Table of Content
2. What led to the speculative bubble
2.1. The Nixon Shock
2.2. The Plaza Accord
3. What led to the burst
4. Japan today: the ageing population, the declining birth rate, and the unmarried
5. Possible remedies for the future of the shrinking Japanese economy
As the trade-war tension between the US and China has been intensifying in recent months, China ponders over the devaluation of Chinese Yuan as one of the options to counter the trade deal that restricts their exports to the US. Also, it might be that it is what China has learned from the ways in which Japan has long been used as a pawn by the US in the bilateral trade relationship. The following shows one of the ways to read how Japan blew up in the early 90s.
During the post-war period, the economic miracle lifted Japan from the ashes and rubble to a new economic power within the global order. During the post-war period between 1955 and 1973, Japan displayed the unparalleled economic growth with the 22% annual capital formation (Gordon, 2003, p.246). Although the country once grew to the extent of even threatening the hegemonic power of the US, much like China today, it let an economic bubble emerge out of the overinflated property and stock markets, which eventually evaporated after the markets came crashing down in the early 1990s. It was followed by decades of economic stagnation, which are now ubiquitously called the “lost decades.” (Lise et al., 2014)
Contrary to the widely accepted perception that the bursting of the bubble was merely triggered by the gullibility of the masses, it seems that there were a number of events that led to the eruption. The following should thus be read as a contrarian view.
- What led to the speculative bubble
In 1965, the trade balance between the US and Japan shifted from Japan’s chronic deficit of exports over imports to a surplus, thanks to a series of process innovation, such as Kanban system, Just-in-Time, lean supply chain management, amongst others. And since then, the trade balance had diverged further (Fig.1). The Big Three, such as GM, Ford and Chrysler that symbolised the unprecedented ascent of the US economy in the post-war era was in slow decline by the 90s together with the city of Detroit; once the beacon of industrial America. In the meantime, American consumers turned to more reliable vehicles of Toyota, Nissan, Honda and Mazda, but the decline of the Big Three was not a matter of competition in a free market economy per se, but that of national pride (Gordon, 2003, p.293).
Fig. 1: Trade Balance between the United States and Japan, 1963-79
Source: Gordon, 2003, p.292; U.S. Department of Commerce, Statistical Abstract of the United States (Washington, D.C.: US Government Printing Office, 1963-1979)
2.1.The Nixon Shock
In August 1971, President Nixon announced on the national television that the United States would unilaterally abandon the Bretton Woods Agreement and the gold standard that had stabilised the global currency market since 1944, which technically allowed the US dollar to be freely devalued and thereby reduce its sovereign debt. As a result, the yen appreciated sharply against the US dollar, which made Japanese exports considerably more expensive and consequently helped the gap of the US trade deficit to be narrowed between 1972 and 1974 (Fig.1). The exchange rate between the US dollar and the Japanese Yen fell from 348 JPY in 1971 to 271 JPY in 1973, more than 20% of the USD depreciation against the yen (McKinnon, 2010).
In the meantime, the state leaders of the 7 leading capitalist economies, including Japan, started a series of annual ‘summit’ meeting on a regular basis with the first one being held in 1975, which came to be known as G7 summits. They discussed the coordination of macroeconomic policies, whilst Japan’s participation in such meetings symbolized the nation’s growing significance in the global economy and the source of national pride. It simultaneously, though, forced Japan to modify its economic policies that serve international interests.
2.2. The Plaza Accord
Despite the Nixon Shock in 1971, by the middle of the 1980s, the gap in the trade surplus between the US and Japan had widened again even further, and Japanese exports to the US were valued more than double the amount of American exports to Japan, and annual US trade deficits with Japan rose to around $50 billion (Gordon, 2003, p.292). In response, the US pursuit of self-interest galvanised a collective force amongst Western economies.
In 1985, the ministers from the G7 countries held a meeting at Plaza Hotel in New York and came to an agreement to coordinate ways of currency purchases to boost the yen that was thought to be considerably undervalued and thereby, as Americans believed, Japanese imports gained a competitive advantage in international trade (Gordon, 2003, p.294; p.295; p.314). It came to be known as the Plaza Accord, and yet again, the US utilized their political leverage to contain Japan’s trade increases.
At the beginning of 1985, USD to JPY was 251.97 JPY, which had remained unchanged till the end of May and the dramatic descent began, as the USD was rapidly devalued and fell by over 20% to 200.2 JPY by the end of 1985 (Pound Sterling Live, 2018). And by 1988, USD/JPY had fallen to 128, over 50% devaluation in a matter of a few years (McKinnon, 2010).
Table 1: $US to ¥JPY exchange rate in 1985, the year of the Plaza Accord
Source: Pound Sterling Live
|January 02, Wed||USD/JPY||251.97 JPY|
|February 25, Mon||USD/JPY||263.42 JPY|
|May 31, Fri||USD/JPY||251.48 JPY|
|December 31, Tue||USD/JPY||200.2 JPY|
As a result of JPY being appreciated against other currencies, in particular, USD, Japanese exports stagnated. To encourage its deterred exports, the Bank of Japan (BOJ) loosened its monetary policy. Also, at the Plaza Hotel, the G7 nations, apart from Japan, pressured the Japanese government to encourage domestic demand, and the Finance Ministry complied with the request by lowering interest rates and embarking on fiscal expansion (Gordon, 2003, p.295).
