Monthly Archive: April 2016

Asset Price Bubble

propertyAn asset price bubble is a situation in which the price of a certain asset is inflated over and above its real value. When the “bubble” bursts, then the asset prices fall drastically, causing severe economic problems. The best known example of an asset price bubble is the Japanese Asset Price Bubble which occurred in the 1990s. Let us examine how the Japanese Asset Price Bubble occurred.

The Causes of the Asset Price Bubble
In the 1950s, the Japanese began creating innovations to enter the world market; however, they found this to be difficult due to their limited resources. In the Japanese culture, long term relationships were valued and this aspect of their culture was also reflected in how their businesses were run. Japanese companies would usually have employees that remained with the company for life. Japan also had families of companies. An example of this is Mitsubishi, which began as a bank, which was later used to fund the other companies in the Mitsubishi group. The advantage of having a family of companies was that the companies could provide resources to each other. Mitsubishi Bank would accept deposits from outsiders and deposit these funds in the other companies in the group. In this way, they were able to reach the export market and went on to accumulate foreign reserves.
The Japanese government also took steps to encourage this system by allowing the companies to be named Japan Incorporated, to give the companies higher credibility overseas. Furthermore, they also provided support through a loose monetary policy. As a result, the banks in Japan during the 1960s-70s were very rich as they were receiving money from local depositors as well as from foreign countries. The banks thus began to invest in Japan real estate and the stock market. The non-bank companies of the Japan property investment also began to invest in the stock market and real estate as they too were making surpluses from their export activities. Due to the influx in investment in these sectors, in 1985, stock prices began increasing drastically, thus creating the asset price bubble.
How the Bubble Finally Burst
The government realized that the loose monetary policy was further enhancing the asset price bubble; therefore in 1990 they decided to tighten the monetary policy to minimize the damage in the event of the bubble bursting.
As a result of the tight monetary policy, the financial statements of the companies that had invested in the stock market and real estate saw a drastic drop in the values of their investments.  This was because of the unsuitable accounting policies adopted by the Osaka Property, where they showed their assets at their highest values, rather than their historical values.  Therefore, due to the tight monetary policy, their asset values declined and they experienced huge capital losses.
The practice of maintaining families of companies, which started out as a strength to the Japanese economy, thus became a burden when these difficulties began, as a problem of one company in the family would affect the rest of the companies in the family as well.