Did We Learn The Wrong Lessons From Japan?

More on bubbles. I've been writing about the collapse of the Nikkei 20 years ago for The Spectator. You can read it below. I can't help feeling the world took the wrong lessons from Japan. We keep being told we have to print more money, and raise government spending, so that we don't have a Japanese-style lost decade. But it hasn't worked for them. Anyway, here's the piece.

Twenty years ago this month, as we’ve been reminded by countless documentaries, the Berlin Wall was coming down. Eastern Europe was convulsed by a series of revolutions from which Communism never recovered. Yet, much further east, something else was happening which arguably has had just as profound an impact on how the global economy had developed since then. The rampant bull market in Japanese equities reached its final, frenzied peak.
For stock market historians, December 29th, 1989, will always be a key date. On that day, the benchmark Japanese index, the Nikkei 225, which includes companies such as Honda, Nissan and Sony, hit its all-time peak of 38,957.44, having quadrupled in value from 1985. When the markets re-opened for the first trading day of the 1990s, the index started falling. And falling, and falling, and falling.
And, give or take a few blips, it has been falling relentlessly ever since. Over the next two and half years, the Nikkei fell by 63%. By that was far from the end of it. In March this year, amid global financial panic, the Nikkei touched a fresh low of just over 7,000, more than 80% down in the peak. Even today, as the anniversary nears, it has managed only to claw its way back to 9,500, a quarter of its level two decades ago.
Nor is it just stocks. In the 1980s, the Japanese property market went even crazier, reaching levels that might even make a salesman from Foxtons blush. That market carried on rising even as stocks started to collapse: in 1991, an alarming calculation found that the value of Japan's land was about $18 trillion, or four times the value of all the land in the United States (even though Japan is only about the size of California). Since then, Japanese property prices have plunged as calamitously as stocks, and today remain about 60% below their 1991 levels.
It was, and remains, the Mount Everest of bear markets. And it is an event that dominates the thinking of both investors and policy-makers the world over.
Like all bubbles, there was of course some substance to the Japanese boom of the 1980s. The country was on a roll. Its car and electronics manufacturers were flattening the old, bloated giants of American and European industry. Take just about any product you can think of, and the Japanese version was more reliable, better designed, and cheaper as well. Management theorists flocked to witness its lean, flawless factories: futurologists predicted that pretty soon we would all be wearing kimonos and eating sushi.
The trouble was, like every bubble, it took the kernel of a truth, and stretched it to absurdity. Land in Japan might be short supply, but there wasn’t that little of it. There was a limit to how many Sony Walkmans we wanted to buy, no matter how good they were. And in a free market, the European and American car manufacturers were always going to smarten up their act to compete with the likes of Toyota. The bubble was always going to pop one day. What no one quite foresaw was how spectacularly it would burst, or with such calamitous consequences.
Twenty years later, what are the implications of that crash? For investors, there are plenty, even if the lessons are nearly all dismal ones.
The Nikkei crash blows just about every investment cliché out of the water. Buy and hold? Well, you wouldn’t want to have bought and held this market. Buy after the crash? Well, not really. If you bought the Nikkei in 1992 or 1993, you’d still be out of pocket. Stocks always perform in the long-term? Wrong again. Maybe the Nikkei will recover one day, but it’s likely to be your grandchildren who see it back at 40,000. Maybe even your great grand-children.
More significant, however, might be the influence of the Nikkei crash on policy-makers. We hear a lot about how central bankers are trying to avoid the mistakes of the 1930s. But so much has changed since before WWII, few lessons from that era are really very relevant to today’s world. What central bankers are really trying to do is avoid the mistakes of the Bank of Japan in the 1990s.
Initially, Japan’s monetary authorities didn’t reckon they had much to worry about. Sure, stocks were down, but they looked pricy anyway. The Japanese carried on raising interest rates until August 1990, long after the Nikkei collapsed. It was only once it became clear that growth, which was averaging around 5% annually in the 1980s, had evaporated, that they started to take action. Interest rates were cut, dropping from 6% in 1991, to 1.75% in 1993. And the government started to pump money into the economy: a budget surplus of 1.3% of GDP in 1990 became a deficit of 5% by 1995.
The trouble was, none of it seemed to work. The Japanese economy spluttered a bit every time it was stimulated, then stalled again. As the slump stretched into this decade, the Bank of Japan tried something new. Because it couldn’t cut interest rates anymore, it started printing money, or what was called ‘quantitative easing’. In effect, Japan’s response to the Nikkei’s collapse has been an economic laboratory for how the rest of the world should cope with the financial shocks of the last year. All we’re doing now is what they did a few years ago. There’s only one snag: none of the prescriptions really seemed to work.
For the world’s leading central bankers, the lesson has been that Japan didn’t act quickly enough or aggressively enough. Monetary and fiscal policy “should have become even more aggressive in an effort to prevent a deflationary slump,” argued a key paper on the Japanese experience published by the US Federal Reserve. And that has been the intellectual rationale for the speed and aggression with which the Fed, and the Bank of England, along with other central banks, have both cut rates and printed money in the past year.
But there is an alternative explanation. Just as plausibly, the Japanese propped up the banking system too long: its half-dead, zombie banks acted as a drag on the economy. They allowed too many bankrupt companies to stagger into a financial twilight zone. And they ran up so much government debt that they crowded out the private sector, and left the country fundamentally insolvent. And whilst they printed money like crazy, that just fuelled bubbles in other countries – as hedge funds and other borrowed cheap yen – while Japan stagnated. All they achieved was to turn a short nasty slump, into a long, catastrophic one.
Rather worryingly, we are doing very similar things. Our banks are propped up with billions, but still refuse to lend. And we’ve become even more indebted: in the three years after the Japanese bust, public debt rose by 140%, but ours is already up by 170% since 2007, including the cost of bank bail-outs. And whilst we’re printing money, all that seems to do is create asset bubbles elsewhere.
Central bankers and policy-makers in both the UK and US think they have learned the lessons of the Nikkei’s collapse, and the two decades of economic stagnation that followed. They are determined to avoid Japan’s mistakes. But it is equally possible they are just repeating them – except on an accelerated timetable. In which case, rather disappointingly, sometime around 2030 we’ll be looking back and wondering how the slump that followed the credit crunch managed to last two whole decades.