Japan’s Monetary Policy: Independent Financial Advice
Book Review: “Princes of the Yen”
This book, written by Richard Werner in 2003, explains how the Japanese Central Bank created huge bubble in the 1980’s and then deflated the bubble in December, 1989 resulting in 20 years of a soft depression.
The book is well written with clear explanations of what happened. The Central Bank forced commercial banks to increase lending so as to create a boom and a bubble. The banks went to bizarre methods to pressure corporations to borrow an excessive amount of money. This caused a ridiculous real estate bubble where the Emperor’s Palace was worth as much as all the land in California.
What shocked me was that the Central Bank went to great lengths to disguise the bubble with Japanese domestic lending sometimes being conducted offshore in dollar denominated loans that were instantly converted to Yen and then wired home to Japanese corporations. This confused international economists.
Bubbles and Booms
The deception reminded me of the mortgage bubble of 1997-2007 in the U.S. where vast amounts of poor quality mortgage loans were falsely labeled as “AAA” paper and then sold to unsuspecting banks. (In both cases the loans were authorized using asset based underwriting instead of the more reliable income method or cash flow method of underwriting). In both cases a major, sophisticated act of deception fooled economists. People need to be suspicious and remember the cliché “if something is too good to be true then it must be a fraud unless proven otherwise”.
There is a huge gap between an over-idealistic economist (who assumes that all economic data is accurate and all market participants are reasonable, fair minded people who would not participate in a bubble) and who uses complicated math to understand the economy versus the real world of greedy, deceptive people who use fraud to create bubbles. This gap has caused professional economists to miss something that in common sense was an obvious error of enormous consequences.
The book implied that disputes between the Ministry of Finance and the Bank of Japan caused the Bank of Japan to engage in deliberate creation of a bubble and subsequent crash so as to pressure Japan’s government to change economic policies. The result was that for 21 years since the bursting of the bubble in December, 1989 that Japan has been trapped in a Soft Depression and has no sign of recuperating. So my analogy is that if the political clash in U.S. Congress over the budget deficit and debt ceiling is not handled properly then perhaps the U.S. will fall into a similar long term Soft Depression.
However, another idea of mine is that since the Japanese Soft Depression was a man-made error that is a statistical outlier then perhaps deflationists should not assume that other countries will experience deflation because of what happened in Japan. In other words the Japanese Soft Depression is “not applicable” to the U.S., even though it provides valuable insights into how a deflation can last for a surprisingly long period. Also Japan's wartime system of a government micro-managed economy, which continued after the war, is very different from the U.S.
There are differences between Japanese banking versus U.S. banking. In Japan loan applications for corporations are analyzed based on balance sheet items instead of the income or cash flow method used in the U.S. So that was prime incendiary material for creating an asset-inflation firestorm in Japan. In the U.S. (with the exception of now outlawed easy qualifier mortgage loans) lending has been based on income and cash flow analysis which is much more stable and reliable than asset based (balance sheet based) lending.
The book did not mention China but the story of the Japanese Central bank creating a bubble reminds me of China’s great 30 year boom with extremely high growth rates and extremely high real estate prices. I worry that if China’s boom was similar to Japan’s then China will suffer a similar depression which in turn would affect the world economy. Since the world economy outside of Emerging Markets is very fragile then what happens to China will affect the world.
I wrote a post “Western nations have learned nothing and may repeat Japan’s mistakes”.
Investors should seek independent financial advice.