When Tokyo Out-Valued America
What we can learn from Japan’s bubble economy
In 1985, representatives from Japan and the United States signed a deal to reevaluate the Japanese Yen at Plaza Hotel in New York City. As a result of this accord, the value of the Japanese Yen soared to double the value of the Dollar. This deal was what started one of the biggest economic bubbles in human history.
Before the Bubble
The United States insisted on the Plaza Accord because Japan’s undervalued Yen put Japanese exports at advantage over American exports. Lower valuation of Yen meant that Japanese manufacturers could export and sell goods at lower and more competitive price. To prevent losing more money on their trade with Japan, the United States came up with a deal to adjust the value of the Yen. With in a year from the deal, the Japanese Yen was valued as twice as high as the Dollar.
With less competitiveness in the export market, Japan experienced a decrease in GDP in 1986. To stimulate the stagnant economy, the Japanese government chose two strategies:
- To halve the national interest rate from 5% to 2.5%
- To loosen restriction on loans
While the Japanese government saw this as a treatment to boost their domestic economy, they did not predict the heavy bubble that was about to form in the market.
Frenzy Investing — Stocks
With Low interest rates and loose restriction of loans, individuals and businesses started taking out loans to invest. People invested in businesses with little to no understanding of the business they invest in. The more money that flew into the stock market caused the stock prices to inflate to astronomical levels.
NTT (Nippon Telegraph and Telephone Corporation) is the prime example of the stock price inflation. Going public in 1985, the market capitalization of NTT tripled by 1989, becoming the most valuable company in the world. NTT’s market capitalization was at 276 billion dollars, tripling IBM’s market capitalization (IBM was the second most valuable company). In fact, 16 of the 20 largest companies in the world were from Japan in 1988.
The Nikkei index soared to the sky during this period; by 1989, the Nikkei index hit 38,000 points. To put this to perspective, in 1985, the Nikkei was sitting at 12,000 points. This was astronomical, considering that the Nikkei 225 index is around 20,000 points today.
Frenzy Investing — Real Estate
From the 1960’s to the 1970’s the price of real estate in Japan saw a 2500% increase. Witnessing the ever-soaring real estate market, the inflation in real estate price peaked during the bubble period. With easier loans and lower interest rates, the prices of land and buildings became astronomical. The average price of real estate in Tokyo tripled within a year from 1987 to 1988.
The frenzy drove the market to madness. Everyone wanted to buy a piece of land in Tokyo. With insane prices on houses, some banks even gave out a 100 year loan to home buyers. With every property purchased, investors would leverage the property for more loans to invest.
“Sell Tokyo, Buy America”
Many genuinely believed that the combined price of assets in Tokyo alone was enough to match that of the United States. In fact, a considerable amount of money in Japan was being invested in to the States. Mitsubishi purchased the Rockefeller Center in 1989, Sony purchased Colombia Pictures, and Panasonic purchased Universal Pictures.
When the Bubble Popped — Lost Decade
While Japan’s economy was thriving in 1980’s, it was rotting from inside. Many Japanese did not realize that they were only profiting off of an extremely over valued market. Investors poured their money into companies that multiplied their valuations while never generating viable cash flow.
The Japanese government realized the abnormality in the market and raised the national interest rate from 2.5% to 6% in 1989. However, the market kept its frenzy until the government imposed a 6-month ban on all mortgage loans in 1990. This commenced the start of the demise of the economic bubble that had been building up for years.
Banks began asking for a quicker pay-back on their loans that investors could not afford to repay. During the bubble period, investors bet most of their life savings and loans into the stock and real estate market. With no money to circulate in the market, the year 1990 began the collapse of the Nikkei 225 Index. Numerous businesses went bankrupt, costing banks trillions of Yen.
The economic decline lead to a 15 year decline in real estate prices and a significant decrease in the stock market. The Lost Decade is referred to Japan’s 10 years of economic decline and stagnation since 1990. Since 1990, Japan’s GDP growth rate has been in the negatives or lower positives.
Japan’s economic collapse of the 1990’s proved to the world how dangerous an overvalued-economy truly is. We live in an unpredictable time with Covid-19 and an uncertain economy. What we can learn from Japan’s mistake is that no economic prosperity lasts forever and that careless investing should always be avoided. The Japanese government let the bubble rise up for 4 years, neglecting economic signs of a collapse. Whatever economic hardships that we experience in the future, we must look at Japan and how their naive approach costed them a decade.