Japan, what went wrong

Japan was admired by the rest of the world for its economic success for a very long time. But nowadays, Japan is used as a warning instead. What went wrong in Japan?

The success of the Japanese economy after the Second World War is well known. Japanese products were exported all over the world. One explanation for the success was the undervalued Japanese currency. The Plaza Accord in 1985 changes things a little bit. It was decided that the Japanese Yen should appreciate against the US dollar.

This would make Japanese goods more expensive in the US. In order to offset the expected decrease in exports, Bank of Japan decided to change to an expansionary financial policy. Due to the long success of the Japanese economy, the Japanese share and real estate prices were already very high.

The expansionary financial policy created an extraordinary bubble, real estate and stock prices skyrocketed to unsustainable levels. With the benefit of hindsight, it is easy to see the overheated economy with ridiculously inflated asset prices but as long as everything keeps on going upwards it is easy to get excited and forget that all bubbles will sooner or later burst.

Once the bubble burst towards the end of 1990, the Japanese economy started a decline which would go on for two decades. The reason for this is easy to explain, the Japanese banks had lent far too much money for buying assets at highly inflated prices. Once the asset prices crashed, the borrowers either went bust or got stuck with huge loans. Since asset prices had decreased too much, borrowers could not sell the assets to pay off the loans.

So why have the Japanese banks not seized the assets from lenders who can’t repay their debts? Well, that would only depress assets prices even more. And the amount of bad loans would most likely force many of the banks to ask the government to bail them out. The most painless solution was to not force debtors to pay or take their assets but that created a sort of zombie economy with banks and companies which in essence were bust but kept on going anyway.

This has kept the unemployment down and prevented a huge crash. But the recovery has taken much longer than anyone had expected.

One way out of a recession is increased consumer spendings. But the Japanese have preferred to save a lot of their income rather than go shopping. In a recession people often cut down on their spendings and try to save money instead. After all, in a recession unemployment goes up so it makes sense for people to build up a buffer.

Since neither the Japanese consumer nor the companies have been spending enough to get the economy going, the government has stepped in and increased its expenses in order to prevent the country from entering a deep depression.

That the Japanese prefer to save money rather than spend it is a mixed blessing. The Japanese government has been able to borrow a lot of money without paying any penalty interest rates. In 1991, the government’s debt was 66% of the annual GDP. In 2012 it had grown to a whopping 214%. Italy, often mentioned as a warning, has a debt of 126% of the annual GDP. If the Japanese government had not been able to borrow from Japanese households and companies, it would probably have gone bust by now.

The ageing population in Japan does not make things better. But the main problem was that after the bubble burst, the sinking assets prices stalled the economy. Japan has tried different ways of getting the economy going again but it looks like without inflation, which would increase asset prices, not much happens. This is why quantitative easing has become a popular solution for several central banks.

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