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Japan underwent its own credit crunch almost 20 years ago. The subsequent economic pain and deflation left the country weakened but its experience could shield it from the shocks currently battering the US and UK economies.

The Japanese credit-crunch story certainly sounds familiar enough. Financial deregulation, stable inflation and long-term economic growth meets with excesses of cheap capital to produce a startling asset bubble that sends stock and property prices soaring.

In a prequel to the US sub-prime loans catastrophe, a very similar set of circumstances combined in Japan in the late 1980s that was to blight the economy for the next decade and a half.

The source can be traced back to policies introduced in post-war Japan to help rebuild the country’s shattered industrial production and infrastructure.

Around 40 per cent of Japanese industrial capacity had been lost during the Second World War and the country relied on US support throughout the 1950s. Factories were equipped with the latest technology and a well-trained disciplined workforce invoked Japan’s renowned productivity to boost economic growth.

Government policy encouraged savings and a naturally cautious population was only too happy to oblige. Cash built up quickly in banks and was used to further investment, helping to create the keiretsu, the dominant industrial conglomerates.

Having sorted the basics, Japan then tackled value-added sectors in the 1960s with a passion for engineering and cost reduction, firstly in automobiles and secondly in technology.

The country was and remains highly dependent on imports of fuels and raw materials, making it prone to the volatility that can affect world markets.

Nonetheless, the economy continued to expand and by comparison with the United States, Japanese growth was strong after the first petrol crisis and into the 1980s.

At the same time, the economy began to mature and face inwards, relying less on exports and world markets and more on domestic consumption. GNP in the 80s rose from $9068 (£5077) in 1980 to $23,801 10 years later – providing Japan’s mature and diversified manufacturers with an extensive market.

The government continued to encourage savings and the money sloshing round the system became easier to obtain as loans. On top of that, Japan’s large trade surpluses pushed up the yen, allowing local companies to invest more cash in research, development and productivity. That, in turn, lowered the cost of Japanese manufactured goods that again swelled the country’s trade surplus.

All that stockpiled cash had to go somewhere and equities, buildings and trophy buys, including film studios, artwork, international golf courses and Los Angeles tower blocks, were de rigeur as the decade drew to a close.

The yen’s continued appreciation made financial assets extremely attractive buys, especially as exporter competiveness eventually fell. Banks were happy to lend on 120 per cent loan to values with little or no checking that loans would ever been repaid.

When the Bank of Japan finally got wise to the growing bubble, it reacted as central banks often do: with knee-jerk measures with unintended consequences. It suddenly and infamously cut rates in a bid to difuse the speculative markets, but simply fuelled another highly leveraged buying orgy. A swift reverse course burst the bubble in spectacular fashion.

The Nikkei 225 index of leading shares plummeted, halving from a peak of 39,000 in a year. Investors then watched it fall relentlessly over the next 13 years to just 7600, some 80 per cent off its peak.

The fall in property values made America’s and the UK’s woes look like ripples on a pond. Many homes lost 80 per cent of their value and some commercial property was worth just 1 per cent of its peak level by the time markets settled well over a decade later.

The economy froze over. Consumers were scared to spend, banks were left nurturing huge portfolios of unserviceable loans and industry unable to invest for expansion.

The government spent a cool ¥100trn (£524bn) on building projects, massively upping the money supply and prompting gloomy consumers into another round of cash hoarding, fearing greater taxes in the future.

Interest rates peaked at 6 per cent in 1991 and fell to just 0.5 per cent by 1995. But zero interest rates failed to kick start the economy and government loan guarantees simply allowed the rotten core of bad loans to fester.

The banking sector only recoverd when the reforming government of Junchiro Koizumi gained power in 2001. Mergers were forced through and bad debts ring-fenced in a bid to free up the system.

The process may have been long winded but economic reforms have stood Japan in good stead, says Simon Somerville, manager of the Jupiter Japan Income fund.

“They simply do not have the crisis. Balance sheets are strong and households are not in debt. The banks are now overcapitalised.”

While others freeze investment plans, Japan’s corporations are finally doing what they have promised for the last 10 years and a recent $50bn (£28bn) acquisition spree is likely to continue, adds Mr Somerville. Pharmaceutical companies have bought up Indian and US assets, while Tokio Marine snapped up mid-size US non-life company Philadelphia Consolidated for $4.7bn in August.

Share prices are below book value, companies have large cash piles and face increasing pressure to mount buyback operations.

Traditional reluctance to do so is melting away. Toyota recently bought back and cancelled 4.5 per cent of its outstanding shares.

Dividend growth was over 20 per cent over the last five years and buybacks are also boosting yields to more acceptable levels. Total shareholder yields on Topix ex Financials stocks should be 3 per cent for the year ended March.

More buybacks are expected and Mr Somerville says a change in attitude by Japan’s biggest equity holders, the life companies that generally vote in line with board recommendations, should accelerate the process.

Equities remain at the mercy of global markets and can swing substantially if sentiment changes. When Japanese Reits recently failed to obtain international financing to buy residential developments from hard squeezed construction firms, hedge funds bailed out, cutting Reit prices by half.

With global demand slowing, Mr Somerville remains underweight on exporters, although he recently switched a position in Honda to Toyota on the strength of its small car range.

His largest holding remain inward looking and reliant on the domestic economy. East Japan Railway and NTT DoCoMo continue to make up almost 12 per cent of his portfolio.

He says: “It will be a tough year with the slowing global economy and costs up, especially the oil price. The price of the yen also hurts profitability but Japan remains a safe haven.”