Wed Mar 24th, 2010 at 03:08:47 AM EST
It's been a week since I first left this as a comment on DailyKos, but it is something I have been pondering for over a year. I am placing it before the readers of European Tribune to see if others recollect the same sequence of events, and their effect. Please do not let your initial reaction be your first judgment, because the "common wisdom" has been repeated so long and so often, that even I had come to believe it. Until, that is, this past month, when I was searching through some old files of mine and found a summary study I had forgotten about. What really caused Japan's Lost Decade? What do you remember about that period of time, the late 1980s, and early 1990s, not long after London's Big Bang?
One thing that caught my attention in the recent Atlantic profile of Treasury Secretary Tim Geithner was Geithner's being posted to Japan just as the infamous "Lost Decade" was beginning. There is one paragraph in which Geithner purveys the usual Versailles version of what caused the Lost Decade: that Japanese officials were unwilling to recognize that Japanese banks had been bankrupted by bad loans made in a frenzied real estate bubble.
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The cure, according to this establishment "common wisdom" was for Japan to force the banks to write off the bad loans - and this has been repeated quite a bit since the U.S. financial system melted down for similar reasons. Here's the paragraph from the Atlantic profile of Geithner:
Geithner was sent to Tokyo as assistant Treasury attaché in the U.S. Embassy in the spring of 1990, arriving just after the Japanese real-estate bubble burst and the Nikkei index began its dizzying fall--the beginning of Japan's "lost decade" of deflation and stagnation. The United States' role was that of the stern parent, urging Japan to confront the reality that its banks were paralyzed by bad loans. The Japanese government was loath to recognize the problem, preferring to wait in hopes that its banking system would heal itself. This strategy of denial necessitated lots of diplomatic feints and thrusts, and part of Geithner's brief was keeping abreast of the recondite details and knowing their possible second- and third-order effects. For the most part, the U.S. pressure failed. But working on the problem was enlightening. "You learn much more about a country when things fall apart," Geithner says. "When the tide recedes, you get to see all the stuff it leaves behind."
I'm not going to outright assert here that the "common wisdom" about what caused Japan's Lost Decade is all wrong - I'm merely going to suggest that it is, based on my admittedly dim memories of what was happening at the time, almost exactly twenty years ago. I first posted this as a comment about a week ago, and since then I have not been able to find any substantial corroborating information on the internet. But this is what I remember, so I want to throw it out there and see if others remember the same sequence of events, and arrive at similar conclusions.
Through the 1950s and 1960s, as I understand it, the Japanese financial system was much more closed and tightly controlled than in the U.S. This began to change in the 1970s, what with the U.S. waging a war on credit, two oil shocks, and Paul Volcker killing off inflation by killing off American industry.
But the real big changes came in the 1980s, when the Reagan administration, a bunch of yahoo "free market zealots, beat the bejeebers out of Japan and forced the Japanese to open their financial markets to greater "participation" by foreign firms. Can you guess what that meant? Yeah, Goldman Sachs, Salomon Brothers, Morgan Stanley, and the rest of the crew get to set up shop in Tokyo. Or, if they were already there, suddenly found that they had a lot less restrictions.
My suspicion is that the Japanese decided to let the wolves into a fresh hen house in the hopes of staving off any trade retaliation by the Reagan administration against the flood of Japanese cars, steel, machine tools, electronics, and other stuff that was flowing into the U.S. In the late 1980s, I used to get the reports from the U.S. International Trade Commission that had to be done whenever there was a formal complaint by a U.S. company of dumping or some other unfair trade practice. Back in the 1970s and 1980s, most of U.S. industry was still run by, you know, industrialists instead of MBAs, so when the Reagan yahoos came along with their neatly packaged theories about more competition will be you stronger, there was outcry and uproar. Wow, you should have seen the fuss some of the folks at the Pentagon put up about the decline of the U.S. industrial base. I'm pretty sure Pat Buchanan coasted on their position papers for the next decade. I suppose Reagan's defense build-up alleviated some of the pain the military-industrial guys felt.
