By Roland De Courson / AFP
Tokyo: The US financial crisis is bringing back memories in Japan of its own economic implosion in the early 1990s — and offering US policymakers a textbook case of what not to do.
Much like the turmoil on Wall Street, the Japanese crisis was set off by the collapse of a speculative real-estate boom. Japan’s post-World War II miracle economy was soon shattered after policymakers’ bad — or lack of — decisions.
The world’s second largest economy, though hit again by a global slowdown, has since healed to the point that two Japanese financial institutions this week said they would buy large chunks of two leading Wall Street casualties.
But Japan’s long recovery came only after its so-called “lost decade” in the 1990s of recession in which its model of guaranteed lifetime employment for all company workers was all but destroyed.
The crisis stemmed from the speculative bubble of the 1980s when an economy that seemed invincible led investors to put their money in real-estate, which saw prices soar to ridiculous levels.
Famously, the land underneath the Imperial Palace in central Tokyo was said to be worth more than the entire state of California in 1988. Tokyo’s benchmark Nikkei index in late 1989 was at 39,000 points, compared with 12,000 now.
The stock and real-estate booms crumbled within months of each other. Japan was soon plunged into recession and deflation, a toxic cocktail for banks.
A loose monetary policy had allowed Japanese banks to lend money almost blindly during the euphoria of the 1980s. After the crash, they were suddenly saddled with giant debts they could not get back, as they had been guaranteed by real-estate assets that were in freefall.
The banks’ refusal to see the imminent disaster — and the government’s reluctance to force them to — only worsened the crisis.
“If there is one lesson from Japan’s experience, it is that forbearance adds to the costs,” said Richard Jerram, the chief Japan economist at Macquerie Securities.
“No country procrastinated for as long as Japan has done in the face of a financial system crisis,” he said.
The Bank of Japan slashed interest rates from 6% in 1991 to 2% in 1994 to try to ensure a steady flow of cash in the system.
Starting in 1992, the Japanese government also took to public spending to revive the economy.
But economists say that authorities’ response was too late and too tepid and was accompanied by policy errors that prolonged the crisis into the 21st century.
The public spending consisted in part of construction projects — “bridges to nowhere” — that were popular in local communities that backed the ruling Liberal Democratic Party but worsened the public debt.
Hoping to get its balance sheet in order, the government in 1997 raised the consumption tax from 3 - 5%. The move was a disaster, with the economy plunging back into recession.
John Makin, professor at the American Enterprise Institute for Public Policy Research, said Japan’s other major mistake was not ensuring enough liquidity, believing that low interest rates were enough.
By 1998, the central bank took the unusual step of reducing interest rates all the way to zero. But it was not until reformist prime minister Junichiro Koizumi took charge in 2001 that the government forced banks to get rid of non-performing loans to bring them back to health.
“The banking system must move promptly or be moved promptly to reveal the full extent of its exposure to the depreciating assets,” Makin said.
Six central banks including the Bank of Japan last week announced coordinated action to ensure credit. The US Federal Reserve announced a $180 billion cash line.
The US government has also proposed a $700 billion rescue plan to buy toxic mortgage-related assets from banks suffering the gravest US financial crisis since the Great Depression of the 1930s.
Makin said that so far, there was no reason to believe the United States was headed into its own lost decade like Japan.
“Japan’s experience in the 1990s, while painful, provides helpful guidance and a compelling reminder that the worst approach to dealing with the unusual set of problems we currently face would be to deny that they exist,” he said.