Japan's Financial Bubble Burst

Image from Mason Stevens

From 1950 to 1980, Japan was at the top of the world. In fact, it became a powerhouse for the economy post-World War II, and this mark in history was called the "Japanese Miracle." This all stemmed from the decision to depreciate the US dollar against the yen, and that's when the yen sharply appreciated.  

Image from Reutars

Between 1950 and 1980, the real estate value in Japan multiplied by five times and was even at the same value as the United States. Prices skyrocketed, and the Japanese business world was booming. This sudden burst of money for everyone sounds like THE dream; however, this reality is indeed impractical. It becomes predictable that the economy, in the long run, stymied this dream. In addition to this sudden burst of aggregate demand within the country, the yen strengthened, and exports became more expensive. Furthermore, this made imports from overseas countries more expensive, and foreigners wanted to buy less from Japan. With exports becoming more expensive, competition for exports within Japan has lessened.

These events would decrease the country's aggregate demand, so the government slashed interest rates in response. The expansionary monetary policy had increased purchasing power, so aggregate demand increased again in borrowing and asset purchases. Furthermore, with the government being less strict on borrowing rules, the country was in trouble regarding risky investments and its economy.

We've not divulged what the economy has done to businesses yet by only looking at the economy. Over time, businesses developed the nickname

Image from Bloomberg

"zombie firms" because of how much they decreased productivity and investments in efficient companies. These zombie enterprises were solely surviving on the little bank support or government subsidies they could get, even though it didn't fully cover their debt in service costs (costs that involve labor, utilities, materials, and overhead (products that help support the main selling product)).

Image from Nikkei Asia

One of the "zombie firms " well-known at the time was Daiei. Daiei was well known for being a major retailer, and it expanded rapidly during 1980 because of the massive lending and booming asset prices. It's a well-known supermarket in Japan, and after the financial asset bubble hit Japan's economy, Daiei was hit with severe economic difficulties. The enterprise couldn't cover its debt-serving cost over its operating profits. The central bank/federal bank

decided not to let Daiei go bankrupt so the company could stay afloat despite its insolvency.

Image from Wikipedia

Another one of the "zombie firms" was Hokkaido Takushoku Bank. After the financial asset bubble, Hokkaido Takushoku Bank continued to lend out loans to customers, which led to its downfall. This bank failed customers because of their disappointment in the real estate and construction sectors. Later, this led to economic stagnation by stymieing companies from other productive companies gaining market share. The economic stagnation depressed overall productivity and investment across the economy in Japan at the time.

What followed was less government regulation and market discipline, which delayed the economic market's getting back on track. All of this, including mass borrowing/lending, contributed to an action called evergreen lending. So, World Connect mentioned that what followed was the economy going through deflation in the early 2000s in Japan. In addition, due to the decline in productivity, workers' wages increased, but this made it more expensive for companies to hire labor. The Chicago Booth found out that increased labor costs had a congestion effect and made it harder to find a job due to a decrease in job creation.

With fewer jobs, higher company costs, and a decline in productivity, this would have to be the end of what's gone wrong, right? No. Since the market had decreased the overall price level of all goods and services, zombie firms were able to create more distortions in the market. More distortions had a harmful impact on new competitors, lessened investment, and affected industries. By harmful impact on new competitors, the normal pathway was for unproductive firms to exit the market, but in Japan's case, they didn't. Why? Because unproductive firms were addicted to massive lending due to little to none government regulation. With no space to enter, the market had fewer newly productive firms created at its usual rate.

Economy restructuring had to happen at some point, and that wake-up call was during the early 2000s. It is easy to predict that corporate restructuring (reducing labor and increasing asset sales) took place for the zombie firms to eventually recover. However, there wasn't a distinct innovation. Therefore, there wasn't a significant impact on the economy overall, so deflation and stagnation still persist to this day.