Japanese asset price bubble

Based on Wikipedia: Japanese asset price bubble

At the peak of Japan's property bubble in 1989, the grounds of the Tokyo Imperial Palace—a patch of land just over one square kilometer—were estimated to be worth more than all the real estate in California combined. This wasn't a quirky statistical artifact. It was a symptom of one of the most spectacular economic manias in modern history, one whose aftermath would reshape Japan for three decades.

The Japanese asset price bubble, known in Japanese as baburu keiki or simply "the bubble economy," ran from 1986 to 1991. When it finally burst, it didn't just pop—it imploded in slow motion, dragging Japan into what economists would come to call the Lost Decade. Though calling it a decade is generous. Japan's average nationwide land prices didn't start rising year-over-year again until 2018, some twenty-seven years after the bubble's peak.

How Strong Currency Became a National Emergency

To understand how Japan inflated this bubble, you need to understand a peculiar fear that gripped Japanese policymakers in the mid-1980s: the terror of a strong yen.

In September 1985, finance ministers from Japan, the United States, the United Kingdom, France, and West Germany gathered at the Plaza Hotel in New York. The Americans were frustrated. Japan was running massive trade surpluses, selling cars and electronics to American consumers while the weak yen made Japanese goods artificially cheap. The resulting Plaza Accord was designed to fix this imbalance by deliberately pushing the dollar down and the yen up.

It worked—perhaps too well.

The yen surged from around 240 to the dollar to 128 by the end of 1987. For an economy built on exports, this was devastating. Japanese goods became expensive abroad overnight. The country plunged into what the Japanese called the endaka fukyō—the "strong yen recession."

Here's where the story takes a fateful turn. The Bank of Japan, Japan's central bank, decided that fighting the strong yen was a national priority. The solution? Make money cheap. Flood the system with credit. Cut interest rates aggressively.

By February 1987, the Bank of Japan had slashed its official discount rate—the interest rate at which it lends to commercial banks—to just 2.5 percent. This was extraordinarily low for the time. The idea was simple: cheap money would stimulate domestic spending, offsetting the damage from expensive exports.

But cheap money has a way of finding trouble.

When Money Gets Too Cheap

When borrowing costs drop dramatically, people don't just spend more on ordinary goods. They speculate. They buy assets—real estate, stocks, anything that might appreciate—often with borrowed money. And when everyone does this simultaneously, prices rise, which makes the speculation look smart, which encourages more speculation, which pushes prices higher still.

This is the anatomy of a bubble.

Japan's version was remarkable for its speed and scale. Commercial land prices in Tokyo jumped 42 percent in a single year from 1984 to 1985. Then they jumped another 122 percent from 1985 to 1986. By 1987, a single square meter of commercial land in Tokyo cost an average of 6.5 million yen—about $45,000 at the time.

The Ginza district, Tokyo's glittering commercial heart, became the world's most expensive real estate. At the peak, a single square meter there cost 30 million yen—roughly $220,000. Not an apartment. Not a building. A square meter. About the size of a king-sized bed.

The stock market joined the party. The Nikkei 225, Japan's benchmark stock index, rose from around 10,000 in early 1984 to nearly 39,000 by December 29, 1989. That's a gain of more than 280 percent in five years. To put this in perspective, the American stock market's famous 1990s bull run—the one that ended in the dot-com bust—took a full decade to produce similar percentage gains.

The Geography of a Bubble

Bubbles don't spread evenly. They radiate outward from a center, weakening with distance, like ripples from a stone dropped in a pond.

Tokyo was ground zero. The capital's commercial districts experienced the most extreme price inflation, driven by genuinely intense demand for office space. In the early 1980s, Tokyo had emerged as a global financial center, attracting international banks and corporations. Supply couldn't keep up with demand, and prices rose accordingly.

But then speculation took over. Rising prices attracted speculators, whose buying pushed prices higher, which attracted more speculators. The useful information that prices carry—about supply and demand, about genuine economic value—got drowned out by noise.

The bubble spread to the cities surrounding Tokyo: Yokohama, Saitama, Chiba. These commuter towns saw their land prices surge as investors sought opportunities outside the increasingly expensive capital. Then it spread further, to Osaka and Kobe and Kyoto, then to secondary cities across the country.

But the intensity varied dramatically. The six major cities—Tokyo, Yokohama, Nagoya, Kyoto, Osaka, and Kobe—saw commercial land prices rise 303 percent between 1985 and 1991. The rest of urban Japan saw increases of "only" 81 percent. Still a bubble, but a smaller one.

Geography mattered in another way too. Southern Kanto, the region south of Tokyo, commanded higher prices than Northern Kanto. Cities with historical and economic ties to Tokyo saw bigger bubbles than those without. The bubble wasn't random; it followed the existing economic geography, amplifying existing patterns of wealth and activity.

Corporate Japan and the Feedback Loop

Something strange happened to Japanese stock ownership during the 1980s. Corporations began buying each other's shares in large quantities, a practice called cross-shareholding. The percentage of shares held through these cross-ownership arrangements rose from 39 percent in 1950 to 67 percent by the late 1980s.

Meanwhile, the portion of trading volume accounted for by corporations jumped from 19 percent to 39 percent during the decade.

This might sound like a dry corporate governance detail. It wasn't. It fundamentally changed how the stock market worked.

When most shares are locked up in cross-holdings and not available for trading, the remaining "float"—the shares actually available on public markets—becomes thin. A thin float means that relatively small amounts of buying or selling can move prices dramatically. It also means that stock prices become easier to manipulate and increasingly disconnected from underlying business performance.

