This is my highly simplified account–although as an active investor in Japan for much of the 1980s I did live through this one in a way most American investors didn’t.
The point of what follows, which I’m not sure I’ve made clear, is that what popped this bubble, which is the closest I’ve experience to what’s going on in the US today, was seeing interest rates begin to rise.
Japan decided to rebuild itself after being devastated in WWII by concentrating on export-oriented manufacturing. The US was the only developed country whose industrial base remained standing after the war, so it was the target destination for Japan’s exports. To make sure Tokyo’s plans weren’t upended by unfavorable currency movements, it tied the yen to the dollar. (The most important firms in this rebuild were the industrial conglomerates founded by nineteenth-century samurai stationed in Tokyo and with too much time on their hands. These zaibatsu were the driving force behind Japan’s twentieth-century militarism. They were outlawed by US occupying forces but basically just renamed themselves keiretsu and carried on. As I see it, even today they remain the dominant political force in Japan.)
Japan was so successful it became the model for other developing countries. It was so successful, in fact, that in the 1970s the US forced Japan to reset the peg from 360 yen = 1 dollar to 308. In the Plaza Accord of 1985, the US forced a second revaluation of the yen from 250 yen = 1 dollar to 160.
the 1985 endaka (“high yen”)
After the Plaza Accord, all at once every Toyota, Nissan or Honda exported to the US became 50+% more expensive. It didn’t help matters, either, that the yen strengthened further to 120 yen = 1 dollar in short order, mostly because of trade and government spending problems in the US that hurt the value of the greenback.
Tokyo’s response to the doubling in dollar value of its currency was to lower short-term interest rates from 5% to 2.5% in several steps. This was both to stop the yen from strengthening further and to help the keiretsu to finance automating their manufacturing operations.
the Tokyo stock market
Given that much food and fuel in Japan is imported, suddenly Japanese consumers had a lot more discretionary income. And interest rates were cut in half. So there was an explosion in the stock market. More than that, interest shifted away from export-oriented names to domestic demand beneficiaries, from retail to utilities to property developers. By 1989, things had gotten pretty wacky (see my posts on tobashi, for example). Real estate speculation was rampant. Trading on margin was through the roof.
popping the bubble
Then Yasushi Mieno became the head of the Bank of Japan in mid-1989. To end the market craziness he began to raise rates late that year, boosting them to 6% over the following eight months.
The Topix index was cut in half.
Mieno announced his plans in advance but the index didn’t peak until he actually began.
why I think this is important
Late 1980s Japan is the closest period I can think of to what is happening in the US today. I don’t think speculation here is anywhere near as intense as it was in Japan back then. But then–as now, I think–many market participants, even professionals, don’t seem to grasp the essential relationship between stocks and interest rates, in two respects:
–one reason, maybe the reason, stock prices are so high is that interest rates are so low; and
–as/when the world begins to recover from the pandemic, interest rates will begin to rise. That will compress PE multiples.
To my mind, the scariest thing about the comparison is not irate Japanese brokerage customers disemboweling their brokers with samurai swords. It’s the thirty years of economic stagnation that followed the bubble bursting, due to a set of preserve-the-keiretsu-status-quo economic policies that are essentially the Trump economic platform.
There’s a practical issue here that I don’t know the answer to. How quickly, if at all, can Biden undo the severe economic damage Trump has caused over the past four years? This has a bearing on how soon and how high interest rates will rise.
Hi, nice article, very informative. I’ve read that in the US, interest rates are expected to remain low through 2023. What do you think that means for the stock market? Do you expect the bubble to burst sooner than that or are you expecting it to coincide with when interest rates actually rise? Curious about your thoughts. Thanks!
Thanks. The current situation is so unusual I think it’s very hard to figure out exactly when it will change. My sense is that the stock market has already tried a couple of times last year to anticipate a rise in interest rates–anticipation is what normally happens in the US–but quickly realized this was a mistake and reversed itself. I’ll write more about this in the coming weeks but I think the most useful thing we can to is to figure out what kinds of stocks we’ll want to own in a rising rate environment and/or which will be hurt the most.