The combination of those monetary policies, in effect, gave way to speculative investors to embolden, who already had incentives to invest thanks to the appreciated yen and the fiscal expansion that drove local governments to invest in all manner of public works (Gordon, 2003, p.295).
In the previous decades, Japanese people were known as unswerving savers and in the 1970s, households saved over 20% of their income, despite their unprecedented earning power and productivity (Gordon, 2003, p.249). Thus, the twin forces of the Plaza Accord and monetary easing came to Japanese savers as an alluring impetus too much to handle. Incentivised by the loosened monetary policy, banks also expanded their national and international investment extensively, which included toxic assets and non-performing loans (NPLs), while the shadow banking sector also grew exponentially. To illustrate the growth of banks’ investment and lending, the scale of unpaid Japanese international banking assets grew by 30%, reaching $1,967 billion (Itoh, 2000, p.85). Driven by the appreciated yen, the loosened monetary policy, and easy bank loans, suddenly, a large number of speculative investors collateralized their houses and poured their life savings to invest in stock markets and real estates, which consequently created a speculative bubble.
- What led to the burst
Despite the public euphoria, an alarm bell began to ring. Between 1989 and 1990, in an attempt to softly deflate the rapid growth that was hinged merely on speculation, financial officials increased borrowing rates from 2.5% to 6% by tightening credit. Much to their dismay, however, investors reacted rather frenziedly. The primary index of the Tokyo stock exchange Nikkei nosedived from the peak of 40,000 yen at the end of 1989 to 20,000 yen by the end of 1990 (Gordon, 2003, p.314). The overinflated bubble popped. By mid-1992, the Nikkei average was down to 14,000, while consumer confidence plummeted, and BOJ responded by bringing down interest rates, and this trend has perpetuated in the following decades (Gordon, 2003, p.316).
What ensued was the prolonging economic stagnation and a deflationary trend. Due to the slowed investment and the banks with mounting toxic debts that were virtually insolvent, industrial production sharply fell by 11% between 1991 and 1994 (Gordon, 2003, pp.316-317). Instead of spurring the banks to clean up their balance sheets, the Ministry of Finance kept the banking sector on the government’s life support, in effect, allowing the NPLs to remain unresolved on the banks’ ledgers. With little credit to circulate as the quintessential symptom of credit crunch due to the non-functioning banks, business activities contracted. Although the GNP recovered in 1995, thanks to the cheap yen that boosted exports, the recovery was short lived and the recession set in.
- Japan today: ageing population, declining birth rates, and the unmarried
Close to three decades since the burst of the Japanese asset price bubble, what is like in Japan today? Apart from its mounting national debt, the shortage of able workforce looms as a serious issue. Baby boomers are retiring, and the ballooning ageing population weighs on the pension scheme and other social welfare systems, making them utterly unsustainable. Until the mid-1970s, the birth rate had been over 2%, providing a constant stream of the able workforce that could replace the old one. The figure, however, had plummeted to 1.34% by 1999, while the life expectancy has kept stretching. Few incentives have been given to young people today to be married and have children due to the side effects of the prolonged recession with low-economic growth, the growing number of financially independent women, and increasingly individualized urban lifestyle prevailing in Japan. McKinsey & Company (2015) estimated that Japan’s working-age population would decline to 71 million in 2025, compared with 79 million in 2012.
During the above-mentioned period of 2012-2025, Japan’s dependency ratio is expected to rise from 0.60 to 0.73 (McKinsey & Company, 2015). The dependency ratio is an age-population ratio of those not in the labour force (aged 0-14 and 65+) and those in the labour force (aged between 15 and 64).
Exacerbated by the low birth rate and decreasing productivity due to the shrinking manufacturing sector, the human capital of female workers has been expected to be optimized. Indeed, the renowned economist Itoh (2000) argued that women’s labour participation in the Japanese economy would become vital more than ever before. The reality, though, is that in spite of the increased women’s labour participation and the help of AI and other robotic technology, the nation’s productivity has slowed for much of the last two decades, and compared with other major advanced economies, the gap has been widening (McKinsey & Company, 2015).
- Possible remedies for the future of the shrinking Japanese economy
The long-debated alternative, which is a highly contentious one, is to welcome more skilled foreign workers to boost the country’s productivity and the declining able workforce. Contrary to the level of urgency, Japan has been known for its strict immigration policy and the tradition of ethnic purity and preservation (The Economist, 2018b). With only 2% of residents being foreigners, compared with 16% in France and even 4% in South Korea, Japan is ethnically highly homogenised (The Economist, 2018a). Now, the country has been faced with tough choices; whether to embrace a pragmatic solution of accepting more foreign workers even in the face of antagonistic nationalism, or to accept the harsh reality as a shrinking nation while preserving its ethnic homogeneity. That said, there might be a third way, which is to be in denial of all these and to live in the land of unicorns. However preposterous it may sound, this is what people may do in Japan, just as in the West today.