The U.S. market downturn and a lesson from 1990 Japan


NEW YORK, April 13, 2014 — Despite the positive spin that economic reporters have been putting on the Obama Recovery for the past several months, the markets are demonstrating that the “Street” itself is as spooked about the end of the bull run as a herd of cattle resting tentatively at night on a trail drive north. Investors who are paying attention are jittery and ready to scatter at the slightest disturbance. There’s good reason.

The Japanese have been there and done that.

While this week’s pullback on Nasdaq and the Dow may be partially normal profit taking and a reaction to some of the earnings reports that came in below expectations. However, another possibility is that it is a prelude to another market crash.

Look back at Japan in 1990 to see what things look like before they implode. “Baburu Keizai” is a Japanese phrase that may foreshadow America’s future. The phrase translates to “bubble economy.”  The history behind the phrase goes back to 1990, the year of the most epic financial meltdown in modern Japanese history. “Baburu Keizai” is thought to have been coined by Yasushi Mieno, the 26th governor of Japan’s Central Bank, the Bank of Japan.

Leading up to January 1990, Japan had seen a meteoric  rise in asset values, not only in the securities markets, but also in real estate. Our Federal Reserve sometimes uses the expression, “the economy is ‘overheated.” It was said in 1990, with a little hyperbole, that a square inch of land in the fashionable Ginza district of Tokyo cost more than a square mile of good land in the U.S. The Nikkei 225 Average had shot up to nearly 39,000. Barkley Rosser noted that in 1990, the aggregate value of all land in Japan was fifty percent greater than the value of all land in the rest of the world.

In the five years before its 1989 peak, the Nikkei stock average rose 275 percent. Property values exploded to the extent that the small tract of land surrounding the Imperial Palace in Tokyo was said to be worth more than the entire state of California. The house that former Prime Minister Kiichi Miyazawa occupied (provided him by his political contributors), stood on a mere sixth of an acre. Its market value was estimated at 2.7 Billion Yen, or approximately U.S. $22 million.

On balance, not all of the conditions prior to the bust in 1990 were attributable to speculation or “irrational exuberance.” In 1985,  the Plaza Accord was signed between four major world currency players — the UK, France, West Germany and Japan — to intervene in the currency markets with the intent to depreciate U.S. dollar against the yen (JPY) and the West German Deutschemark (DEM). The unexpected result, among others, was the sharp appreciation of JPY from around USD/JPY 200 in 1985 to around 135 in 1990, which harmed the competitiveness of Japan’s exports, thus triggering a cratering and subsequent stagnation of GDP for a long period.

At the time, some economists, including Mieno, were concerned about roreika — the demographic graying of the Japanese population — combined with a historically low birth rate, below replacement level. In Governor Mieno’s estimation things were headed for a collision course. Mieno decided to deal with it pro-actively by raising interest rates by just a small increment. The intended effect was similar to turning the gas burner on the stove down a quarter of a turn, to bring the boil down to a simmer.

Unfortunately, the reaction to this exceeded Mieno’s worst expectations. The Nikkei tumbled 50 percent within two years, and the effects resonated and dragged Japan into what economists call “the Lost Decade.”

In reality, the lost decade has lingered well beyond a decade. As things stand today, the Nikkei has not even recovered half of its value prior to the events of 1990. Today, the Nikkei 225 is below 14,000. There have been intermittent rallies since the 1990 crash, but as Martin Weiss, writing in Money and Markets notes:

Between 1995 and 1996, for example, the Nikkei Index rallied for 13 months, gaining 59.4 percent from its lows and recovering a full third of its early-1990s decline.  Between 1998 and early 2000, it did even better. Its rally lasted 18 months, and the average rose 63.7 percent, recouping 37 percent of its prior decline since 1990. The biggest rally of all began in 2003. The Nikkei rose by a whopping 136 percent, from a low of 7,700 to a high of 18,157 over the course of 51 long, glorious months — only to come crashing down again to brand new lows in the global debt crisis. (By comparison, the Nikkei’s most recent rally, which began in 2012, is not nearly as impressive.)

All of these rallies coincided with re-inflation of asset bubbles in stocks and real estate. More significantly, they were all precipitated by infusions of stimulus from the Bank of Japan, coupled with the central bank trimming interest rates down to zero. Additionally, consumers abandoned savings and spent extravagantly during the ephemeral market rallies. During these rallies there was  periodic (and short lived) perceived growth in the national GDP and upticks in employment.

There are some differences between the American economy and Japan’s economy, but the big picture is alarming. Day after day, we hear from pundits and economic reporters that the economy is on the upswing. There is no inflation, the job market is getting better by the day, the stock market is rallying, and housing is on the rebound. Our GDP’s annual growth rate, as measured from November of last year to the end of January, is up, though the government’s final growth estimate dropped from 3.2 to 2 percent.

Most investors aren’t fooled by this. Nor are the banks. BofA, Credit Suisse, Goldman Sachs and the rest have all downgraded their projections for Q1 2014 to between 1.6 and 1.9 GDP on an annual basis.

A curious cycle repeats itself from month to month. Fictitious reports are issued about growth in retail, hiring, and an economic rebound, no doubt intended to be a self-fulfilling prophecy, and then the real numbers show up like party-crashers to spoil all the bragging we have done.

The reality is far different from the official reports. Several key U.S. tech stocks began slumping in March as the Fed scaled back quantitative easing (QE), prompting investors to lock in profits. Tesla Motors fell 6 percent, Facebook declined 5 percent, and slipped 4 percent. The tech-heavy Nasdaq composite index is down 3.1 percent this month, while the S&P is down 2.6 percent, recording the largest drop for both since 2012. The Dow dropped 410 points for the week, closing at 16,026. Facebook, Netflix, Twitter, JPMorgan Chase & Co and the Biotech index are off sharply. The downturn spread to Japan, with SoftBank and other smartphone-related shares being sold Friday.

So, what is this? Just profit taking, the precursor to a major correction, or the first hints of a “Baburu Keizai” burst?

If the inflation numbers the government is reporting are as fabricated and misleading as many sage economic observers believe, we may be around the corner for a Fed rate hike to coincide with tapering of QE4. It is hard to picture that plane making a smooth landing. That could be when these overvalued stocks and real estate crash again, leading to a double dip.

The Japanese can take us to school on irrational exuberance.

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