What happened to Japan?

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.


4 thoughts on “What happened to Japan?

  1. This is something I’ve been thinking about a lot lately, that what is good for the individual may deepen the economic crisis. My question is, will Americans react as the Japanese did? I know people who have been in and out of bankruptcy multiple times. They recover and keep going, even prospering. I won’t say anything about the ethics of this, only that it seems to be normal in some places.

  2. Laura,

    I know people who have been in and out of bankruptcy multiple times. They recover and keep going, even prospering.

    I think their ability to recover depended on the ready availability of credit, i.e. lenders so desperate to lend that even past bankruptcy didn’t bother them. That has changed, of course; commercial lending is nearly dead, consumer credit is following fast, and mortgage lending is back to its old conservative ways—a solid credit history and a 20% down payment might get you a loan.

    But just because I haven’t figured out how things might change back doesn’t mean that they won’t.

    My question is, will Americans react as the Japanese did?

    More on this in the next post.

  3. More on this in the next post.

    Strike that. I decided that what I wanted to say about this is way too speculative for a post, at least at this early stage. But I’ll mention it here briefly.

    For her history studies Maggie has been reading about the Great Depression, not about the politics but about everyday life. One of the books we found via interlibrary loan is called Daily Life in the United States 1920-1940, and we like it enough that we may even add it to the bookstore; at the moment Chris and Maggie and I are tussling over it before it needs to go back to the library.

    The book gives a brief but very useful overview of how radically everyday life changed in the early years of the twentieth century, as we made the shift from a producing culture to a consuming culture. And reading it has reminded me of how the key factor causing that shift was not progress itself, nor the people’s pre-existing need for the things that progress brought, but big business’s need for a market to soak up the goods it was now able to produce in staggeringly large quantities. A huge effort was needed to effect the shift to a consumer economy, and a huge ongoing effort has been needed to keep that economy running and growing.

    I have no expectations yet, but I am beginning to wonder if that effort will soon become unsustainable, mostly because it will become unprofitable. It costs a lot of money to encourage consumers to spend their own money, but if they have no money to spend then there is no benefit in encouraging them to try. So perhaps we are about to enter a phase that I will call the Great Unwind, where the layers and layers of social and economic activity aimed at propping up the consumer culture will no longer be affordable and will begin to peel away, slowly diminishing the pressures on citizens to, say, pay $5 for a cup of coffee.

    It may be a pipedream on my part, but in any case I’ll add this as a weblog category and begin to track stories that I think point in this direction.

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