The Japanese bubble of the 1980s is one of the most famous in history. It generates both curiosity and fascination. The world believed Japan was going to dominate the global economy for decades. We analyze the Japanese housing and stock market bubble, including why people believed that “this time is different.”
- Introduction and Economic Context
- What caused the Japanese Bubble
- The Japanese Stock Market Bubble
- The Japanese Housing Bubble
- Why the Japanese Bubble Popped
Introduction and Economic Context
For people interested in finance, it is difficult not to remember the Japanese bubble of the 1980s whenever they think of the economy of Japan. As we will discussed below, it reached gigantic proportions. And even though it popped over three decades ago, Japan remains the world’s third largest economic power.
We should bear in mind that Japan was one of the countries that lost World War II. Apart from the vast destruction consequence of multiple bombings, Japan was also the victim of the only two atomic bombs that have ever been dropped on the civilian population. The bombs at Hiroshima and Nagasaki were followed by the total capitulation of the Japanese army.
After the war the country was occupied by American troops. The United States encouraged the reconstruction of Japan as a means to gain an ally in the Cold War. The Japanese economy was reoriented from arms production to other types of industries.
However, Japan’s economic miracle is partly a consequence of having maintained a war economy. It was a capitalist system with a high degree of central planning. The authorities decided which industries should be prioritized and then forced the banking system to expand the amount of credit available to companies in these sectors.
Huge amounts of capital in the hands of industrial companies allowed the economy to grow very strongly. That was made possible by a highly skilled workforce and a society that admired effort and sacrifice. In addition, companies began to implement constant improvement practices, known as Kaizen.
The country’s growing productivity made it possible for Japan to start exporting its products all over the world. That economic growth led to higher corporate profits and rising wages. However, instead of increasing consumption in line with those rising wages, Japanese society chose to save much of that money. That provided cheap and abundant capital to the country’s companies, so they could continue to grow.
Additionally, this virtuous cycle was reinforced by the largest demographic boom that the country had every experienced in its history.
The economy grew above 10% annually during the 1960s. And it remained above 5% for the next two decades. That impressive growth made the gap between the US and Japanese economies much smaller than it had been.
By the mid-1980s, Japan overtook the United States in terms of GDP per capita. Japanese companies dominated many sectors, especially those that were considered key for the future, such as automotive and electronics.
In the West, many people began to think that Japan would become the hegemonic economic power of the future. Japanese companies not only expanded their businesses around the world, but also went on a shopping spree, acquiring many foreign businesses and assets.
As a curiosity, Eton College, where much of the British elite has studied for a long time, taught Japanese to its students in the 1980s. This feeling of Japan taking over the world can be seen in some American movies of the late 1980s and early 1990s.
What caused the Japanese Bubble
As in all bubbles, the main ingredient for the creation of the Japanese bubble was credit expansion. Since the beginning of the 1980s, the Japanese banking sector started to increase the amount of loans available for the purchase of real estate. Interest rates were cut, credit criteria relaxed, and people were allowed to borrow more money.
At the same time, Japan was experiencing very strong economic growth, and the population boom led to the number of people looking to start a family hit an at all-time high. Demand for real estate had never been this high.
The GDP of the Tokyo metropolitan area was at the time larger than that of the United Kingdom, and similar to that of the entire Soviet Union.
As if this were not enough, a lot of money came in from abroad to invest in the Japanese stock market. Everyone wanted to be invested in the new economic superpower. That gave a boost to companies listed on the Tokyo Stock Exchange and the overall Nikkei index.
Bubbles began to form in both the real estate and stock markets.
Furthermore, the Japanese bubble took place while the Japanese Yen was trading at extremely high levels. The large trade surpluses led to an imbalance between demand and supply for Yen that led to an appreciation of the Japanese currency.
The Japanese Stock Market Bubble
To analyze the Japanese stock market bubble, let us look at the Nikkei index. The Nikkei is a stock market index that tracks 225 of Japan’s largest companies. Some of these companies are Honda, Sony, Mitsubishi or Panasonic:
As you can see, the growth of the Japanese stock market was spectacular. The Nikkei reached its all-time high on December 29th, 1989, at 38,957 points. In 1970, less than two decades earlier, it was trading below 2,000 points. Between 1971 and 1990, the index had an annualized return of 17%.
