Toyoo Gyohten was the senior Ministry of Finance (MOF) official handling international affairs back in the early '70s, and a source of wisdom to those of us trying to understand Japan's financial maze. He now heads Japan's Institute for International Monetary Affairs. In a recent address to the Aspen Institute in Colorado he has neatly summarized the many policy mistakes behind the bubble economy of the late '80s.

Japan then had a problem of Catch-22 dimensions. The United States was angry over Japan's persistent trade surpluses. But the rapid yen appreciation that should have cut the surpluses had also harmed the economy to the point where the fall in domestic demand had cut imports and firms were expanding exports in order to survive. Instead of falling, the trade surpluses had increased. An even angrier U.S. began to demand concrete measures to expand domestic demand.

Normally this should have been done through fiscal stimulation. But Japan's conservative policymakers opposed any increase in government debt. As Gyohten puts it, MOF's "obsession with the idea of fiscal soundness" forced Japan foolishly to rely solely on monetary stimulus. Interest rates were slashed and even as land prices began to boom the Bank of Japan (BOJ) convinced itself there was no real problem since other price indicators were stable. Like almost everyone else in Japan at the time, it believed that inflated land prices were inevitable anyway in land-scarce Japan.