PACIFIC PERSPECTIVE : When Japan’s Bubble Bursts : Write four lines of deck to supplement information in the head, and end it with a paragraph symbol. : When its sky-high land prices tumble, the shock waves will be felt worldwide. Now is the time for preventive measures.

Over the course of history, all land price bubbles have collapsed. In the past three decades, Japan has created the largest one by far. What happens when it bursts? The world is now so tightly connected that a serious impact will be felt in the capital markets everywhere. Most economic activity would be promptly inhibited.

The total valuation of all the land in Japan is estimated at $20 trillion or more, an amount that could buy all the land in North America more than twice over. The Japan Land Agency reported a rise of 13% in the July ‘89-June ’90 period alone. The price of land in Japan is 3 to 30 times the global norm.

The high prices were created by low taxes, speculation by corporations with high cash flows, a society-wide preference for landholding and home ownership, and regulations that prevent downside shifts. Administrators and academics in Japan have now begun to consider the stability problem seriously, but no solutions emerge. All recognize that any precipitous action would damage the economy. Restrictions have been placed on borrowing that uses? land as collateral, and more realistic taxes are being discussed. But such actions would only prevent further escalation of prices. Reductions in land price of 10% to 15% per year are being considered, but there is no precedent for maintaining control over an extended period.

Although the action to be taken is painful, it should result in some long-term benefit. Highly leveraged landholders could be asked for more collateral, leading to distress sales. The government might then set a price floor by creating a land bank, which is badly needed for urban redevelopment. It could halt the slide in price by offering to purchase land, for, say, half the appraised value before a set date, and then again pay half of the new appraised value in the same manner. This could be repeated until a new plateau is found. This policy would cause inflation, but it would simultaneously reduce rents to levels comparable to the rest of the world and reduce the likelihood of hyperinflation. Extensive public landholding would later allow the construction of urban environments better suited to a highly educated populace.

Various triggers could set off a collapse in land price. A Tokyo Stock Exchange drop perhaps double or triple the size of the one experienced in August, a very sharp adjustment in the price of petroleum or a severe earthquake would be sufficient. Quite likely the trigger will be some event not yet imagined.

Once a steep slide has begun, the effects build up quickly when so much wealth is at risk. More collateral is demanded on loans. Some land is put out for immediate sale. Quoted prices may be stable, but real transaction prices that take into account side payments would slide. Rumors magnify; concerns spread rapidly. Mortgage holding institutions scramble for liquidity. Suddenly the dimension reaches a scale that causes paralysis. Deal-making halts first in Tokyo, then New York, London and elsewhere because the ubiquitous Japanese financing is questioned. The exchange rate skids despite supports.

In America, the cash to pay for Middle East oil is suddenly missing when Japanese purchase of U.S. bonds first halts, and then selling begins. The pressure on medium-term interest rates causes them to jump sky-high. American financial analysts have sometimes worried about such a stoppage, but no one has made sufficient preparations. All kinds of improvised crisis action will be attempted. If a depression results, it will be like no other the world has experienced.

The Japanese government is considering preventive action, but the policy shift required by the scale of the problem is so drastic and unprecedented that it appears politically unfeasible. The expected asset value loss is about 50 times the S&L; debacle in the United States, and it would have to be accommodated in a much shorter time span. No one in Japan seems to have thought through the global consequences. Normal international contingency plans would be swamped by the scale of such a debacle.

Other scenarios are possible but in our opinion less likely. It should be noted that Japanese manufacturing for export seems to be in good shape. In a financial storm it could serve as an employment stabilizer.

Institutions worldwide should reduce their own vulnerability accordingly. Doing nothing is like not wearing a seatbelt when the warning sign goes on for unprecedented turbulence ahead.