Japan: From Feudal Isolation to Economic Superpower

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1:13David McWilliams: The Range Rover Sport. Exclusive offers available now. Explore further at rangerover.com. To understand the economy, you have to understand human nature. This podcast is powered by ACAST. How are you doing there? It is time for the podcast. And the podcast today is going to come in two parts, today and on Thursday. and both parts are going to be dealing with the economic history and the economy of Japan because this week marks the 80th anniversary of the dropping of two nuclear bombs on two Japanese cities, Hiroshima and Nagasaki, which marked the end of the war in the Pacific. Japan is the only country to have suffered and the nuclear attack on its soil.

2:12David McWilliams: And against that background, we're going to just talk about Japan. It's a country most of us don't know very much about, incredibly important economy, society, absolutely crucial in the theatre that is that part of Asia, geostrategically, but also from an economic and manufacturing perspective. Japan, Japanese cars, Japanese gadgets, Japanese everything have been part of our lives for many, many decades. So we are going to talk about the history of Japan with Russell Jones, who was an ex-boss of mine for many, many years. He's written a fantastic book called A Modern Economic History of Japan.

2:50David McWilliams: And we're going to talk to Russell in a couple of minutes. So that's a two-parter today and on Thursday on the economy, the society, and the geostrategic importance of Japan. Johnny Boy, how are you? I am good. I'm good. I'm still buzzing on the news that we are going to be appearing down in the Electric Picnic this year. John, this is, John and I are going to be. Two outlads at the. Well, you know, the funniest thing is this is my 20th Electric Picnic. Is it really? Wow. The 20th. I have been hosting the Leviathan tent in Electric Picnic since 2005. I think it's the second Electric Picnic. John Reynolds, who passed away a couple of years ago, asked us down to start Minefield.

3:38David McWilliams: We've been doing it ever since. But John, you and I are going to be on the podcast tent. No, actually, we're going to be in a big tent. Five o 'clock, Friday, the opening day of Electric Picnic. If you want to hear the David McWilliams podcast live, turn up at Minefield, 5 p.m. Friday afternoon for chat, for gossip, for analysis, for all sorts of carry-on. I think Fatboy Slim is our support act. He is, yeah, yeah, yeah. Yeah, well, we're a pair of fat boy slims or slim fat boys or whatever it would be. Okay, so anyway, that is John and I at Electric Picnic. We'll talk to you about that in a couple of weeks' time closer to the date, but we would love to see you if you are going to EP.

4:17David McWilliams: Yeah. So, Michael, what else has been going on this week? What's rattling around your head? I'll tell you what's rattling around my head. Do you remember Chemical Alley? I do, yeah. Right, so Chemical Alley. There were no bombs. There were no bombs. Yeah, it was Saddam Hussein's. information minister, our disinformation minister, right? And of course, Chemical Alley's job was to tell Saddam Hussein what he wanted to hear. Now, this weekend, Donald Trump has, in an extraordinary move, fired, can you imagine this, the chief statistician of the American Department of Labor, right? Her name is Erica McIntaffer, right?

4:58She was a PhD in economics, public servant,

5:04David McWilliams: a brilliant economist and statistician. And it was her job to collate what is called the non-farm payrolls every month. Now, the non-farm payrolls are the most observed indicator of where the American economy is going. They're basically engaged. Jobs, yeah. So jobs in the non-farm Secra, right? So it's a combination of survey, survey data. It's been accurate for years and years and years. The statisticians are public servants. Their job is just to tell the story, just to give the number, which is how many jobs have been created in the United States. Donald Trump didn't like the latest one because he felt that the number was too low, that he wanted a big, big employment number.

5:48David McWilliams: So he wanted a beautiful number. He wanted the United States economy to generate, let's say, a quarter of a million jobs, right? Yeah. When you drill down into the data, what you see is the American economy is slowing very rapidly on an employment perspective. Over the last three months, on a seasonally adjusted basis, it's only producing about 35 ,000 jobs, which is very, very low for the United States, okay? Because they had big numbers earlier on in the year, didn't they? You know, in the hundreds of thousands. Yeah, so I'm going to tell you, so the figure for July was plus 73 ,000, right? Donnie didn't like that.

6:21Yeah.

