Excellent analysis. The back story, how and why the Japan real estate bubble got to be that way, is where the finger of blame might be pointed at the usual Wall Street suspects. I hope Japan and other likely future victims know and have studied the real story well.

I would guess that Geithner played virtually no role in anything, other than a pretty face to fool the yokels and NY Times pundits. Like his role now.

fairleft

That all sounds about right to me...

The Conventional Wisdom never actually talks about the Japanese Bubble in detail - much as Serious People are already learning now to talk about the deficit and ignore the bubble that precipitated the latest crisis.

One thing that is clear to me from a number of ET discussions that doesn't seem to have made much mileage elsewhere (except Naked Capitalism some days) is that a number of things interacted:

• deregulation
  
• the resurrection of old tools from the 20s (typically called "financial innovation")
  

 - the networked economy (which allowed the tools to grow further than in the 20s)
- the structure of the banking system

The effect was that far more than ever in the past, money creation was in the hands of the banks and other private financial institutions. For them, increasing the money supply led to more deals they could skim transaction fees from...

Of course, one can't ignore the Greenspan put, etc. but your diary suggests to me that a critical part of making such a massive bubble was the move of the control money creation into the private sector, using instruments that did not show up under many of the conventional measures of money supply. Thus the parallels between your memory of the Japan crisis and the latest crisis are rather strong.

At the same time, the decision to abandon measures which did highlight some of what was going on was just insane... who knows if that was malice or incompetence...

My take is that the Japanese interest rates were low because wealth - and they gathered a LOT of it being diligent exporters - is pretty evenly spread in Japan (much more so than most other countries) and Mrs Watanabe preferred to keep her money patriotically stashed in the Post Bank or JGBs.

But as alternatives to getting derisory returns on debt, the Japanese began to pitch in to property and stocks, and even levered up to do it. Eventually it all went pear-shaped and credit started to drain out of the system in a classic debt deflation.

Now, turning to your points, firstly, while US players had quite a role in developing the futures markets, and providing liquidity, don't forget that derivatives - particularly cash-settled index derivatives like the Nikkei - are the tail, not the dog. There may have well have been margined stock buying - I'm not sure of the extent of that, and don't forget the extent to which Japanese corporations hold stock in each other. But the point is that derivatives followed the market, and did not lead it.

Secondly, when bonds are at or near zero; stocks are collapsing, and property too, then the more risk friendly Mrs Watanabes who had been in those domestic markets finally had nowhere else to go than overseas

European Tribune - Comments - What really caused Japan's Lost Decade?

the Japanese could not impose severe capital restrictions to ensure that cheap money actually stayed in Japan and did what it was supposed to.

Capital restrictions are only of use to protect currency eg Mahathir of Malaysia putting two fingers up to the global markets and coming out just fine. But currency weakness is hardly a problem for Japan.

The mistake you make here, and it's exactly the same cosmic misapprehension - particularly in relation to the nature and effect of QE - that permeates almost all conventional economics, is that keeping Yen in the domestic financial economy doesn't mean that Yen gets out into the real economy. It didn't; it still doesn't; and it never will. Conventional economics is bollocks in many respects, but particularly because its assumptions in respect to money and credit are diametrically wrong.

The point is that in order to be effective money must be lent or spent into the economy, and that requires fiscal, not monetary, action.

Governments abdicated credit creation to private banks hundreds of years ago, but if banks are unwilling or unable to lend or spend money into circulation then it is incumbent on governments to do so directly, through the creation of Public Credit (aka QE). Allocation of such Public Credit would ideally be managed professionally by someone with a stake in the outcome (ie banks acting as service providers), and under the supervision of a competent Monetary Authority. There is not and never has been a need for a Central Bank - Hong Kong has never had one, for instance.

It is only ideology that prevents QE funding for investment, public and private, in productive assets. QE is actually LESS inflationary than bank credit to the extent that it comes without unjustified salary excesses, and dividends to shareholders on the capital supporting credit creation.

The Big Lie is that private credit creation by banks as credit intermediaries is necessary: it's not, and it never has been.

