Back in the 80s I read business books, lots and lots of them. One of the big topics then was the inevitability of the world following the Japanese example. They really did seem to be invulnerable, and people in my own field (computer software) spent a lot of time watching and worrying.
All that changed in 1990, of course, but as far as I know there’s no consensus as to what exactly led to the change, or why the mighty Japanese haven’t been able to break out of a now eighteen-year-long slump. As our own crisis develops, some people are looking again to the Japanese to see if they can figure out what happened, and if there are any lessons there for us to learn. Here’s an intriguing theory, described by Bill Bonner in The Daily Reckoning.
Richard C. Koo has prepared a remarkable report: “The Age of Balance Sheet Recessions – What Post-2008 US, Europe and Japan Can Learn from Japan 1990-2005.”
His argument is not far from the one we made six years ago. In the 1980s, Japan ran up stock and property prices in a spree of debt and leverage. Then, when the bubble popped, the usual monetary stimulus didn’t work. The Bank of Japan cut rates to almost zero…still, few people were willing to borrow.
The economy did not recover; instead, it got worse and worse until 2005 – 15 years later – when stocks had lost 72% of their value, land was down 81%, and golf course memberships had sunk 95% from their peak.
The problem, he explains, was that it was a “balance sheet recession,” not a typical business cycle downturn. Companies, banks, and individuals had to pay down the debt that they had accumulated in the boom; they did not want to borrow more money, even at zero interest rates. For 7 years, from 1998 to 2005, net business borrowing went negative – meaning, businesses were paying off more debt than they were taking on.
This came as a shock to modern economists. Japanese officials were flummoxed. U.S. economists accused them of not acting swiftly enough…or not having the stomach to let the big banks fail. But almost no one seemed to understand what was really going on. They should have. Irving Fisher described it back in 1933, observing that when people who are deeply in debt get into trouble they usually sell assets. He called it a “stampede to liquidity.” Investors dump stocks and property for any price they can get – desperate to pay off their debts before they are dragged into bankruptcy.
This is the phenomenon known to economists as the “fallacy of composition.” What is good for every individual investor – cutting expenses, paying off debt – turns out to be bad for the economy itself. Asset prices fall. Sales fall. Unemployment rises. The slump deepens.
In Japan’s case, combined capital losses from land and stocks grew from 1990 until 2002, at which time they reached $15 trillion – or 3 years worth of Japan’s GDP.