Time May Cushion U.S.
From Effects of Bubble

By DAVID P. HAMILTON
Staff Reporter of THE WALL STREET JOURNAL

TOKYO -- In the phrase heard 'round the world last week, Federal Reserve Chairman Alan Greenspan actually referred to the Japanese stock market of the 1980s when he spoke of "irrational exuberance." Yet his words, taken as a sign of his concern over soaring U.S. stock values, carried a distinct echo of a similar warning by his Japanese counterpart seven years ago.

Back then, the Nikkei Stock Average had more than tripled in four years. And new Bank of Japan Governor Yasushi Mieno warned on Dec. 25, 1989, that rampant speculation and rising asset prices threatened Japan's long-term economic health. In the elliptical language practiced by central bankers, Mr. Mieno said that "in light of the current price situation, we will respond to potential problems in the future at an early stage."

Mr. Mieno backed up his words with sharply higher interest rates. Within the next 10 months, he raised the discount rate to 6% from 3.75%. Financial markets initially discounted Mr. Mieno's admonition, and the Nikkei hit its all-time high four days later. But the market soon got the message. The Nikkei fell almost 4% over the first seven trading days of January 1990. By October, it had lost almost half its value. Mr. Mieno held rates high for another several years, helping to create an economic hangover that still lingers.

Does a similar outcome await the U.S.? Probably not. Mr. Greenspan had the luxury of speaking out well before the U.S. stock market reached the heights of the Japanese market, and the economic circumstances in the U.S. today are far different from those in Japan in 1989.

"In Japan in 1989, there were several bubbles going at the same time," says Scott Pardee, a former top Fed staffer and now a senior adviser to Yamaichi International (America) Inc. in New York. "One was the stock-market bubble. Two was the real-estate bubble. And, three, the exchange rate was vastly out of line. And in that real-estate bubble was hidden the overextension of credit by the financial system. Here [in the U.S.] we have a stock market which is strong, but doesn't have price/earnings ratios of 100. We don't have the same excesses in real estate and banking."

In short, unlike Mr. Mieno, Mr. Greenspan spoke well before things got out of hand. Mr. Greenspan spoke at a time when economic growth is moderate and inflation is under control, so there's little reason to expect the sort of steep increases in interest rates that Mr. Mieno imposed. An increase in U.S. interest rates of a quarter to a half percentage point, the most that Wall Street pessimists anticipate, could deflate the stock market without triggering a recession.

Tricky Business for Central Banks

Still, the situation the two central bankers faced illustrates the tricky business of deflating speculative frenzies -- and the dangers of waiting too long to do so. Central bankers worry when stock prices or real-estate values rise too rapidly, primarily because they fear the consequences when an unsustainable boom collapses. "What goes up too fast comes down damn fast," says Peter Kenen, a Princeton University economist. And the resulting harm to the economy can be painful, as Japan's experience proves.

In Japan, low interest rates put in place after a sharp recession in the mid-1980s fueled an explosion of investment and consumption. With the economy growing at 6% to 7% a year, money sloshed through the sluices of the Japanese economy. The dizzying rise in stock prices helped spur overinvestment in plant and equipment by Japanese manufacturers, who grew used to raising capital almost free by issuing new stock. The total value of Japanese stocks in 1989 was nearly 150% times the size of the Japanese economy; today, the value of U.S. stocks, though at a historic high, adds up to 100% of the U.S. economy's annual output of goods and services.

Property Speculation

At the same time, real-estate prices in Tokyo and Osaka nearly tripled, creating an instant bonanza for homeowners. Japan's huge banks, desperate for new customers to replace corporations that had turned to the stock and bond markets, showered new loans on property speculators -- many of whom then fueled both real-estate and stock-market bubbles by borrowing against their land holdings to play the stock market.

Another big difference concerns the independence of the U.S. and Japanese central banks. The Fed brooks interference from no one. The Bank of Japan, by contrast, has long been at the mercy of the powerful Ministry of Finance, so much so that the top job rotates between career Finance Ministry and Bank of Japan officials.

As a result, Mr. Mieno, an uncharacteristically independent career employee of the central bank, succeeded Satoshi Sumita, a former ministry official who, many charge, left the monetary floodgates open for two years at the ministry's behest, and then only reluctantly started to close them. "If you can blame one man for the problems of Japan, it's Satoshi Sumita," says Russell Jones, an economist at Lehman Brothers Japan Inc. "He was absolutely in the pocket of [the Finance Ministry], a terribly weak central banker."

Mr. Mieno's action also stemmed from a nagging social worry. Postwar Japan has prided itself on having an equitable distribution of wealth. But the asset bubble, central bankers feared, was dividing Japan into a society of haves and have-nots: Property prices had risen so high that much of Japan's vast middle class despaired it could never buy a home, and some families began taking out 100-year mortgages. The Fed, serving a nation that has long lived with stark contrasts between rich and poor, doesn't see achieving economic equality as part of its mission.

To be sure, Japan's example is a cautionary tale: It's hard for any central banker to get his timing precisely right. Mr. Greenspan himself said in November 1988: "One should not conclude too quickly that the Japanese stock market has risen too high in the past few years."

Mr. Mieno apparently reckoned that he could let some of the air out of the stock and real-estate markets without harming manufacturers, exporters and workers. "Tightening money after prices start rising requires strong tightening, and substantially affects the economy," he said at the time of his first rate increase. "That's the reason I believe it is necessary to respond early." For Japan, it was already far too late.

Of course, it's far from clear that Mr. Greenspan has succeeded in cooling off Wall Street. The U.S. stock market Monday recovered all the ground it lost on Friday after his admonitions. The Dow Jones Industrial Average rose 82 points to close at 6463.94.

Copyright © 1996 Dow Jones & Company, Inc. All Rights Reserved.