The Bubble Economy: Japan's Extraordinary Speculative Boom - Christopher Wood

[Nomad]

I recently picked up this fascinating little book (first published in 1992) about the Japanese bubble economy of the 1980s. One sobering fact that struck me while reading Mr. Wood's history is that it has now taken 31 years for the Nikkei to reclaim its nominal high from 1989.

For those who are interested, I have compiled notes from the 2006 edition with approximate page numbers preceding each line. These are not intended to be a complete summary and all mistakes are my own:

6 Between 1985 and 1990 Japanese companies raised some 85 trillion yen ($638 billion) through the stock market alone in what seemed at the time like virtually free financing

 7 "The bursting of the Bubble Economy has already laid to rest one myth, namely that Japanese stock prices always rise. It is in the process of demolishing another myth, namely that Japanese land prices cannot fall. The third myth, which will also soon be discredited, is the growth myth. The frantic economic growth of recent years based on a liquidity-triggered boom in private sector business investment is simply not sustainable."

 7 By October 1, 1990, the Nikkei lost 48% from its all-time high of December 31, 1989

 8 At the high, the Nikkei represented 42% of world market cap and 151% of Japan's GNP (vs. 29% of GNP in 1980)

 11 Two trends abruptly ended the financial mania in Tokyo. The first was the doubling of interest rates between early 1989 and late 1990 engineered by a central bank finally determined to burst a dangerously bloated speculative bubble. The second was the phased deregulation of Japan's financial system, largely in response to foreign pressure.

 11 Among the reasons cited during the bubble for lofty PE ratios were the peculiarities of Japan's accounting system and the country's cross-shareholding system, as a result of which more than 60% of shares owned are never traded

 12 Money became virtually free in Japan, sparking a liquidity boom to beat all others. The banks used a rising stock market to literally create bank capital and boost their lending, and this extra credit was funneled into the two main markets (shares and property), boosting the value of banks' favorite collateral (shares and property) and allowing them to lend still more

 13 "In a consensus society where there are few contrarians, yesterday's collective euphoria can too easily degenerate into tomorrow's collective panic."

 15 By March 31, 1989, Japan's total private sector non-financial debt was greater than 277% of GNP

 18 "The belief in the power of administrators is as seductively convincing as it is wrong, since it is based on the extraordinary premise that Japan is somehow immune from the laws of economics and the cyclical whims of markets. Japan's managed economy may delay the impact of market forces, but it can never repeal them."

 23 Deregulation of interest rates began in 1985, but Japanese banks did not pass increased costs on to their borrowers - instead, they filled the widening hole in their operating profits by recording capital gains from the sales of stocks held in their huge portfolios

 29 The Governor of the Bank of Japan, Satoshi Sumita, presided over precipitous monetary easing following the Plaza Accord and lasting from 1985 to 1989

 35 Japanese banks had trouble liquidating the same assets they bought in the '80s. Wood: "It is hard to sell assets that yield almost nothing for the simple reason that no one wants to buy them."

 40 Despite the collapse of the bubble, no Japanese bank had made any significant provisions against bad debts; in collusion with compliant regulators, they hoped to recover their money

 43 The post-crisis bewilderment of the BOJ, reflected in a September 1991 paper, shows the "naïveté of the official bureaucratic mind, which assumes that rules will be adhered to in the midst of a credit boom, when history indicates precisely the opposite." The BOJ report found that "financial institutions' credit departments became 'dominated' by those seeking to promote loans; that loans were made against land and shares that were 'over-optimistically valued'; and that in some cases there was no on-site inspection of a property before a loan was made against it."

 50 Japanese real estate was so overvalued by 1989 that in theory Japan could buy the entire United States by selling off metropolitan Tokyo, or all of Canada by hawking the grounds of the Imperial Palace

 51 Property prices in most parts of Japan did not fall precipitously in 1991, largely because there were so few transactions. Although there was a wide gap between what sellers wanted for their property and what buyers were prepared to pay, the market was essentially frozen.

