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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 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.
“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).
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
Jap
an-C
hin
a W
ar &
WW
II
World
War
I
Number of banks
P.114
Cf. Number of Japanese banks in 2012: 144
Kikan Ginko Visualized
OWN OWN
BANKCOMPANY
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
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)
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
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
0
100
200
300
400
500
600
1918 1919 1920 1921 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 & LiabilitiesNaokichi Kaneko,
Suzuki manager
Suzuki & Co.
P.117
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
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
PP.116-120
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.
• 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.
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
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
2006 2007 2008P
GDP growth 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
$ bi l l ion
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
Ethiopia: High Inflation in 2008
-20%
0%
20%
40%
60%
80%
100%
2002 2003 2004 2005 2006 2007 2008 2009
Total
AverageTotal Y-to-
YFood 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
Real Exchange Rate
60
80
100
120
140
1999 2000 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
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.
• 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.
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.
