Crisis in Japan and its consequences
In late 1980s some ‘forecasters’ claimed that Japan, which had been developing much faster than the US for a long time, would soon overtake it in terms of GDP per capita and, in the first decade of the 21st century, the total gross domestic product and industrial production. In the 1990s Japanese growth rates were more than twice less than in the US and reached even negative figures in 1998 ending up around the zero in 1999-2000.Japanese decline came about because of a lot of factors – from ‘infection with the Asian illness’ to structural ailments of Japanese economy. However, most analysts believe that organic vices of the financial system that came to the foreground played the most important role.
In a somewhat sensational book intended to destroy the myth of the everlasting Japanese miracle, Professor D. Hayes (a European citizen living and working in Japan) writes: “The core of the Japanese financial system has kind of inherent mould. Whether we look at the Japanese financial system from a micro or a macro perspective, we see one and the same picture everywhere: fraud, nepotism, absolute lack of competence”. You can also read the following in the summary on the book’s cover: “Japan allowed large-scale infiltration of organized crime into its financial institutions".
The author might be exaggerating Japanese vices a little. However, he adduces ample evidence of his main premise: after it created a highly performing export-oriented industry after the Second World War and took a worthy place in the global market, Japan kept a poorly regulated and vulnerable financial system. This was concealed and eclipsed by economic progress until a certain time. However, in the 1980s Japan saw a speculative boom with excessively bloated bank credit, stock markets and real estate transactions. The price for this boom and organic weakness of the financial system had to be paid in the 1990s. This diagnosis should be taken and considered seriously.
Japanese stock index in dollar terms grew almost tenfold between 1979 and 1989. It is hard to find an example of similar growth of fictitious capital in the entire history of stock markets. Stock prices grew worldwide, but at a much lower rate: they on average tripled in the US and Western Europe in the same period. The price to earnings ratio in many Japanese companies exceeded 100 while its normal level is usually at 15-20. It is calculated as the ratio of the stock's price to net earnings per share. A high level means that the stock price is too far from real earnings of the company and has a large and dangerous speculative component.
Property prices showed breath-taking growth. A square meter of land in Tokyo’s prestigious neighborhood cost up to USD350,000 at the height of the boom. The area under one 100 dollar bill cost more than its face value. An apartment of medium size (two bedrooms) could be bought only for one or one and a half million dollars. This boom was made possible only by huge flow of loans from banks and other financial institutions. Property trading became a goldmine for the Yakuza. Interests of financial circles were closely linked with interests of the Yakuza which took the job of ‘clearing’ the plots of land and buildings to be sold from unyielding small owners and tenants.
When the stock market and land boom suddenly came to an end in early 1990s, Japanese banks ended up with massive bad assets - loans advanced on security of property and securities or, quite often, unsecured at all. In 1997-1998 Japanese stocks fell 2.5 times as compared to the peak. City properties lost even more value – by 70-80% in many cases. In these conditions borrowers appeared unable to repay loans. The prolonged banking crisis became a very important feature of Japanese economy.
Special mortgage lending institutions (jusens) were the first to go bankrupt as their aggregate amount of bad loans was officially estimated at 7 trillion yens (about 70 billion dollars at an average exchange rate of that time). Jusens’ losses were mainly covered by commercial banks which financed and controlled them. In late 1994 two large banks were closed and soon the Long-Term Credit Bank of Japan, one of the country’s major banks, ended up in danger. The government tried for several years to organize merger of the sinking giant with other banks but was forced to take over its obligations.
The crisis in Asian countries that in many respects copied the Japanese model of development oriented on intensive export expansion dealt a new strong blow to Japan’s financial system. In fall 1997 the global financial community buzzed as a disturbed hive at news of bankruptcy of the third largest stock trading firm, Yamaichi Securities. Making this urgent announcement on 3 December 1997, BBC added a banner headline to it saying that ‘the news… was met with falling stock prices worldwide and concerns that the shock of the Japanese economy could push the entire world to decline'. Japanese securities trading firms are similar to American investment banks and conduct issue of or trading in securities and capital management. Their transactions are made worldwide and are not second to American and European competitors. In the 1990s largest firms were involved in scandals related to payment of smart money to the mafia, giving of bribes to officials etc.
