Economic Development of Japan

1. Economic Development of Japan No.7 Showa Financial Crisis

2. The Showa Financial Crisis, 1927 Kamekichi Takahashi & Sunao Morigaki, History of Showa Financial Crisis, 1968 (reissued 1993). Part I—Fundamental causes of 1927 financial crisis Pre-modern nature of the banking system Accumulation of fundamental causes (bubble & burst) Economic damage after Great Kanto Earthquake Damage to businesses and banks after 1920 Depression Part II—Immediate causes and development Immediate causes/breakout/solution Part III—Economic impact and historical significance Impact on financial structure and market True cause of Showa Financial Crisis

3. Policy Issues for Consideration • When a large bubble collapses (1920), should weak businesses be rescued or made to disappear? • What should be done when bad debt continues to rise with no prospect of automatic solution (1920-27)? • Inject public money to write off debt? • How to avoid criticism that big businesses are helped? • Or accept financial crisis and concentrate on post-crisis restructuring? • What measures are needed to stop bank runs (1927)? • What should be done when bank runs are completely over (after 1927)?

4. Causes of the Showa Financial CrisisAccording to Takahashi & Morigaki Fundamental causes (more important) • Internal problems in the banking system (kikan ginko) • Rescuing weak businesses generously without serious restructuring after the bubble burst. • The 1923 earthquake and exchange rate instability further weakened Japanese economy. Immediate causes • Political fights over the unsettled earthquake bills. • Minor misstatement by Finance Minister Kataoka.

5. “Fundamental causes of the Financial Crisis were as follows: 1/ Despite the fact that Japan’s economy grew strongly in quality and quantity during WW1; 2/ The banking system remained pre-modern with many defects; 3/ As a result, after excessive speculation ended in 1920, both government and private businesses made the mistake of implementing only temporary measures and hoping that the next boom would bail them out. But the economic malaise was deeply rooted, and temporary measures only made things worse. In addition, the 1923 earthquake and exchange rate instability further damaged the economy. Profits fell, bad debt rose, and most banks were on the verge of collapse.” (Takahashi & Morigaki, 1993, p.7)

6. Pre-modern Banking System • 1927 Banking Crisis was caused by Japan’s internal problems, not by global economic shocks. • Japanese banks were too small and too many. They lent to too few and too carelessly. --Bank management also run other businesses and used bank money to finance them. --Lending was concentrated on one company based on personal connections. --No sense of responsibility, no monitoring (especially rural banks). --Bank presidents were wealthy men who did not actually supervise banking business (especially rural banks).

7. P.114 Kikan Ginko(機関銀行 institutional banks)Collusion between bank & business • In the 1890s, as demand for industrial funds rose, many small private banks were set up. Such banks may have been necessary in initial industrialization. • However, each bank served only one (or few) business. • Lending limit to one borrower (10% of bank capital) was repealed in 1895. Large vs small banks Large zaibatsu banks Group companies Small kikan ginko  Local SMEs Number of banks Cf. Number of Japanese banks in 2012: 144

8. WW1 Bubble and Burst • WW1 boom greatly increased fund demand --Some large banks tried to modernize management --Many kikan ginko lent to narikin for speculation --Total number of banks remained about the same • Speculation fever continued in 1919-1920 • 1920—stock market fell, prices plummeted, credit crunch began. Bankruptcies—Mar (7) Apr (45) May (106), Jun (127) Bank runs—169 (21 closed), Apr-Jul 1920

9. Policy Response in 1920 • Joint statement of Chambers of Commerce--“Government should supply sufficient funds and lower interest rates to overcome short-term difficulty.” • Prime Minister Hara--“Credit crunch is a temporary phenomenon; stability will return sooner or later.” • Finance Minister Takahashi--“Crisis is the result of over-optimistic expansion and speculation during War.” • BOJ Governor Inoue--“This is a reaction to the previous boom. Bold restructuring is necessary. Each business must make effort; do not just ask for help.”  Actual policy response was generous assistance

10. Rescue Measures by Bank of Japan, 1920 • Infusion of bank reserves (35 banks, 109 mil yen) • Supply liquidity for forex banks (3 banks, 50 mil yen) • Loans to targeted industries through their banks (sugar, wool, cotton, chemicals, steel, machinery, paper, power, shipbuilding, textile, railroad, etc; 360 million yen) This caused: 1/ Business dependency on BOJ rescue measures 2/ Political connection became important in obtaining rescue “Easy rescue in 1920 led to ballooning of banks’ bad debt, but authorities continued to avoid needed business restructuring for fear that they would be criticized of previous inaction or subsequent shock. This was the “Cancer in the Business Community.” The government could not cure the cancer and invited the brutal natural force, namely Great Depression, to solve the problem.” (MT, p.77)

11. PP.114-15 Two More Blows to Japanese Economy Great Kanto Earthquake, 1923 100,000 dead; 200,000 houses burnt or destroyed Loan recovery problem, deposit withdrawal, credit freeze Earthquake bill problem (Seisho laundered bad debt) Yen Fluctuation Business criticized forex speculation (high yen deflation) Agreed policy goal was “return to old parity” ($1=2 yen) Business restructuring & tight budget considered necessary USD/100yen

12. P.117 Suzuki Shoten & Bank of Taiwan BOT Assets & Liabilities Million yen Naokichi Kaneko, Suzuki manager Suzuki & Co. Bubble ends Earthquake --BOT and Suzuki built relations through camphor trade.--When Suzuki business expanded during WW1, BOT lent more.--After WW1, Suzuki debt turned bad.--Loans to Suzuki rose sharply after bubble burst (kusare en—unhappy but inseparable relationship)--Suzuki and BOT expected government bailout (“too big to fail”)