 59 By the end of 1991, Japanese real estate investors were trying to sell overseas trophy properties bought only a few years prior as "long-term investments" in an increasingly desperate bid to cut their losses and raise cash

 60 In the late 1980s, Japanese property companies piled into golf course development. The economic rationale of these developments hinged on pre-selling golf club memberships, which have an active secondary market in Japan. This golf club membership market became ludicrously overheated, and at the peak, Japan's 1,700 golf courses had a membership market value of some $200 billion

68 By the end of the Japanese bubble, condo prices within a 12-mile radius of Tokyo spiraled to more than 10x wage earners' annual income

88 Japan faced more currency difficulties than the UK and the US during their rise as economic powers, because the latter countries were able to invest their money in essentially sterling and dollar worlds, respectively. The Japanese had to assume forex risk every time they invested overseas, because there were no substantial investment outlets in offshore yen.

92 Japan's extensive system of cross-shareholdings, where companies would buy each others' shares to promote business relationships, resulted in a large amount of non-traded stock and commensurate overvaluation. At the peak of the market in 1989, only about 8% of Japanese bank shares traded freely, with the rest tied up in supposedly long-term holdings.

93 In 1988, Nomura ran a two-page ad in international print media titled "Copernicus and Ptolemy." The ad derided as Ptolemic flat-earthers those skeptics  'who point to sky high prices and claim that Tokyo is much too expensive and the market is unstable . . . instead of deepening their knowledge and enlightening themselves with the Copernican point of view.'  Less than two years later, the mood had changed drastically: A group of Japanese stock pundits were discussing where the market was heading and had to have their faces blurred like drug dealers or government witnesses. No one in groupthink Japan wanted the dishonor of being associated with a declining market.

94 The average daily trading volume on the Tokyo Stock Exchange in 1991 was one-third of the levels seen in 1989

102 Even by the 1980s, Japan barely had a corporate bond market, because the post-1945 government kept the bond market all to itself. Companies' financing needs were funneled through the three long-term credit banks under the guiding hand of the then all-powerful MITI. In 1989, bond issues accounted for a minuscule 2% of all corporate financing.

108 After the Nikkei collapse, Japanese securities firms attempted to hang on to clients by recommending boringly sensible strategies such as government bonds rather than the speculative shares in the late 1980s

111 During Japan's bubble, companies became accustomed to generating short-term profits through stock speculation. Such profits, called zaitech, accounted for 15% of the 1989 earnings of the companies listed on the Tokyo Stock Exchange.

112 Between 1987 and 1989 Japanese companies issued some $115 billion of bonds with warrants attached. In theory, everybody won. Many warrants quadrupled in price as the market soared, and the bonds usually carried coupons as low as 1% to 3%. By the time companies swapped their dollar exposure into yen (whose interest rate was lower than the dollar's), their cost of capital turned negative - they were paid to borrow. The companies' managers were sure that the warrants would come into the money and be exercised, allowing them to pay off the bondholders with the proceeds. This turned out to be a miscalculation.

120 One of the big scandals of the Japanese bubble is that securities firms reimbursed certain politically-connected investors' losses and tried to deduct those payments as businesses expenses on their tax returns

126 One favorite loss-reimbursement ruse was buying back warrants at inflated prices. Another was dealing in government bonds with favored clients at slightly above or below prevailing market prices.

129-30 A marked feature of Japan's bubble economy was how yakuza gangsters became involved in the stock and property markets. The notorious crime lord Susumu Ishii solicited loans from Nikko and Nomura in an attempt to corner the shares of the Tokyu railroad corporation. Ishii bought 29 million shares in 1989 (2% of Tokyu) and the stock rose 164%. There is evidence that Tokyu shares were heavily promoted by Nomura, and in October 1989, dealings in Tokyu accounted for 90% of turnover at several Nomura branches.

132 A former head of research at Cosmo Securities was found dead in a cement mixer in 1988 after making the mistake of agreeing to manage money for an Osaka crime syndicate. Evidently, his performance during the October 1987 crash had not pleased his clients.

180 After the bubble, Japan's money supply growth slowed. Undercapitalized banks saddled with bad property loans were reluctant to lend, and companies were not so keen on borrowing as their cost of capital rose. Investors were no longer willing to pay premium prices for equity-linked securities like bonds with warrants.

