When Forests Fall on Banks : Part Two

By Lance Olsen, Unfiltered 8-13-07

A Case History in Dangerous FRECLnomics
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" A certain political and historical correctness requires us to assign some measure of purpose, of rationality, even where, all too obviously, it does not exist."

John Kenneth Galbraith, A Journey Through Economic Time

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Many of this year’s news analyses of troubles in the finance industry extend to the clearly related trouble in the closely related real estate industry. So far, so good. But if FRECLnomics has any validity at all, all or almost all these analyses fail to connect other relevant dots. For example, the typical news story connecting the finance industry (F) to the real estate industry (RE) fails to connect reckless lending with the construction industry (C) or the logging industry (L), but recklessness of lending and logging are requisites to reckless construction of homes and businesses.

There is no good excuse for leaving such important dots unconnected, and very good reason for connecting them. Japan, the second largest economy in the world, has provided one of the more spectacular case histories against which Americans and others might weigh their nations’ exposure to the reckless lending and logging that lurk behind construction booms.

During the ‘80s, Japan’s finance industry poured mountains of money into construction of real estate, including office towers and homes. Fed by this enthusiastic lending boom, Japan’s construction industry needed wood -- lots of it. In response, the logging industry commenced cutting on historic scale. With only two percent of the world’s population, Japan was buying over 30 percent of the forests felled across the planet. When all was said and done, the wisdom of this logging could be measured by the wisdom of Japan’s lending.

There was often more to Japan’s consumption of forests than the naïve eye could detect. For example, the casual observer of a high office tower in downtown Tokyo would only see a skyscraper of concrete, glass and steel. Captured by the glittering stimuli apparent to the eye, a naïve observer might scoff at the idea that forests fell so that the skyscraper could go up.

But every concrete slab in every such building was made by pouring wet concrete into a mold made of plywood. During the ‘80s, Japanese builders were using these plywood molds – construction frames – only once before throwing them away.

Then the builders turned to L, the logging industry, which turned to forests as far away as Montana and Malaysia. No casual visitor to Tokyo see the falling forests of the world. But the grizzly bears of Montana and Alaska felt the pressure as forests fell all around them. So did the sun bears of Malaysia and elsewhere in Southeast Asia.

Even the polar bear, whose homelands are typically north of the tree line, was and will be affected by the Japanese FRECL’s contributions to global warming. For example, while the sun bear of tropical Malaysia took direct hits as forests fell there, the polar bear’s icy world began to melt as carbon dioxide from Malaysia’s falling forests contributed to the overheating of the atmosphere.

People around the planet felt the pressure of logging as directly as any bear did. In fact, people are the ultimate canary in this worldwide mine, because we can predict what will be happening to the likes of bears by simply recording what happens to people.

In reporting on the logging industry in Malaysia, The Economist stressed that logging companies had built schools for forest-dwelling villagers, and offered them jobs. At first, then, loggers could cut with little objection from the locals. But it wasn’t long before the villagers were standing in the road to block the logging trucks.

Why? The forest that had been the foundation of the villagers’ economy for generations was the same one being cut and hauled away. In trying to protect their own economy by placing restraint on the circulation of logs, these ordinary Malaysian villagers briefly held the Japanese economy in their hands, by placing restraint on Japanese building.

At this point, it was clear that the combined boom in logging and building could not continue without political support. And that support came from the very top of political power centers, in both Japan and Malaysia.

According to The Economist, top-level Malaysian politicians saw any Malaysian who tried to interfere with logging as “a number one traitor.” The locals who stood on roads to block logging trucks only did so until their own government threw them in jail. With the villagers jailed, the Malaysian government kept felling the forests, and Japan kept buying.

As forests continued falling, concern about Malaysia’s forest economics extended from the nation’s villages to its cities. In his Shadows in the Forest, Peter Dauvergne cites a Malaysian journalist who said Japan was buying Malaysian logs “because they are dirt cheap.” The journalist said that’s why Japan was using Malaysian timber “for junk furniture and throw-away construction frames.”

