At the time, few people bothered to listen to what Yoshimi Watanabe had to say about the deepening U.S. credit crisis. In retrospect, that’s a shame.
“If there is a big hole in the bottom of a bathtub, no matter how much water you keep adding, you will never have enough hot water,” he explained to an Associated Press reporter in Tokyo. Fixing that big hole, he said, would require drastic action, primarily from the U.S. government and Federal Reserve, but also from lawmakers and central banks around the world—sharp interest rate cuts, flooding the market with liquidity, and hundreds of billions of dollars in public money to clear bad debts from major banks.
Now, of course, all this sounds obvious. But what makes Watanabe’s prescription impressive is that he delivered it last April, five months before Henry Paulson and Ben Bernanke realized that they were sitting—cold, naked and wet—in a rapidly draining tub. Their unprecedented effort to plug the leak has pretty much followed Watanabe’s recipe word for word.
How did he see this coming? And how could he have so accurately predicted the scope of the rescue plan that would be needed? Because Watanabe is the financial services minister for the government of Japan, meaning he’s the politician largely responsible for trying to manage an economy that is still rebuilding from its own disastrous credit bubble, which exploded almost 20 years ago. He’s been watching this particular horror movie for a long time now, and while he doesn’t know how it ends, he’s in a good position to fill us in on all the plot points we might have missed while the U.S. was merrily inflating its own market bubbles.
Back in the 1980s, Japan was the undisputed rising star of the world markets. Between 1985 and 1989 the Nikkei stock index almost quadrupled in value, driven by the astonishing success of its international exporters like Sony, Toyota, Nikon and Hitachi. And as wealth flooded into the country, the value of real estate soared. In the late 1980s, apartments in Tokyo’s exclusive Ginza district ran for 50 million yen per square metre. As British market analyst Mark Shipman once noted, that meant that if you put a dollar bill on the floor in a Ginza apartment, the space that it covered was worth around US$10,000. Put another way, a 600-sq.-foot apartment would run you close to US$80 million.
The Japanese people and their corporations went right on investing in their own economic miracle, and they did so by piling on astonishing levels of debt. When the bubble popped in 1989, the government repeatedly insisted that it was only a minor correction, that everything would soon return to normal. It didn’t, and the Japanese wasted years trimming interest rates down to zero, and offering one useless stimulus package after another. Meanwhile, the economy stagnated for a decade. Japanese companies were stuck with debts that they could never hope to repay, but the banks just kept rolling over their old loans into new ones, because if they admitted that the companies were essentially bankrupt, then the banks themselves would have to admit that they too were insolvent.
“Japan’s property and stock market bubbles burst. That implosion was worsened by a banking crisis and excess corporate debt. Nearly 20 years later, Japan is still struggling,” Stephen Roach, chairman of Morgan Stanley Asia, warned last March in another prescient appraisal of America’s economic woes. “An equally lethal interplay between the bursting of housing and credit bubbles is now at work in the United States.”
There are certainly differences to be found in Japan’s economic picture in 1989, but the similarities are more bracing: the soaring asset values; the rampant overconfidence among investors; the sudden plunge; the initial reluctance of politicians and financial authorities to acknowledge the depth of the problem. (Who will ever forget Bernanke’s assurance in May 2007 that the subprime mess was “contained” and would affect only a handful of the poorest homeowners and would not result in any broader turmoil?)
The biggest and most painful similarity, however, could end up to be the one that affects small investors and retirement savers the most. For two decades Canadians and Americans have been assured that if they just buy mutual funds and forget about them for 20 or 30 years, they will appreciate at seven to eight per cent a year, and they will enjoy a wealthy retirement. Over and over, the industry has harped that “buy and hold” is the secret to investment success, because the stock market always goes up over the long term. Now would be a good time to ask a Japanese investor how well that has worked over the past 20 years.
Japan’s stock market peaked just shy of 39,000 in December 1989, then crashed and has been drifting lower ever since. This week, it was bouncing around 9,000. If you bought a mutual fund based on the Nikkei exactly 15 years ago, you’ve lost 57 per cent of your investment. If you bought 10 years ago, 28 per cent of your money is gone. So much for patience. There have been rallies of course, and some brief periods of growth where real money could be made. But passive, patient investors have been devastated.
To its credit, the U.S.’s phase of denial didn’t last nearly as long as Japan’s. They are now taking the kind of radical steps that are necessary to recover from a post-bubble implosion. But the world has changed, and those sitting back waiting for a phoenix-like resurgence in the stock market are kidding themselves. The lessons of Japan are now more important than ever. The way to survive in a post-bubble economy is to reduce debt, put a little money away each month in safe investments, and prepare to weather the storm ahead. It doesn’t sound like a lot of fun, but it works.
Yoshimi Watanabe and others know what it takes to plug the hole in a leaky bathtub, but nobody knows how long it’ll take to fill it back up again.