The really pernicious dynamic was the feedback loop between land prices and stock prices. When land prices rose, the value of corporate real estate holdings increased. This made corporate balance sheets look stronger. Stronger balance sheets justified higher stock prices. Higher stock prices made it easier for companies to raise capital. Easier capital meant more money chasing assets. More money chasing assets meant higher land prices.

Round and round it went.

Warning Signs and Willful Blindness

The Bank of Japan wasn't oblivious. By the summer of 1987, officials were expressing concern about "excessive monetary easing." They could see that money supply and asset prices were rising sharply. They hinted that they might need to tighten policy.

Then came October 19, 1987—Black Monday.

Stock markets around the world crashed. The Dow Jones Industrial Average fell 22 percent in a single day, still the largest single-day percentage decline in its history. Japan's market was dragged down too.

Facing this global financial chaos, the Bank of Japan blinked. Raising interest rates while markets were in turmoil seemed reckless. Better to wait for calm.

It took nearly two more years. The Bank of Japan didn't raise its discount rate until March 31, 1989—well after the bubble had inflated to grotesque proportions. By then, the easy money had been flowing for four years.

Some economists argue that the delay was about more than just Black Monday. They point to pressure from the United States, which wanted Japan to keep rates low and consumption high to reduce trade imbalances. Others argue that the Bank of Japan was simply slow to recognize the danger, trapped in its own success narrative. The Japanese economy was growing. Unemployment was low. What was there to worry about?

Economist Richard Werner, who has studied the bubble extensively, argues that these external explanations are insufficient. The Bank of Japan, he contends, had its own reasons for pursuing the policies it did—reasons that had more to do with institutional politics and power than with sound macroeconomic management.

The Pop

When the Bank of Japan finally did act, it acted aggressively. The discount rate rose from 2.5 percent to 6 percent over the course of fifteen months. Credit conditions tightened sharply.

The stock market responded first. By August 1990, just eight months after its all-time high, the Nikkei 225 had lost half its value. It had fallen from nearly 39,000 to under 20,000.

Land prices took longer to turn. They have a stickiness that stocks lack—people are reluctant to sell property at a loss, and transactions are slower and less transparent. But by late 1991, land prices were falling across the country. The bubble was officially declared burst in early 1992.

The pattern of collapse mirrored the pattern of inflation, running in reverse. Tokyo fell first and hardest, then the surrounding prefectures, then the secondary cities. Residential land prices in Tokyo dropped 19 percent in a single year. Commercial land prices fell 13 percent.

But these numbers don't capture the real damage.

The Wreckage

When asset prices collapse, the debts remain. This is the cruel arithmetic of bubbles.

Consider a company that bought a piece of land for 100 million yen, borrowing 80 million from a bank to do so. If the land's value falls to 50 million, the company now has an asset worth less than what it owes. It's underwater. It can't sell the land without crystallizing a loss that might bankrupt it. It can't borrow more, because its collateral has evaporated. It's stuck.

Now multiply this by thousands of companies and millions of individuals.

Japanese banks found themselves holding enormous quantities of what are politely called "non-performing loans"—loans that borrowers couldn't repay, secured by collateral that had collapsed in value. These zombie loans clogged the financial system. Banks couldn't lend to new borrowers because they were nursing old losses. Companies couldn't invest because they couldn't get credit. The economy ground to a halt.

The technical term for this is a "balance sheet recession." Unlike a normal recession, where demand temporarily falls and then recovers, a balance sheet recession persists until the excess debt is worked off. That can take a very, very long time.

Japan's balance sheet recession lasted for most of the 1990s and, arguably, into the 2000s and beyond. Growth stagnated. Prices fell—Japan became one of the few modern economies to experience sustained deflation. A generation of Japanese workers entered the job market during the Lost Decade and never fully recovered.

The Long Shadow

The Japanese bubble offers lessons that resonate far beyond Japan.

First: monetary policy is powerful, but its effects are unpredictable. The Bank of Japan cut rates to fight a strong yen and stimulate the domestic economy. It succeeded—but the stimulus flowed not into productive investment but into speculation. The money didn't go where policymakers intended.

Second: bubbles are easier to diagnose in retrospect than in real time. While the bubble was inflating, many serious people argued it wasn't a bubble at all. Japan was different, they said. Its economy was genuinely superior. Its companies were genuinely more competitive. The prices reflected real value. These arguments sound absurd now. They didn't sound absurd then.

Third: the aftermath of a bubble can last far longer than the bubble itself. Japan's bubble inflated over five years. Its aftermath lasted nearly three decades. The asymmetry is striking and disturbing.

Fourth: geography matters. Bubbles don't spread evenly. They concentrate in particular places and spread outward along predictable paths. Understanding these patterns can help identify where risks are building—and where the damage will be worst when prices fall.

The connection to construction productivity—the topic that led us here—is perhaps indirect but illuminating. Japan built enormously during the bubble years. Then it stopped. The overhang of vacant buildings and deflated land values made new construction economically irrational for years. Why build when existing buildings sat empty? Why invest when prices only seemed to fall?

This is one of the hidden costs of asset bubbles: not just the immediate destruction of wealth when prices fall, but the long-term paralysis that follows. Investment freezes. Innovation stalls. The future gets postponed.

The Tokyo Imperial Palace grounds are still worth a lot of money. But not more than California. Some lessons, eventually, get learned.