Japan's Lost Thirty Years?

　　Image Source: Yahoo Finance

　　urst of Japan's asset bubble, the economy has been trapped in a state of low growth, low employment, low inflation, low wealth, and low leverage, a period referred to as the “Lost Thirty Years” of Japan, lasting for 30 years.

Formation of the Asset Bubble

　　The roots of this can be traced back to the Plaza Accord of 1985. In the early 1980s, to address high inflation in the U.S., the U.S., U.K., Germany, France, and Japan signed the Plaza Accord in New York. The agreement called for several countries to sell off dollars to raise the value of other currencies. The U.S. aimed to reduce exports by devaluing the dollar and strengthening the yen.

　　Image Source: XiaolinShuo

　　Facing economic downturns, soaring exchange rates, and stable inflation, the Japanese government naturally turned to interest rate cuts. Lower interest rates could stimulate the economy and devalue the domestic currency. The central bank subsequently reduced the benchmark interest rate from 5.0% in 1985 to 2.5% in 1987. While this easing helped the economy recover slightly, the excessive rate cuts stunted long-term economic growth and set the stage for the bubble.

　　In simple terms, low interest rates increased market liquidity, making borrowing easier and causing more funds to flow into the real economy and capital markets. Increased funding in the real economy led to inflation, while in capital markets, it created asset bubbles.

Development of the Asset Bubble

　　Japan experienced the latter. A significant amount of capital flowed into the stock and real estate markets, with commercial property prices tripling from 1985 to 1991. Property prices in major cities like Tokyo soared to extreme levels. By 1990, seven of the ten highest market capitalization companies globally were Japanese.

　　Previous rate cuts were managed without major issues; however, the 1986 cuts had a profound impact. This is attributed to Japan's zaibatsu, or large industrial conglomerates. The core of Japans economy was long controlled by these groups, with banks being central to their structure. During times of economic growth, these groups could enhance efficiency, integrate resources, and reduce unnecessary competition, promoting overall development. In downturns, they could exacerbate economic decline.

　　In a low-interest environment, banks' profitability declined, leading to excessive credit expansion.

Collapse of the Asset Bubble

　　After the bubble burst, why did Japan enter a prolonged period of stagnation？ The asset bubble burst in 1990, and while recovery might have been expected within a year or two, the situation worsened. The overall economy was severely damaged, with many industries losing vitality.

　　By 1997, despite substantial bailout funds, Nissan Insurance announced bankruptcy, the first major insurance company to do so post-WWII.

　　Over the next thirty years, Japan implemented various extreme measures to stimulate the economy, including negative interest rates, money printing, and massive government debt. However, these measures failed to significantly alter the situation, leaving Japan still struggling on the brink of deflation.