Sunday, May 3, 2009

II. Possible Lessons from the Japanease (slump) bear market

(It has been roughly four months that i promised to write on Japanese prolonged bear market).

Boom and depression are the two extremes of business cycle which are generally pursued to be caused by an array of economic factors such as over production, under consumption, over capacity, price dislocation, over confidence, overinvestment, over saving, over spending and discrepancy between savings and investments. The foremost celebrity monetary economist Irwing Fisher attributed the business cycles to the over indebtedness and thereby deflation.  In his own words, depression in the economy is result of over indebtedness which leads to distressed selling of assets. He articulated (in 1930s) the chain of factors that lead to depression in the following way….

Over indebtedness leads to a) distressed selling and b) contraction of deposit currency as bank loans are paid off and to a slowing down of velocity of circulation. The contraction of deposits and of their velocity precipitated by the distress selling causes c) a fall in the level of prices and d) a still fall in the level of corporate net worth, precipitating bankruptcies and e) a like fall in profits leads to concerns to the private – profit society to make f) a reduction in output, trade and employment. These losses, bankruptcies and unemployment leads to g) pessimism and loss of confidence which in turn lead to h) increased hoardings and still more contraction in velocity of circulation. All these factors cause i) complicated disturbances in interest rates.  Here the complicated disturbances in interest rates are vowed to my previous post on counter cyclical regulation.

The above lengthy introduction serves as the basis for my arguments on the possible lessons from the Japan’s prolonged bear market.

 From the humiliating defeat of 1945 war, Japan has raised to the second largest economy by 1989. The tremendous growth has been attributed to the hard work (Popularly known as Japan kind of doing) rendered by its citizens and supply led and export oriented policies adapted by the then governments. During the second half of the 1980s, Japan experienced a sea change, there was a sudden spurt in the asset prices, real estate prices reached unimaginable hights, stock markets were experiencing thumping Bull Run. High asset prices coupled with low/negligible unemployment rates, increased productivity and positive trade deficit prompted the irrational speculating activates. Though inflationary situation forced the Bank of Japan to keep the interest rates high, the capital gains from the asset markets (stocks/real estates) encouraged the investors to go for investing with borrowed money. Banks also added to this malady by promptly sanctioning the loans to the investing activities. There is hardly anyone who has not stepped into the band wagon of making quick buck. By the end of 1989 Nikkie index touched 39,000 mark which raised three times more than the economy’s growth. 

Such a growth led by the speculation coupled with over indebtedness became unsustainable and rate of growth of the asset prices slowed down, interest rates over took the capital gains. Thus as Fisher rightly mentioned way back in 1930s, the over indebtedness and higher interest rates forced the distressed selling resulting in steep fall in asset prices. The crash in asset market and resulted mass corporate defaults increased the proportion of distressed assets in banks’ books. Non repayments, delayed repayments and deposit withdrawals caused the banks to adapt conservative measures. Steep rate cuts by the Bank of Japan could not yield the desired fruits, moreover resulted in debt trap. Hesitant banks keep carrying the distressed assets on their books, resulting many defunct businesses were continued to float. Such an uncertain environment counter acted against all the monetary measures taken by the Bank of Japan, further steep cuts of interest rates forced the economy into deep debt trap. Hence, the failure of the transmission of monetary policies, continued business uncertainty forced the prolonged disarray in the Japanese economic system….(to be continued)

 (Comments and suggestions are welcome)

The author is highly benefitted from the writings of Irwing Fisher and Graham Turner.

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