Bubble Economy
Book By Christopher Wood
Article & Review by GlobalMacroForex
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This book was
written in 1992 just as the Japanese economic bubble was starting to
burst.� It�s amazing that Christopher
Wood�s predictions were so accurate and (unfortunately) true.� The extent of the bubble�s rise and the
following correction (20+ years of misery, nicknamed the �lost decades� )
truly were misunderstood by the market at the time.� This is the Nikkei
225, the most prominent Japanese stock index. |
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Central Bank Policy
Woods criticizes the insane policies of the Bank
of Japan.� The Ministry of Finance
appointed Satoshi Sumita to head the Central Bank who negotiated the 1985 Plaza
Accord.� This agreement was made in
America, with the goal of lowering the USD/JPY exchange rate.� By artificially propping up the yen, it
fueled an investment bubble in property and equity shares.�
Yasushi Mieno then took over as head of the Bank
of Japan.� He hated the easy credit
policies of his predecessor and hiked rates, which was just enough to pop the
huge bubble.
Main Bank System
One of the primary causes of the crisis in the
view of Christopher Woods is the overreliance on bank credit.� Unlike America, which has a liquid and deep
bond market, Japan essentially exclusively relied on bank credit.� To make matters worse, the banks held shares
of equities, making their capital positions very depend on market
conditions.� Banks collectively owned 9%
of the entire Tokyo stock exchange�s market capitalization in 1990.
�This
is the fatal flaw of Japan�s financial system.�
The capital of the world�s biggest banks, and therefore, their ability
to lend, goes up and down with the short-term whims of the Tokyo stock market.�
Woods points out how when the Bank of
International Settlements (BIS) started to force Japanese banks to comply with
higher equity to liability ratios, some banks sold stocks and then rebought
them to book the gain as equity capital increases.�� This trick obviously only works in a rising
market and disastrously caused selling when these banks� loans turned
sour.� Once the asset prices fell, it
took banks nearly 20 years to start loaning again.
In addition, Woods questions Japan�s laws and
cultural stigma on bankruptcy.
�Bouncing a check is commercial suicide in
Japan�
He
points out the Japanese culture of assuming ever larger market share but being
unwilling to admit failure due to the large stigma attached, combined with
loose laws from the BIS and local regulators, created a climate where banks had
many loans on their books that were really nonperforming/delinquent but weren�t
being classified as such.
Under
the Japanese main banking system, the biggest lender in a bankruptcy assumes
the debts of nearly all other creditors.�
This leads to a situation where the largest main banks are not only
being less willing to recognize loan losses, but also even further
leveraged.� With this massive leverage, a
small number of sour loans can topple banking giants.
Land Boom
Japan had a ridiculous bubble in land prices.� At the end of 1989, Japan�s combined real
estate had a market value of 4 times the entire US market.
�While
other countries previously had currencies backed by gold.� It is not unrealistic to say Japan is a land
standard.�
The average size of a bank home mortgage had
exploded from �5.6 million to �11 million in 1990.� The decline in prices to �back-to- earth�
levels was quite painful over 20 years as this graph from RightWayCharts shows,
Banks were fueling this run-up in the land.� There were bank loans of 66 trillion yen in
March 1991, two-fifths of which went directly to property and construction
companies.� And two-thirds was
collateralized with land.� Banks were all
too willing to extend loans guaranteed and collateralized with land because the
prices were rising quickly.� Once land
prices started to crash and loans went sour, banks were stuck with depreciating
assets, causing them to be forced to liquidate shares.� This further exacerbated the crash since the
banks owned such a huge percentage of the equity market.
Interbank Euromoney Borrowing
�Euromoney� is a term used to refer to bank
deposits outside of the nation that issues the currency.� The name originates from American dollars
being loaned around Europe.� Used in this
sense, it doesn�t mean the actual Euro currency.
Japanese banks were borrowing Euroyen and
Eurodollars to fund a whole variety of loans, including not only the domestic
Japanese real estate loans but loans on property abroad as well.� These short-term interbank loans need to constantly
be rolled over and so are subject to extreme interest rate shocks when the
markets turns to a risk-off environment.�
In addition, the eurocurrency markets are even more risk-prone than
onshore interbank lending to credit shocks because onshore regulators guarantee
bank deposits.� Unlike the eurocurrency
bank market which would need to set up foreign currency swaps to get the
liquidity in a credit crunch.
The Japanese went on an overseas real estate lending
binge with these cheap Euromoney interbank loans.� In 1991, 12.4% of total American banking
assets, valued at $408 billion, was owned by Japanese banks. In addition, there
was a heavy concentration of loans made on property in California.� 24.5% of total bank assets in California by
June 1991 was owned by the Japanese banks.�
Unloading all these foreign assets when interbank lending dried up was a
serious challenge.
Life Insurance Companies
Life insurance companies owned 13% of the
companies traded on the Tokyo stock market at end of 1990.� As Japanese policyholders cashed in life
insurance policies this caused massive selling of equities.� Life insurance companies are supposed to be
stable and reliable vehicles to protect one�s family should horrible
circumstances come to fruition.� Many
Japanese households were not aware they were really speculative hedge funds;
gambling away their savings on the stock exchange.
Life insurances companies had no choice but to
sell to meet their debt/payout obligations.�
These concentrated holdings represented a �fair weather friend� to banks
whom they frequently had cross shareholder holdings with.� (The bank would buy shares of the life
insurance company and vice versa.)
Golf Club Memberships
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Between 1989 and 1991, 160 new golf courses were
created with 2000 more under construction.�
For a tiny archipelago, the prices of these memberships were
soaring.� The memberships were being
traded like securities in a nation that perpetuated the myth that 99% of the
population was middle class.� This
chart from The Economist magazine shows the price of these memberships after
the bubble burst, |
Conclusion
The main lessons to be drawn from the Japanese
bubble are the dangers in allowing central banks to grant easy money and the
business community's over-reliance on bank credit.� Central banks shouldn�t always be handing out
what bankers want.
Also, there is a need to diversify the types of
assets being securitized for bank loans as these assets will all fall uniformly
in value.� Similar to the United States
real estate bubble, there is a huge error in thinking that just because an
asset has always risen in value in the past, that it will always continue to
rise.