On December 29, 1989, Japan’s Nikkei 225 stock index closed out a triumphant decade at 38,916. The Nikkei had begun the 1980s below 7,000 and had pushed above 10,000 in August 1984. It had nearly quadrupled in just five years.

But the Nikkei slid back below 30,000 barely seven months later, and would spend most of the 1990s below the 20,000 line. In the first few years of the 21st century, it often traded below 10,000. A rebound from 2003 to 2007 brought hopes that Japan had moved beyond its “lost decade.” But by late 2008, the Nikkei was back in the four-digit range, and in March 2009 it hit its lowest point since October 1982.

The Nikkei’s rise and fall exemplifies the building and bursting of an asset bubble. It also indicates that cleaning up the mess in the aftermath of a busted “bubble economy” can be a lengthy process indeed. The story takes on particular resonance amid the current U.S. economic crisis, with Japan’s 1990s economic policymaking often cited, albeit with varying interpretations, as a case study in what not to do.

The fall of the Nikkei was intertwined with plunges in other asset markets in Japan, particularly a real estate market that had become wildly inflated. At the height of the bubble, a square meter of Tokyo’s luxury-shopping Ginza district could reap a few hundred thousand dollars, and the nearby site of the Imperial Palace, though unlikely to be for sale, was famously estimated to be worth as much as all the real estate in California.

The reputation of Japan as a world-beating economic juggernaut also went southward as that nation sank into protracted malaise. The 1980s were rife with alarms in America and elsewhere about Japanese exports and overseas investment, reaching a crescendo when the Mitsubishi Estate Company bought a 51 percent stake in Rockefeller Center in 1989. Michael Crichton’s 1992 novel Rising Sun, in retrospect, marked a cresting of a wave of anxiety about Japan’s prospective economic dominance.

The 1985 Plaza Accord was widely seen as signifying Japan’s emergence as a major financial player. This international agreement pushed the dollar down and the yen up, in an effort to restrain America’s trade deficits and Japan’s trade surpluses. As such, it also had a dampening effect on Japan’s export-led growth, which prompted the nation’s monetary authorities to pump out more yen to encourage domestic consumption and investment. This would work all too well, fueling the upward surge of asset prices.

Equity prices soared, with Japan routinely outperforming the rest of the world. Moreover, a euphoric sense took hold that there was nothing unsustainable about the country’s stratospheric price/earnings ratios. The P/E on Nippon Telephone & Telegraph was over 300 by late in the decade. “The Japanese have their own way of thinking about stocks, and I don’t understand it yet,” a puzzled but intrigued Peter Lynch wrote in his 1990 book One Up on Wall Street. “Every time I go over there to study the situation, I conclude that all the stocks are grossly overpriced, but they keep going higher anyway.”

A Long Way Down

By the time Lynch’s words saw print, this mysterious levitation was already ceasing to occur. The Bank of Japan, worried about soaring housing prices, had started lifting interest rates, putting a brake on the mania fueled by easy money. And there was trouble brewing in the world economy, exacerbated by Saddam Hussein’s invasion of Kuwait.

The crash took place in stages, like a slow-motion nightmare. Initially, there was widespread belief that Japan was merely going through a mild recession, prelude to a continued boom. Property values continued rising for months after the Nikkei started its descent, but by 1992 both were in steep decline. Interest-rate cuts failed to reverse a growing banking crisis, as dud loans piled up and banks’ stock holdings headed down.

The interlocking nature of Japanese stock ownership, with financial institutions owning large chunks of other companies, had once seemed to be an ingredient of the nation’s economic success, one that contributed to the Nikkei’s 1980s rise. Increasingly, it now came to be seen as a problem, with banks’ stability tied to a volatile equity market.

As Japan moved in and out of recession throughout the 1990s, Japanese stocks put in a lackluster performance, notably contrasting with the bull market taking shape in the U.S. and various other countries. The Nikkei fell below 13,000 in 1998 before rallying to almost 19,000 at end-1999. These gains mostly slipped away in 2000, however, and as equities fell worldwide following the September 11, 2001 terrorist attacks, the Nikkei went lower than 10,000 for the first time since 1984.

