Japanese Asset Price Bubble

Time occurred

1986 – 1991

An overview

The Japanese Asset Price Bubble, often referred to as the “Bubble Economy,” occurred in Japan from 1986 to 1991. This period was characterised by excessively inflated real estate and stock market prices, ultimately leading to a severe economic downturn.

• Real estate prices in Japan, particularly Tokyo, soared to unprecedented levels. At the peak, the land in Tokyo was valued higher than the entire land value of the United States.

• The Nikkei 225 stock index surged, reaching an all-time high of 38,957 in December 1989.

In early 1992, this price bubble burst and Japan’s economy stagnated. Its collapse resulted in a prolonged economic downturn, a banking crisis, and significant social and economic challenges for Japan.

What caused the Japanese asset price bubble?

The Plaza Accord’s Influence on the Yen

The Plaza Accord was a pivotal agreement among major economies in 1985 (United States, Japan, Germany, France, and the United Kingdom) which aimed to correct the global trade imbalances by depreciating the U.S. dollar relative to the yen and the Deutsche Mark. However, this agreement triggered an unintended side effect: the yen appreciated significantly and more than expected which eventually hurt Japanese exports and made the Japanese country experience recession.

Loose monetary policies triggering over-investment

In response to the economic slowdown caused by the stronger yen, the Bank of Japan (BOJ) adopted an accommodative monetary policy, aggressively dropping interest rates from 5.00% to 2.50% between 1985 and 1987.

As a result of such a move, money growth was out of control. This made borrowing cheaper and encouraged the investment of excessive capital into real estate and the stock market, leading to over-investment, a key ingredient that manifested the Japanese asset price bubble.

The table below showcases the interplay between the GDP growth rate, official discount rate adjustment and the Yen appreciation against the U.S. dollar, which underlined the conditions for speculative investment.

Adopted image from Link

Financial Deregulation

During the 1980s, Japan’s economy blossomed with annual GDP growth rates that outpaced those of Western counterparts like the United States. Following the bloom, Japan underwent deregulation and eased restrictions on financial and capital transactions, which boosted the demand for the Japanese yen. The removal of financial restrictions allowed the Japanese yen to be purchased and invested freely outside Japan. This allowed for increased lending and speculative investment by financial institutions, fueling speculative bubbles in these markets.

Speculative Behavior

There was a widespread belief among investors that real estate and stock prices would continue to rise indefinitely. This belief led to speculative buying, further inflating asset prices. On the other hand, Japanese corporations that benefited from rising asset values increasingly engaged in speculative investments in real estate and equities, often using their stock as collateral for loans.

Regulatory and Supervisory Failures

Regulatory oversight did not keep pace with the rapid financial innovation and liberalization. This allowed for excessive risk-taking by banks and other financial institutions. While many financial institutions failed to implement adequate risk management practices, leading to the accumulation of bad loans.

Impacts

Economic Impacts

The effects of the bubble economy in Japan were profound and far-reaching, shaking the foundation of financial institutions and the broader economy. The most notable impact was that Japan experienced deflation at which Japan’s GDP growth slowed dramatically, averaging around 1% per year in the 1990s, compared to the high growth rates of previous decades.

As real estate and stock prices plummeted, the Nikkei 225 stock index, which peaked at nearly 39,000 in December 1989, fell to around 14,000 by August 1992 and fluctuated at lower levels for years. Meanwhile, real estate prices dropped by as much as 80% in some Japanese areas.

Adopt image from Link

Financial System Impacts

The collapse in asset prices led to a significant number of non-performing loans (NPLs) on the balance sheets of banks. Many banks faced severe solvency issues, requiring government intervention and bailouts.

Many companies had borrowed heavily during the bubble years and found themselves with massive debts when asset prices collapsed. This led to widespread corporate restructuring, bankruptcies, and a focus on debt reduction.

Social Impacts

Unemployment increased significantly as companies restructured, downsized, or went bankrupt. Meantime, there was a general loss of confidence among consumers and businesses, leading to reduced spending and investment.

Policy and Government Impacts

The Japanese government implemented numerous fiscal stimulus packages to try to revive the economy. These included public works projects and tax cuts. However, these measures led to a significant increase in public debt, which remains a major issue for Japan.

References

Constantin T 2024, Japanese Asset Price Bubble Explained Briefly, Market Bulls, available at <https://market-bulls.com/japanese-asset-price-bubble-explained/>.

John, V 2017, What Was Japan’s Bubble Like In 1989?, Forbes, available at <https://www.forbes.com/sites/johnfvail/2017/05/12/what-was-japans-bubble-like-in-1989/>.

Ito, T & Iwaisako, T 1995, Explaining Asset Bubbles in Japan, NBER Working Paper No. 5358, Cambridge, MA: National Bureau of Economic Research.

Watkins, T., n.d, Bubbles in Japan’s Economy, San José State University, available at <https://www.sjsu.edu/faculty/watkins/bubble.htm>.