Tuesday, October 21, 2008

Are we in danger of turning Japanese?

Japan's stock market lost more than three quarters of its capital over two decades - it might be enough to bring tears to the eyes of even the most inscrutable investor.

'Pushing on a string'' might sound like a daft if harmless activity but I fear it will be seriously bad news for all of us if the phrase ever enters mainstream usage.

Devotees of the dismal science of economics use it to describe the point at which interest rate cuts and other attempts to boost activity - such as pumping billions into bust banks - fail to restore confidence.

For a Chancellor or Prime Minister to discover he is pushing on a string is akin to a sailor being blown onto a leeward shore and, seeing he is running out of sea room, discovering that the auxiliary engine will not start.

I first heard the phrase nearly 20 years ago when the Japanese stock market began its long decline from a peak of 38,000 in the Nikkei index, despite a series of increasingly desperate rate cuts. It came to mind again this week when the Tokyo market fell by another 11pc overnight to stand below 8,500 on Thursday. Losing more than three quarters of your capital over two decades might be enough to bring tears to the eyes of even the most inscrutable investor.

While we should always take a long-term view of equity-based investment, there is a limit to what human flesh can bear - or, as the economist John Maynard Keynes put it: "The market can stay irrational longer than you can stay solvent.''

Here and now, the Japanese experience is a terrifying reminder that some stock market sagas do not have a happy ending - as I pointed out in this newspaper in August, 2007, when the credit crunch began to bite.

Again, in an article headed "Western banks sink in the shadow of the rising sun'' in March this year, I wrote: "First there was Northern Rock in Newcastle; now there is Bear Stearns in New York. With banks being bailed out by taxpayers on both sides of the Atlantic, no wonder investors have that sinking feeling.

"While government intervention has prevented either bank going bust, it might be dangerously complacent to underestimate the seriousness of the global credit crisis. At worst, we could be looking at a repeat of what happened in Japan 19 years ago. Then, as now, banks got into trouble with rash lending against what proved to be grossly inflated property values.

"Before the bubble burst, the ground occupied by the Imperial Palace in Tokyo was valued at rather more than all the real estate in California and the shares on the Nikkei index were briefly priced at more than all those in America.

"Bearish analysts say the main reason that the market has failed to recover is that Japanese banks were propped up by government intervention, which allowed huge losses on bad debts to remain unrealised. International institutions were not fooled and the guilty banks have been unable to borrow - or lend - on normal terms since then.

"Once confidence has been destroyed it is very difficult to restore. Without confidence, there can be no credit - at any price.

"Nobody knows what share prices will do next week or next year. That does not matter for most pension savers who do not plan to retire next week or next year. History strongly suggests the best returns will be received by those who wait for the odds to work in their favour. Selling now will certainly turn paper losses into real ones.''

That is as true now as it was then. Unfortunately, it is also a fact that shares in London have lost about a third of their value since then.

No wonder more people are beginning to worry about parallels with the Land of the Rising Sun - and whether its past may foreshadow our future.

Ian CowieLast Updated: 4:54PM BST 20 Oct 2008

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