Mania and Depression in Markets

Severe market crashes happen. I believe they are a natural byproduct of markets; absolutely inseparable from the markets themselves.

The human condition of optimistic euphoria fueled by greed has resulted in countless booms and busts.

Throughout history, many economies have experienced tremendous bouts of euphoria which lead to unrealistic asset valuations. The euphoria never lasts and the subsequent crashes prove to be cautionary tales.

From 1985-1990, Japan’s economy went through a memorable boom-bust cycle.

It all started In 1985, when America, on behalf of automobile producers, grain exporters, and engineering companies, convinced the world’s major economic powers to devalue the $USD to reduce their trade deficit. In theory, devaluing the $USD would spur US exports because it would be cheaper for other countries to buy US goods.

Japan gave into America’s proposal and their increasingly stronger Yen caused a massive wave of consumerism in Japan; they had immense buying power.

The Japanese government felt it had to react to the strong Yen. In an effort to compensate for a potential decline in exports, Japan lowered interest rates to spur the country’s growth. Thier intent was to encourage corporations and individuals to speculate with a cheap money supply.    

“The strong yen, low interest rates, zaitech(financial speculation) and the willingness of banks to lend, led to a speculative boom in real estate and the domestic stock market.”  

-The Pit and The Pendulum,  David Harding and James Holmes.  

At the height of the boom, the Japanese Nikkei hit about 40,000, ~+500% on the decade.   

The bubble popped when the Bank of Japan began to raise interest rates in hopes of deflating property prices. As Japanese stocks and real estate were in the midst of a large downturn in 1990, the Japanese government reversed its rising interest rate policy and lowered rates into negative territory to blow air back into the bubble. But the Japanese government was too late; investor sentiment was already dead. The people’s fear of loss outweighed their desire to speculate. Japanese citizens prefered to keep money in a bank account with negative interest rates and lose a bit each year than to risk it in the markets again. Ever since, Japan has been quite risk averse.

Lessons to take away:

1: It's never one single thing that causes a bubble, it's a combination of complex events.

2: Bubbles do not occur in isolation. When economies inflate, many jobs and services are built upon the bubble, so when the impending bubble bursts, the reverberation is widespread.