It was the same story across the Pacific Ocean, in the United States. Under firm political pressure from Congress and the White House, the US Forest Service was pursuing much the same policy Malaysia was. For example, the Wall Street Journal reported that towering, 500 year old trees from Alaska’s Tongass National Forest were being sold for “the price of a six-pack.”

But the similarities did not stop there. Like low-ranking Malaysians who resisted logging operations, low-ranking Forest Service employees including Bill Shoaf felt heat from on high when they questioned the wisdom of logging on the Tongass National Forest.

Shoaf was not opposed to logging. He was in charge of making sure that Tongass timber fell. But when he started doing his homework in preparation for more felling, he ran into a couple problems that would end his career.

Shoaf ran into his first problem when calculating how many acres of the Tongass National Forest were “loggable.” In his book, The Taking of the Tongass, he says that higher-ranking Forest Service officials had somehow found more loggable acres than existed on the entire Forest. Recognizing a problem in that, Shoaf took his findings to his bosses in the Forest Service.

He ran into his second problem at that point. Told that their logging plans were not realistic, his bosses re-assigned him to other work. Why? Although a relatively low-ranking employee in the Forest Service, Bill Shoaf had just walked into the buzzsaw of international trade.

“This was an exceedingly high-stakes game,” he says in The Taking of the Tongass. “Now that the cold war had thawed, the new buzz phrase was ‘balance of trade with Japan’.”

So, how well did Japan’s economy do?

One answer is that, all through the booming ‘80s, Japan just seemed to get richer and richer. The world press was abuzz with stories describing Japan as the world’s new economic superpower, and calling its economy a “miracle economy.” Some worried Americans even said that Japan had taken the steering wheel of capitalism, and would leave U.S. capitalism in its dust.

American anxiety ran deep for reasons both general and specific. First, almost every living American up to 1980 thought of the three little words “Made in Japan” as code for cheap trinkets that we generally described as junk. At first, this perception inhibited American perception of Japan as a superpower.

The rude awakening came on a case by case basis, such as Japan’s great success in selling the likes of cameras, cars, and computer chips in the American market. As even small newspapers across America would eventually report, the Japanese were building cars of higher quality than Detroit was making, and the result was a river of American money circulating to the Land of the Rising Sun.

That circulation of money became a major story in its own right, mostly because it seemed a one-way street. Flooded with U.S. dollars from its sales to millions of ordinary Americans, Japan was not buying very many American goods. Instead, as a torrent of articles and books fretted in the 1980s, the suddenly wealthy Japanese were buying America itself -- from sea to shining sea, Americans saw story after story of Japanese businessmen buying not just American logs but also some of the USA’s most famed landmarks.

Not since Pearl Harbor had Americans been so nervous about the Land of the Rising Sun, but this time it was fear of a rising economic power rather than a military one. And all of it seemed proof aplenty that the planet’s so-called tree-huggers would indeed endanger the Japanese construction boom if they stopped or slowed the logging that fed it.

Another, perhaps less widely reported change unnerved many of the Americans who noticed it. During the 1980s, under the conservative leadership of the Reagan administration, the United States transformed itself from the world’s biggest lender to its biggest borrower.

The seemingly rich Japan lent substantial amounts of money to its American ally, then publicly scolded America for living beyond its means.

Then, in 1990, Japan’s alleged financial miracle turned to mud. On both sides of the Pacific Ocean, jaws dropped in surprise at the news of it. There should have been much less surprise than there was. There had been warnings of trouble ahead for the world’s second-largest economy, including Bill Emmott’s The Sun Also Sets. But warnings never impress people as much as the actual event – in this case, the crash of the Japanese economy.

When Japan’s economy did hit the wall, environmental reporters had little to say, but the planet’s business and financial press immediately commenced a rigorous postmortem analysis. What did they find? Part of the answer was as simple as the old American adage that there can be too much of a good thing.

.During the ‘80s, Japan’s finance industry lent so much money into construction of real estate that the nation ended up with lots more buildings than the real-world market needed, or wanted. Economists have a variety of words for describing the situation: e.g., excess, oversupply, surplus, and overcapacity. Under whatever name, that single and seemingly simple problem was enough to set off a series of falling dominoes that would rock Japan’s economy to its core.