6:21David McWilliams: So he fired the actual messenger. He shot the messenger, right? And he said that the figures were rigged. So in one swoop, he's undermining the entire economic infrastructure and establishment in the United States. And he's going to put a patsy in there, a chemical alley, who's going to massage the figures upwards. Now, the problem for the world is that the financial markets look at these figures as an indicator of where the Federal Reserve is likely to go on interest rates. So this is why they're so crucially important. If you drill down the figures, basically the American economy is what you could call at stall speed.

6:57David McWilliams: It is not growing fast enough to actually drag the economy in any notional place. In particular, the figures on unemployment, John, tell us, you know, how many people are hiring, how many people are available to work, all these very, very crucial indicators. The last three months, on a seasonally adjusted basis, the American economy is creating about 35 ,000 jobs per month. That's very low. In the previous six months, if you look at the same figure, it was about 87 ,000 jobs per month. So what you're seeing is there's been a sharp fall in the last three months in the average seasonally adjusted amount of jobs created.

7:36Yeah, yeah, yeah.

7:37David McWilliams: Donnie doesn't like this, so he fires the economist. But, I mean, this is the sort of thing that all dictators do. They massage the numbers. They change them. But the numbers don't lie, Mac. I mean, are you saying that, you know, this department is the only department that has access to, like, the definitive numbers? I mean, does it not become obvious to everyone when Social Security receipts goes up, for example, and, you know, there are more people on the street looking for work? I mean, is that not kind of plain as day, like no matter what a chemical ally might be saying, you know? What I'm saying is that for the last 40 years, on the last Friday of every month, the non-farm payrolls are released at 9 a.m.

8:30David McWilliams: American time, Washington time. Every single president has recognized the integrity of statistics. I'll give you just an observation. Really civilized societies have really good statistics. I know you find this really weird, but statistics are the foundational number of all societies because without statistics, you can't measure progress. Without precision, you're into the world of makey-uppy economics. Without numbers, you can't create an edifice against which to actually base policy. And what Donnie is saying is, I don't like the numbers. I don't like the numbers I'm going to get somebody else in so basically what he is doing he's attacking the evidence and that comes back to the idea of you know your truth is not my truth yeah yeah yeah bullshit so a weird weird weird week to start talking about economics but it's Donny J what can I say and let me tell you something else about Donny J he's got into this extraordinary spat an exchange with the former Russian president, Medvedev.

9:40But what it's about is Medvedev made some inappropriate or threatening comments. And on the basis of that, Trump has shifted two of the nuclear submarines to appropriate regions, he says. And then there was this back and forth on social media. But here's one of the things that Medvedev said, which is kind of a bit scary. He said, he, as in Trump, he might as well recall his favorite films about the walking dead. And also remember how dangerous the mythical dead hand can be, he added with a laughing emoji. You know, the dead hand is the launch mechanism for Russian nuclear missiles if the leadership is taken out.

10:27They're launched automatically.

10:29David McWilliams: Wow. It's extraordinary. The one thing I know about Medvedev is his name is Mr. Bear, which is kind of appropriate for a Russian leader because a Medved is a bear in Russian. Okay, so there you go. And number two, Deep Purple played his 50th birthday party. So there you go. No way. Really? Yeah, yeah, yeah. He's a heavy meddler. Sorry, he's a heavy meddler. Oh my God. Wow. Right, okay. So basically, Donny J has YMCA. Your man has Deep Purple. Go figure. Smoke in the water, man. Exactly. Anyway, speaking of nuclear, let's go and discuss Japan because this week marks the 80th anniversary of the only time nuclear bombs have been deployed and attacked and landed on humans ever, which was this week in 1945.

11:18David McWilliams: And I want to go and talk to Russell Jones. Now on the line from London, I have not only an old friend, but a man who risked his reputation by giving me a job. which in fairness is always, always a high risk strategy from a person in a conservative investment bank. But many, many years ago, my first boss in the United Kingdom was none other than the chief international economist of UBS at the time, Russell Jones, who I'm not sure if he's got over the trauma 30 years later of having to sort of negotiate to husband, to curate, to keep this young fella out of trouble. But it is great to see. And I'll just give you a little bit of background on Russell.

11:59David McWilliams: He has spent 40 years at the top end of economic analysis across a variety, not just of countries, but a variety of continents. when he debased his currency profoundly by giving me a job. He had just come back to the UK from a stint in Japan. He then left to go back to Japan. Japan has been his, not so much life's work, but certainly a country that he has lived in, he has worked in, he's understood, he has analysed. And now he has produced an amazing, amazing book on the economic history of Japan, which Martin Wolf, who we know is probably one of the greatest arbiters of good economic narratives, is one of Martin Wolf's summer economics reads, which is basically FT, economic book of the summer.

