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How The Japanese Economic Miracle Came to an End

In his book "Princes of the Yen," economist Richard Werner explains the far-reaching influence and control that central banks wield over the future of a country. The inventor of quantitative easing, Werner predicted in 1991 the “imminent collapse” of Japanese banks and the resulting recession. His predictions came true, and the period witnessed the end of the Japanese economic miracle and the beginning of an extended malaise, the "lost decade."

Throughout his work, Werner has strived to elucidate the effects of money and credit creation. According to him, this form of monetary stimulus can be used positively to fund productive investments or to create asset bubbles with extreme overvaluations. As "The Princes of the Yen" claims, if this delicate process is not handled carefully, it can turn an economic recession into a depression. Unfortunately, it seems the Bank of Japan fell into this trap in the 1990s.

After the Occupation

At the end of WWII, the American occupying force entered Yokohama to find a nation in industrial and financial collapse. At that time, the entirety of the Japanese banking sector was effectively bankrupt. However, US-backed central bank governors had an easy-fix: create new reserves and buy all the bad debt throughout the financial system. This move flushed the financial system with "good money" while simultaneously alleviating bad investments.

Although originally indicted on war crimes, much of the Japanese wartime bureaucracy was effectively left in place. Prime Minister Kishi Nobusuke created the LDP during his tenure, a leading party since its inception, which incorporated many of these ministers and politicians

As such, the LDP oversaw what was effectively a reborn wartime economy. The Ministry of Finance, at the top, controlled financial policy while the Bank of Japan (BOJ) controlled lending. The BOJ directed loans to industries and subsectors, effectively deciding how the post-war economy developed. While this led to fantastic growth—the economy grew by an unbelievable 17% in 1959—and financial equality, it also created intense market share competition. This competition forced companies to fight for market share until bankruptcy and led to the creation of cartels.

A Historic Crisis

By the 1980s, with a swollen amount of national debt held by the Ministry of Finance, central bankers began calling for reforms and the opening of the Japanese economy. Proposals by former BOJ governor Haruo Maekawa spoke of increasing the living standards of the population, although others claimed he was following the behest of Western traders. To enact change, the Ministry of Finance, above the BOJ in the pecking order, would need to be downgraded. Understandably, this proposed overhaul of the fiscal and monetary system was widely criticized.

According to Richard Werner, the proposal by Haruo Maekawa suggested that monetary policy could be used to promote a historic crisis. Central bankers believed that systemic change could only occur in a crisis like situation. The opening of the Japanese economy to Western trading influences would indeed require such a drastic measure. So the need for a disaster was born.

Werner continues that bubbles like that seen in 1980s Japan, are an effective way to create a crisis. After all, no one is likely to object to any policy or situation providing them massive gains. However, excessive growth created by excessive lending is bound to be unsustainable. When the limits of excessive lending are reached, the bubble bursts, leading to a sharp economic downturn.

Increased Lending

To this end, the BOJ significantly increased its lending program. Subordinate bankers receiving loans from the BOJ were swamped. Many would later note that the pressure from the BOJ to take loans far exceeded the need for institutions to borrow. For a certain period, this credit boom led to an increase in real estate prices and stock market valuations. Individuals also enjoyed excess spending capacity. Young people in their 20s and 30s were reportedly purchasing a second or even third home. At the height of the bubble, the garden surrounding the Imperial Palace was worth more than the state of California.

During this period, market excesses abounded as nearly everyone became a professional speculator. While much was written about this period of "great success," in reality, all growth was due to excessive lending enacted by the BOJ. Nevertheless, this situation of “excess money” couldn’t last forever.

A Credit Crunch

By the end of the 1980s, real estate valuations in Japan were "out of control." In 1989, the BOJ decided to restrict real estate-related lending to ease the problems created by the skyrocketing price of land.

With a change in BOJ lending, land and asset prices suddenly stopped rising. In 1990, the stock market dropped by 32 percent. The following year, all lending was dramatically curtailed. Due to the sudden drying up of credit-inflows, bankers subordinate to the BOJ were left in dire straights. These banks had lent an excessive amount to other parties. As credit dried up, bankers became uncertain whether these loans would be repaid by the private borrowers, many of whom were risky borrowers with bad credit scores. Fearful they would soon face a money-inflow problem, banks stopped lending. Exacerbating the problem, stocks held by banks as collateral continued to drop in price further worsening balance sheets.

This credit crunch then spread throughout the economy. Thousands of companies went bankrupt while others enacted massive layoffs. Five million employees lost their jobs and were unable to find work elsewhere. Suicide became the leading cause of death for young men, and once lively shopping districts shuttered stores. During this period, BOJ governor Yasushi Mieno noted that "Thanks to this recession, everyone is becoming conscious of the need to implement economic transformation.”

And with this downturn, Werner claims, the BOJ had gotten its wish. An economic crisis had shaken society while paving the way for broad reform. Yet, the age-old adage "beware what you wish for" still applied. Revitalizing the economy would prove to be harder than imagined. The struggle would lead to the end of the esteem of the Ministry of Finance while elevating the BOJ and its wary monetary policy that had helped crash the Japanese economy.

By - Luke Mahoney.