"The future is already here -- it's just not very evenly distributed" William Gibson

A chart of the Nikkei index since 1970, of the BoJ prime rate for the same period and the Yen vs US$ might be a helpful start. Below is some timeline information:

Here is a chart of the Nikkei:

Feb 23, 1986 - Two of the other five newly admitted firms are US securities companies, Morgan Stanley and Co. and Goldman, Sachs and Co. The remaining three, Vickers Da Costa Ltd., SG Warburg, and Jardine Fleming Holdings Ltd., are British.

Feb 14, 1986 - As an exchange member, it will no longer have to pay commissions to Japanese traders. Goldman, Sachs; Morgan Stanley and three British securities firms will all begin trading on the Tokyo exchange in the next few months.

Apr 5, 1987 - Fueled by investments from Japanese banks, insurance companies and securities firms--some the largest in the world--Japan has become the biggest foreign holder of US debt. Moreover, its direct investments range from Sumitomo Bank's $500 million participation in Goldman, Sachs & Co. ...(Prevented by law from exercising voting rights in Goldman.)

Aug 16, 1989 - TheVfall Street Journal, reported on Aug. 16, 1989, that Salomon Brothers, Merrill Lynch, Goldman Sachs, and Morgan Stanley Japan Ltd. are doing well in Japan, but "on the whole, foreign losers vastly outnumber the winners.
 

"It is not necessary to have hope in order to persevere."

Crises, depressions, hard times, dull times, brisk times, periods of speculative advance, "eras of prosperity," are primarily phenomena of business; they are, in their origin and primary incidence, phenomena of price disturbance, either of decline or advance. It is only secondarily, through the mediation of business traffic, that these matters involve the industrial process or the livelihood of the community. They affect industry because industry is managed on a business footing, in terms of price and for the sake of profits. So long as business enterprise habitually ran its course within commercial traffic proper, apart from the industrial process as such, so long these recurring periods of depression and exaltation began and ended within the domain of commerce.(3*) The greatest field for business profits is now afforded, not by commercial traffic in the stricter sense, but by the industries engaged in producing goods and services for the market. And the close-knit, far-reaching articulation of the industrial processes in a balanced system, in which the interstitial adjustments are made and kept in terms of price, enables price disturbances to be transmitted throughout the industrial community with such celerity and effect that a wave of depression or exaltation passes over the whole community and touches every class employed in industry within a few weeks. And somewhat in the same measure as the several modern industrial peoples are bound together by the business ties of the world market, do these peoples also share in common any wave of prosperity or depression which may initially fall upon any one member of this business community of nations. Exceptions from this rule, of course, are such periods of prosperity or depression as result from local (material) accidents of the seasons and the like, - accidents that may inflict upon one community hardships which through the mediation of prices are transmuted into gain for the other communities that are not touched by the calamitous act of God to which the disturbance is due.

The true, or what may be called the normal, crises, depressions, and exaltations in the business world are not the result of accidents, such as the failure of a crop. They come in the regular course of business. The depression and the exaltation are in a measure bound together. In the recent past, since depression and exaltation have been normal features of the situation, every strongly marked period of exaltation (prosperity) has had its attendant period of depression; although it does not seem to follow in the nature of things that a wave of depression necessarily has its attendant reaction in the way of a period of business exaltation. In the recent past - the last twenty years or so - it has been by no means anomalous to have a period of hard times, or even a fairly pronounced crisis, without a wave of marked exaltation either preceding or following it in such close sequence as conveniently to connect the two as action and reaction. But it would be a matter of some perplexity to a student of this class of phenomena to come upon a wave of marked business exaltation (prosperity) that was not promptly followed by a crisis or by a period of depression more or less pronounced and prolonged. Indeed, as the organization of business has approached more and more nearly to the relatively consummate situation of to-day, - say during the last twenty years of the nineteenth century, - periods of exaltation have, on the whole, grown less pronounced and less frequent, whereas periods of depression or "hard times" have grown more frequent and prolonged, if not more pronounced. It might even be a tenable generalization, though perhaps unnecessarily broad, to say that for a couple of decades past the normal condition of industrial business has been a mild but chronic state of depression, and that any marked departure from commonplace dull times has attracted attention as a particular case calling for a particular explanation. The causes which have given rise to any one of the more pronounced intervals of prosperity during the past two decades are commonly not very difficult to trace; but it would be a bootless quest to go out in search of special causes to which to trace back each of the several periods of dull times that account for the greater portion of the past quarter of a century. Under the more fully developed business system as it has stood during the close of the century dull times are, in a way, the course of nature; whereas brisk times are an exceptional invention of man or a rare bounty of Providence.

