By Patrick Corby

In the second half of the 1980’s there was a rapid increase in available credit within Japan. The influx of credit was mostly due to the failure of Japanese authorities to allow the Japanese Yen to appreciate.

Their thinking was that appreciation would be bad for the overall economy as it would lead to a decrease in the current account surplus; the Yen would became more valuable. This change in value would be reflected in exchange rates as more Dollars, Sterling ect. would have to be traded to receive the previous amount of Yen. The knock on effect would be to decrease demand for Yen and therefore exported products leading to a narrower gap between Japanese importing and exporting – a decreased Japanese surplus.

A shift in export demand would cause businesses and employment that relied on this sector to decrease, impacting negatively for Japan politically.

The flip side of this consideration is that this change would free up individuals and money into the domestic economy; as exporting businesses faded out their capital would flow back into Japan. Or that after appreciation imports would be relatively cheaper, meaning that consumption domestic or otherwise could increase along with savings and investment in Japan.

Alas Japan, as per politics, decided to fend off the creative destruction and conservatively disallow the Japanese economy to naturally develop. The authorities artificially created downward pressure on the Yen.

In order to accomplish this downward pressure of the Yen, Japan rapidly increased foreign currency reserves in Japanese banks mostly by buying Dollars. This form of credit manipulation not only kept the Yen down but released the continued excess Dollars took to restrict the Yen into the Japanese economy. This lead to rapid continued credit expansion to keep the Yen down instead of the release lead shift in equilibrium promised from appreciation.

Furthermore, as with all forms of credit expansion, this increased the willingness and ability to loan as long as authorities pushed more and more Dollars into Japan.

True to the Keynesian theory Japanese politics, along side their policy on the Yen, relaxed policy on bank loans and construction hoping that the extra credit would flow into imports (also restricting appreciation) and domestic economic growth especially through real estate.

Interest rates, normally a cultural ear twitch in economic change, were kept artificially low relative to the increasing credit supply. Leading to an increase in the demand for loans as companies and individuals rushed to take advantage of the low interest.

As new easy credit saturated the economy, overall demand increased and speculation flared. Prices were bid up and banks capital, which was mostly made up of real estate and stocks, increased along side it. This allowed banks to double down and increase loans as their equity speculatively increased, again fueling the speculative bubble.

The market value of stocks in Tokyo was twice that of the US even though Japanese GDP was half of that in the US. Nomura, the largest investment bank in Tokyo, had more capital because of speculation than the top 5 US investment banks together. Sony, Sharp, Toyota, Nissan, Honda, Nikon and Cannon were seen as world leaders.

What Pops an Economic Bubble

The price of housing began to far exceed that of rent obtained on properties. Consequently property owners had a negative cash flow that after operating costs were deducted could not meet interest payments on the loans for the property itself. They therefore geared up on more loans to make the payments. With rapidly increasing real estate prices they had the collateral to back new loans. As long as speculation continued prices would rise and with it collateral for new loans.

Incredibly by the end of the 1980’s the market value in Tokyo for housing was twice that of the US; Japans land is proportionally only 5% of the area of the US.

In 1989 speculation became cautious as 3 generation mortgages became evident. Regulations came into play that restricted bank loans and therefore the fuel to the speculative fire. Unable to loan, defaults on interest payments became evident. These owners became distressed sellers and sought to offload their properties while the prices were high.

This reduced credit from cautious banks and increased sales from indebted owners brought the credit induced speculation to a screeching halt.



With this the economic reversal started on a deflationary path back to fundamental values. Sellers put downward pressure on real estate prices, stocks began to rapidly decline, Banks capital decreased along side the decreased values of stocks and property, loans dried up, credit constricted.

This deflation lead to a decrease in imports and gave impetus to business to sell abroad as domestic consumption decreased. The increase in exports and decrease in imports meant that Japan’s current account surplus increased. The appreciation of the Yen now unable to be kept down came full circle and started to damage not only original exports but those businesses that had developed in the speculative boom. This reduced exporting business and employment. Exactly what Japanese authorities had tried to prevent but on a more massive level.

Eventually Japan went into full recession in 1991 a decade after expanding it’s credit. Some say it’s still not out, losing a decade of production to inflationary policy, malinvestment and reining in the feral beast of political credit expansion.

The Bottom Line

Credit expansion leads to speculative inflation



At some point there will be no greater fool to fuel