181 Corporate Japan indulged in investment overkill in the late 1980s, embarking on the bigggest capital spending spree in the country's postwar history. Fueled by super low interest rates, capital spending accounting for 66% of GNP growth between late 1986 and early 1991. During this time, Japan's net new investment was a massive $3.5 trillion.

182 "When money seems free it is likely to be spent a good deal more lavishly than when its cost is prohibitive. Examples of wasteful Japanese investment range from fancy new headquarters buildings and brand-new laboratories without qualified staff to fill them to spending on every sort of staff amenity - shiny new corporate dormitories for employees, swimming pools, saunas, and so forth."

187 "[The] view that debt does not matter only makes sense, as does a lot of other economic hocus-pocus, when perfect equilibrium is assumed. In this case, the assumption is that all debts are serviced on time. But when debts go bad creditors get hurt, as money disappears and the money supply contracts."

Edited April 15, 2021 by Nomad
Font size got messed up on transition to new COBF board

[Viking]

WOW. Great summary. Thanks for posting. I have never read anything in detail on Japan’s experience in the late 80’s. This book looks like a solid place to start.

 

A question: was there a way to ride out the storm? I am thinking a large cash position would have worked out very well. (Miss the massive drop in real estate and stock market prices; although it looks like it took years - and decades in some cases - to play out.

[randomep]

68 By the end of the Japanese bubble, condo prices within a 12-mile radius of Tokyo spiraled to more than 10x wage earners' annual income

 

Why is this a big deal?  Isn't the general rule of thumb that a house should cost around 10x salary? Because right now in silicon valley that's what it looks like now......  oh right we are in a housing bubble...

 

 

[Cigarbutt]

The book was published in 1992 and reading contemporary documents from the period, the consensus view was that the downturn was to be temporary and it took a long time to fully appreciate the extent (and duration) before recovery.

The chapter on land (ch.3) is quite interesting. Mr. Wood suggested the following (this was almost heresy at that point):

"It is the reason Japanese property prices are not again likely to reach the peak levels seen in the late 80s until the beginning of the next century at the earliest." 

!

A reasonable strategy (to ride the storm) then: buy long term JGBs and fall into a coma for 15-20 years. :)

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For reference, randomep:

No need to worry because interest rates are low. 8)

[thowed]

111 During Japan's bubble, companies became accustomed to generating short-term profits through stock speculation. Such profits, called zaitech, accounted for 15% of the 1989 earnings of the companies listed on the Tokyo Stock Exchange.

 

*cough* BITCOIN *cough*

 

Many thanks for this - terrific summary, and many 'rhymes' to remember here, I think.

[Cigarbutt]

111 During Japan's bubble, companies became accustomed to generating short-term profits through stock speculation. Such profits, called zaitech, accounted for 15% of the 1989 earnings of the companies listed on the Tokyo Stock Exchange.

*cough* BITCOIN *cough*

Many thanks for this - terrific summary, and many 'rhymes' to remember here, I think.

A fascinating aspect is that during the actual financial-engineering-zaitech period and even at the height of the 1989 bu**le, there was widespread optimism (general sentiment) and widespread institutional sentiment about future prospects for earnings growth, stock market return etc. ie the typical institutional investor did not consider that zaitech was speculation, it was felt to be justified by underlying fundamentals. Now, it's quite obvious but it wasn't at the time, at least for the involved and vested people. Where are they now?

Moving away from the present period for the US markets, this reminds me of the time i was following large US banks in the period leading to the 2007-9 adjustment phase.

The above does not show the phase before 2005 (but the pro-cyclical (within quite an unusual musical chair cycle) picture had been occurring for some time for the buyback activity) and, at the time, it was felt that buying back shares at increasingly high prices was sound capital allocation. A lot of buyback activity doesn't make sense over the full cycle but if you happen to hold during the 'right' period, it doesn't really matter.

For the Japan bu**le, a lot of the insights came from Mr. Shiller (the 1996 Why Did the Nikkei Crash? is interesting about the perception of market fundamentals) who, very recently, reproduced an opinion (this time in the NYT). His point is pictured in the introducing video:

https://www.nytimes.com/2021/03/05/business/stock-market-prices-bubble.html

Identifying bubbles is not that hard. Profiting from them can be hard.