Great Financial Crises, Part 9: Japan's Bubble and the Lost Decades

In the late 1980s, Japan seemed unstoppable. Its companies dominated electronics and cars, its banks were among the largest in the world, and Tokyo land was so expensive that people joked the grounds of the Imperial Palace were worth more than all the real estate in California. Then the bubble burst, and Japan entered decades of slow growth and falling prices. In Part 9 of Great Financial Crises, we look at Japan's bubble economy.

The ingredients

A strong yen and cheap money

In September 1985, the world's major economies agreed in the Plaza Accord to push down the US dollar. The Japanese yen rose sharply, hurting exporters. To support the economy, the Bank of Japan cut interest rates. According to CNBC's summary, its policy rate fell to 2.5%, the lowest since Japan moved to floating exchange rates in the early 1970s. Cheap borrowing fuelled speculation.

Banks and land

Japanese banks lent heavily against land as collateral. As land prices rose, borrowers could borrow more, which pushed prices higher still. Companies borrowed to buy property and shares, and many earned more from financial investments than from their core businesses, a practice known as zaitech.

Cross-shareholdings

Companies and banks often held each other's shares in tight networks. Rising share prices boosted bank capital, encouraging more lending, another self-reinforcing loop.

The peak

On 29 December 1989, the Nikkei 225 stock index closed at a record 38,915. Valuations were extremely high by international standards, and commercial land prices in big cities had multiplied over the decade.

The burst

In 1989 and 1990, the Bank of Japan raised interest rates sharply to cool speculation, and authorities restricted lending for property. According to CNBC, by September 1990 the Nikkei had fallen to about half of its record high. Land prices began a long slide that lasted more than a decade.

A slow-motion banking crisis

As asset prices fell, borrowers could not repay, and banks were left with huge amounts of bad loans. Instead of recognising losses quickly, many banks kept lending to weak companies to avoid writing off loans, creating so-called "zombie" firms that survived without being productive. Regulators often went along, hoping prices would recover.

The problems came to a head in 1997 and 1998, when several major financial institutions failed, including Hokkaido Takushoku Bank, the brokerage Yamaichi Securities and the Long-Term Credit Bank of Japan. The government eventually injected public money into banks and pushed them to clean up their balance sheets in the early 2000s.

The lost decades

Japan's economy did not collapse, but it stagnated. According to CNBC's summary, GDP grew only about 0.7% a year from 1991 to 2011. Prices fell gently for long periods, a condition called deflation. Deflation encouraged people to delay spending and made debts heavier in real terms.

The Bank of Japan cut rates to zero in 1999, introduced quantitative easing in 2001 and later went even further, including negative interest rates from 2016. Japan became a laboratory for policies later used by other central banks after 2008.

A 34-year wait

The Nikkei fell below 8,000 at its low during the 2009 global financial crisis. It did not surpass its 1989 peak until 22 February 2024, more than 34 years later, helped by corporate reforms, a weak yen and renewed foreign investment.

Why it matters

Japan's experience is a warning that a bursting bubble can cause long-term damage, especially when bad debts are not dealt with quickly. It also shows that a stock market can stay below its peak for a generation, an important lesson for anyone who assumes markets always recover quickly.

Lessons for investors today

1. Valuation matters. Buying at extreme valuations can mean decades of poor returns.
2. Diversify internationally. A Japanese investor who held only Japanese stocks waited 34 years to break even in price terms.
3. Debt and land are a powerful combination, in both booms and busts.
4. Recognise losses early. Delaying the clean-up of bad debts prolongs economic pain.

In Part 10, we look at a slow-burning American crisis: the collapse of the savings and loan industry.

Sources

• CNBC – Japan stocks are roaring back: how this rally differs from the 1990 bubble high
• AP via Boston Globe – Japan's Nikkei breaks its 1989 record (Feb 2024)
• Nippon.com – Japan Data

Great Financial Crises: the full series

• Part 1: Tulip Mania (1637)
• Part 2: The Mississippi and South Sea Bubbles (1720)
• Part 3: The Panic of 1907
• Part 4: The Wall Street Crash and Great Depression
• Part 5: Weimar Hyperinflation (1923)
• Part 6: The 1970s Oil Shocks and Stagflation
• Part 7: The Latin American Debt Crisis (1982)
• Part 8: Black Monday (1987)
• Part 9: Japan's Bubble and Lost Decades (you are here)
• Part 10: The Savings and Loan Crisis
• Part 11: The Mexican Peso Crisis (1994)
• Part 12: The Asian Financial Crisis (1997)
• Part 13: Russia's Default and LTCM (1998)
• Part 14: The Dot-Com Bubble (2000)
• Part 15: Argentina's Collapse (2001)
• Part 16: The Global Financial Crisis (2008)
• Part 17: Iceland's Banking Collapse (2008)
• Part 18: The Eurozone Debt Crisis
• Part 19: The Covid Crash (2020)
• Part 20: The 2023 Banking Turmoil

This series is for education only and is not investment advice. Figures are taken from the sources listed and other commonly cited historical records, and may vary slightly between sources.