12:51David McWilliams: And Russell is in Barnes, a house I've been in. I can recognize it. Russell, how are you? Great to see you. Great to see you, David. And flattery, as always, gets you absolutely everywhere with me. So thank you for that introduction. Very kind. It's all lies, but thank you. No, it's all good. Now, Larissa, Ross, let's get into Japan. As I said there, when we met 30-odd years ago, you had just come back from Japan. You were the chief international economist of UBS. And yet I always felt that Japan was a place where you still, part of you resided in. You've now written this modern economic history of Japan.

13:35David McWilliams: let's start 120, 130 odd years ago. Japan is a feudal society. I want to get really deep into it because we can do all the tariffs, the non-tariffs of what's happening with Japan right now but I want listeners to get a sense of how much knowledge you have about this place. So let's go back. Japan is a feudal society. It is an isolated society and in around 1860s, it begins to have this dramatic change. What is that? It's called the Meiji Restoration. Remind us what that is. I think what it boils down to is an exercise in self-preservation, actually. The US Navy had turned up in the middle of the 19th century with all this technology and had threatened Japan.

14:26And the Japanese authorities thought, you know, If we're going to avoid becoming subservient to the Western powers, the US, European powers like the UK and Germany and so on, we're going to have to build our economy up. So it was really an attempt to try and avoid becoming just another colonial nation. Japan was an incredibly proud country. It had been a bit like the UK, an island nation. It hadn't been invaded for a very long time. although it had shut itself off it it had huge pride in itself and what it didn't want to be was just another colony at a time when you know the major powers were just accumulating colony after colony and it took the decision that in order to avoid that fate it would have to very rapidly develop itself and what the Meiji restoration really did was take all that they could find, all they could learn from the economies, the world economies that were dominant at the time, and try and integrate them into their own society, into their own country.

15:36And they did a phenomenally successful job at it. You know, just to give you an example, the central bank was modeled on the central bank of Belgium. You wouldn't quite believe that. They took their constitution from Germany. they learned where the military was concerned from all the major powers. So they were applying a lot of knowledge which had been accumulated over time in other countries. They also themselves decided that if they were going to be a major power, they themselves had to colonize other countries. And so they fought a series of wars against countries in their immediate hinterland.

16:13I mean, they destroyed the Chinese in the last decade of the 19th century in a war. They were the first, if you like, Asian country or underdeveloped country, if you like, to defeat a major power when they defeated Russia in the first decade of the 20th century. They acquired land in Korea and essentially Korea became became the Japanese colony by, you know, by the beginning of the First World War. So, you know, they learned a lot from the powers that were very strong, not just the good bits, but unfortunately, you could argue some of the bad bits as well. And they also, I think, adopted a sort of political system, which was focused around the empire, but really was focused around the military.

17:02The military were really running the show. Over time, I'm afraid that sort of curdled into the horrors of the middle of the 20th century. But it was something that, you know, at the beginning of their development, they used very much to get the population on side, to give them a goal, to give them a target for the future. But it was an extraordinary period of economic development. I mean, Japan really was the first country ever to escape economic backwardness. and they did it in a remarkably short period of time.

17:36David McWilliams: I mean, I think this is an episode that many Westerners are not aware of, this unbelievably rapid development. Now, other countries were going through at the time, you can argue the Germans were going through it. The British had obviously led the way 100 years previously, maybe 150 years previously. But as you said, this was the first, what was regarded as non-European or what I would call proto-European societies. Like the Americans are sort of a proto-European society. the Aussies, the Kiwis are in fact European adjacent, or were at least at that stage. This is the first non-European society that emulates the Europeans so much so that it actually surpasses the Europeans in many areas.

18:17Yeah, very true. I mean, there were, as ever, you know, certain serendipitous circumstances came along, of which the most obvious one was the First World War, which Japan didn't really get involved in, although it sided with the Western allies with the UK and France and the US and so on. I think it got a couple of German colonies in the Pacific, and that was about it. But because everybody else was so absorbed in fighting the war, it allowed it or was given the latitude to move into markets which had hitherto been dominated by certainly by the UK, for example. And it had a remarkable period of expansion during the First World War, you know, growth rates, which were far in excess of anything it had before, and far in excess of any other country, it built up a big external surplus.

