The modern Western economy is increasingly predicated on a single, unspoken assumption: that governments will do whatever is necessary to protect the wealth effect. Rising asset prices are no longer treated as a happy side effect of growth—they are the primary guarantor of household solvency, fiscal receipts, and political legitimacy. The housing bubbles of the early 2000s cemented this dependency. The equity booms of the 2010s and 2020s institutionalized it. Each crisis—whether the Global Financial Crisis or the pandemic panic of March 2020—has only deepened the conviction that the state must stand ready to stabilize valuations whenever they are threatened.
Yet history offers two extraordinary counterexamples. Japan and China, each in their own way, rejected the dogma that asset prices must always rise. They demonstrated that governments can allow or even engineer the destruction of household wealth. But they also proved how high the cost of such rejection can be—and how narrow the preconditions for enduring it.
Japan’s experience is the archetype of passive capitulation to deflation. At the peak of its late 1980s bubble, Japan’s economy was saturated with speculative excess that dwarfed anything in Western markets. In 1989, the Nikkei touched nearly 39,000, more than quadrupling in four years. Real estate valuations reached surreal extremes: the land beneath the Tokyo Imperial Palace was notionally worth more than the entire state of California. Banks had built their balance sheets on this collateral. Corporates and households had leveraged against it. The illusion was total.
When the crash began, policymakers faced an impossible choice. They could attempt to reflate asset prices by slashing rates to zero, monetizing bad debts, and engineering a massive currency depreciation. Or they could let valuations fall to something approximating reality, at the cost of growth, confidence, and political prestige. Unlike the United States decades later, Japan chose the latter. The wealth effect was sacrificed to preserve currency stability and to avoid the moral hazard of explicit bailouts.
For a generation, Japan paid the price. Equities collapsed by more than 60%. Land prices deflated for decades. Consumption stagnated. Banks became walking corpses, unwilling to recognize losses or extend new credit. And yet, remarkably, Japan’s society tolerated this grinding deflation. The reasons were structural and cultural: a high savings rate, a still-young demographic profile in 1990, and a social fabric that placed a premium on collective endurance over individual grievance.
China’s decision to destroy the wealth effect, by contrast, was neither passive nor defensive. It was an act of political theater designed to remind its citizens who ultimately owned the capital markets. In 2014–2015, Beijing’s propaganda machine explicitly encouraged retail investors to buy stocks on margin. The Shanghai Composite doubled in a year. Speculation was framed as an expression of patriotism and national destiny. Then, as the mania crested, the Party abruptly changed course.
Initially, Chinese authorities did attempt to prop up prices—banning large shareholders from selling, pressuring funds to buy, and threatening short sellers with prosecution. But when these measures failed to arrest the decline, they allowed the market to collapse. Tens of millions of households were wiped out. This was not, as in Japan, an unavoidable deflationary spiral. It was a calculated demonstration that in China, no asset is ever beyond the reach of the Party’s discipline.
These two episodes are united by a single theme: both governments were prepared to sacrifice household wealth because they judged the alternative to be worse. In Japan, reflating the bubble would have destroyed the yen’s credibility and rewarded reckless speculation. In China, sustaining the boom would have entrenched the illusion that wealth could grow independently of state sanction. Each government was willing to endure the social pain because they retained buffers—Japan’s cultural stoicism and demographic resilience; China’s authoritarian capacity and capital controls—that made such sacrifice survivable.
It is precisely these buffers that Western democracies lack. The United States and Europe today have no such reserves of cultural cohesion or institutional authority. Western retirees cannot wait decades for asset prices to recover. Western households rely on the wealth effect not merely for psychological reassurance but for basic consumption. Western political systems are too fragmented, too populist, and too addicted to instant gratification to tolerate prolonged drawdowns.
This is the most sobering lesson of Japan and China’s experiences. They do not disprove the logic that governments are trapped in the cycle of wealth effect protection. They prove how high the bar is for any state to break it. In the West, the preconditions simply do not exist.
Indeed, if one compares the policy reaction to the 2020 crash with Japan’s stoic acceptance or China’s ruthless discipline, the contrast is total. Within weeks, the Federal Reserve slashed rates to zero, backstopped corporate debt, and flooded the system with liquidity. Congress passed trillions in fiscal transfers that flowed directly into brokerage accounts, fueling one of the fastest recoveries—and most speculative manias—in modern history. Every intervention only reinforced the belief that markets will be defended at any cost.
In this context, Japan and China function as cautionary mirrors. They reveal that wealth effect destruction is possible—but only under circumstances that are anathema to Western democracies. For Japan, it meant decades of stagnation and a psychological resignation to decline. For China, it meant reaffirming the absolute primacy of state power over private capital. Neither outcome is acceptable in societies where prosperity is the central legitimating narrative.
This is why Western governments will continue to protect the wealth effect. Not because they believe it is optimal, but because the alternative—mass insolvency, consumption collapse, political disintegration—is simply unthinkable. Each future crisis will demand larger interventions. Each intervention will entrench expectations. Over time, asset markets will drift toward becoming quasi-public utilities: their valuations, once anchored by fundamentals, will increasingly be sustained by policy fiat.
And yet this too is a trap. The more that governments assume responsibility for sustaining the wealth effect, the more fragile the edifice becomes. Moral hazard is no longer an unintended side effect—it is the structural foundation. When the next reckoning comes, there will be no easy path to discipline, no cultural stoicism to absorb the losses, and no authoritarian mechanism to enforce acquiescence.
The question is not whether the wealth effect will be protected. It will be. The question is what price Western societies will pay to maintain an illusion that has already become their most sacred, and most dangerous, economic dogma.