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Historical Development, Bubble and Bust

banking problem, Japanese stocks, structural flaws, Japanese exports, average stock

The structural flaws in Japanís economy came to a head in the late 1980s, first generating a five-year period of financial euphoria known as the bubble, and then bringing on a collapse. After the value of the yen rose sharply in 1985, Japanese exports fell and economic growth slowed. In 1986 a report by the government-appointed Maekawa Commission recommended fundamental structural reforms to avoid long-term stagnation. Instead, the Bank of Japan (BOJ) cut interest rates to stimulate investment and growth. This raised the price of stocks and real estate, which began to escalate in a self-feeding spiral. By 1989 the average stock was valued at 100 times the annual corporate earnings, an overvaluation of 400 to 500 percent. Rising stock and real estate prices stimulated an investment boom that led to rapid economic growth.

Fearing a crash, the BOJ steadily raised interest rates in 1989 and 1990, hoping that the economy would slow gradually. Instead, the bubble burst abruptly, as Japanese stocks lost nearly 70 percent of their value between 1989 and 1992. The financial bust ended the economic boom. From 1992 to 1994 growth averaged a meager 0.5 percent a year.

Presuming that Japan was just suffering from a normal recession, the government responded with standard recipes to stimulate the economy. The BOJ once again lowered interest rates, and the MOF increased government spending. The economy appeared to respond, with growth rebounding significantly in 1995 and 1996. Anxious to balance Japanís budget and calculating that it was safe to ease stimulus measures, the MOF reduced government spending in 1996 and raised Japanís consumption tax (a tax added to the price of goods and services) in 1997. A few months later, the value of several Southeast Asian currencies fell sharply, triggering a regional economic crisis and jeopardizing Japanese trade and investments in the region.

Had Japanís economy been healthy, it could have absorbed these setbacks. Instead, a new recession began in April 1997. Within a year and a half of its 1997 peak, Japanís GDP fell 5 percent. In the late 1990s Japanís stock market was still 65 percent below its 1989 peak, and commercial real estate prices remained 80 percent below their highest levels.

The combination of financial collapse and recession meant that many companies could no longer repay their debts to banks. Over time, the size of the unpayable debt kept increasing. By 1998 the MOF said that bad debts amounted to about 80 trillion yen ($600 billion), or about 15 percent of GDP. Many private estimates were twice as high.

In 1998 the government reversed itself again and created three large spending packages. It also addressed the banking problem with a series of bills that authorized the nationalization of failed banks and the sale of bad assets, and provided funds to protect depositors and inject government funds into the banks. The government hoped to spark recovery by 1999, but Japanís economy remained stagnant in 2002.



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