On November 14, 2002, the Nikkei sank below the Dow Jones Industrial Average, closing at 8,303 compared to the Dow’s 8,542. This crossing of paths would not last long, but prior to Japan’s lost decade, it would have been difficult to imagine such a thing happening at all. On the last trading day of the 1980s, when the Dow closed at 2,753, the American benchmark had been about one-fourteenth of the high-flying Nikkei.

The rebound that began in 2003 brought the Nikkei from a low of 7,607 on April 30 of that year to 18,261 on July 9, 2007. But a steady descent brought the index into the 13,000 range by mid-2008 and the decline became precipitous as equities around the world deflated last September. With the Nikkei lately still mired in four digits, Japan’s economic debacle is ongoing, and the lost decade now threatens to stretch into a pair of lost decades.

Disputed Lessons

The lessons of Japan’s experience, and how to apply them to the United States, are subjects of considerable and often ideologically charged debate. Early this year, 200 economists signed an ad in the New York Times stating in part: “More government spending did not solve Japan’s ‘lost decade’ in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today.”

The libertarian Reason Foundation, in a February report Avoiding an American “Lost Decade”: Lessons from Japan’s Bubble and Recession, criticized the Japanese government’s 1990s stance of loose monetary policy and massive public-works spending. “This short-term, static view attempted to prevent the economy from experiencing any negative effects from the correction, but it only prevented Japan from rolling out of its own asset bubble downturn and made the crisis worse,” the report concluded, warning that similar policies now threaten to turn the U.S. into “a zombie business economy.”

Alternatively, some commentators discern a diametrically opposed lesson that government interventions should be larger than those in Japan. Robert L. Borosage of the left-leaning Campaign for America’s Future argues that Japanese policymakers were too concerned about limiting their deficit spending in the 1990s; Borosage thinks Franklin Roosevelt made a similar error in the late 1930s by not expanding the New Deal.

Similarly, some draw the lesson that government interventions should be faster than Japan’s were. “After the bubble burst, Japan’s powerful bureaucrats, who had earned a reputation for brilliance in the 1980s, dithered for years,” wrote commentator Michael Elliott in Time magazine recently. “In the face of slumping demand and price deflation, they cut interest rates too slowly, delayed a fiscal stimulus and failed to restructure so-called zombie banks, whose bad loans made them dead in all but name.”

In Elliott’s view, the U.S. has avoided such dithering. “You can criticize the details of the U.S. response to the collapse of credit markets, but in comparison to Tokyo, Washington has acted at warp speed,” he wrote. However, some analysts, such as Adam Posen of the Peterson Institute for International Economics, worry that the U.S. is repeating Japan’s mistake of propping up financial institutions indefinitely without demanding a substantial restructuring from them.

For financial advisors, such contentions and ambiguities over government policy have a relatively clear practical implication: A protracted period of weakness in the U.S. stock market is a possibility that needs to be taken into account in building client portfolios. The assumption that equities will be an outperforming investment over the long run has to be tempered by the realization that the long run, as in Japan, can be long indeed.

Postwar Origins

In 1943, Japan’s government combined the country’s stock exchanges into a controlled wartime institution, which collapsed along with Japan’s war effort in August 1945. There was some informal, over-the-counter trading in the occupied country over the next few years, and formal trading resumed at a reorganized Tokyo Stock Exchange on May 16, 1949.

Share prices gained for a while, but then crumbled in the aftermath of North Korea’s invasion of South Korea on June 25, 1950. The Nikkei 225 index, which officially began to be tracked on September 7, 1950, is retroactively calculated to have dropped from a high of 176 in September 1949 to a low of 86 in July 1950.

In 1952, though, with the Korean War winding down and the Japanese economy showing signs of strength, the Nikkei went above 360. The following year, it hit a high of 456. In 1960, the index crossed into four-digit territory, reaching a peak for the year at 1,356. In 1969, the Nikkei moved above 2,000.

By 1970, Japan had come to be seen as a major economic power, and that year Time magazine ran an article titled “Toward the Japanese Century,” which touted the nation’s fast growth and vast potential. “It would not be surprising,” eminent futurist Herman Kahn told Time, “if the 21st century turned out to be the Japanese century.”


Kenneth Silber is a senior editor at Research. His work on science, economics and history has appeared in a variety of publications, including
The Wall Street Journal. Ken is a regular contributor to the Gabe Wisdom Show/Business Talk Radio; go to http://www.researchmag.com/Pages/Research-Magazine-Podcasts.aspx to hear his podcasts.