In the mid- to late 1980s, Japan experienced a prolonged bubble economy and entered a decade-long recession after it burst.
The economy in China currently has several things in common with Japan's economy before its bubbles burst, such as a large foreign exchange reserve, an international dispute over currency revaluation, excess liquidity, and soaring asset prices.
All these factors raise fears that China will make the same mistakes Japan did.
But great differences exist between China's present economy and Japan's in the 1980s, which means China has little chance of experiencing a long-term Japanese-style recession.
Nonetheless, it is still an urgent task for China to draw lessons from Japan and prevent major disruptions to China's economy.
A bubble builds
The bubble economy in Japan was created by many direct and indirect factors. The former includes a long-term expansionary monetary policy, excess liquidity in markets, and a large amount of money pouring into the asset market. The latter includes excessive public optimism about equity and housing prices, which produced the "myth of equity" and "myth of land."
TAKING A TOLL: Pedestrians pass a board in Tokyo on November 27 last year showing share prices falling because of financial turbulence in Europe and the Middle East (XINHUA/AFP)
First, the Japanese Government made a mistake by carrying out expansionary macroeconomic policies.
To mitigate the impact from significant appreciation of the Japanese yen after the signing of the Plaza Accord in 1985, Japan adopted expansionary fiscal and monetary policies to stimulate domestic demand. From January 1986 to February 1987, Japan reduced its rediscount rate from 5 percent to 2.5 percent and maintained the record low rate until May 1989.
Japan in fact did not adjust its policies in due time in line with its then changed situation. It maintained a loose monetary policy against unrestrained domestic demand and soaring asset prices, resulting in cheap money flooding into its economic system, which already had abundant capital. At the same time, businesses enjoyed low costs in financing, prompting a large amount of borrowed funds to go into non-production sectors and create huge asset bubbles.
Second, the stock and housing markets had surplus funds, which fueled robust speculation from both individuals and enterprises.
The lower cost of direct financing for enterprises and higher profits from the equity and real estate markets encouraged massive funds to flow into those two markets, rather than manufacturing and U.S.-favored information technology as expected. Money also flowed into the entertainment industry through special financial trusts, foundation trusts and bank trusts. The move caused asset prices to skyrocket, forming a bubble economy.
Statistics from the Bank of Japan, the country's central bank, show Japan's companies raised 405 trillion yen between 1985 and 1990. Of that money, only 36 percent went to real business investment, while the rest was invested in stocks and real estate.
Third, Japanese banks supported corporate investment in the real estate market. In the 1980s, with the promotion of the country's financial liberalization, large enterprises relied on the securities market for financing, which weakened the role of banks as financial intermediaries and threatened their survival.
Bank loans declined from 80.5 percent of total assets in 1970 to 65.7 percent in 1989. In desperation, banks in Japan turned to risky small and medium-sized businesses, real estate companies and even individuals, even though they did not have great demand for funds. By setting up non-bank companies, these banks heavily financed enterprises and individuals who were engaged in real estate and stock speculation.
Fourth, excessive optimism intensified investors' confidence, causing asset prices to rise even higher. The decreasing availability of land and the growing population helped swelling land prices create the "myth of land," while the small-scale stock market with fewer tradable shares stimulated the "myth of equity."
Lured by the expected yen appreciation, investors flooded into equity and real estate markets. The materialization of these expectations to a certain extent attracted more speculators to the equity market, even students and older people who knew nothing about stocks.