First, because their construction did not meet real-world market demand, these buildings could not fill with tenants and businesses. Left unfilled, they triggered the next step in Japan’s long downhill slide. Left unfilled, the buildings could not earn money for Japan’s enthusiastic real estate developers. Then, without earnings to put in their own pockets, the developers could not repay the banks.

Enter, that dirtiest of four-letter words in the world of money : loss.

Because they were not making money, Japan’s empty buildings started losing value fast. In one of the darkest scenarios for financiers, Japanese real estate’s value even fell below what the banks had lent to build it. As a result, bankers couldn’t sell the buildings for enough to recover their money.

The Economist would report that Japanese real estate had lost more than two-thirds of its value, that Japan’s banks were in “desperate straits,” and that “The size of the hole staggers the imagination.” Environmentalists had been saying much the same thing about the hole left in forests.

Having financed a forest-busting construction boom, now the banks themselves were busted. For all practical purposes, the forests may as well have fallen on the banks.

Japanese homeowners were busted next. Many Japanese people had borrowed money to buy new homes when the boom was hot and home prices were on their way up. In those circumstances, buyers can panic, fearing that if they don’t buy now they won’t be able to afford more costly homes later.

In buying panics, buyers keep bidding higher and higher, which means that buyers do see their home’s price going up after they buy it. Seeing that, they feel richer. It can all seem very rational.

It’s a trap. Economists call it a bubble. Mistaking high price for high worth, Japan was inflating a bubble that would blow up in bankers’, builders’, and homebuyers’ faces like the soap bubbles that pop before the eyes of children. The pain begins at once.

When Japan’s bubble burst, home prices that had gone up started going down. When that happened, Japanese homeowners found themselves making payments on loans for homes that were worth less than they’d borrowed to buy them. For all practical purposes, the forests may as well have fallen on them.

But the downturn didn’t stop there. The damage to homebuyers immediately spread to the economy as a whole. Afraid that their homes could lose even more value, and increasingly afraid even for the future of their national economy, ordinary Japanese became increasingly wary of spending on much of anything but necessity.

Japanese consumers’ fear of spending kept them away from the nation’s retailers. The prospect of operating empty stores forced retailers to cut prices in hope of luring buyers back. But Japan’s shoppers did not flock to the stores. Instead, the falling prices of retail goods just made many ordinary Japanese even more fearful: Why take the risk of buying something today when it may become even cheaper tomorrow?

With stories still not full of shoppers, retailers set even cheaper baits to lure them. But this only confirmed what shoppers had suspected, so they kept the reins on their spending. The net effect was a greatly reduced circulation of money throughout the suddenly stressed Japanese economy.

Falling prices were not the only pressure point for ordinary Japanese people. By 1996, for example, The Economist would report that Japanese taxpayers had become “furious at having to pay for the bad loans their banks made before the bursting of their country's bubble economy in 1990."

With the banks busted as of 1990, bankers could no longer make the giant loans required to keep Japan’s construction boom going. If the borrowed Japanese boom had ended there, the pressure on forests from SE Asia to SE Alaska would have been eased.

The likes of bears, elephants and tigers would have found survival a little easier. Malaysia’ forest villagers could have been let out of jail. America’s Forest Service could have felt an easing of its conflicts at home. America’s most powerful ally in Asia would have been spared the pain of continuing to build what its economy did not need. And ordinary Japanese people could have avoided new economic pain atop the old.

But Japan’s ruling political party – the grossly mis-named Liberal Democratic Party, which is neither liberal nor democratic -- decided to keep the construction boom going. Their decision to follow their bankers’ bad example only added fire to a classic example of John Kenneth Galbraith’s dictum: “Prestigious stupidity can be a controlling fact in economic life.”

That was then, and it will be easy for many Americans to shrug off Japan’s spectacular debacle as something of an earlier time, and another country. But today’s similar American debacle of FRECLnomics shares much with Japan’s example of prestigious stupidity in the realms of finance and forest, because many an American politician has put his or her prestige on the line to perpetuate this nation’s giddy construction boom.

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