19:11The First World War was, it was a very good war for Japan. Unfortunately, what came next was a little bit more challenging, it started to really encounter some racism. And if you look at episodes like the Versailles Treaty and the Paris Peace Conference that went along with it, Japan was treated pretty appallingly by the Western powers. And what also happened is once the First World War was over, it lost a lot of the markets, which it had managed to inherit from countries like Britain and so on. And the 20s were a very, very difficult period for Japan, a period of stagnation, you know, a lot of internal unrest, banking crises.

19:56I mean, really, the precursor to what happened in the 1990s happened in the 1920s. But it continued to expand and it continued to develop, it continued to, you know, build new industries and so on. I I mean, it wasn't a completely dead decade, but it was a more challenging period.

20:14David McWilliams: Russell, can I ask you, many, many people, because I want to go, it's a whistle-stop tour through a century's history of a very complicated country. But can I ask, you know, economically, what was behind the Japanese strike on Pearl Harbor from an economic perspective? Because that's the one that, you know, many people say, hold on a second. Are you serious? You're actually going to take on the Yanks in the Pacific, where they have a massive military and a massive naval advantage. What was the economic logic behind the Japanese expansion in the Second World War? Japan, as it is today, was dependent upon foreign raw materials, commodities it needed to help its manufacturing sector to expand.

21:02and at that time to help its military sector to continue to run the campaigns that it was already waging in China and so on. The US and the Western powers had increasingly imposed economic and political sanctions on Japan at that time. And in particular, just ahead of 1940, they had cut off Japan's oil supplies from Indonesia, which was the primary source of those. And so I think the calculus in Tokyo at that stage was we have to strike very quickly in a surprise fashion in such a way that we deal a major blow to the United States. You know, the US hadn't really done a lot of rearmament by that stage.

21:52It was way behind the curve. And the feeling was, you know, we give them a really big bloody nose and then they'll negotiate and we can negotiate from a period of strength. At the same time as they launched the attack on Pearl Harbor, they also launched the attack on Malaysia and ultimately Singapore and on the British Empire and gave Britain probably the biggest military defeat of its history. You know, the fall of Singapore was an absolute trauma, as traumatic to the UK as, you know, the strike on Pearl Harbor was to the United States. So, you know, I think most people, most sensible people in Japan at the time knew that, you know, if they got into a real arm wrestle with the Western powers, they couldn't win it.

22:38But the hope was by striking quickly, you know, delivering these humiliating defeats, they could encourage the Western powers to sort of negotiate. Unfortunately, that calculation didn't quite play out as they hoped. And, you know, the U.S. took a much more bellicose attitude thereafter than they had prior to that. And, you know, I've always thought that wars are typically won by GDP. You know what I mean? That big countries have the capability to last much longer in a major conflict. And if you were to add up the GDP of Japan, Germany and Italy and put it against the United States, the United Kingdom and the British Commonwealth in 1940, there was only ever going to be one winner in a long war because the Western allies had the biggest GDP.

23:32So, you know, once Japan's initial thrust into Asia had failed, you know, it was really a matter of time before it suffered a defeat. And boy, what a defeat.

23:44David McWilliams: That's what I'm saying. So we're talking here about, you know, 80 years after the dropping of the first and then second atomic bombs on Japan. let's talk about what the Germans describe as YAR zero. We start again. How does Japan, from a totally defeated nation, from a totally humiliated nation, from a nation that is still the only people in the world who have suffered a nuclear attack, how does it go from there in 1945 to when I was first beginning to be aware of Japan economically, let's say in the 80s and in the 80s every second airport would have a book called The Rising Sun, Beware Japan, The Coming Japanese Force.

24:31David McWilliams: How does it go from total defeat and humiliation to complete ascendancy in effect, global ascendancy by the 1980s as an economy, as a society, as a financial power? Boy, that's a very big question, very complicated question to answer. I mean, first of all, I cannot underline too much quite how devastated Japan was in 1945. The atomic bombs were just, if I can use the phrase, the icing on the cake, in the sense that there'd been this bombing campaign for the prior six months that had devastated every single urban center. The conventional bombing raids actually did far more damage than the nuclear weapons did remarkably, not least to Tokyo, which was just flattened.

25:20There was one raid in March 1945 in particular that was just off the charts. You can't believe it. But yes, to your point, absolute devastation. Boy, how did they recover from that? They were lucky they had a sugar daddy, frankly. You know, the United States occupied it in 1945. Initially, the US tried to, if you like, impose some very liberal political conditions on Japan. They did this for about two years. They introduced a new constitution. They gave a lot of the people rights that they'd never had before. And in many ways, the Japanese population around this time had more constitutional rights than the US did or US population itself did.

