Japan entered the global financial and economic crisis in a far more precarious situation than the world’s other developed countries. In 1990, Japan suffered the collapse of a massive housing and equities bubble that triggered an extended period of financial distress and economic malaise — the famous “lost decade” — which actually persisted through 2003. Mild growth from 2003 to 2007 convinced some that Japan had finally reached the path to recovery, though STRATFOR strongly disagreed at the time. Now the global crisis of 2008-2009 has erased gains made during this period and caused further deterioration in Japan’s already-dismal public finances.
Considering its rapidly diminishing population, it is difficult to overstate the challenges facing Japan in the coming years. But first it is necessary to review Japan’s recent past to see how bad of a position it was in before crisis struck in 2008-2009.
Japan’s Economy
Despite the widespread devastation of World War II, Japan rose quickly from the ashes. The United States rehabilitated the country as an ally against the Soviet Union, and a significant aspect of this process was turning Japan into a booming capitalist economy based broadly on the American model. Under the “San Francisco system,” which was developed from the U.S.-Japanese peace treaty after the war, the United States gave Japan privileged access to American technology and consumer markets while maintaining military and naval bases in Japan to serve as strategic outposts against the Communist Soviets and Chinese. The relationship proved remarkably fruitful for a Japan that needed to escape from the agony of defeat, and within a few decades Tokyo had transformed itself into the world’s second most powerful economy.
Throughout the 1960s and 1970s, the Japanese economy seemed to have no limits to its dynamism. It grew at double-digit rates into an innovative and high-volume exporter as Japanese companies seized greater global market share in their respective sectors. Indeed, Japan came to rival the United States in the financial, automotive and high-tech industries, and its consensus-seeking management style and emphasis on labor security were hailed as great improvements on its U.S. capitalist model.
Yet it was during this time of economic strength that Japan’s financial and economic system developed characteristics that would eventually weaken it. The state was heavily involved in every sector of the economy and played a prominent role in choosing the direction of Japan’s development, especially by way of the Ministry of International Trade and Industry and the highly regulated banking system. Banks were managed closely by the Ministry of Finance and Bank of Japan not as competitive businesses but as instruments of the government, and they were expected to channel the high amount of savings by Japanese citizens into loans for industrial development. The Fiscal Investment and Loan Program, controlled by the Ministry of Finance, used tax revenues and public savings (through the popular government-run Postal Savings System) to finance massive industrialization and infrastructure projects, providing Japan with fast, state-directed development.
The banks were also closely intertwined with the corporate world. Giant conglomerates called keiretsu — reincarnated from pre-World War II industrial groups led by elite families — combined mutually supportive manufacturing enterprises with their own closely knit banking system. Government planning and political linkages guaranteed cheap and virtually limitless credit for these key groups, creating conditions that seemed suitable for unlimited expansion. The strategy prized rapid growth and high employment levels above efficiency and profitability.
The result was the so-called “iron triangle,” consisting of elected politicians, bureaucrats who ran critical government ministries, and banking and industrial magnates — all of whom were connected through professional or family ties and many of whom held multiple posts in different areas over the course of their careers. As long as economic growth continued apace, banks could provide cheap credit and businesses could grow, employing more people and providing more votes for established politicians who worked (and contended) with bureaucrats in managing various interests and perpetuating the system.
The Bubble Bursts
The flaws inherent in this political and economic structure were not immediately apparent. Though no longer advancing at double-digit rates as it had done in the 1960s and 1970s, the Japanese economy maintained strong growth (4-7 percent) throughout the 1980s, which seemed to signal that it had successfully made the transition from a high-growth to a sustainable-growth economy. Investment in real estate and stock markets reached feverish highs. From 1985 to 1990, the Nikkei 225 stock index rose by about 60 percent (to nearly 35,000 points, compared to the 9,000-10,000 range today) and urban real estate prices quadrupled. A gigantic asset bubble was taking shape.
A crucial factor in Japan’s bubble economy was Japan’s expansionary monetary policy. With interest rates relatively low (well below those of Europe and the United States), credit was abundant, feeding the inflationary trends already raging in equities and real estate. Risks multiplied rapidly due to the mutually reinforcing relationship between bank lending and rising asset prices. Banks counted their equity holdings as part of their capital reserves, so the higher the prices, the more they could lend. At the same time, new loans were collateralized through real estate prices, which were climbing sky high due to high demand, limited supply and rampant speculation. High-priced property added more apparent strength to banks’ loan portfolios. With reserves looking strong, banks could lend profusely, and with massive credit flowing through the system, corporate profits, shares and property prices continued to rise.
