The Cause of Japan’s Boom and The Reasons for Its Prolonged Bust

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The Cause of Japan’s Boom and The Reasons for Its Prolonged Bust
  Benjamin Weingarten Japanese Politics The Cause of Japan’s Boom and The Reasons for Its Prolonged Bust Japan’s asset bubble and its subsequent burst from the late 1980s through the 1990s looks like an eerie portent of what may be in store for the United States. In both cases, and as with many crises, people tend to look at the symptoms of the events rather than their root causes. However, if we do not look at the root causes, we will never learn why the mistakes were made. Thus, in this paper I will look at the root cause of Japan’s asset bubble, and also the reasons its bust was so prolonged. I will provide an Austrian critique of the cycle, that the Japanese asset bubble was largely caused by government  policy, and that it was in fact more government intervention that contributed to Japan’s staggeringly long economic downturn. While the complexity of Japan’s economic system may have been great, I believe the root causes of its problems were quite basic. In order to understand the dynamics of Japan’s cycle, I will reference the Austrian theory of the business cycle. The Austrian economists argue that the boom and bust cycle is a natural outgrowth of government intervention in the markets through the central bank. The central bank attempts to stimulate economic growth by lowering its interest rates, increasing the money stock which encourages banks to lend out money to  businesses or consumers. The consumers spend and businesses invest. Ideally, the central bank is able to turn off the monetary spigots when sufficient credit is produced for desired consumption and profitable projects, and the bank raises its rates to cool growth. The problem with this is that according to the Austrians, no group of central bankers has the ability to factor every variable in to select the “natural” rate of interest, or the “rate that governs the allocation of resources between current consumption and investment  (consumers’ time preference) for the future,” (“Natural and Neutral Rates in Theory and Policy Formation”). The boom occurs when the central bank holds rates below the natural rate, incentivizing consumers and businesses to spend or invest in more unnecessary or riskier ventures than they would were the cost of money at its natural level. The Austrians refer to this as malinvestment. As the money is spent or invested, this leads to a general rise in prices, though often more-so in particular sectors. (Rothbard, 9-14). This is exactly what occurred in Japan, specifically in the financial and real estate sectors. The bust occurred when Japan raised its interest rates (Grimes, 2). I will describe this in detail in the following paragraphs. When we look at the case of Japan, it represents a classic example of the Austrian theory of the business cycle. Below I show Japan’s interest rates from February of 1980 to August of 1990: BOJ Discount Rates: 1980-1990 012345678910       F    e      b   -      8      0      A    u    g   -      8      0      F    e      b   -      8      1      A    u    g   -      8      1      F    e      b   -      8      2      A    u    g   -      8      2      F    e      b   -      8      3      A    u    g   -      8      3      F    e      b   -      8      4      A    u    g   -      8      4      F    e      b   -      8      5      A    u    g   -      8      5      F    e      b   -      8      6      A    u    g   -      8      6      F    e      b   -      8      7      A    u    g   -      8      7      F    e      b   -      8      8      A    u    g   -      8      8      F    e      b   -      8      9      A    u    g   -      8      9      F    e      b   -      9      0      A    u    g   -      9      0 Date    I  n   t  e  r  e  s   t   R  a   t  e   (   %   ) Source: Bank of Japan Statistics  As one can see, there is a secular trend of lower interest rates from early 1980 through early 1989. As one might expect, the monetary stock increased at a year-over-year rate of 9.07% as depicted below:  Japanese Monetary Stock (M3+CD's) 1980-1990 01,000,0002,000,0003,000,0004,000,0005,000,0006,000,0007,000,0008,000,0009,000,0001980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990  Year     M  o  n  e  y   S   t  o  c   k   (   i  n   1   0   0  m   i   l   l   i  o  n  y  e  n   ) Source: Japanese Statistics Bureau  So what are the implications of this data? As Christopher Wood notes, Japan’s  bubble was fueled by cheap and super easy credit (2). Japan’s gross consumer debt increased seven-fold from 9 trillion yen in 1979 to 67 trillion in 1991 (2). Per capita consumer debt reached $2985 in Japan, just below the $2915 of the US (2). Between 1985 and 1990, Japanese industrial companies raised some 85 trillion yen ($638 billion) through the stock market, at what were essentially free financing levels, fueling the  biggest spending spree since 1945 (6). These were companies that made up the real industrial economy. In terms of the stock and real estate markets, the numbers were even more staggering. According to what Wood aptly describes as the unstable liquidity-triggered boom, at the height of the bubble the stock market’s capitalization made up 42% of the entire global market’s capitalization, when in 1980 it had made up a comparatively meager 15%; Japan’s market worth had increased to 151% of GNP, from 29% in 1980 (8). Land values in 1990, even after the stock market crash were still five times Japan’s GNP (8). Japan’s lax monetary policy led it to become the marginal supplier of world credit, acting as the lender and purchaser of last resort (8). So why did  Japan lower its interest rates between 1986 and 1987 to 2.5%, a historical low? Japan’s central bank took on a loose monetary policy partially at the behest of the US government which convened the G7 at the Louvre Accord in 1987 in order to stabilize international currency markets and halt the slide of the US dollar (20). As you’ll note in the earlier graph of interest rates, Japan’s cut to 2.5% coincided with the Accord in February of 1987. The slide in interest rates during the 1980s led to major and unsustainable increases in asset prices, as the easy credit incentivized people to take on more debt and companies to invest in riskier ventures than they would have were the interest rates reflective of the time preferences of the Japanese. Many have attributed the boom to a handful of other factors as well. For example, in a report published by the BOJ, economists argue that aggressive lending, deregulation of deposit rates, cross-shareholdings amongst financial institutions, and inflation in land prices because of tax  policy and zoning regulations all contributed to the boom. ( Okina, 412; 416-417 ) . Others have contended that the boom was caused by group-think and the pervasive belief that market prices would rise forever (Wood, 7). To be sure, all of these things negatively impacted Japan, but I would argue that they were generally mere symptoms of the lax-interest-rate-fuelled boom. Banks would not have lent as aggressively were it not for the major amounts of liquidity provided by the government. Deregulation meant that Japanese banks would have to compete in a world where capital raising was determined by providing the cheapest capital, not political clout. Liberalization certainly proved cruel to a financial system that had been largely socialized, but this I would argue is more a reason for
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