26:09And then in 1947, with the Cold War starting to brew, the US did a remarkable change. It's called the reverse course. and decided, you know what, it might be a good idea to have a strong, economically powerful Japan in the Asian theater as our ally. And so the US came in and they stabilized the currency. There'd been rampant inflation after the war. And certainly when the Korean War kicked off in 1950, they decided to use Japan as the major manufacturing hub to support the operations of the United Nations troops in Korea. And so there was a huge inflow, a huge demand for Japanese industry. And the Japanese knew how to build up heavy industry.

27:05They'd spent the run up to the Second World War doing it. So there was knowledge there. But the U.S., you know, was basically building up Japan for its own purposes. And once that spark had ignited in the early 50s, the U.S. continued to be a strong supporter. It gave them a security umbrella that meant they didn't have to spend much on defense. The U.S. actually helped to determine the nature of the political system in Japan. I mean, the suggestion is that the CIA put the Liberal Democratic Party in power in 1955.

27:47David McWilliams: Never. And the Liberal Democratic Party, which was of the right, really remains in power to this day, although it's having a few problems at the moment. But it's been a dominant political party. And the U.S. was very keen that it should be. At the same time as that, we had a very sympathetic international environment. environment. You know, world trade was growing rapidly, trade barriers were coming down. And that was great for a manufacturing nation like Japan. Japan had an incredibly competitive exchange rate. The yen was set at 360 yen to the dollar in the late 1940s. And it stayed that way until the early 1970s.

28:25And that exchange rate became progressively more and more undervalued.

28:29David McWilliams: This is great stuff. I mean, because I tell you, Russell, there's a, I mean, it's always It's fascinating to me. I might just lodge this idea in listeners' heads, and we might come back to it as later. What I've always been intrigued after the Second World War is how America treated its enemies better than its friends. So Japan and Germany get treated incredibly well by America. Absolutely. Britain had to pay back all the bloody money. Britain didn't get any favour. It's a really weird thing, the way the Americans behaved after the Second World War. They said, like, our enemies, we're going to treat them even better than our friends.

29:00David McWilliams: I mean, they were, you know, they were on a sort of a cultural war with the French for at least 30 years after the Second World War. But that's another, that's another different point. So, you know, that's one for the comparing and contrasting American administrations then and now, God forbid, okay, in terms of their responsibility, their longevity. But let's come back to this point. So, Japanese, you've got open trade. You have an industrial base. You have a sugar daddy. You have an undervalued exchange rate. All these things are pointing in one direction, which is an export miracle, in effect.

29:30You also had an incredibly well-educated workforce. I mean, education is very highly valued in Japanese society. Even before the Meiji Restoration, you know, literacy rates in Japan were far higher than they were in most countries. So, you know, your workforce was well-educated. It was incredibly well-motivated to rebuild Japan, proud nation and all that. You had a bureaucracy that was very, very smart and knew how to channel resources into what I'd call a sort of industrial vanguard of companies. You know, the big industrial conglomerates were given so many advantages by the bureaucracy, and that generated economies of scale and so on.

30:17You know, the manufacturing behemoths moved into the global market and just aided up. It was, you know, an extraordinary combination of factors, a lot of moving parts, a lot of them feeding off each other. I think at the same time, the Japanese didn't make any policy mistakes, or at least not any egregious ones. You know, they kept taxes low. They essentially, you know, monetary policy was run very sensibly. There was quite a constriction of consumption so that resources could be channeled into investments. Huge capital accumulation in that period. You know, the economy grew, you know, at a double digit rate in the 50s and 60s.

31:01They announced in 1960 the so-called income doubling plan over the next 10 years. They actually achieved it in about eight. I mean, it was mind boggling. Absolutely mind boggling. But, you know, I think the international, to go back to the point I made, there was a sympathetic international environment. And the world sort of let them off a bit for some of the things they did. But, you know, the fact is, you mentioned Germany as another country that was treated very well by the US. You've just got to look at where Germany and Japan were situated geographically. You know, Germany is on the edge of Eastern Europe, on the Soviet bloc.