...

It will be noted that the explanation here offered of depression makes it a malady of the affections. The discrepancy which discourages business men is a discrepancy between that nominal capitalization which they have set their hearts upon through habituation in the immediate past and that actual capitalizable value of their property which its current earning-capacity will warrant. But where the preconceptions of the business men engaged have, as commonly happens, in great part been fixed and legalized in the form of interest-bearing securities, this malady of the affections becomes extremely difficult to remedy, even though it be true that these legalized affections, preconceptions, or what not, centre upon the metaphysical stability of the money unit.

(Veblen's _Theory of Business Enterprise_ Chapter 7, The Theory of Modern Welfare; e-text)

The brainless should not be in banking -- Willem Buiter

The most ridiculous thing about the Villagers' take on the Lost Decade is that a generation of regulators in the US (Bernanke, but apparently from what you quote also Geithner) have spent their adult life lecturing everyone about all the mistakes the Japanese made to bring about the "Lost Decade" and then went on to make the same mistakes - same asset bubbles, same refusal to write down debt, same absurdly low interest rates throughout.

The brainless should not be in banking -- Willem Buiter

... collapse, and quite a lot less goes into thinking through why a whole decade was lost as a result.

But that's General Theory Keynesian Macro 101, which only gets complicated if you try to put it into the terms of the neoclassical catechism.

In the 1980's, domestic value added of most Japanese export products was in the range of 90%, and imported value added focused on raw materials. In the 1990's, Japan Inc. decided to shift that to closer to 60% domestic, 40% imported, with a lot of that labor intensive production stages, first in Southeast Asia then in China.

Domestic business fixed investment plummeted while FDI (Foreign Direct Investment) rose. In the depressed economic conditions that result, the only reasonably monetary policy is a nil or negligible cash rate.

Obviously the combination of a rising Yen income and pressure from the Washington Consensus institutions of IMF and World Bank to "open up financial systems" made for a toxic combination of income in own currency and borrowing in another, with the protection against adverse cross exchange movements being largely neglected under the "self regulation" dogma for maximizing transnational corporate economic power. ... however, that failure of financial deregulation in the "Asian Financial Crisis (sic)" was laid at the feet of "crony capitalism", and not at the feet of the failed financial deregulation policy.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

Andy Xie gives a fairly good, albeit pessimistic, account of things in his very recent piece entitled Our Next Economic Plague: Japan Disease

Unlike my own tortured and convoluted sentences, Xie writes with simple clarity unusual amongst his ilk.

IMO these banking issues, derivatives etc. are more or less not the cause but the symptoms of the problems. We don't have a "market economy", but an economy of different kind of monopoly rights and structures. The money does not circulate in real economy, but in financial assets. It's a kind of georgist-marxist dystopia, where year after year it becomes more difficult to finance a house, public services and new enterprises (investment) with earnings from labour. Japan had a housing bubble, so the real economy shrunk and debtors/creditors got into trouble. When the economy was loaned up and could not take more debt, banks created some kind of "derivatives" to speculate then on existing loans. I don't see how these derivatives could be the problem. They are not at all real economy and have no cost effects on production of wealth.

Re: "Turbo-capitalism"

He may not have coined it, but that term was used in a book of the same name by Edward Luttwak.  As something of a paleo-com, he didn't approve of it, but didn't think anything should (or could) be done about it, except let it run its course.

Thank you for the story. Those were tough years for everyone. I don't have much to offer but a collection of observations:

1. American emphasis on the Wall Street did begin in 1983 when Reagan (or Treasury Secretary Regan) pushed for a "Yen/$" commission to address the currency.  In fact, the commission exclusively worked for opening up financial services markets to the Wall Street.

2. After the bubble, Japanese banks began liquidating not just property-related loans, but business loans as well. Small businesses suffered, and their owners had their homes seized, because they had been forced by the banks to submit a personal guarantee of all business loans. Amazingly, the Japanese media praised the banks' debt collection as a necessary step and achievement of social good of some kind.

