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Is China facing the Japanese bubble trap?
As the world debates whether the RMB is undervalued, the real concern is whether after the RMB revalues, China will repeat the mistakes of Japan during the 1985 post-Plaza Accord period. In that decade, the yen rose from roughly 240 yen to one U.S. dollar to as low as 80 by August 1995 and then depreciated to 147 in June 1998 before joint intervention stopped the depreciation worsening the Asian crisis. During this period, Japan suffered the worst asset bubble with the stock market falling by more than 80 percent, land prices falling by over 60 percent and the banking crisis took nearly a decade before it was finally resolved. The Japanese public debt rose to nearly 200 percent of GDP, one of the highest in the OECD countries and Japan had almost zero growth for nearly two decades, as interest rates were kept near zero.
The worst part of the Japanese dilemma is that with a huge overhang of the public debt and an aging population, Japan may face both a decline in population and also an implosion in the wealth holdings if interest rates were to go back to global levels. Note that unlike the U.S., which has a lot of foreign debt owed in U.S. dollars, the high level of Japanese debt is yen debt owed to its own citizens.
There are many foreign commentators who think that after the recent increase in credit in the Chinese banking system, equivalent to nearly 40 percent of GDP, with a broad money to GDP ratio of 180 percent of GDP, that China may be facing a Japanese-style meltdown.
What is the truth and what is the correct analysis?
In the period 1950-70, Japan enjoyed high growth, high capital formation, rapid monetization and rising property prices, very similar to what China is going through. The interesting point is that monetization did not appear to be highly inflationary, so in the run up to 1989 at the height of the asset bubble, the Bank of Japan was initially reluctant to raise interest rates. Exactly like what happened with the US subprime bubble, there was also insufficient regulatory action to stop banks exposing themselves to real estate loans.
Koyo Ozeki is Japan analyst for PIMCO and his analysis in December 2009 is very illuminating (www.pimco.com). The amount of bank lending equivalent to nearly 40 percent of GDP also went into Japanese real estate between 1985-mid 1990s. In the case of Japan, most of it went into commercial real estate. Real estate loans to individuals for mortgages only accounted for 20 percent of the total credit growth.
What was interesting was his comparison of Japan (1985-91), U.S. (2000-2007) and China (2003-2009). During these periods, Japan and US grew by roughly 3 percent per annum, whereas China grew by 10 percent. Real estate bubbles during this period were roughly two times in price growth for China and the U.S., but five times in the case of Japan. He felt that since in China, there is “overwhelming shortage of residential property that meets its new living standards; it will likely take a considerable amount of time for supply to catch up to demand. He “sees little risk in the foreseeable future that increase in loans to the real estate sector will pose a threat to the financial system”, but also recognize that “a rapid increase in lending could lead to a rise in bad debt in the future.”
As the world debates whether the RMB is undervalued, the real concern is whether after the RMB revalues, China will repeat the mistakes of Japan during the 1985 post-Plaza Accord period. In that decade, the yen rose from roughly 240 yen to one U.S. dollar to as low as 80 by August 1995 and then depreciated to 147 in June 1998 before joint intervention stopped the depreciation worsening the Asian crisis. During this period, Japan suffered the worst asset bubble with the stock market falling by more than 80 percent, land prices falling by over 60 percent and the banking crisis took nearly a decade before it was finally resolved. The Japanese public debt rose to nearly 200 percent of GDP, one of the highest in the OECD countries and Japan had almost zero growth for nearly two decades, as interest rates were kept near zero.
The worst part of the Japanese dilemma is that with a huge overhang of the public debt and an aging population, Japan may face both a decline in population and also an implosion in the wealth holdings if interest rates were to go back to global levels. Note that unlike the U.S., which has a lot of foreign debt owed in U.S. dollars, the high level of Japanese debt is yen debt owed to its own citizens.
There are many foreign commentators who think that after the recent increase in credit in the Chinese banking system, equivalent to nearly 40 percent of GDP, with a broad money to GDP ratio of 180 percent of GDP, that China may be facing a Japanese-style meltdown.
What is the truth and what is the correct analysis?
In the period 1950-70, Japan enjoyed high growth, high capital formation, rapid monetization and rising property prices, very similar to what China is going through. The interesting point is that monetization did not appear to be highly inflationary, so in the run up to 1989 at the height of the asset bubble, the Bank of Japan was initially reluctant to raise interest rates. Exactly like what happened with the US subprime bubble, there was also insufficient regulatory action to stop banks exposing themselves to real estate loans.
Koyo Ozeki is Japan analyst for PIMCO and his analysis in December 2009 is very illuminating (www.pimco.com). The amount of bank lending equivalent to nearly 40 percent of GDP also went into Japanese real estate between 1985-mid 1990s. In the case of Japan, most of it went into commercial real estate. Real estate loans to individuals for mortgages only accounted for 20 percent of the total credit growth.
What was interesting was his comparison of Japan (1985-91), U.S. (2000-2007) and China (2003-2009). During these periods, Japan and US grew by roughly 3 percent per annum, whereas China grew by 10 percent. Real estate bubbles during this period were roughly two times in price growth for China and the U.S., but five times in the case of Japan. He felt that since in China, there is “overwhelming shortage of residential property that meets its new living standards; it will likely take a considerable amount of time for supply to catch up to demand. He “sees little risk in the foreseeable future that increase in loans to the real estate sector will pose a threat to the financial system”, but also recognize that “a rapid increase in lending could lead to a rise in bad debt in the future.”
