An Unmitigated Disaster

By Ichiro Suzuki

The Tokyo Stock Exchange closed 2020 with its Nikkei index at 27,444, the highest since it peaked at the end of 1989 at 38,915. Well done, but here is a bad news. 31 years after what proved to be a historic bubble’s peak, the index still “has to rise 40%” to match the peak level. A truly unfortunate person who bought the index on the final trading day of 1989 would still be in a 33% deficit, if he or she held onto it for three decades. After the Great Crash of 1929, the Dow-Jones Industrial Average reclaimed the previous peak 25 years later, despite having lost almost 90% of the peak value. One might argue that recovery of the Dow-Jones was greatly assisted by war demand. In the war years, the U.S. government accounted for two-thirds of capital investments, revitalizing factories that had been left idle throughout the Depression-plagued 1930s. But how about the Nasdaq? The late 20th century tech bubble on the advent of the Internet was genuinely reminiscent of the frenzied 1920s that were full of decadence and preceded the most painful decade in U.S. history. As was widely expected, the tech bubble had popped in the spring of 2000, and lost nearly 80%. Nonetheless, the Nasdaq rewrote its high 15 years later. At the end of 2020, 20 years and 9 months later, the Nasdaq stood at 12,500, more than 150% above the tech bubble’s peak at 5,010. Guess where it will be at the end of 2031, 31 years after the bubble’s peak that is how far time has traveled for the Nikkei.

No developed country stock market had suffered as protracted a performance slump as the Nikkei had over the past three decades. Its dismal behavior truly stands out in the history of global financial markets. The Japanese market not only lost 80% of the peak value, but also spent 20 years to reach the bottom. (In the case of the TOPIX, it took 23 years from the peak). In contrast, for both the Dow-Jones at the end of the 1920s to the early 1930s and the Nasdaq at the outset of the 2000s, the bottom was reached around three years from the peak. Duration of Japan’s descending period was simply horrifying. So what did Japan get so wrong to be mired in possibly the longest slump ever experienced in history? Here’s a list of what went wrong.

1. Tightening overdrive
In response to surging real estate prices that drove home ownership beyond anyone’s dream, new Bank of Japan governor Yasushi Mieno had embarked on a very aggressive tightening of monetary policy as soon as he rose to the helm of the central bank. The result was superb. Governor Mieno had engineered a spectacular collapse of the real estate market. Initially, the media hailed it calling him a central banker possibly to be remembered as the one who restored equality in the Japanese society. However, his drive went too far. It created sellers’ frenzy, driving them to dump almost everything they had at any price as soon as possible. A spectacular fall had changed people’s expectations on real estate prices 180 degrees indefinitely, from never to fall to never to rise.

2. Refusal to admit the problem and failure to clean up banks
On the collapse of real estate prices, bad debts mounted on the balance sheets of Japanese money center banks, exerting downward pressure on their capital base. Bank management in general was slow to react, refusing to admit they were in trouble. Wishing for the market’s recovery in the future, banks did not move to unload non-performing loans. This made them operating with insufficient capital throughout the 1990s. It was not until 2002, a dozen years after the collapse of the bubble had began, that banks were ordered to recapitalize balance sheets by Prime Minister Junichiro Koizumi. Japan’s move was almost ten years behind the action taken by President Franklin D. Roosevelt, who ordered to close banks as soon as he entered the White House in March 1933, in order to examine their balance sheets. It was three and a half years fter the stock market’s peak in the fall of 1929.

3. Aging of population 
Working age population, between 16 and 65, peaked in 2000 and got onto a very slow descending trend. Demographic challenge weakens long-term demand for houses, adding extra downward pressure on expectations for house prices.

4. Japanese employment practice
On top of all these things, there is another serious flaw in a way Japan dealt with a severe economic downturn, that is “we are in this together” mindset. It aims to spread the pain as thinly as possible among as many people as possible. This Japanese way of sharing hardship tries to minimize lay-offs while imposing pay cuts on everyone. Jobs are saved, but with smaller paychecks for those with jobs. This is how the Japanese society has survived the last 30 years since the burst of a historic bubble. This practice has kept the labor market from imploding. The unemployment rate didn’t go higher than 5.7%, registered in 2009 in the middle of the global financial crisis. It also kept a division in society from becoming larger, as it happened in the U.S. notably. The price Japan paid for this practice was a missed opportunities to reallocate work force to where there was demand. It also instilled an expectation of never rising wages and salaries, which fed deflationary expectations. 

5. Advent of the digital age
Rise of the Internet in the 1990s had coincided with a decade of Japan’s initial struggle after the burst of the bubble. The Japanese economy has totally failed in readjusting itself to the new age of the Internet that brought disruptive changes to the way business is done. The Japanese society’s aversion to radical changes allowed itself to move only slowly, and this did not bring as huge productivity enhancement as the Internet was supposed to deliver. In addition, hardware-centric nature of the Japanese tech industry lost competitiveness to their foreign rivals. Japan excels in ‘making things’ or in creating what’s visible, and software is invisible.

6. Super normal rise of the yen
While the economy was suffering from the bubble’s burst, the Japanese currency kept rising in the first half of the 1990s, at a rate over 10% per annum against the US dollar until the spring of 1995. The Bank of Japan obviously kept money tighter than necessary, obsessed with bringing down real estate prices. The yen’s relentless rise brought down inflationary expectations further, on top of hurting competitiveness of the manufacturing industries. The currency’s upswing had accelerated a trend of offshoring factories that had been already in place since the 1980s. 

Over the last 30 years, China meticulously studied the trajectory of the post-bubble Japanese economy, pledging themselves never to repeat mistakes Japan had made. Of the above six factors, China shares only aging of population with Japan, which is beyond the realm of economic policy makers and a central bank. At least, China is not repeating the same mistakes though the country appears to have their own unique problems. 

Mr. Suzuki is a retired banking executive based in Tokyo, Japan.

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