Oil casts shadow on economic revival in Japan

Ground Floor: In Ireland, the boom may indeed be getting boomer but in Japan the first hike in interest rates in six years (albeit from zero to 0.25 per cent) may be signalling, finally, that the bust has stopped getting bustier. It's hard to imagine a wild welcome for interest rate hikes, but economists were as one in expressing delight that the Japanese were able to make a symbolic move upwards.

This return to normality after the bust comes with a sense of relief that the fall after the boom has finally played its way out of Japan's economic consciousness. The country has been mired in a mixture of recessions and almost zero growth for more than 10 years, ever since the collapse of the stock market back in 1990.

The falls were precipitated by a number of things, although a sudden bursting of the property bubble was part of the equation. At the time, banks and businesses were heavily overweight in land-based assets, or had substantial investments in other companies who were.

When prices fell, the domino effect meant that everyone suffered. Banks were left looking at reams of bad debt and were unable to lend for other business purposes. Companies who couldn't access credit moved their centres of operations overseas, unemployment went up and people stopped spending. At the same time, government debt was continuing to rise.

At the peak of the boom times, land prices went so high that - depending on who you were talking to - Tokyo city was worth more than the US.

The Ginza district (Tokyo's upmarket shopping and entertainment area) was the setting for extraordinary price levels and in 1989, some properties were valued at around $1.5 million (€1.2 million) per square metre. An average house near the city cost over $2 million. There were accounts of executives eating gold-sprinkled food with gold chopsticks, while Japanese investors were among the main buyers of artwork, amassing masterpieces without any real consideration of the price or provenance.

The frenzy reached its peak in 1990 when Portrait of Dr Gachet, by Van Gogh, was bought for $86.5 million by Ryohei Saito, the late chairman of Daishowa Paper Manufacturing. Banks were offering art-secured loans - typically 50 per cent of the work's value at 2 per cent above the long-term lending rate - to attract high net-worth clients.

Money was sloshing around the system, secured by high land prices and high asset prices and everything in the garden was rosy.

Then, in 1990, the Bank of Japan raised interest rates from 2 ½ per cent to 4 per cent with a further hike to 6 per cent, causing the hard landing so feared by investors and economists alike.

Since money was no longer available for speculative art purchases, prices collapsed, and by 1999 up to 10,000 paintings were stored in bank vaults, security for failed corporations and valued at around 20 per cent of their acquisition price. The bust had taken hold. Even seven years later, when banks were lending to companies at levels close to zero, they were still suffering defaults.

Part of the reason that the downturn lasted so long, though, was that the government began subsidising loss-making businesses so that they wouldn't fail. Banks weren't declaring the real extent of the losses on their books and the government continued to run an unsustainable budget deficit.

By March 2001, the then finance minister stated that "the nation's finances are now abnormal, in a state relatively close to collapse". He warned that the government needed to act urgently to get to grips with the deficit and actually work towards creating a healthy economy instead of just sounding positive. (The immediate impact of his statement was to send the yen hurtling to a 19-month low against the dollar.)

Recovery has been slow and painful and that's why so many analysts are now welcoming Japan's return to positive interest rates. The Bank of Japan said last week that the economy was likely to expand for a sustained period and that it expected consumer prices to continue to rise. The economy grew at an annualised 3.1 per cent in the first quarter and consumer prices have been rising since the end of last year.

Obviously, the interest rate hike is fraught with the danger that the bank has moved too soon. But - as with every central bank - not moving soon enough could possibly spark yet another unrealistic bubble. (Though I can't help feeling that many Japanese have been scarred so deeply from the last bust that a feeding frenzy on asset prices is highly unlikely. Still, fear and greed have short memories!)

The governor of the Bank of Japan has called the moved "a delightful moment for the future of the Japanese economy" and reassured the markets that the bank had no intention of raising rates at consecutive meetings, confirming that low interest rates would still be a feature for a long time. Nevertheless, politicians - who generally don't regard rate increases as delightful - are nervous.

Hopefully the Bank of Japan will do better with this rate hike than the last. In August 2000 they made the same move but were blind-sided by the bursting of the dotcom bubble, which threw the economy into a slump again. This time they're part of a global trend towards higher interest rates, which might make the move more sustainable. But the same dark cloud hovers on the horizon for Japan and the global economy. Oil prices. There's still room for bustier.

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