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“What has been will be again, what has been done will be done again; there is nothing new under the sun.” Ecclesiastes 1:9

  • Excessive monetary easing is present in the market just like in Japan from 1986-1989
  • The Federal Reserve continues to hesitate the tightening of monetary policy like the Bank of Japan (BOJ) hesitated back in 1990.
  • Asset prices are rising rapidly in the United States and other developed nations due to easy monetary conditions like in the 1987-1989 period before the bubble bursts in Japan


    It has been said that whilst the world has modernised with technological advances and new discoveries in science, that history is doomed to repeat itself again and again because the nature of man never changes. Two chief traits that dominated man in the past and continue to dominate man today are greed and fear, which inevitably results in the cycle of history repeating.

This also ensures that in every financial crisis or crash, similarities will be found. In the course of our research, we have found that one crisis in the nineties in particular bears remarkable resemblance to the current situation we have today. This crisis that bears so much resemblance, is none other than the famous asset bubble explosion Japan experienced back in 1990. To give everyone a better idea of the damage done when the bubble burst, the Nikkei 225 chart above shows it as it is, with the Nikkei 225 losing 80% of it’s value over two decades.

Excessive monetary easing

Much like today, the Japanese Asset Bubble that finally popped in 1990 was characterised by a period of excessive monetary policy from 1986 to 1989. The Bank of Japan (BOJ) had earlier slashed interest rates in an attempt to stimulate the economy following the “endaka” recession which was caused by a fast appreciating Japanese Yen, which came about as a result of the Plaza accord signed in 1985.

Today, just like back in the late eighties, an unprecedented amount of monetary stimulus has been added with overnight interest rates slashed to more or less zero around the world, with many countries looking to find ways to further weaken their currencies to improve their competitiveness in a slowing economic environment. Moreover, this is the first time in history that governments around the world have engaged in quantitative easing which has long been considered a ‘nuclear’ option for many central banks in a bid to fight falling inflation and economic growth.

Whilst the easy monetary policy stance was undertaken by central banks around the world in order to combat the effects of the 2008 financial crisis, many of these developed nations are now beginning to show growth despite low inflation rates, much like Japan back in 1987 and 1988. Despite this, central banks continue to be reluctant to tighten rates due to the fear that tightening too soon could lead to another recession or in a worst case scenario prolonged deflation and stagnant growth. This brings us to the next similarity, which was the reluctance by the Federal Reserve to tighten monetary policy despite confirmations of fairly strong economic growth in the United States over the last two years, much like the BOJ hesitated back in 1987.

Today, just like back in the late eighties, an unprecedented amount of monetary stimulus has been added with overnight interest rates slashed to more or less zero around the world, with many countries looking to find ways to further weaken their currencies to improve their competitiveness in a slowing economic environment. Moreover, this is the first time in history that governments around the world have engaged in quantitative easing which has long been considered a ‘nuclear’ option for many central banks in a bid to fight falling inflation and economic growth.

Whilst the easy monetary policy stance was undertaken by central banks around the world in order to combat the effects of the 2008 financial crisis, many of these developed nations are now beginning to show growth despite low inflation rates, much like Japan back in 1987 and 1988. Despite this, central banks continue to be reluctant to tighten rates due to the fear that tightening too soon could lead to another recession or in a worst case scenario prolonged deflation and stagnant growth. This brings us to the next similarity, which was the reluctance by the Federal Reserve to tighten monetary policy despite confirmations of fairly strong economic growth in the United States over the last two years, much like the BOJ hesitated back in 1987.

A continual reluctance to tighten monetary policy

The BOJ was reluctant to tighten monetary policy in 1987, despite the Japanese economy having returned to growth in the second half of 1987. This was due to the fear that tightening would cause an appreciation of the Japanese Yen which was the cause of the “endaka” recession in 1986. The events of Black Monday and the dire predictions that would follow suit from several of the world’s leading economists finally frightened the BOJ enough to hold off raising rates until March 1989, which would then cause the massive Asset Bubble that had been built up to pop.

Much like the BOJ in 1987, the Federal Reserve today continues to delay hiking rates stating in the September meeting that a high US dollar had already tightened monetary conditions somewhat with the Federal Reserve being particularly concerned with the volatility in the stock market flash crash seen in early August. This has almost been an exact replica of the reasons that kept the BOJ from hiking back in 1987.

However, just like the BOJ back in the 1987/88 period, the Federal Reserve is beginning to express concern regarding excessive monetary policy but has failed to act on this concern so far. One can only hope at this point that they do not allow assets to reach astronomical prices like they did in Japan in the 1980s before finally popping the bubble with a tightening of monetary policy, which is our third and final similarity.

Risks of rapidly rising asset prices

Just like in 1987, asset prices have risen tremendously around most of the developed world. One key asset that is in focus in many parts of the developed world is real estate, just like how prices rose in Japan rapidly before the bubble burst. UBS recently ran a report regarding the bubble like prices of real estate around the world due to easy monetary policies. We can see from the UBS Global Real Estate Bubble Index below, which cities are most at risk of a real estate bubble given record high prices in many of the key cities around the world. Like in 1990, current real estate prices have reached levels in many developed cities that are out of the reach of the local population, especially those living in major urban business centers.


Source: Bloomberg, UBS Real Estate Bubble Index

Whenever such high prices are prevalent in key markets, a painful correction is usually round the corner, like Japan in 1990 and the United States in 2008. The only difference this time, is that the potential real estate bubble is worldwide and not just in one single country. Following the financial crisis of 2008, many investors especially in Asia had skewed their new investments into real estate rather than the stock market due to the negative experiences many of them had with the equity market in 2008. This has caused real estate prices around the developed world to generally rise with key cities like Hong Kong, Sydney, Vancouver and London seeing prices reach astronomical heights. Hong Kong prices alone have risen almost 300% since the lows in 2009, which is a similar price increase relative to what Japan experienced in its key prefectures prior to the asset bubble bursting.

Stock markets around the world on the other hand whilst having reached high levels have largely stayed within reasonable valuation levels, although considered high by historical standards. This is one asset class that has managed to stay within reasonable boundaries unlike the Nikkei 225 back in 1990 which reached a P/E valuation of well over 100x before the bubble finally popped. So far, no developed stock market has come close to this valuation in recent times with the exception of the Nasdaq back in 2000, which is a saving grace at this juncture after having looked at the rapid price increases of the global real estate market.

Conclusion

In conclusion, the risks of a 1990 style Japanese Asset Bubble collapse remains a very real possibility in many parts of the world as long as monetary policy continues to remain easy. The main asset class that is likely to be an issue is probably the real estate market from the look of how prices have increased in recent times. The stock markets in the developed world whilst expensive relative to historical levels is not deep into bubble territory yet based on valuations. Even China, during the recent run up reached a P/E high of only 45 before the crash. Whilst there are certainly similarities that abound at this juncture between what happened in Japan in 1990 and now, it is probably not too late for central banks to act before the bubbles in the various asset classes get really out of hand. With the Federal Reserve likely to start hiking in December this year, we could see some bubbles pop in various asset classes especially real estate which will likely cause some pain in the short term, but could very well save the world from potential ‘lost’ decades in the future. A failure to tighten could result in asset prices reaching the kind of levels they reached in 1990 in Japan, resulting in losses like what were seen in the Nikkei 225 when the bubble is finally burst, that scenario will be dire for us all if it does indeed play out.

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