13. PP.115-16 Earthquake Bill Problem • BoJ accumulated bad debt by rediscounting earthquake bills (431m yen, of which 100m yen deemed bad). Banks also held un-rediscounted bad debt. • Government’s proposed Earthquake Bill Laws(1) 100m yen forgiven (Gov’t gives bonds to BOJ)(2) Max 170m yen rescheduled (banks borrow from Gov’t for 10 years; receive firms’ repayments to pay back this debt, government bonds as collateral) • Parliamentary debate in early 1927 --Seiyukai Party criticized political intention of Kenseikai government --Data gradually revealed, BOT/Suzuki debt size reported

14. PP.116-120 Three Waves of Bank Runs in 1927 • First Wave(March)—FM Kataoka misspeaks • Second Wave(March)—BOT refuses to make any more loans to Suzuki • Third Wave(April)—BOJ refuses to lend to BOT; Privy Council rejects imperial edict to protect BOJ assets; BOT closes.  Nationwide bank runs Government response Wakatsuki Cabinet (Kenseikai) falls, Tanaka Cabinet (Seiyukai) inaugurated. FM Takahashi immediately imposes 3 weekmoratorium on debt repayment (Apr.22- May 12)which ends bank runs

15. Aftermath of the 1927 Bank Run • 36 banks closed (excl. BOT). One year later, they were reopened (15), merged (8), bankrupted (5), or in restructuring process (1). • Depositors often resisted restructuring of closed banks for fear of deposit loss (only 50-70% recovered). • Special laws were passed for liquidity injection and BOJ loss compensation (max 500m yen). This created liquidity glut, lower interest rates, and bailout of unrecoverable debt at a few banks (6). • The banking sector was restructured, but real growth and the production sector (firms) were not affected very much.

16. PP.120-21 Bank Loans Bank Deposits Mil. yen • Five largest banks—Mitsui, Mitsubishi, Sumitomo, Daiichi, Yasuda • Depositors shifted deposits to large banks, causing excess liquid and low interest rates • Small rural banks shrank or disappeared, causing shortage of SME loans. 5 banks 38.3% 5 banks 29.6%

17. Special Topic: A New Macroeconomic Problem under Financial Globalization • In 2007-08 and 2010-11, global commodity inflation and high capital mobility caused large foreign exchange inflows to many countries (interrupted by the Lehman Shock). • Receiving too much foreign exchange inflow relative to GDP causes inflation, consumption boom, construction boom, property speculation, asset bubbles, etc. • In a financially integrated world, many developing countries have become prone to the cycles of excessive capital inflows, overheating, and currency overvaluation. • This is a new macro management problem different from the traditional one caused by fiscal & monetary expansion.

18. Foreign Fund-Driven Overheating & Bubble Many countries faced this problem around 2005-08: Large export earnings from extractive resources (“Dutch Disease”) Russia, Kazakhstan, Mongolia, UK, Nigeria, Zambia, South Africa, Botswana, Mauritania, Angola… Other large inflows (manuf. exports, remittances, FDI, ODA, bank loans, securities, etc.) China, Vietnam, UAE, UK, (Ethiopia?) • Large inflow (up to 20-30% GDP) • Increase in money supply & credit • Consumption & construction booms, asset bubbles, inflation, trade deficit, currency overvaluation, rise in foreign reserves

19. Vietnam: Overheating 2007 & 2011 • Large inflows of remittances, FDI, ODA, securities investment • Bank lending rose sharply and “conglomerates” invested aggressively in property in 2007 • Another inflation surge in 2011 • Vietnam vs. Japan 1927: (i) capital inflow boom vs. export-led boom; (ii) no increase in manufacturing capability

20. VNDirect Securities Joint-stock Company Research Newsletter （May 2008） Trade & CA Balance VNDS TB CA Capital Account FDI (net)Portfolio Add to this Viet Kieu Remittances, WR, ODA

21. Ethiopia: High Inflation in 2008 Annual Chanages in the Consumer Price Index %100 80 60 40 20 0 2002 2003 2004 2005 2006 2007 2008 2009 Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.

22. Nontradables (construction, trade, r. estate) Tradables (% of GDP) Imported consumption goods Foreign Savings = CA deficit Domestic Savings Domestic manufactured goods

23. Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.

24. IMF/WB Advice to Ethiopia • Possible Solutions - short term stabilization measures and longer term structural measures to raise supply response and productivity • Stabilization response good so far- inflation is coming down and reserves are increasing. Need to stay the course – initial conditions more difficult here. Global demand shock is making adjustment even harder but more important • Protect growth critical investments, social safety and ensure adequate recurrent allocations; raise low tax effort. Control of PE borrowing important. Little scope for fiscal stimulus • Reverse the appreciation of the real exchange rate i.e. more e.r. flexibility • External financial assistance that supports permanent resolution of these problems critical to help restore macro stability and maintain its strong growth and social spending performance • Close monitoring of risks to the financial system Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.

25. Alternative Diagnosis (Ohno) • Recent overheating is often caused by too much purchasing power injected from outside, not traditional monetary/fiscal expansion. Vietnam: Remittances, FDI, ODA, portfolio money Ethiopia: Remittances, FDI, ODA (maybe) Zambia, Mongolia: Copper export receipts • Proper responses: (i) mitigate private sector overheating by relatively tight fiscal and monetary policy; (ii) regulation and monitoring on capital inflow and real estate loans；(iii) detection and mitigation of asset bubbles and rich-poor gaps • Currency overvaluation is the result (symptom) of excessive inflows; it is not part of the cause or part of the solution. • If excessive ODA inflow is part of the cause, donors also bear responsibility.