Anyway, the cast of cutthroats from Wall Street now have a bigger presence and a freer hand in Tokyo, and, interestingly enough, the Japanese stock market goes on a speculative tear. From around 10,000 in 1980, the Nikkei index more than triples to around 35,000 by the end of the decade.
At the same time, contrary to the expected outcome of Reagan's idea of forcing U.S. companies to compete in world markets, the U.S. trade position is collapsing, and the dollar is getting slammed, especially against the yen.
Then comes October 1987, and Wall Street has one of its historically spectacular belches of indigestion. Try to imagine the pressure a bunch of panicked Reagan yahoos - who are watching their whole philosophy of free markets collapse along with the Down Jones Industrials average - put on the Japanese to help prevent financial Armageddon. One way the Japanese obliged was by holding their interest rates absurdly low for much loner than made any sense. And, they offered lots of easy money from the Bank of Japan. David Hale, an influential U.S. business economist at the time, wrote in August 1989:
During the second half of the decade, it was the Japanese MOF [Ministry of
Finance] which used a mixture of direct intervention and moral suasion to protect the US financial system from sharply rising interest rates at a time when foreign private investors lost confidence in the US dollar.
Ridiculously low interest rates, and lots of east money, of course, result in massive bubbles in Japanese stocks and real estate. Why would the Japanese put themselves in such extreme financial straits at the behest of St. Ronald? Two words: nuclear and umbrella.
In December 1989, the new Bank of Japan Governor Yasushi Mieno began to try to carefully deflate these speculative bubbles with a series of calibrated increases in interest rates.
But it doesn't work. The financial markets don't respond as expected, and it proves to be nearly impossible to gauge markets responses and exercise restraint. What the Japanese didn't quite realize at the time - and this is what blindsided them - was that the American financial firms had developed new capabilities, which had fundamentally altered the character of the financial markets. These new capabilities were called derivatives, and the Japanese just were not accustomed to dealing with them. In fact, there had been no futures markets in Japan until 1988. The American firms had developed program trading, which tied trading of stocks in the stock market, to trading in Nikkei index futures in the futures market. Even worse, the American firms were betting big against higher interest rates in Japan. They would lose a lot of money if Mieno were actually able to engineer the careful escalation of interest rates needed to deflate the housing and stock market bubbles in a controlled fashion.
Suddenly, and unexpectedly, a gradual decline in the Japanese stock market turned into a panic collapse. I don't know why, but it is clear that a propagation mechanism - the program trading technology, linking the Chicago futures markets with the Japanese stock markets and futures markets - had quietly been put in place by Salomon Brothers, Goldman Sachs, Morgan Stanley, and a few City of London outfits, and the Japanese were clearly playing catch up.
It took a while for the Japanese to figure out what the hell was going on, and when they did, they tried (bless their honest but naive souls) to restrict some of the more egregious aspects, such as the leveraged trading of financial derivatives, but that caused a whole new dust-up with the Americans in summer 1993. And by that time, the bubbles in Japan had burst uncontrollably and the "Lost Decade" had already begun.
One last thing that has bothered me for years: the carry trade. In order to combat the Lost Decade, the Bank of Japan resorted once again to absurdly low interest rates. But, because of Japan's acceptance (and how willing was that acceptance?) of the neo-liberal "Washington Consensus," the Japanese could not impose severe capital restrictions to ensure that cheap money actually stayed in Japan and did what it was supposed to. Has anyone looked at what effect the carry trade had on Japan's attempts to fight the Lost Decade? My observation is that every discussion of the Lost Decade I have ever seen has never mentioned the development of the carry trade, and how much cheap money was exported from Japan.
So, my friends, that's what I remember was happening at the time, along with my suspicions of what was going on behind the scenes. Obviously, it would have seriously slowed down the development of American "turbo capitalism" (as Der Speigle called it a year or so ago), if the story got out and gained traction that what pushed Japan into a Lost Decade was not so much Japanese mismanagement, as American financial engineering run wild. It is my suspicion that Timmy earned big brownie points by helping to write the "victor's history" of what caused of Japan's Lost Decade, and thereby cover up, or, at the very least, deflect attention from, the role of Wall Street. And Timmy has gotten his rewards. For which we will be paying for a very, very long time.