It was a typical west London dinner party, of the kind where the guests agree not to talk about house prices but then do so anyway. One smug homeowner was in the middle of explaining why buying property makes sense when my usually placid Japanese friend Takashi suddenly jumped up in anger. ‘That’s nonsense,’ he shouted. ‘I know what it means to see house prices collapse. You British know nothing about that.’
Like many other young Japanese professionals, Takashi remains traumatised by his country’s experience. Property prices in the Land of the Rising Sun have so far fallen by 54 per cent since peaking in 1990. In some parts of Tokyo they have lost nine-tenths of their value. On average, they are back to 1979 levels, nailing the lie that house values always do well over long periods. The horrific house price crash Britain suffered in the early 1990s, with all its misery, negative equity and repossessions, was a brief setback by comparison.
To understand the causes of Japan’s downfall, we must go back to the early 1980s, when it was the world’s economic dynamo and its banks and electronics companies appeared unstoppable. Protectionists in the West were up in arms, demanding something be done. The result was the 1985 Plaza Accord: the G5 (the US, Britain, France, West Germany and Japan) agreed that the yen must be made to appreciate sharply against the dollar to reduce America’s trade deficit.
The strategy worked almost too well. As the dollar slumped against the yen, making Japanese goods more expensive, demand for Hondas and Walkmans dropped and Japan was plunged into recession. The Bank of Japan responded by slashing interest rates and injecting huge amounts of money into the economy. Growth took off again, fuelled by cheap money; but excess liquidity started to spill over into property and share prices. The authorities, lulled into a false sense of security by low consumer-price inflation, maintained rock-bottom interest rates for far too long, allowing a grotesque property and equity price bubble to develop. The Bank of Japan eventually removed the punchbowl in 1989 but by then it was too late. The bubble burst and Japan’s economic miracle came to an end. The collapse was exacerbated by the behaviour of Japan’s dysfunctional banks, which had lent heavily to property investors: as land prices slumped, bad debts exploded and the banks faced catastrophe. The strong yen didn’t help either. By the time Bill Clinton’s treasury secretary Robert Rubin launched his strong dollar policy in 1995, partly to help rescue Japan, the yen had appreciated by 341 per cent since 1971.
After paltry economic growth during the 1990s, Japan took another turn for the worse — provoked by a premature interest rate rise in 2000. After years of declining asset prices, prices of consumer goods started to fall, and deflation set in. Too little money was chasing too many goods, causing prices to decline continuously. Companies were squeezed as the real level of their debt started to rise while it became ever harder to boost sales.
In response, the government tried some old-fashioned Keynesian recipes, spending huge sums on public works; this achieved nothing other than to push the national debt to crippling levels. The central bank cut interest rates to zero; but because prices were falling, real interest rates remained at about 2 per cent. The authorities also started printing money in vast quantities, injecting it into the economy by buying back government bonds. But Japan’s cartelised banking system remained bogged down by bad debt and was simply incapable of responding rationally, and it took until 2004 for semi-decent economic growth to return.
Last month the Bank of Japan finally increased interest rates to 0.25 per cent, signalling Japan’s official return to normality. Although prices are still falling on some measures, core inflation is expected to reach at least 0.5 per cent this year. Economic growth of 3 per cent also looks likely, while bank loans are increasing at their fastest rate for a decade. Property prices have even started rising again in some areas, and corporate spending is slowly recovering.
But the economy remains fragile and the Bank of Japan will have to tread carefully. As Japan’s dire performance of the past 16 years has shown, it is very difficult for an economy to recover from a deep economic crisis and a house price collapse. The obvious answer is to avoid getting into one in the first place but that, like a dinner party devoid of any talk of house prices, is easier said than done.