers couldn’t foreclose on the loans because then they’d be stuck with real estate that they didn’t want, and—more importantly—couldn’t sell.
September 1985 Plaza Accord
A fourth reason why the bubble got so big was the September 1985 Plaza Accord, named after the Plaza Hotel in New York City where it was signed. This was a joint agreement among France, West Germany, Japan, the United States, and the United Kingdom to push down the value of the US dollar in relation to the German deutsche mark and the Japanese yen.
The dollar had risen during the early 1980s, and that hurt US exporters—especially in manufacturing. President Ronald Reagan did not want new import restrictions on cars, or on farm and construction equipment. So instead, he pressed for an international agreement on exchange rates. Reagan’s goal was to make US exports cheap and thereby reduce the US trade deficit.
Central banks now agreed to sell lots of dollars and buy lots of deutsche marks and yen, driving down the value of the dollar while driving up the mark and yen. That intervention pushed the exchange rates from a high of about 260 yen per dollar in early 1985 to a low of 140 in early 1987.
The Plaza Accords didn’t do much to help US exports to Japan, but it made US real estate and even companies seem cheap if you were spending Japanese yen.
Effect of the Plaza Accord
So, Japanese investors went on a buying spree—but they bought US real estate and US companies because everything seemed like a fire sale. But many of those purchases were terrible investments.
So, the net effect of the Plaza Accord was to inflate the Japanese asset bubble even more. Japanese investors could now overpay for real estate around the world. And because the Plaza Accords were supposed to slow Japanese exports by increasing their relative price, Japanese government officials viewed the accord as a correction of the economy, much like Black Monday had been for much of the world’s economies in 1987.
In effect, the Plaza Accords became a reason for the Japanese government to ignore the growing bubble rather than do something about it.
Common Questions about Japan’s Asset Bubble
Under pressure from the United States, Japan deregulated its financial markets and opened them to foreign competition. That led to a flurry of ill-advised lending and liquidity. Until then, Japanese banking had been highly regulated, with a strict distinction between ordinary commercial banking and investment banking.
When the real estate bubble burst, all the Japanese bank loans to shaky businesses went bad, and the banks’ balance sheets suddenly turned red. Furthermore, the bankers couldn’t foreclose on the loans because then they’d be stuck with real estate that they didn’t want, and—more importantly—couldn’t sell.
The September 1985 Plaza Accord was a joint agreement among France, West Germany, Japan, the United States, and the United Kingdom to push down the value of the US dollar in relation to the German deutsche mark and the Japanese yen.