3. That experience raised, semi-consciously, a serious fairness issue, which neither the media or pundits dared to address. Rescue big banks with the government money so that they shut down small businesses? That's good for the entire economy?  Am I part of the "entire economy"?... In my view, this unspoken resentment still permeates through the Japanese society.

4. The BOJ did undertake implicit inflation targeting under the zero interest rate policy. It did work, but not the way Paul Krugman anticipated. The policy helped to rekindle the commercial property bubble during the 2000s. The irony is, of course, the bubble burst again.

I will become a patissier, God willing.

BBooks - thanks for sharing these memories.

Too many things to respond to at once, but after all that passed, it is amazing  that Americans did their eery best to imitate Japan's mistakes. When I think of NINJA loans, or the laughable cov-lite terms private equity buyers could obtain  with but a veneer of equity - spreads that themselves were dwarfed by the routine fees swallowed by the manager, I am reminded of the heady days on the Tokyo bourse with their absurdity.

But first, I think it is important for people to remember that the Japanese bubble was squarely a Japanese affair. The credit extended was Japanese. The borrowers were primarily Japanese. The punters and specs were all Japanese. The gaijin were peripheral. I'd argue their presence didn't matter. Their profits were rounding errors, and for the most part were just opportunistically gaming ludicrous structures that existed [and persisted!!] in a way they only could in Japan." Yes, they helped distribute warrant bonds, but didn't underwrite a single issue, and rather than goose the market further, the warrants served to allow foreign portfolio managers to reduce their risk to an overvalued market. And when the arbs did the same, it was the Japanese domestics who bought the cash equity sold short as hedges

Second, "We" did dance on their heads imploring them to goose domestic demand following our "bonnie situation" caused by our little 1987 experiment with portfolio insurance, and they relented, against, I understand, the prevailing BoJ sentiment, probably for all the reasons you cited. But perhap there is another way to see it. Low rates were the proverbial icing on the cake. Things were percolating awesomely, anyway, before the arm twisting on rates. When free money actually arrived in Japan, the combination with prior frothy momentum meant a further orgy of capex (why not - capital is "free" with bonds+warrants), construction, and speculation. Like the hawkers to cash-strapped municipalities of strategies leveraging CDOs to fund their deficits because they could (however badly it ended), japanese companies borrowed free money because they could, mis-allocating it in the most absurd ways, adding unneeded capacity, launching new subsidiaries to vertically integrate in crowded markets, building unnecessary towers, yet more real estate, golf-courses, hotels, expanding cross-holdings,  just punting the market and bell-ringing forays into overvalued trophies in UK & US. NOT so much like in the US where a larger share was privately appropriated via fraud (though this existed too) but misallocation out of sheer mis-extrapolation of what made financial sense with rates near the zero boundary. And these are the costliest mistakes - Mistakes that make you pay 75 cents on the dollar too-much for a property.  Mistakes you never recover from, and burnish indelible lessons and fear upon one's grey matter. And all this stretched the boundaries of the normal and sustainable economic activity and then went way beyond. It wasn't artificial - it was "real" in the sense that it happened. But it was a rare occurrence in large monte carlo simulation. The confluence of things that bred the scale of the activity were numerous and varied,  both internal and external, financial, and behavioural, but a fluke, and not likely to be reproduced in japan ever again. Ever. The bubble was the confluence feeding back recursively as happens in bubbles, until "The Wafer-Thin Mint" moment.  But perhaps the mistake of observers  is to compare subsequent economic activity against an impossibly-steroidal, benchmark, one against which they will always be disappointed. To wonder why they didn't return to robust growth (in comparison to The Top, might be turned on its head to ask, why, following the POP!, output didn't quickly shrink 15 or 20 percent??  They were gripped by a maniacal overconfidence that took hold of them: they built, worked, invested, and relatively-speaking even consumed in a way that crammed a decade of growth into a much shorter time-frame, coinciding with the peak of the demographic bulge. It satiated demands, seemingly once and for all and scarred them in process, before they went headlong over the the demographic cliff, from which there appears little imminent prospect of return.