31:44And Japan is, you know, very close to Russia in Asia. They were very important military or geopolitical hubs that the US was very keen to support. But yeah, there were a lot of factors coming together to help Japan to grow in the way it did. And the real sort of antipathy towards Japan only began to develop in the 1970s. You know, the US suddenly started to realize, blimey, this is a competitor now. We better start.

32:17David McWilliams: We're not babysitting anymore. We're not. We're certainly going to babysit a lot less than we used to. And, for example, when Nixon decided to abandon the Bretton Woods fixed exchange rate system in 1971, I mean, it came as a massive shock to Japan because suddenly their exchange rates started to appreciate very rapidly. The undervaluation was being corrected. I mean, Nixon also imposed a 10 % trade tariff, something you may be familiar with tariffs, but Nixon did it before Trump did it. And again, that was a big shock to Japan. But, you know, to go on with a positive story, the way Japan adjusted in the 1970s, both to the change in the exchange rate environment and to two big oil shocks, was extraordinary.

33:06I mean, the flexibility in the economy and the structural change that was put in place was remarkable. You know, it still continued to outperform, even if it wasn't growing at 10 % per annum.

33:19David McWilliams: Can I just ask you that flexibility? So if you contrast Japan's ability to ride two oil shocks reasonably well with Europe's inability, not just Britain, Germany, France, Italy, all these major industrial countries start to splutter in the mid to late 70s. The Japanese don't do this, despite an overwhelming dependence on imported. And is that because of the structure of societies that discipline the society, the way in which they're, you know, how did they manage to do what the Europeans couldn't do? I think that the attitudes were very important. I think that certain institutional factors were very important.

34:03If you look at the Japanese labor market, for example, about a third of all wages are determined by profits, that's to say bonuses, and overtime. So when the economy starts to hit tough times, the wage bill automatically starts to fall because bonuses drop and overtime hours disappear. So wage inflation was adjusted much more rapidly to the two oil shocks in Japan than it typically did elsewhere. The Japanese were also very canny. For example, after 1974, they suddenly started giving a lot of money to Palestine or to Palestinian-related entities. They switched a lot of their oil demand to the Middle East from other places like Indonesia to try and stay on side with the Middle Eastern countries.

34:59So, you know, they were smart. The institutions helped. The attitude of mind helped. And there was still, you know, they were still, I think, getting a pretty easy ride, although the rest of the world was starting to see them as competition, they were still treated better than most. They were still allowed a bit of a free ride in some aspects. But it was a very, very impressive performance. You know, the Japanese economy could still grow at about 4 % a year in the 70s and early 1980s, which, you know, relative to, say, jolly old England, which was bumbling along at two, two and a half if it was lucky, or the US, which was a bit more than that, was still a very impressive performance.

35:46Very impressive.

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37:43David McWilliams: So now we get up to the 80s. And this is where some of our Irish listeners said the ears might prick up because we are talking about the mother and father of a property boom, the mother and father of a bank stroke, land stroke property explosion in Japan. This is where I first begin to hear about Japan. I hear that at a certain stage in the late 80s, the land upon which the Imperial Palace was built in Tokyo was worth more than the entire real estate of California. how do they go from this incredibly disciplined, export-orientated, prudential policy, high savings ratio, massive capital formation, all the good stuff, right?

38:31David McWilliams: How do they go from that to channeling their inner paddy and go mad with property? Okay. Okay. I think the first point to make is that a lot of the underlying forces behind the economic miracle had started to fade. You know, the capital accumulation is always subject to diminishing returns, especially as you get closer and closer to the technological frontier. And Japan had caught up. Oh, whoa, whoa, whoa, whoa, whoa. What does that mean in English? Capital formation suffers diminishing marginal returns as you get closer to the technological frontier. Even I, who's apparently an economist, can't follow that.

39:08Well, you know, Japan have been built on an awful lot of investment, But the rate of return on that investment starts to diminish as you catch up with best practice. Okay. Okay. And best practice would, let's say the United States is best practice. So you've built up your industry through all this investment. Your industry is now, is getting more and more efficient. It's getting almost as efficient as you can. And that means the rate of return on that investment automatically or naturally starts to fade away. Okay, I get you. Okay. Another point was that a lot of Japan's high growth here had been built on very positive demographics.

