Economic Development of Japan
No.7 Showa Financial Crisis
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
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)?
Causes of the Showa Financial Crisis
According 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.
“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)
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 owners 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 and no monitoring (especially
rural banks).
--Bank owners were wealthy men who did not actually
supervise banking business (especially rural banks).
P.114
Kikan Ginko (機関銀行 institutional banks)
Collusion between bank & business
1980
1970
1960
1950
1940
1930
1920
1910
1900
1890
1880
Cf. Number of Japanese banks in 2012: 144
1870
World War I
Japan-China War & WWII
• 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)
Number of banks
was repealed in 1895.
2500
Large vs small banks
2000
Large zaibatsu banks
1500
 Group companies
1000
Small kikan ginko
500
 Local SMEs
0
Kikan Ginko Visualized
A respected & influential
man in the community
OWN
DEPOSIT
Local
residents
OWN
LOAN
BANK
COMPANY
No disclosure of bank or company performance
No prudential regulation or deposit insurance
Concentration of bank lending to one or a few companies
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
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
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)
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
60
50
40
30
20
10
1942
1939
1936
1933
1930
1927
1924
1921
1918
1915
1912
1909
1906
1903
1900
0
1897
USD/
100yen
Suzuki Shoten & Bank of Taiwan
Naokichi Kaneko,
Suzuki manager
BOT Assets & Liabilities
Million yen
600
Loans
500
Suzuki & Co.
P.117
400
Lo an s t o Su zu ki
300
200
Deposits
100
0
1918
1919
1920
1921
Bubble ends
1922
1923
1924
1925
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”)
1926
Earthquake Bill Problem
PP.115-16
• 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
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 week
moratorium on debt repayment (Apr.22- May 12)
which ends bank runs
Aftermath of the 1927 Bank Run
• 36 banks closed (but not 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.
Bank Loans PP.120-21
Bank Deposits
Mil. yen
10000
10000
9000
9000
8000
8000
7000
7000
6000
6000
5000
5000
4000
4000
3000
5 banks
38.3%
2000
1000
3000
2000
5 banks
29.6%
1000
0
0
1926
1927
1928
1929
1930
1931
1926
1927
1928
1929
1930
1931
• 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.
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.
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 (export receipt, remittances, FDI,
ODA, military aid, bank loans, stocks & bonds, 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
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
VNDirect Securities Joint-stock
Company Research
Trade & CA Balance
% GDP
2002
2003
2004
2005
2006
VNDS
2007 2008
0
Newsletter （May 2008）
貿易収支
-5
Trade
balance
-10
2006
2007
2008P
GDP growth
8.2
8.4
6.2-6.5
-15
GDP (＄billion)
60.9
71.2
84
-20
Inflation (%)
6.1
12.6
17-18
VND/USD
16051
16010
16500
Export （％GDP）
64.8
68.3
69
Import （％GDP）
73.6
85.7
91.8
Current
account
経常収支
-25
$ billio n
7
6
Capital Account
直接投資（ネット）
証券投資
5
($ billion)
2006
2007
2008P
4
Trade balance
-5.4
-12.4
-20
3
Transfer (net)
4.8
5.5
6
2
Current account
-0.2
-6.9
-13
1
Capital inflow
6.5
12.4
10-14
0
Capital outflow
-0.4
0
0
Foreign reserves
11.4
21.9
15-20
2002
2003
FDI (net)
Portfolio
2004
2005
2006
2007
Add to this Viet Kieu Remittances, WR, ODA
Ethiopia: High Inflation in 2008
Annual Chanages in the Consumer Price Index
%
100
Annual Changes in the Consumer Price Index
100%
80
80%
T otal Average
T otal Y-to-Y
60
Food Y-to-Y
60%
Nonfood Y-to-Y
40
40%
20
20%
0
0%
-20%
2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
2009
Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.
2a. Tradable vs. Non-tradable Sectors
Real Exchange Rate
Sectoral Share in GDP, in %
N ominal and Real Effective Exchange Rates
Non-tradeable Sectors
(Construction, Wholesale and retail trade,
Hotels and restaurants, Transport and
communication, Financial intermediation,
Real estate and business activities,
Education and Health)
45%
(2000=100)
43%
140
Real effective
exchange rate
US dollar
per Birr
120
43%
41%
40%
41%
40%
39%
39%
39%
37%
Nontradables
39%
(construction,
trade, r. estate)
36%
36%
35%
34%
33%
34%
100
34%
35%
34%
33%
33%
Nominal effective
exchange rate
27%
33%
Tradables
30%
29%
60
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
34%
Tradeable Sectors
(Crops, Mining and
Manufacturing)
33%
31%
80
35%
35%
34%
34%
What explains this unusual pattern after FY04?
 Real Exchange Rate
Tax Policy–Manufacturing vs. Services
Investment climate (financial sector; telecom, land)
25%
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
15
Source: MOFED, Government of Ethiopia
2c. Domestic Savings vs. Foreign Capital
2b. Imports vs. Domestic Production
(% of GDP)
25%
Imported
consumption12%
goods
14%
12%
12%
20%
12%
19%
8%
15%
8%
7.5%
8%
5.5%
6%
5.3%
4%
5.4%
Manufacturing sector
value added, as a
share of GDP
5.7%
14%
11%
10%
10%
5.3%
5.2%
5.2%
What explains this unusual pattern after
FY04?
 Real Exchange Rate
 Industrial Policy
 Investment climate (financial sector;
telecom, land)
5.1%
5.2%
Domestic
manufactured
goods
5%
FY00
FY01
FY02
Source: MOFED, Government of Ethiopia
FY03
Domestic
Savings
8%
5%
What explains this unusual pattern after
FY04?
6%
 Real Interest rate
 Debt relief (increased nonconcessional borrowing)
 Remittances (feedback from growth)
Domestic
savings
6%
5%
5%
4%
4%
3%
3%
0%
FY98
FY99
10%
9%
5.2%
0%
FY98
11%
12%
9%
10%
5.3%
5.5%
3.5%
2%
Foreign Savings
= CA deficit
7.6%
5.2%
5.5%
19%
18%
18%
Share of imported
consumption
products to GDP
8.9%
Foreign
savings*
21%
20%
18%
10%
20%
FY04
FY05
FY06
FY07
FY08
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY09
16
Source: MOFED, Government of Ethiopia
17
1. Causes
• Twin problem of low reserves and high inflation
• Problems related to both external and domestic factors
External factors:
- steep increases in import prices
- weak global economy
Domestic factors:
- expansionary fiscal and monetary policies raising
domestic demand
- food supply disruptions
- overvalued exchange rate
- deficiencies in export and import competing sectors
Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.
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 critical investments, social safety and ensure adequate
recurrent allocations; raise low tax effort. Control of public
enterprise 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.
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.