Japan’s Lost Decade (1990s) and the Asian Financial Crisis (1997)

In reverse chronological order, we look at the Asian Financial Crisis (AFC).

First, a timeline:

Timeline of the Panic. http://www.pbs.org/wgbh/pages/frontline/shows/crash/etc/cron.html. Frontline, PBS.

Second, the mechanics of currency speculation and debt:

Tejvan Pettinger. (22 Apr 2014). http://www.economicshelp.org/blog/10546/currency/how-speculators-gain-profit-from-currency-speculation/. EconomicsHelp.

Ayse Evrensel. Speculation: Taking a Risk to Gain Profit. http://www.dummies.com/education/finance/international-finance/speculation-taking-a-risk-to-gain-profit/. Dummies, John Wiley & Sons Inc. [Likewise, you can refer to an earlier post on carry trade.]

Bonds are debt instruments where borrowers (like companies, and even the Asian Development Bank which sells ‘green bonds’ to finance climate change programmes) offer a promise of interest payments to lenders (who effectively buy a piece of paper that signifies the promise.) Some, but not all bonds promise the return of the original sum invested at maturity (end of the loan period).

Eurobond – a bond ‘…sold outside the country of the currency in which it is denominated.’ [See Definition of eurobond. http://lexicon.ft.com/Term?term=eurobond. Lexicon, Financial Times.] For instance, a US$ bond being sold in Indonesia.

Third, how and why the AFC occurred with other related information:

a. Long term origins (Thailand) – capital inflows – Japanese banks accounted for more than 50% of foreign loans in Thailand and 25% in South Korea. The Japanese were lending overseas because local demand was suppressed by the deflation and property bubble burst in the early 1990s. The loans went largely to real estate whose collateral included ‘overvalued property and stocks.’ [See Michael R. King. Who Triggered the Asian Financial Crisis? Review of International Political Economy, Vol. 8, No. 3 (Autumn, 2001), pp. 438-466. http://www.personal.ceu.hu/students/05/Corina_Haita/financial%20crises%20review/4177393.pdf.] Their withdrawals in 1997 precipitated the devaluation of the Thai Baht according to King. This took place because of Thai Eurobond defaults (non-repayment) and the bankruptcy of Thai financier Finance One. Post devaluation, other foreign lenders pulled out as well. This phenomenon is also called ‘capital flight’.

b.The Asian economies involved were mainly export oriented. Thai exports had fallen below government forecasts of 18% (for 1996) due to competition from India, China, Vietnam and Myanmar. This reduced the demand for the Thai Baht. There was another medium term factor. A 1998 report from the Australian Parliament estimated that Japanese imports accounted for 5 to 7% of the Gross Domestic Product of Indonesia, Korea, Taiwan and Thailand. The figures goes up to 12% in the case of Malaysia. Due to the economic decline of the early 1990s, Japan was not buying more from these countries in spite of its trade surplus. It was therefore unable to encourage Asian growth.

c. The same report stated there was: ‘common agreement that the affected Asian currencies had been out of line with their economic fundamentals. For years, if not decades, many of the Asian economies had fixed their currencies against the $US…

Now we trace Japan’s Lost Decade

In similar fashion, the timeline:

  • Japan’s Nikkei 225 stock exchange peaked in 1989 and went downhill.
  • (Overall) Japanese property prices only collapsed in 1991.

Japan Times highlighted the appreciation of the Japanese Yen after the Plaza Accord (1985) as the underlying tipping point.  Consequently, there was domestic property speculation; and the Japanese bought the American Rockerfeller Center, golf courses in Hawaii and California. [I am rather doubtful of the return on investment (ROI) from the golf courses though.] In December 1989, the Japanese stock exchange index, Nikkei nearly hit 39,000 points. By December 1990, a mere year, the drop was more than $2 trillion. In 2010, the Nikkei was at 10,365 points – a 73% collapse. Both monetary and fiscal measures had failed to jump-start the comatose economy.  [The mechanics of the crash would be analysed later.]

The spark (ironically perhaps) stemmed from the Bank of Japan (otherwise known as the BOJ, the central bank) in an eventual attempt to rein in (take your pick)

  • over the top property prices
  • imprudent loans by banks and other financial institutions
  • Inflation (more than 2% when inflation previously had been low and stable between 1986 and 1988)

The rates rose to 4.25% then to 6% in 1990. (Now contrast that to the negative interest rates currently…)

Before you lambast the BOJ, one has to consider there was a considerable praise for the management of the Japanese economy from international commentators (as well as internal pressure to keep things running smoothly).

Going back further, the BOJ cut interest rates by half to 2.5% between 1985 and 1987. Arguably, this was a response to the more expensive Yen. Globalisation had also intensified competition in the finance sector. The local banks felt compelled to lend to companies and individuals. (They would have loathed to surrender market share.) Others also raised the issue of enveloping overoptimism. The borrowers then played the stock and real estate markets. Consumption (even the public) went into overdrive as it became ‘…one big expensive party.’

