Neo-Meiji and the Bubbles

Recently, I went to a talk titled ‘What Does China Want?‘. A fairly interesting and informed discussion followed the talk. I raised a comment on the fact that I saw China’s strategic involvement in infrastructure-building and intelligence dissemination in South Asia as a subtle and covert form of neo-colonialism. A debatable point indeed! I also sought to know whether the much-needed reforms in China would be from bottom-up or top-down. I personally feel it has to be from top-down, probably when the glaring contradictions in the regime blow up.


The last question I raised, about whether China can learn anything from Japan, just as it did after the Meiji Restoration (I was first drawn to this topic after watching ‘The Last Samurai’; a great cinematic production, I must say). Quite frankly, as told to us by the speaker, if the positives are to be counted, China probably far outweighs Japan in terms of key economic parameters and factors, and there is nothing much that China can possibly learn from Japan. But what China can definitely learn from Japan is to not make the conspicuous lapses that occurred during the Japanese economic boom.

Liberalization and the Japanese Boom

Beijing views Tokyo’s handling of the liberalization of capital flows over 30 years ago, in its bid to regain its lost glory in the Second World War, as key factors that led to the creation and subsequent bust of the bubble of assets in Japan in the early 1990s.


Recently, at an annual parliamentary meeting that began on 5th March 2015, China announced an economic growth target of around 7% for this year (the slowest in around 25 years!). To help develop the economy, China is carrying out three key financial reforms that Japan undertook over the past decades – liberalizing interest rates, internationalizing its currency and opening up its capital account. However, any errors in judgement or mismanagement could lead to catastrophic repurcussions.

As per Reuters,

Chinese policymakers see the 1985 Plaza Accord between Japan and the Western powers, which effectively approved a stronger yen and the opening up of the capital account during the 1980s and 1990s, as pivotal events for Tokyo which ultimately led to Japan’s “lost two decades”, sources say.

The surge in the yen that followed the agreement hit the country’s main exports; Japanese auto makers, for example, started shifting more production overseas.  This started to hamper economic growth and prompted the Bank of Japan to ease monetary policy.

However, much of the cash from the easing, along with hot foreign money that followed the liberalization of the capital account, flowed into stocks, property and other assets, often magnified through leveraging.

China definitely does not want to make the mistake of creating any imbalance even if growth is slow. Getting encumbered by any international partner’s financial condition and not considering the stability of domestic economics are mistakes Japan made, as its assets bubble grew to ginormous proportions, and then burst, which China would not or rather should not make.

Japan’s Bubble Blast

Japan’s traditional society experienced massive changes after Japan’s defeat in the Second World War. The Marshall Plan provided aid from the United States to rebuild Japan’s economy and the two countries’ newly-found bonding gave Japan an opportunity to export manufactured products to the United States.


Japanese industry was initially dominated by large family-controlled financial and industrial conglomerates known as zaibatsu (“financial clique”), which evolved into keiretsu conglomerates in the latter half of the twentieth-century. Typical keiretsu conglomerates were arranged in the form of groups of interlocking industrial corporations organized around a domestically-run bank, which provided banking and financial services to the corporations. Most corporations within a keiretsu carried names that were variants of their keiretsu’s overarching brand name; for instance Sumitomo (Sumitomo Chemical, Sumitomo Heavy Industries, Sumitomo Precision Products, Sumitomo Metal Industries, Sumitomo Corporation, Sumitomo Life (Insurance), Sumitomo Coal Mining, Sumitomo Warehouse Co Ltd, etc.).


Keiretsu conglomerates received a high level of support from the Japanese government. This system of crony capitalism came to be known as “Japan, Inc.”, a concept that was revered as well as reviled by Western commentators for the unfair advantage that it brought to the Keiretsu over domestic businesses. Japanese industry gained an edge by copying Western products, improving them and then selling them back to the West for cheaper prices (eerily like the precursory measures taken by certain colonial powers to increase their clout and finally their domination in their now-erstwhile colonies!). Since Japan had a relative lack of natural resources, Japanese companies took the convenient and smart way by developing efficient, innovative manufacturing methods and improving the quality of the products made thereby, giving Japan a strong competitive advantage in high value export products such as electronics. So effective was this approach that by the 70s, assembly line robots in automobiles’ manufacturing in Japan, which made more fuel-efficient vehicles, shook up the industry in the States, where one still had the good old way of assembling cars by hand.


By the ’80s, Japan extended its domination to electronics. It manufactured the majority of the world’s consumer products in electronics, and introduced revolutionary new products such as the pocket transistor radio.  Japanese manufacturers also established a foothold in the growing computer hardware industry. They slowly began to monopolize the semiconductor-chip market. There was a time when people felt that firms like Hitachi would acquire the American big-fish such as IBM and Intel! Not to forget, Japan also slowly edged past USA in the video-game industry.


Japan’s economic boom caused the country’s living standard rise immensely. The Japanese had the world’s longest life expectancy (no wonder most of the Guinness Book of World Record entrants for the long-living individual have been Japanese) and this was further reinforced by competent healthcare. By the ’80s, Japan’s GDP per capita surpassed that of many of the Western countries and the country became the world’s largest creditor.

