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NO. 36 -- September 26, 1997

 

Feature Article

ASSET PRICES IN JAPAN: THE BUBBLE AND ITS BREAKING1 by Arthur J. Alexander

Although Japan has experienced several bubbles in stock and land prices since the end of World War II, the tripling of asset prices between 1985 and 1989 and their subsequent collapse during the next several years was exceptional, both in terms of the scale of the rise and fall and the decade-long time span over which it occurred. Analysts are still trying to explain the bubble fully, but a consensus seems to be emerging.

The economy was passing through a transitional phase in the mid-1980s as manufacturing companies, the long-term customers for bank loans, sharply reduced their demand because of slower economic growth and more active capital markets. Also, the Ministry of Finance and the Bank of Japan had been deregulating financial markets since the late 1970s, giving banks more opportunities to seek new customers. Financial market participants, including individuals, sought higher returns as they took advantage of greater access to credit in the liberalizing markets. The combination of liberalized markets and shifting patterns of credit demand altered the customary relationship between money and credit expansion.

In the wake of yen appreciation, in late 1985 the monetary authorities loosened monetary policy to stimulate the economy, which created a sharp rise in the supply of money and a fall in interest rates. Instead of continuing to flow to manufacturing companies as in the past, the increased credit stimulated by this supply of money flowed into asset-backed loans, which fed into prices. Companies subsequently raised low-cost funds on the booming stock market and recycled these funds back into asset markets. Higher prices justified even more lending and borrowing, and the bubble was born. By late-1989 the fear that asset prices might spill over into general wage and price inflation prompted the money managers at the Bank of Japan to curtail the easy money policy, thereby placing the brakes on the unsustainable runup in asset prices and causing a collapse.

Banks' inadequate credit analysis and weak internal controls contributed to a serious nonperforming loan problem in the aftermath of the bubble's collapse. Companies used a portion of the low-cost money raised on the stock market to expand investment in plant and equipment at home and in assets abroad. Low returns on these financial and real investments are continuing to hold back the Japanese economy.

A mid-1980s shift in the relationship between the money supply and other financial variables clouded the vision of government policymakers and delayed a response to the rising asset prices. Such shifts are even more likely in the future as deregulation policies pick up speed. A lesson of the bubble is that government decisionmakers will have to approach policymaking more cautiously in the future as familiar rules of thumb lose their reliability.

1This report is based on two lectures by Arthur Alexander in May and July 1997 at the Japan Information and Culture Center, Washington, D.C., on stock market and land prices in Japan.

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Weekly Review

Sato Forced Out Of Cabinet by Barbara Wanner

Faced with plunging public approval ratings and growing pressure from within the ruling Liberal Democratic Party and from parliamentary allies, September 22 Prime Minister Ryutaro Hashimoto accepted the resignation of Koko Sato, a veteran LDP lawmaker convicted of bribery, as director general of the Management and Coordination Agency. In an apparent effort to contain the political damage caused by Mr. Sato's appointment to the cabinet only 11 days before, in a televised news conference immediately following his fateful meeting with the embattled politician Mr. Hashimoto apologized to the Japanese people for his "misjudgment" in selecting a man with tainted credentials to serve with him at the nation's helm.

 

Fast-Track Faces Rough Road by Eric Altbach

After months of delay the Clinton administration finally announced a proposal for fast-track trade negotiating authority September 16, and the chilly reception from both sides of the congressional aisle may be an indication of difficulties ahead as time runs out on this legislative session. The White House had kicked off its fast-track campaign with a press conference September 10, but had held back the actual bill until the next week in an effort to win the support of Democratic leaders in the Congress, who were concerned that the administration would not push hard enough on labor and environmental standards that Republicans oppose. With a Republican majority in Congress, President Clinton was forced to walk a tightrope in trying to craft a bill that not only would be acceptable to the Republican leadership, but would also still attract enough Democratic supporters to provide the administration with at least some bipartisan cover. Democratic Minority Leader Richard Gephardt (D, Mo.) and a number of Republican Senate Finance Committee members already have harshly criticized the administration's proposal, which indicates that U.S. Trade Representative Charlene Barshefsky and the administration's fast-track czar Jason Berman may have fallen from the wire in their first try at this partisan balancing act.

 

Scandals And Bad Loans Dog Japanese Financial Sector by Jon Choy

While Japan's top manufacturing firms are on a tear, top domestic banks and securities companies remain bogged down by scandals and troubled balance sheets. As Prime Minister Ryutaro Hashimoto proceeds with plans to deregulate and reform key aspects of Japan's financial system, many analysts interpret these troubles as warning signs that even top-ranked banks and stock brokerages may not be in good enough shape to survive the upcoming financial market "Big Bang."

 

International Capital Flows Become Major Issue At Hong Kong Meetings by Douglas Ostrom

When the finance ministers and central bank chiefs of the Group of Seven industrial nations met in Hong Kong September 20, virtually all analysts agreed that the Japanese economy and its growing external imbalances would be a major topic. Although that prediction turned out to be correct, none of the participants appeared to have any idea as to what policies to suggest to Tokyo. Moreover, a harsh exchange about international capital flows and global speculators overshadowed the G-7 talks in the media. The dispute, between Malaysian Prime Minister Mahathir Mohamad and investor George Soros, took place the same weekend at the World Bank-International Monetary Fund meetings, which also were held in Hong Kong.

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