39:50You know, late 1940s, early 1950s, Japanese families have got four kids. Yeah. You know, by the mid-1980s, they're having less than two. So the population growth is diminishing. The population is starting to get older. And we're going to get onto that a bit later, I think. So those are two very powerful forces, the capital accumulation and demographics. They feed off each other. When they both start to slow, the economy starts to slow. So I think, as I said, the economy has already slowed down from about 10 % a year to 4 % a year GDP growth. Come the 1980s, there's a lot of hubris around. You know, Japan thinks it's won, as always happens after very long periods of economic growth, countries start to get overconfident.

40:40And there was an element of that there. And at the same time, Japanese policymakers looked at what was going on in the United States, in the UK, in places like that, where you had the rise of factorism and Reaganism. And they thought, oh, you know, a bit of deregulation wouldn't be a bad thing. and unfortunately they decided that the first place they should deregulate was the financial sector and the financial sector had been like this is like a drama where the villain it's like

41:11David McWilliams: a theater where the villain just walks in the back grim reaper and there is dun dun dun and he keeps coming back again and again yeah yeah yeah okay the financial sector had been incredibly controlled for 30 years to channel money into the manufacturing sector. And they decided to open it up. And at the same time as that, Japan was under increasing pressure to get its external surplus down. So the US and Europe were saying, you know, you've got to expand your economy more, you've got to use fiscal and monetary policy to boost the economy. The Japanese themselves were very keen on tightening fiscal policy.

41:53So the only macro weapon that they used in its essence at that stage was monetary policy. And you ended up with very low interest rates at a time of rapid financial deregulation. Now, you know, we've all seen that story before somewhere, you know. And, you know, the net result was an asset price boom, very rapid accumulation of debt, especially in the corporate sector. And yeah, 1985 to 1989 was probably the most egregious period of asset price excess in recent historical memory. It was an extraordinary period. It was bonkers, absolutely mad.

42:34David McWilliams: I mean, Ireland, we tried our best to emulate that. We really did. We really gave it a good go. But again, so for Irish listeners, the Celtic Tiger period of rapid increase in credit, complete deregulation of finance, very low interest rates because we'd actually joined the euro. So straight away, we get kind of German interest rates we hadn't had then before. We used to have more like British interest rates. We get this kind of interest rate, massive cut. And as always happens, as house prices go up, FOMO hits people. People want to get involved. Everyone tells stories of, you hear about your man, and he bought that for 100 quid, he sold it for a million.

43:14David McWilliams: Oh, my God, I'll be doing the same thing. Same thing happened in Japan. They also liked the Paddy's. The Paddy's ended up buying property in Bulgaria and in all over the place. Japanese corporates in particular start buying trophy assets, golf clubs, all sort of things in the United States. And then it goes all tits up in around 1990. Absolutely. And what happens after that? Let me give you an anecdote about the level of hubris that was running. I mean, I first started to visit Japan in the late 80s. I didn't actually live there until 1990, but I was visiting on a regular basis. And I remember going to see one fund manager.

43:52And by this stage, the Nikkei was very close to its peak, which was just under 40 ,000. I remember asking him, I said, so where do you think the Nikkei is going, you know, Mr. Watanabe or whatever? And he said, oh, I think 100 ,000 is a pretty reasonable estimate, you know, as a target.

44:09David McWilliams: Yeah, yeah. And, you know, that didn't quite work out. So where did it end up? So he's predicting 100 ,000. Where did it actually go in the end? Just below 40 ,000 on the very last day of trading in December 1989. And it didn't recover that level until about 18 months ago. Wow. Yeah. Wow. So let's just hold it there because I'm listening to Russell here. We're talking about a modern economic history of Japan, the book that Russell has just written. It gives us an extraordinary insight, as you've just got firsthand, of the story of one of the least understood societies, economies in the world, and one of the most important societies and economies in the world.

44:58David McWilliams: It still is, despite everything, still in the top five economies in the world. It still is a massive financer, we're going to get onto this, of the United States. It still is a massive purchase over American treasuries, all that stuff. It still is in the glare of Trump when it comes to tariffs, etc. But what I want to do is I want to stop us there. So we're here, we've got from 1860s to the peak of probably the most extraordinary financial bubble the world has ever seen. In the next episode, I want to start there with Russell. And then I want Russell to explain to us what has happened in Japan since then.

45:42David McWilliams: So it's 40 years of absolutely breakneck growth, which comes to a crashing halt with a property stroke banking boom. And I want to hear now the next 40 years. So listeners, bear with us. This is our Japan week, middle of August. It's our Japan week. We will be back on Thursday with part two of our discussion of Japan with Russell Jones. Talk to you on Thursday.

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