Monday, 8 October 2012

7 Biggest Crashes of All Time, IV.

In the fourth post of our series on stock market crashes (the first three posts can be found here(about 1907), here(about 1929), and here(about 1987)), we present a unique one - firstly, because this particular crash originated and stayed in Japan, instead of the USA, and secondly, because it wasn't a traditional crash at all, but more of a gradual collapse. Nonetheless, it's effects had probably the most severe consequences in modern financial history. Intrigued? Then scroll below to read about the Japanese asset price bubble, bursting in 1990.


The Lost Decade
Date: Starting in March 1990
Location: Japan
Causes: burst of the 1980's asset price bubble
Duration of panic: N/A
Biggest percentage change of market index: -63.2% until August 1992 (Nikkei 225)
Length of recession: 13 years
Results: A decade of deflation and economic mismanagement called the Lost Decade, followed by stagnation/slow growth

Early history

Japan's economy, while following a path distinct from European growth models, has nonetheless developed a model resembling European feudalism, with land cultivated by peasants in exchange for protection, a rigid social structure, etc. Hence the economy had a huge growth potential, and after a successful top-down modernisation attempt in the 19th century called the Meiji Restoration, Japan began a period of massive growth and industrialisation not unlike that of the newly united Germany in the same period. And just like German growth, Japan's also proved very volatile, struck heavily by the Great Depression both politically and economically. It were these circumstances which caused the rise of radical nationalism in Japan and their subsequent entry - and then defeat - in the Second World War.


After the World War, Japan was devastated. Many cities lay in ruin, and the economy was merely a shadow of it's former self. However, the growth for potential was still there - hence Japan, aided by the Marshall plan and the determination of it's people - Japanese always tended to save up quite a lot of their income - the archipelago country began to blossom again. The large rate of saving, combined with the traditional Japanese inclination to co-operate instead of competition, lead to the creation of large, cross-owned, sometimes dynastic companies called keiretsu - a form of property criticised by many as being a hotbed of crony capitalism (capitalism built solely on personal relations).
These keiretsu have profited enormously during much of the latter 20th century, especially in the 1980s, where their expansion in electronics and car production using advanced production technologies, combined with the always readily available cheap funding, has lead to what should be a familiar scenario for many of our readers - an asset price bubble. 

Immediate causes

In the decade before the 1990 collapse, house and asset prices tripled(!). Unbeknownst to many at the time, the Japanese stock exchange index, the Nikkei 225 reached it's peak on December 29, 1989. The Japanese Central Bank, concerned with the unregulated growth, started raising interest rates in March, 1989 to curb the growth - but just like it was the case in America in 1987, the move has proven to be the trigger of the subsequent collapse.

The crash

In a strict sense, there was no crash - prices began to fall gradually, with the most radical falling period taking place from 1900 until the August of 1992; by this point, asset prices, land and housing prices and the Nikkei 225 fell more than 60(!) percent, largely losing the gains of the previous decade. The worst thing was that no one knew how to stop it - the causes and the obviously bad response to the Japanese bubble is strongly debated to this day, with economists like Paul Krugman blaming a liquidity trap (where the lowering of interest rates to near-zero fails to stimulate the private sector), while others like Scott Sumner overly tight monetary policy.


The successive Japanese governments tried everything - bank bailouts, stimulus programmes, leading to a change from a government surplus of 2.1% in 1991 to a deficit of 10% by 1998. However, nothing seemed to be able to stop the downwards slope - in 1999, the economy entered a deflation (the opposite of inflation, where money is worth more and more over time). The failure of the Japanese Central Bank to step in by printing money is one of the key reasons of why Japan has experienced a second Lost Decade, where even though the economy wasn't in a recession (or not always), but prices have deflated for a decade. The 2008 crisis has only made matters worse - and after 23 years, there is still no hope of Japan ever returning to it's previous rates of growth.

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