To put it mildly, Japan—the world’s third-largest economy—has been in a rut lately. By lately we mean the past 24 years. To see how bad it’s been, look no further than a performance graph of the Nikkei 225 (Japanese stock index) below. Since closing at an all-time high of 38,916 on December 29, 1989, following a decade that saw the index increase by more than +600%, the Nikkei today sits at about 14,450.
After several false starts over the past two decades, the Bank of Japan finally got serious early last year and adopted loose money policies similar to the US Fed’s QE, sparking a +45% rally in the Nikkei and jump-starting the Japanese economy. Last week, after Japan’s 4th-quarter GDP came in below expectations, the Bank of Japan further juiced its program to encourage bank lending, and signaled that even looser monetary policy could be on the way. Its primary goal is to end the deflation that has crippled Japan’s economy for many years.
Japanese economy since 1990
From the 1960s to the 1980s, Japan enjoyed a vibrant economy and consistent GDP growth. This came to an end in the late 1980s when the Japanese real estate bubble began to burst. Far more than even Spanish and Irish real estate in 2006, Japanese property prices were greatly inflated and came tumbling down, causing widespread loan defaults. As in 2008, this eventually took down the stock market and economy, leading to the first of several recessions over the subsequent two decades. Japan’s failure to tighten its monetary policy (raise interest rates) in the 1980s contributed greatly to this bubble, as did its failure to sufficiently loosen policy in the 1990s. Banks’ reluctance to write off many of the bad loans for years also contributed to what is now referred to as the “Lost Decade” of 1990–2000.
Japan did try to stimulate its stagnant economy in the late 90s by running government budget deficits (adding trillions of Yen to the economy) but these efforts failed to yield significant results. The result of their failed efforts was deflation—a persistent decline in prices—that Japan still faces today. We wrote a blog post about deflation in July 2011 that explains why it is far more debilitating to an economy than inflation.
During inflationary periods, currency becomes less valuable and consumers find themselves having to spend more money to buy the same basket of goods, and persistently high inflation is certainly a problem when it happens. Deflation, on the other hand, causes economies to enter long periods of stagnation as consumers hold off on making purchases because they know that prices will be lower in the future, creating a “deflationary spiral” and often a deep recession. To make matters worse, during deflationary periods, debt obligations (mortgages, credit card balances, etc.) become relatively more expensive to consumers (and the government) because the currency is appreciating in value.
Deflation has certainly gotten the best of the Japanese economy for much of the past 25 years. Some quantitative easing measures were implemented in the early 2000s that finally appeared to be helping, but the Great Recession of 2008 sucked the wind out of Japan’s sails and sent the Nikkei index below 8,000, its lowest level since 1990. After gaining back some of its losses by 2010, the index hovered around 10,000 for three straight years. When the Bank of Japan (likely following in the US’ footsteps) finally announced its plan to purchase 60-70 trillion yen in securities to combat deflation, it woke up both the stock market and the economy.
Last week’s announcement to double their bank lending incentives indicates that the Bank of Japan is finally serious about ending deflation (as well they should be). While the Yen further weakened against other currencies following the announcement, this an expected result of monetary stimulus, and can actually benefit an export economy like Japan’s (as it makes their goods less expensive to importers).
Let’s hope that the Bank of Japan’s stimulus efforts continue to pay off. If they do, and consumers there start spending again, we may finally see the incredible potential of the Japanese economy.
Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)
Director of Business Development – Kenfield Capital Strategies (KCS)
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