How did the crash (in both the stock and property markets) happen?

Interest rates hike – led to a shrinkage of money supply and fall in available loans since it was more expensive to borrow (and buy in particular property) thereby causing weak real estate pricing.  Moreover, it raised property mortgage costs. This resulted in defaults and foreclosure. Because the banks accepted property as collateral and companies bought property to decorate their balance sheets, the fall in values/prices ate into their net worth. Concomitantly, as there was intra-holding of stocks in the keiretsu company networks, the entire house of cards came falling down.  [See also p.11 of Hiro (Hiroyuki) Ito’s PDF slides entitled Japan’s Bubble Economy and its Burst for a description of the ‘vicious cycle’. http://web.pdx.edu/~ito/Bubble_and_GreatRecession.pdf. He is a Professor of Economics at Portland State University.]

Decimation of confidence (1989 to 1992) – an idea from Keynesian economics where the recession came from the reduction in investment (which apparently includes stocks and capital equipment and buildings). One could posit that it was the BOJ who discerned the bubbles were unsustainable and within a very short duration repeatedly pushed up interest rates. Investors; speculators; shareholders and others basically could infer that the situation would not hold up (future stock returns were unlikely to be good), and this fed into the freefall. [Peter Lynch seemed to have questioned amazing price earning ratios of Japanese firms but he was not Japanese.]

It is very hard to discern which factor came first. There is a good chance they were somewhat concurrent and intertwined. However, from studies like The Asset Price Bubble and Monetary Policy: Japan’s Experience in the Late 1980s and the Lessons [Background Paper sponsored by the BOJ] (2000). Institute for Monetary and Economic Studies; one sees that property prices in major cities and Tokyo went downwards before the interest rate hikes. So perhaps there was already a sense that things were over-inflated. The interest increase then put in the devastating hammer blow.


Clayton Naff. (2 Nov 1990). If Japan’s spectacularly inflated land prices should collapse, some…
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<img src="http://b.scorecardresearch.com/p?c1=2&c2=15071286&cv=2.0&cj=1&quot; /&gthttp://www.upi.com/Archives/1990/11/02/If-Japans-spectacularly-inflated-land-prices-should-collapse-some/7146657522000/. UPI Archives.

. (21 Nov 2008). http://econ.economicshelp.org/2008/10/japanese-financial-crisis.html. Economics Help.

Jim Mueller. (6 July 2016). How Interest Rates Affect The Stock Market. http://www.investopedia.com/articles/06/interestaffectsmarket.asp#ixzz4JHCtR5zt. Investopedia.

Can you talk yourself into a recession? http://www.economicshelp.org/blog/20766/economics/can-you-talk-yourself-into-a-recession/. Economics Help.

Benjamin Powell. (19 Nov 2002). Explaining Japan’s Recession. https://mises.org/library/explaining-japans-recession. Mises Institute.

Thayer Watkins. The Bubble Economy of Japan. http://www.sjsu.edu/faculty/watkins/bubble.htm. San José State University Department of Economics.

Barry Nielsen. (3 Sep 2014). Why Housing Market Bubbles Pop. http://www.investopedia.com/articles/07/housing_bubble.asp. Investopedia.

‘At the very peak of the bubble, a 1989 survey of institutional investors showed that the majority of them did not believe that the Nikkei was overvalued (Barsky, 2009, p. 32).’ Jesse Colombo. Japan’s Bubble Economy of the 1980s. http://www.thebubblebubble.com/japan-bubble/. The Bubble Bubble.

Eric Johnston. (6 Jan 2009). <!– –> Lessons from when the bubble burst. http://www.japantimes.co.jp/news/2009/01/06/reference/lessons-from-when-the-bubble-burst/#.V8vDz8sRV2t. The Japan Times.

An Aftermath to Avoid. (Jul-Aug 2010). http://harvardmagazine.com/2010/07/an-aftermath-to-avoid. Harvard Magazine. [Note: this is a distinct publication set up by Harvard University Alumni.]

Fumio Hayashi and Edward C. Prescott. The 1990s in Japan: A Lost Decade. https://www.mpls.frb.org/research/wp/wp607.pdf. [Interesting diversion where constrained productivity growth is the reason for the economic coma.]

Charles W.L.Hill. The Asian Financial Crisis. http://www.wright.edu/~tdung/asiancrisis-hill.htm. Tran Huu Dung Homepage. Wright State University.

The Asian Currency Crisis. http://www.colorado.edu/economics/courses/econ2020/6550/readings/Asian-currency.html. University of Colorado Boulder.

David Richardson. (29 June 1998). Asian Financial Crisis. http://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/Publications_Archive/CIB/CIB9798/98cib23#Thailand. Current Issues Brief 23. Economics, Commerce and Industrial Relations Group, Parliament of Australia.


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