Lessons From The Japanese Stock Market Crash

The rise and fall of the Japanese stock market is an excellent example of the creation and subsequent bursting of an asset bubble. The Japanese stock market crash has been compared to the economic crisis seen in the United States in 2008, and with various interpretations in Japanese policy making, has been a case study in what not to do.Japanese Stock Market Crash

The Japanese stock market, or the Nikkei, started off under 7,000 in the 1980s, and had risen above 10,000 points by August of 1984. In just five years the Nikkei had almost quadrupled, and closed out a spectacular decade on December 29, 1989 at 38,916.

Only seven months later, the Nikkei dropped below 30,000, and would be below 20,000 for the majority of the 1990s. The Japanese stock market often traded 10,000 st the start of the 21st century, although a rebound that lasted from 2003 to 2007 brought about false hopes that the “lost decade” was over.

By late 2008, however, the Nikkei had dropped back into the four-digit range, to close at its lowest point in March 2009 since the fall of 1982. These swings in the market illustrate just how difficult recovering from a busted economic bubble can be.

What Caused The Japanese Stock Market Crash

The Japanese stock market crash was in conjunction with the fall of other asset markets, particularly real estate which had become grossly inflated. Some estimates had the Japanese Imperial Palace worth as much as all of California’s real estate combined.

The Plaza Accord in 1985, an international agreement that drove the yen up and the US dollar down, was an effort to restrain Japanese trade surpluses and United States trade deficits. This agreement was regarded as signifying the emergence of Japan as a significant financial player.

This accord had a muting effect on export-led growth in Japan, and led to the Japanese monetary authority pumping out more yen to prompt domestic investment and consumption. The result was a fueling of the upward surge in asset prices.

In the 1980s, Japan was seen as an economic force, with the height of its power seen in 1989 with the purchase of a 51% stake in Rockefeller Center by the Mitsubishi Estate Company. This caused a wave of anxiety concerning Japanese economic dominance that came to a head in 1992.

Japan routinely outperformed the rest of the world as equity prices rose, and a sense of euphoria prevailed as investors believed that there was nothing unsustainable in the nation’s high P/E ratios, some of which topped 300 by the end of the decade.

The Japanese Stock Market Crash And The “Lost Decade”

The Japanese stock market crash took place slowly, and in stages, giving rise to the theory that Japan was merely experiencing a mild recession, and the boom would continue. Even after the Nikkei began its decent, property values continued to rise for months, although both were experiencing a steep decline by 1992.

As equity markets continued to fall, and banks experienced an abundance of bad loans, cuts to the interest rate failed to reverse an increasing problem in the banking sector. The nature of stock ownership in Japan – with large chunks of other companies being owned by financial institutions – had once been seen as the lynchpin to Japan’s economic success, but was now contributing to the state of economic instability, as the fate of the nation’s banks were tied to an increasingly volatile stock market.

As economists debate the lessons to be learned from the Japanese stock market crash – some argue that the actions of the Japanese government served to worsen and prolong the crisis, while other argue that the Japanese did too little too slowly – the main lesson to be learned from the stock market crash in Japan is that although equities can be an outperforming investment in the long-run, the long-run can be painfully long.