KATTE KABUTO NO O O SHIMEYO
When you have won a victory, tighten your helmet strings
IT IS a curious paradox that a country whose people are so devoted to frugality and thrift should have such a strong propensity to inflation as does Japan. Yet deficit financing has been the rule rather than the exception. The overall national government budget has been balanced in only two of the past 25 years. In the postwar period prices rose to more than 300 times the prewar level. Fiscal policy in Japan has usually had an inflationary bias. Only very occasionally has monetary policy been used effectively to check the upward climb of prices. Classic examples of its effective use were seen, however, in the October 1953-1955 period and in the spring of 1957. The results were so beneficial to Japan’s economic progress that they will probably be cited in future years to illustrate what can be done when a government acts with firmness, intelligence, and determination.
As in the United States, the Great Depression brought an unbalancing of Japan’s budget, a condition that was not to be corrected for some 18 years. The nadir of the depression in Japan was reached in the last quarter of 1931, and thereafter the economy expanded. April 1931 saw the advent of deficit financing; September 1931 marked the beginning of the Japanese occupation of Manchuria. The gold standard was abandoned in December 1931. Korekiyo Takahashi, Finance Minister from 1932 to 1936, who has sometimes been called the “Japanese Keynes,” advocated deficit financing as a way out of the depression. He regarded 600 million yen as a safe limit for deficits, but the militarists needed more for the China campaign they were planning. Consequently Takahashi was assassinated in 1936 for resisting further military expenditures, and thereafter the deficits rose. The sharp growth in military expenditures in the 1930’s provided an inflationary fillip which greatly stimulated the economy. The total Army-Navy budget rose from 434 million yen in 1931 to 7,261 million in 1940. The military budget, which was 29 percent of total expenditures in 1931, rose to 65 percent in 1940. By 1937-38 the budget deficit was up to 1.5 billion yen and in 1940-41 it reached 6.9 billion yen.1
When the pressures mounted during the war period, 1937-45, the government adopted rigid financial controls, capital rationing, etc., and though prices rose, the controls were relatively effective. There was no runaway inflation, and finance was never a limiting or disruptive factor in the expansion of the war economy. The deficits rose in magnitude from 13.4 billion yen in 1941-42 to 76.6 billion in 1945-46, and the money supply (currency and demand deposits) expanded from 30 to 140 billion yen.2 The extent of the latent inflation is apparent.
Real difficulties were encountered immediately after the surrender, when the relaxation of government authority resulted in an expenditure spree and a consequent sharp rise in prices. The Bank of Japan note issue stood at 30 billion yen on August 15, 1945, but in the ensuing six weeks some 40 billion yen more were paid out by military and civilian disbursing officers all over Japan. The resulting sharp rise in prices from September 1945 to March 1946—a 295 percent increase—led to a currency conversion in early 1946. This was effective for only a very short time; by November 1946 the note issue was back to the preconversion level, and prices rose sharply thereafter. The deficits continued to increase from approximately 103 billion yen in 1947-48 to 166 billion in 1948-49. Government debt rose from 150 billion yen in mid-1945 to 531 billion in mid-1949. From the end of 1945 to the beginning of 1949 the money supply rose from 140 billion yen to 787 billion.3
A wage-price spiral set in, and by the end of fiscal 1948 (April 1949) wages of all production workers in manufacturing were 168 times the 1934-36 base, while official wholesale prices were 186 times higher and effective retail prices 220 times higher. Legitimate business was severely handicapped. Limited by official prices, which were changed only once a year when the pressure became too great, legitimate enterprise grew increasingly short of working capital. Wage and raw material costs rose throughout the year (especially on the black market), while fixed official prices tended to force sales on the black market if a profit was to be obtained. To produce the same volume of goods required more and more working capital each year as the inflation heightened. This strain on the working capital position of companies forced them to resort to large “deficit” loans from the government’s newly created Reconstruction Finance Bank (RFB), which began operations in January 1947. Ostensibly the Bank was to grant loans only for acquisition of capital equipment, plant rehabilitation, etc., but its funds were quickly diverted to loans to make good deficits in working capital. Outstanding debentures of the RFB, most of which were sold to the Bank of Japan, rose rapidly from 4 billion yen in January 1947 to 131 billion in March 1949.4
Since ever increasing costs prevented firms from repaying most of their loans from the RFB, and since the RFB could not therefore repurchase its debentures from the Bank of Japan, the loans caused by the inflationary costs were continually monetized by the central bank and more and more money was thereby drawn into circulation and never returned. Thus inflation begot inflation.5
The spiraling inflation made prewar company capitalizations obsolete, but firms were prevented from revaluing assets by a 65 percent tax on “revaluation profits.” Since, in addition to a flat 35 percent tax rate on corporate profits, there was an excess profits tax, the rates of which were based exclusively on earnings in relation to capitalization, any profit, in a postwar economic environment where prices were 300 times the prewar level, was subject to the top excess profits tax rate of 20 percent. To these national taxes were added a prefectural enterprise tax of 15 to 18 percent on business profits. Thus companies were taxed at a combined rate of from 60 to 65 percent. Not only did they have an incentive to sell in the black market because of the pressure of rising costs against fixed official prices, but they were also led to attempt widespread tax evasion.6
In order to hold down production costs and also to ease the plight of the consumer, who was suffering from the high cost of living, the government undertook a vast program of price subsidies. It is estimated that, at the time, half the cost of a ton of ingot steel was met by government subsidy. Imported foodstuffs were resold to consumers at 30 percent less than the landed costs. To enable exporters to meet world prices in spite of inflated yen costs at home, not only were their production costs directly subsidized but in the absence of a fixed exchange rate a complicated system of implicit multiple rates was permitted to grow commodity by commodity. Thus the Foreign Trade Board would purchase goods for export from the producer, paying the producer’s cost of production plus profit in yen, and would then sell the goods in world markets for the going price in dollars, the dollars being paid into the Dollar Trade Fund established by the Occupation. If the Board paid 6,000 yen for a bicycle and sold it abroad for $20 there was thus established an implicit rate of 300 to 1. If wage and raw material costs of the bicycle producer rose and the Board paid him 8,000 yen, but the product continued to sell abroad for $20, a rate of 400 to 1 resulted. The compulsion of a single exchange rate to hold costs down, to force rationalization to meet world market prices, was lacking.
