Japan’s real economic miracle

31st July 2012

The reasons are well-rehearsed and long-standing as Shaun Richard's recent Mindful Money piece makes abundantly clear. There is every form of economic misery – falling stock prices, an over-strong currency, an ageing population, deflationary pressures, low productivity growth, and last year's twin tsunami and nuclear power disasters. Leaving aside the Tsunami, the other factors have been all too present for all too long. 

Yet visitors to Japan from Mars, or even Manchester or Manhattan, would struggle to find signs of all that economic disaster. There are no miseries of mass unemployment as in Spain; no "Occupy-style" activity, and while if they look hard they will find banks reluctant to lend, business does not appear to want for finance.

Measured by conventional economic parameters, Japan ought to have been, not on its knees, but stone cold dead by now. The real economic miracle is not the three decades until the asset/stock bubble burst in 1989 but the subsequent twenty plus years. Japan has defied the gainsayers. But how?

What can we learn from history?

Emerging markets specialist Nicholas Field at fund managers Schroders has been looking at what, if anything, global stock markets can learn from previous financial crises from the US Great Depression in the 1930s to the present problems in the eurozone.

Focusing in on Japan, he says: "Japan in the 1990s had some similarities" with what is now happening in Europe and North America. He includes a burst asset price bubble, quantitative easing and virtually zero nominal growth.

But he points out "the path of real GDP was different. In Japan, it continued to go up even after the asset bubble burst. Unemployment actually fell after the crisis and never reached high levels compared to other countries.

The reason is that both the culture of Japanese business and the Japanese policy response.

The bad news became the good

Oddly, the first defence against a real depression was the factor that sent the Tokyo stock market to all time and unsustainable highs at just under 40,000 on the Nikkei 225 in 1989 – it now stands around 8,560. And that is the Keiretsu system of inter-connected corporates.

This featured so many cross-holdings in the 1980s that few could work out the real value of a company. As A was linked to B and B to C, a rise in A would produce a gain in C as well as B. And then C's rise worked backwards to B and A. After that, the process started all over again – and again until via Cross-holdings in investment trusts pushed the Dow Jones to its 1929 highs as well.

But while in the US, the cross-holdings collapsed, in Japan the Keiretsu funded each other to replace the banks which partially withdrew as the asset price collapse stressed their balance sheets.  At the same time, deferred tax credits from the boom and vast cash deposits continued to inflate capital ratios.

Bust but liquid

The banks may have been technically insolvent but they were liquid – in counter-distinction to many of today's European and North American banks.

"The differences with the US in 2008 are large. The more transparent nature of the funding of US banks and their asset quality led to an immediate severe liquidity squeeze which the authorities could not control," says Field.

This Seeking Alpha article says that "while many speak of a lost decade, or even lost decades, there is really little that warrant such a description. It suffered a 'Great Depression' type shock, without suffering anything even remotely resembling a Great Depression. In fact, it hardly suffered a recession at all."

Long term relationships

It argues that Japan benefited from "relatively underdeveloped capital markets" and the Japanese preference for relational contracts that foster long-term relationships. This gives banks rather than markets a central role in capital allocation.

In fact, in terms like unemployment and GDP per person (arguably the most important economic statistics of a country), Japan was even able to perform better than major rivals suffering no such shock, at least not until 2008, whilst the Japanese shock occurred in 1990.

The pleasant lesson from this is that apparently, it is possible to experience a great financial shock, on a par or worse as that of the 1930s, without suffering anything close to a Great Depression.  There was no panic reduction of interest rates over a short period but companies, using their Keiretsu links, paid down debt on a massive scale.

Ignoring the stock market signals

Companies cut back on dividends, preferring to slash borrowings even if meant they would see share prices shrink. Their directors had far less interest in the stock market than their western counterparts – partly due to a lack of equity-linked bonuses.

Seeking Alpha believes "the jury is still out as Japan has developed a rather large public debt in the process, but on the other hand, one has got to give them credit for dealing with a Great Depression-like financial collapse while experiencing anything but a Great Depression.

It continues: "And there is something else that's truly remarkable about this Japanese experience. Even with budget deficits at 10% of GDP, Japan still generates a net savings surplus. Japan as a whole still spends less than it earns, accumulating foreign assets in the process. Japan remains the world's largest creditor nation."

It concludes: "This is nothing short of astounding, considering the type of financial shock it experienced and the unprecedented levels of deleveraging of private balance sheets, and the leveraging up of the public balance sheet."

Whether the Japanese experience can be reproduced across Europe and North America is another matter.


More on Mindful Money:

What happened to the post-tsunami economic recovery promised in Japan?

The future of emerging markets

Rare earths – the elements of a new investor danger

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