So where did Japan go so wrong?

Japan’s booming export economy and strict fiscal policies led to increased household savings and a cash surplus in the country’s banks that eventually led to more lenient lending. The country’s healthy trade surplus and the Plaza Accord in 1985 caused the Japanese currency to appreciate against other currencies, which in turn made foreign capital investments relatively inexpensive for Japanese companies. As they say, good times can often lead to over-confidence, and that is exactly what happened. Risks were taken. Nearly $40 billion was invested in risky leveraged buyouts in the USA. Acquisitions such as the Pebble Beach golf course, the Rockefeller Center and Columbia Pictures of Hollywood were some of the high-profile acquisitions by the Japanese during that era.


Rockefeller Center

Bank of Japan’s loose monetary policy in the ’80s made matters worse. What eventually happened was the rise of aggressive speculation in domestic stocks and real estate, pushing the prices of these assets shooting up to previously unimaginable levels. As per Reuters, from 1985 to 1989, Japan’s Nikkei stock index tripled to around 40,000 and accounted for more than a third of the world’s stock market capitalization. Some fairly interesting practices were put in place during this period. One of them was the financial invention called “zaitech” or “financial engineering”: the practice of reporting speculative profits and capital gains as income on corporate financial statements. The firms that undertook this practice obtained low-interest loans and used them to purchase stocks and real estate, which surged and helped the firms to report crazily high earnings, as supported by the high asset prices that continued to rise. At one point, it was estimated that an incredible 40-50% of Japanese corporate earnings were derived from financial engineering!


Imperial Palace, Tokyo

Real estate prices experienced similar shoot-ups. As per Impoco in 2008, the land underneath the Tokyo Imperial Palace was rumored to have been worth as much as the entire state of California in the same year! Some of this ‘Bubble Wealth’ found its way into the art market and created an art bubble. Record prices were paid for famous pieces of Western art. In 1987, almost $40 million was paid for what was later found to be a fake version of Vincent van Gogh’s ‘Sunflowers’!


There was only so much that such wealth could do or sustain, and soon enough the Bubble burst. Nikkei stock went from approximately 40,000 to 20,000 during 1990. Japan’s imploding stock bubble also burst the country’s real estate bubble, throwing the country into a deep financial crisis, from which it has not fully risen even today.

So how does this relate to China?

Some sources say that China can face a milder version of a bubble burst. It already did face a slight plunge in the housing sector in 2008, which can still have repercussions. Christian Dreger and Yanqun Zhang’s article beautifully summarizes this problem, showing how property is overvalued in China. Others say that some of the steps that China has taken lately echo eerily the steps taken by Japan before its economic bubble burst.


Ordos (Ghost Town)

China’s growth in the past decade has been fueled by fixed asset investment, such as infrastructure development, which has exploded since the launch of the stimulus program introduced by the government in 2008. This investment accounted for more than 90% of economic growth in 2009. A particularly strange and somewhat eerie phenomenon has risen as a result of China’s building ‘infrastructure’ purely for the sake of creating economic growth – completely uninhabited “ghost cities,” such as Ordos in Inner Mongolia! An article by BBC brilliantly highlights the farcical excesses of China today.


Over the past five years or so, China has pumped more than $13 trillion credit into its economy, in an effort to keep its growth rate up amid a weak global recovery. The Chinese credit boom has rapidly turned the country into one of the developing world’s most indebted countries, according to a new report from London’s Centre for Economic Policy Research. Such credit-driven growth can simply not be sustained for long. The stimulus pumped in by the Chinese government is already running into diminishing returns. Over the five years through 2013, government and private debt grew by about 3 yuan for each added yuan of economic activity. Simply put, the returns are not as high as one would ideally seek in the backdrop of a robust economic growth thus far in China. One is led to wonder what happens when the credit channels cease to function. Will we see another Japanese mess in China? China’s credit bubble is perched precariously over the pin of low returns for stimulus driven growth. Once past the critical point and once the easy money dries up, well, God save China.

Beyond Mistakes: Growth Parallels

Then there are issues where the Chinese and Japanese markets are quite similar, such as the banking sector. Like Japan, Chinese firms rely heavily on bank loans to meet their financing needs as opposed to debt or equity issues. China also heavily regulates its banking sector, for example by limiting the number and locations where banks can open branches, similar to how Japan did the same in the ’70s and ’80s. Just as in Japan, one could possibly see the consolidation in the banking sector due to stronger banks rescuing weaker ones so they could expand their network.

All said and done, China has a lot to learn from Japan. If not any positives, then surely its negatives!


2 thoughts on “Neo-Meiji and the Bubbles

  1. The bubble is something that is unavoidable in the growth curve of a developing nation. The mistakes that Japan made are bound to recur in China’s case as well because a series of stimuli can only sustain an appreciable growth level . More than Japan , China can take a note from the Indian growth story , mainly the banking sector . The Indian banking regulation norms are something which provide a deep cushion during times of depression or the bubble burst .Most world economies lack the vibrancy that is present in the Indian banking sector.

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