March 12, 2006
Picture the scene. You walk into the library two days before your finals. Everything is a blur and that horrible pre-exam fear dominates. What if the wrong questions come up? Where are the photocopied notes you snaffled yesterday?
You sit down for some desperate last minute cramming. The bloke next to you, who you vaguely recognise from your class, takes out a Japanese dictionary. He thumbs it confidently.
You feel sick. Whatï¿½s with the effing Japanese dictionary, you over-achieving bollix?
These are economics finals. So you tentatively ask, ï¿½ï¿½Why the dictionary?ï¿½
With the superior air of a man who has already secured a ï¿½ï¿½milk roundï¿½ï¿½ placement, he sniffs: ï¿½ï¿½If you donï¿½t speak Japanese, youï¿½ll never get a proper job! They are taking over the world, donï¿½t you know?ï¿½ This is all a bit much to take two days before your finals. He moves the dictionary aside to reveal two airport bestsellers: ï¿½ï¿½Japan as Number 1ï¿½ï¿½ and ï¿½ï¿½Yen! Japanï¿½s New Financial Empire and its Threat to Americaï¿½ï¿½.
The year is 1989. The New York Times warns of an economic Pearl Harbour and adds that ï¿½ï¿½forty years after the end of World War II, the Japanese are on the march again in one of historyï¿½s most brilliant commercial offensives, as they go about dismantling American industryï¿½ï¿½.
The land on which the Imperial Palace in central Tokyo sits is valued at more than the entire real estate of Canada – the worldï¿½s second largest country.
Japan was experiencing the most inflated property bubble of the 20th century.
With paper profits from property back home, Japanese investors were busy buying up trophy assets in the US ï¿½ from the Rockefeller Tower in New York to Columbia Pictures in Hollywood. The best-selling book of the year was Michael Crichtonï¿½s Rising Sun, which he said he wrote to ï¿½ï¿½make America wake upï¿½ï¿½.
Corporate America was in the grip of a Japanese hysteria and both mainstream commentators and the political elites believed that the Japanese march to world commercial domination was unstoppable.
Ambitious Dublin students – in an era of 18 per cent unemployment – bought into this and were swotting accordingly.
Last Thursday, almost 20 years later, the Bank of Japan announced it may raise the benchmark interest rate from almost zero by the end of 2006 after ï¿½ï¿½ending a five-year deflation-fighting policyï¿½ï¿½. This deflation followed a ten year recession in the 1990s. Instead of taking over the world, powered by its roaring property market, Japan suddenly, and for most people shockingly, went into an economic crisis that lasted almost 20 years. How did everyone get it so wrong?
People say that pride usually comes before a fall and in the case of the Japanese economy, this was certainly true. The Japanese property bubble lasted almost a decade and was driven by cheap credit, massive financial deregulation and a fair amount of pop-psychology as the herd reacted to the property boom. JP Morgan, the American banker, once famously said that ï¿½ï¿½nothing so undermines your financial judgment as the sight of your neighbour getting richï¿½ï¿½.
In the case of Japan, this was right on the mark. The boom led to almost panic buying, financed by a banking system that lent out money for just about anything. It changed the behavior of Japanese people dramatically. Traditionally, subdued, frugal and hierarchical, the Japanese became loud, flash and freewheeling. Japanese, who hardly travelled before, began buying second houses all over the world from Honolulu to Hounslow.
A great example of the frenzy that later became know as ï¿½ï¿½kamikaze capitalismï¿½ï¿½ was seen in golf courses. As the economy boomed, so too did golf. The game was a central feature of Japanese corporate life and a permanent fixture in the shain ryoko or company outing. Membership of a golf club club denoted a certain privilege and bestowed a clear hierarchical structure on what is a very position-conscious society.
As property prices boomed, banks fell over themselves to lend to golf course developers, seeing golf clubs as a property play.
In 1982, one of Japanï¿½s leading newspapers, the Nihon Keizai Shimbun, launched the infamous Nikkei Golf Membership Index, which calculated the average price of membership in 500 clubs. The market in club membership was sustained by salesmen who earned commissions flogging membership certificates with the free-lending banks financing up to 90 per cent of the so-called ï¿½ï¿½collateralï¿½ï¿½. From its base of 100,the index rose steadily to 160 in 1985 and then took off in the ï¿½ï¿½bubbleï¿½ï¿½ years of the late 1980s to peak at 1,000 in June 1990.
In January 1990 ï¿½ six months before the Golf Index peaked – the Bank of Japan began raising interest rates. Everyone thought the market could sustain what were modest increases of 4 to 6 per cent.
Initially, investors suggested it was only the foreigners who were selling.
When those who had bought at the top of the market began to sell, this quickly led to a stampede. Prices fell precipitously. The formerly faithful banks panicked as bad debts mounted on their balance sheets.
Overnight, credit conditions in Japan went from a flood to a drought. The more the banks retrenched, the more bad loans mounted – which in turn led to more bad debts, which led to more loans being called in as the banks faced bankruptcy. The large Japanese banks which had dominated global banking in the late 1980s saw their share prices collapse.
The economy went into a tailspin. Last Thursday was the first time interest rate rises have been signalled in Japan since 1990.The problem in Japan in the past decade and a half has been what Keynes identified as a ï¿½ï¿½liquidity trapï¿½ï¿½. He described a situation that pertained in 1930s America but is equally applicable to Japan during the 1990s.
In a liquidity trap, no matter how low interest rates go, people who just lost everything will not borrow. This means that cutting interest rates, assuming that you have the competence to do so, does not work. This is the economic equivalent of MRSA where the patient does not respond to traditional antibiotics. It implies that the recovery period is much longer than it would otherwise be and than anyone expected at the time.
Now letï¿½s get back to Ireland. Do you see the similarities? Is your financial judgment impaired by the sight of your neighbour getting rich? Like the Japanese overseas investor, are you RoboPaddy – that unique Irish investor who runs around the world trying to buy the place, purchasing off plans from Alicante to Budapest?
Do you see the share prices of our banks going through the roof in the past few years as their profits (almost exclusively derived from the property-inspired credit expansion) grow? Will they, like the Japanese banks fall to earth? And if they do will some have to be bailed out by the government -as happened in Japan?
Think about it. When we start – like the Japanese ï¿½ to believe our own propaganda, anything can happen. There are two crucial differences of course. Firstly, Japanese manufacturing remained -even throughout the property boom – hypercompetitive, innovative, disciplined and flexible.
Even when the domestic credit economy collapsed, at least manufacturing – which was controlled by Japanese executives – continued to export. We donï¿½t have a domestic manufacturing industry. The second crucial difference is that we do not have a real central bank. If things went pear-shaped here, it is highly likely that our interest rates would be rising not falling.
This is because Germany operates in a different economic cycle to us. No country in the world has ever experienced a property meltdown that was not cushioned by falling or possibly zero interest rates.
Who knows, we might yet be learning Japanese in the years ahead – not to get a job, but to learn some lessons about how things could pan out here.