In general, this crisis affected Japan on a few fronts. Firstly, crisis-struck countries reduced imports of Japanese goods which aggravated difficulties of Japanese companies. Secondly, bad loans of Japanese banks included a lot of debt owned by these countries. Thirdly, many direct investments of Japanese firms in the region generated a loss. All this contributed to intensification of the Japanese decline in 1998-1999. It is a different question that concerns about the Asian crisis and Japanese decline growing into global recession or even depression didn’t materialize themselves. The world was lucky for the second time, it could be said. Unemployment rates became a serious problem for Japan for the first time during the postwar period. In late 1999 the share of the unemployed in the workforce was 4.7% which is a very high figure for Japan. Moreover, according to reliable estimates, if the companies got rid of knowingly excessive workforce this could raise the rates to 8% or possibly even more. The famous system of ‘life-long service’ that had been unique to Japanese companies for many years and was believed favorable, appeared unbearable for many firms in the 1990s and started dying out. This process noticeably intensified in the end of the decade. This is a social and ethical landslide of great significance for Japan.
In general, the 1990s became the time of sobering up for Japan after ‘success dizziness’ that reasonably overwhelmed Japanese society, businesspeople, bankers, politicians in the 1960-1980s. By end of the decade the ruling circles became increasingly aware of the need for reforms that could secure the country’s economic progress for the years to come. Significantly, the financial system appeared on the forefront of these reforms. Rich Japan can invest in these reforms so much that we simply find impossible to imagine. In 1998 the ceiling for spending of budget resources on restructuring of financial institutions was set at 60 trillion yens, equivalent of about 500-600 billion dollars (depending on the underlying exchange rate). This amount includes 25 trillion assigned to replenishment of capital of weak, insolvent banks, 18 trillion – costs of nationalization and liquidation of bankrupt banks and 17 trillion - full guarantee for depositors of bankrupt banks. Though deposits were withdrawn from financial institutions facing difficulties they never resorted to denial of deposit repayment. Money is invested by the state through its specialized agencies mainly by purchasing banks’ (discounted) bad loans and acquiring bank stocks. It is suggested that these and other assets that come into the government’s control should be gradually sold in the market and proceeds used to cover billion-worth costs.
This doesn’t involve creation of a large permanent public sector in the banking system. As early as in late 1999 there was overall approval of sale of the nationalized Long-Term Credit Bank of Japan to American investors. Essentially, the reform of the financial system means its adjustment to the western style, practical implementation of more effective Anglo-American standards and principles, business conduct. The reform includes an element of reducing direct intervention of the state to the degree that the western system involves freedom of the financial market, securing of sound competition, responsible conduct of financial institutions. At the same time, more rigid standards of banks’ capital adequacy, liquidity, loan security accepted in the US and other countries are introduced.
The centuries-old tradition of Japan’s self-isolation affected the financial area inasmuch as the Japanese market was practically closed to foreign banks and other financial institutions. At that time they allegedly took a course for liquidation of this closure that could result in a fresh wind of competition and higher performance. There were increasingly more reports that Japanese banks were actively abandoning unprofitable areas of business, closing branches with low profits, laying off excessive workforce. These measures are especially pronounced during bank mergers that became very common in those years.
Crises of the 1990s from the perspective of new investment theory by Masterforex-V
By laws of economy, crises periodically repeat starting and ending in due time. So, the investor cannot avoid them. We will always face them.
The economic cycle involves periodically repeated rises and declines in economy. The cycle means a period of time in the development of global economy during which there is a rise in production of goods and services followed by contraction, decline, depression, revival and, finally, growth again. In this chart extreme points of development of market economy characterize economic booms and crises.
Economy starts rising with the stage of revival, recovery of business activity – conclusion of new business contracts, gradual and very weak increase in demand for workforce and, as a result, lower unemployment rates, growth in consumer demand.
