Japan: what happens when monetary medicine wears off?

Japan has been the land of the rising stock market in 2013. But as share prices have risen, so have the worries – that Japan is seeing the inflation of an epic new bubble.

Well overnight that bubble spectacularly burst. The question is does Japan show us where the rest of the world is going too?

The Japanese stock market over the past three years have been as flat as a pancake until last November. Then it took off in spectacular style – not so far from doubling in value in about six months.

That’s a remarkable boom that last night, came crashing down; Japan’s leading Nikkei index falling by more than seven percent in one trading day. Here, the FTSE followed some though not all of the drop from Tokyo: today by just over two percent. And in Germany, the Frankfurt DAX index was down by 2 per cent too.

So what’s driving this sell-off?

Well it’s an awful lot to do with what drove shares up in the first place. Last December, Shinzo Abe, became Japanese Prime Minister determined to end his country’s decades of stagnation with radical new boosts to the economy, that have become known as “Abenomics”. He stimulated government spending and ordered the Japanese central bank to print money. Much of it ended up pumping the stock market.

A similar approach has been pursued by Ben Bernanke, the head of the US Federal Reserve.

The Fed has been boosting the American economy by pushing more money into the system – $85bn every month.

So stock markets have become very dependent on central banks – the question: when might this easy money come to an end?

Last night, Mr Bernanke gave investors a bit of a scare, saying: “If we see continued improvement and we have confidence that that is going to be sustained then we could, in the next few meetings, could take a step down in our pace of purchases.” And the markets, not least in Japan, took fright at the early withdrawal of their monetary stimulant.

The problem is that, away from the financial bubble, the real economy isn’t looking great either. China reported its first contraction in manufacturing output for seven months. The world’s second largest economy is slowing.

But Japan’s bubble is one symptom of a wider problem which includes us here in Britain; a world kept afloat by central bank money that has inflated the price of shares, bonds, commodities, property and much else.

The past 24 hours is a sign that economies damaged by the crisis in 2008 have yet to heal fully or at all. It augurs badly for what happens when this anaesthetic is withdrawn.

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