That translates into multiplying our initial investment by 20 in just 19 years. And that is the return in Japanese Yen, a currency that was strengthening throughout this entire period. Returns in US Dollars averaged an annualized 22.7% per annum (multiplying our initial investment by 50), and returns in Pounds Sterling averaged 25.3% (multiplying our initial investment by 73).
In 1989, Japan represented 47% in the MSCI World stock market index (its weight in the 2020s hovers around 6-7%). Back then, the United States accounted for only 28% (around 70% in the 2020s).
The P/E ratio for the entire Nikkei index in 1989 was 60. And corporate profits had never been that high after decades of tremendous growth.
9 of the 10 largest banks in the world were Japanese. The Tokyo Stock Exchange accounted for 50% of all world market capitalization. New York accounted for only 25%. And the third largest stock market in the world was Osaka, which had relegated the London Stock Exchange to the fourth position.
Many years later, once the Japanese bubble had already popped, the Nikkei reached its lowest post-bubble level in October 2008, just below 7,000 points. A cumulative drop of more than 81% over almost two decades.
The Japanese Housing Bubble
If the Japanese stock market bubble was big, the housing bubble was much bigger. Between 1956 and 1990, the price of office space in Japan increased 150-fold. And in the period between 1986 and 1990 alone, in just 4 short years, house prices went up by more than 150%.
To put it in perspective, at the peak of the Japanese housing bubble, the value of all real estate in Japan was worth 4 times as much as the value of all real estate in the United States. As a result, Japanese corporations began buying up many of the most expensive buildings in New York, Los Angeles and San Francisco.
The real estate value of the imperial gardens in Tokyo, located next to the Ginza district, one of the most expensive in the city, was valued higher than all the real estate of California, at about 5.1 trillion US Dollars in 1989. That was as much as the entire GDP of Japan that year.
The value of all office buildings in the Ginza district was higher than the entire real estate of Canada. As an example, the most expensive building ever purchased in Ginza is said to have been priced at $1.5 million per square meter in 1989.
Many people made incredible fortunes. By the end of the 1980s, there were more than 20 golf clubs in Japan where becoming a member cost more than a million US Dollars, with the most exclusive one costing over 4 million.
There is an anecdote according to which in order to get a taxi in Tokyo’s financial district you had to stop it with a 10,000-yen bill (almost $100). Employers had to pay very attractive bonuses and even free holiday trips to hire graduates who were just out of college.
Why the Japanese Bubble Popped
Several things brought the party to an end. First of all, we must emphasize that the Japanese bubble was of astronomical proportions. To think that it could have continued for many more years is unrealistic. Stock market and real estate valuations were very extreme by the end of the 1980s.
However, it was the Bank of Japan that gave the final blow to the Japanese bubble. The same BOJ had been cutting interest rates throughout the 1980s, taking them from 9% in 1980 to 2.5% in 1987. However, in 1989, rates began to rise to cool market exuberance. Later that year, interest rates hit 6%.
At the same time, banks massively reduced credit availability for real estate purchases.
Although the decade that began in 1991 is known as the Japanese lost decade, due to the low level of economic growth, a couple of things are worth mentioning.
On the one hand, the Japanese economy managed to maintain an extremely low unemployment rate. Furthermore, thanks to the strength of Japanese exports, which never went down, the Japanese Yen did not weaken during that decade, but in fact strengthened.
Nowadays, Japan remains the world’s third largest economy. The Japanese bubble was a great lesson for many. It proved that things tend to mean revert. When we are in the middle of a bubble, it is very common to hear people say that “this time is different”.
For some investors and economists at the time, regardless of how optimistic they were about the future of the Japanese economy, the bubble was obvious. Those valuations could not be justified simply because Japanese corporate practices were going to dominate the business world.
For those who want to learn more about the Japanese bubble, here is a link to a very informative documentary on the subject: Princes of the Yen. Its producer spends a great deal of time and effort to explain the causes of the Japanese housing and stock market bubble.
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Japan Stock Market Indexes – Nikkei 225 or TOPIX?