Then pure growth starts. It is characterized by permanent continuous increase of production of goods and services. The highest point of this rise is described as a boom. In this period economy witnesses complete employment, production is utilized at full capacity. At this point real production reaches its maximum. Typically, prices rise, while growth of business activity stops and freezes after it reaches full employment of workforce.
Recession (reduction) – the condition of economy when gross national product becomes smaller during a steady fall. This is a sign that either production is falling or its growth rates are slowing down.
A crisis of the economy is characterized by a slump of production which starts with gradual contraction of business activity. The crisis is different from lack of balance between demand and supply of a certain product or in a certain industry in that it emerges as general overproduction accompanied by plummeting prices, banks’ bankruptcies, standstill of enterprises (firms), growth of unemployment rates etc. Gradually reducing business activity, slower growth rates are called ‘recession’ in economic literature. Higher rates of contraction of economic activity are a feature of economic decline. A crisis is the lowest point of this decline.
In explanation of reasons for cyclical development and crises, economists point out two main conditions.
The first one is connected with the function of money as a medium of exchange. If purchase and sale do not coincide in place and time this can create preconditions for many links in the sale and purchase chain to be broken. The second one is connected with the function of money as a means of payment. The producer has no guarantee that the buyer of its products will be solvent by the time payment is due. Failure to perform some payment obligations can cause a chain reaction that will lead to misbalances in the exchange system and, eventually, production.
Financial crises of the 1990s brought the issue of reforming the global financial architecture to the foreground. As defined by the IMF, international financial architecture means ‘institutions, markets, rules of the game and standards used by governments, companies and individuals in their economic and financial activities’. This notion is much wider than the ‘international currency system’ that we all know. However, the new term does not have an especially rigid definition and isn’t always used in one and the same meaning. The international financial architecture is often referred to along with another concept, very important and fashionable in those years, - globalization. One can say that it is a system of international financial relationships that corresponds to the stage of globalization in global economy. Finally, like globalization, financial architecture implies that principles of open economy become stronger in the world where freedom of movement of goods and capitals across national borders is observed. Without a clear understanding of these fundamental terms it is difficult to analyze IMF materials which, by the way, become more difficult to read with years not only for educated people in general, but for professional economists that do not deal with finance and international economic relationships.
When they started looking for somebody ‘guilty’ of the crises that struck the world and threatened overall depression, the International Monetary Fund responsible for this architecture became the first candidate. The IMF’s chief principle of operation means providing support to countries that are facing temporary difficulties with their balance of payments. IMF’s good and selfish intentions have been the subject of discussions almost since its very foundation. Some have a very negative attitude representing the IMF as a tool that helps ‘the American imperialism’ enslave first European countries emaciated by the war and later developing countries during a few decades. Many developing countries have a strong opposition to the Fund and its policies. In recent years this opposition merges with criticism of globalization as a process and a policy that give unilateral benefits to developed countries and leave billions of people in poor regions behind.
Others believe IMF loans to be a source of funds used to save countries from an economic crisis. One can’t help admitting that the Fund's thick-skulled dogmatism can draw reasonable resentment of developing nations striving for economic growth at any cost and maintenance of independence in policy-making. It would also be equally fair to say that the course recommended by the Fund to its ‘clients’ binds the hands of populist regimes and politicians. It prevents them from pursuing a policy of social extravagance that the population later has to pay for. Bureaucrats existing at the expense of a variety of limitations, quotas, benefits, bans and permits aren’t very happy about the IMF’s recommendations, either.
Experts of the Investments Faculty within the Masterforex-V Academy believe that the series of crises emerging in different regions of the planet in late 1990s showed weaknesses in the international financial structure (architecture) and it took a miracle at that time to avoid more profound consequences which the world experienced in 2008. The global community couldn’t adjust this very complex mechanism called ‘international financial architecture’ for almost a decade. Maybe, everything’s much simpler than it seems, and crises themselves are simply needed for a more effective (subsequently, of course) operation of global economy? In this way, step by step, from one rise to another, from one crisis to another global economy is becoming more advanced and effective (see pattern above).
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