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Lecture 07 Showa Financial Crisis
The document discusses the Showa financial crisis of 1927 in Japan, detailing its fundamental causes, immediate triggers, and economic impact. Key factors included a pre-modern banking system, excessive business rescues without restructuring, and damages from the Great Kanto Earthquake. It explores policy responses, the aftermath of bank runs, and implications for the financial structure, highlighting the need for effective crisis management measures.
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Lecture 07 Showa Financial Crisis
- 1. Economic Development ofJapan No.7 Showa Financial Crisis
- 2. The Showa FinancialCrisis, 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 forConsideration • 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 theShowa 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.
- 5. “Fundamental causes ofthe 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 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).
- 7. 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 0 500 1000 1500 2000 2500 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 Japan-ChinaWar&WWII WorldWarI Number of banks P.114 Cf. Number of Japanese banks in 2012: 144
- 8. Kikan Ginko Visualized OWNOWN 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 A respected & influential man in the community LOANDEPOSIT Local residents
- 9. WW1 Bubble andBurst • 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
- 10. Policy Response in1920 • 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
- 11. Rescue Measures byBank 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)
- 12. Two More Blowsto 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 0 10 20 30 40 50 60 1897 1900 1903 1906 1909 1912 1915 1918 1921 1924 1927 1930 1933 1936 1939 1942 USD/ 100yen PP.114-15
- 13. 0 100 200 300 400 500 600 1918 1919 19201921 1922 1923 1924 1925 1926 Loans Loans to Suzuki Deposits Suzuki Shoten & Bank of Taiwan EarthquakeBubble ends Million yen --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”) BOT Assets & Liabilities Naokichi Kaneko, Suzuki manager Suzuki & Co. P.117
- 14. 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 PP.115-16
- 15. Three Waves ofBank 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 PP.116-120
- 16. Aftermath of the1927 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.
- 17. • Five largestbanks—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. 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 1926 1927 1928 1929 1930 1931 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 1926 1927 1928 1929 1930 1931 Bank Deposits Bank LoansMil. yen 5 banks 38.3% 5 banks 29.6% PP.120-21
- 18. Special Topic: ANew 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.
- 19. 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
- 20. 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
- 21. 2006 2007 2008P GDPgrowth 8.2 8.4 6.2-6.5 GDP (＄billion) 60.9 71.2 84 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 ($ billion) 2006 2007 2008P Trade balance -5.4 -12.4 -20 Transfer (net) 4.8 5.5 6 Current account -0.2 -6.9 -13 Capital inflow 6.5 12.4 10-14 Capital outflow -0.4 0 0 Foreign reserves 11.4 21.9 15-20 -25 -20 -15 -10 -5 0 2002 2003 2004 2005 2006 2007 2008 %GDP 貿易収支 経常収支 0 1 2 3 4 5 6 7 2002 2003 2004 2005 2006 2007 直接投資（ネット） 証券投資 $ billion VNDSVNDirect Securities Joint-stock Company Research Newsletter （May 2008） Trade & CA Balance Capital Account Add to this Viet Kieu Remittances, WR, ODA Trade balance Current account FDI (net) Portfolio
- 22. Ethiopia: High Inflationin 2008 -20% 0% 20% 40% 60% 80% 100% 2002 2003 2004 2005 2006 2007 2008 2009 Total Average Total Y-to- Y Food Y-to- Y Annual Changes in the Consumer Price Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009. 2002 2003 2004 2005 2006 2007 2008 2009 % 100 80 0 20 40 60 Annual Chanages in the Consumer Price Index
- 23. Real Exchange Rate 60 80 100 120 140 19992000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Real effective exchange rate Nominal effective exchange rate Nominal and Real Effective Exchange Rates (2000=100) US dollar per Birr 17 10% 6% 4% 5% 3% 4% 6% 3% 5% 11% 18% 18% 18% 19% 9% 8% 12% 10% 19% 21%20% 20% 11% 14% 9% 10% 0% 5% 10% 15% 20% 25% FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: MOFED, Government of Ethiopia Foreign savings* Domestic savings 2c. Domestic Savings vs. Foreign Capital What explains this unusual pattern after FY04? Real Interest rate Debt relief (increased non- concessional borrowing) Remittances (feedback from growth) 16 5.3% 5.5% 5.2% 5.2% 5.2% 5.1% 5.2% 7.5% 7.6% 8.9% 12% 5% 5.3% 5.4% 5.5% 5.3% 3.5% 5.5% 5.2% 5.7% 8% 8% 12% 12% 0% 2% 4% 6% 8% 10% 12% 14% FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Source: MOFED, Government of Ethiopia Share of imported consumption products to GDP Manufacturing sector value added, as a share of GDP 2b. Imports vs. Domestic Production What explains this unusual pattern after FY04? Real Exchange Rate Industrial Policy Investment climate (financial sector; telecom, land) 15 34% 30% 33% 35% 35% 35% 34% 33% 36% 40% 39% 39% 39% 40% 41% 43% 34% 34% 34% 36% 34% 33% 33% 34% 25% 27% 29% 31% 33% 35% 37% 39% 41% 43% 45% FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 2a. Tradable vs. Non-tradable Sectors Source: MOFED, Government of Ethiopia Sectoral Share in GDP, in % Tradeable Sectors (Crops, Mining and Manufacturing) What explains this unusual pattern after FY04? Real Exchange Rate Tax Policy–Manufacturing vs. Services Investment climate (financial sector; telecom, land) Non-tradeable Sectors (Construction, Wholesale and retail trade, Hotels and restaurants, Transport and communication, Financial intermediation, Real estate and business activities, Education and Health) Imported consumption goods Domestic manufactured goods (% of GDP) Nontradables (construction, trade, r. estate) Tradables Foreign Savings = CA deficit Domestic Savings
- 24. 1. Causes • Twinproblem 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.
- 25. • 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 IMF/WB Advice to Ethiopia Source: IMF/WB joint presentation to the Ethiopian Government, Addis Ababa, April 2009.
- 26. 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.