Thus, by subsidies and a multiple exchange rate system, the Japanese producer was insulated from world market realities, and his mounting costs merely resulted in bigger government budget deficits either through larger subsidies or through greater deficiencies in the Foreign Trade Board’s fund. By the 1949-50 fiscal year, price subsidies had surpassed Occupation costs to become the largest single item of expenditure in the Japanese budget, totaling 202 billion yen out of a general account total of 704 billion yen, or 28.7 percent.7
In the light of such conditions and in view of the apparent inability of Occupation authorities to cope with the situation, the U.S. State and Army Departments in December 1948 issued the “Program to Achieve Economic Stabilization to Be Carried Out by the Japanese Government” (the so-called “Nine-Point Economic Stabilization Program”), and early in 1949 Mr. Joseph M. Dodge, then president of the Detroit Bank,8 was sent to Japan with the rank of Minister to bring economic order out of the monetary and fiscal chaos.
The theory of the stabilization program was that in order to reduce the cost to the American taxpayer of underwriting deficits in the Japanese economy, Japan had to become self-supporting. The United States had been subsidizing Japan to the extent of some $500 million per year, largely used to purchase food and essential raw materials and fertilizers. Until Japan could raise production and exports enough to pay for these essential imports, the United States would have to continue to fill the gap. To maximize exports, costs had to be brought down to the point where selling prices were in line with those in the world market. To bring costs down, inflation in Japan would have to be ended, payrolls trimmed, and rationalization achieved. To end inflation, the budget would have to be balanced, reckless uneconomic credit extension checked, and a single exchange rate established. It was to achieve such ends that the Dodge Mission labored, and in a very short time it produced an amazing financial about-face in Japan.
The achievements of the Dodge Mission9 may be summarized as follows:
1. It ended deficit financing, and, in fact, produced what some termed a “superbalanced” budget, for not only did revenues cover expenditures in all accounts, but there was sufficient excess to provide for retirement of one-fourth of the total outstanding Japanese national debt and also to provide additional surplus funds for investment purposes for the rehabilitation of Japan’s run-down capital plant. A 1948 budget deficit of 62.5 billion yen was converted into a 1950 budget surplus of 125 billion yen. Japan’s yen debt was reduced from 446 billion yen in 1948 to 316 billion yen in 1950.
2. The extent of American aid to Japan was explicitly shown for the first time and provided for in the budget (as a special account) by the establishment of the Counterpart Fund. As shipments of U.S. aid were received, the Japanese government was required to deposit in the Fund the yen equivalent of the cost of the goods. Part of the Fund was used for debt retirement, part for investment.
3. A single exchange rate was set at 360 yen to $1. Prior to World War II, in the mid-thirties, the yen was worth about 28 cents. Immediately after the surrender a military conversion rate of 15 to 1 was established. This was raised to 50 to 1 the following year, as the value of the yen declined, and in mid-1948, with the rapidly developing inflation, to 270 to 1. Of the multiple rates in existence before the setting of a single official exchange rate, on the export side some 80 percent were lower than 360 to 1. The remaining 20 percent of the export industries had to reduce costs to meet the new exchange rate requirements.
4. The deficit loans and enormous credit expansion activities of the Reconstruction Finance Bank were halted. New loans by the RFB could be made only out of the proceeds of repayment of outstanding loans. All RFB debentures were to be retired. Thus the diminished activities of the RFB could no longer result in monetization of inflation-created debt. A number of government wholesaling and distribution corporations, known as Kodans, which, using RFB funds, had accumulated unnecessarily large inventories, thereby adding to inflationary pressures, were eliminated and their functions were restored to private enterprise.
5. Subsidies were eliminated immediately in some areas and in others were reduced gradually. In addition, all subsidies were explicitly shown in the new budget, in contrast with the large degree of concealment in previous budgets. A program for the complete elimination of all subsidies was prepared “to bring the Japanese economy down off its stilts,” as Mr. Dodge put it.
6. Stock markets in the principal cities of Japan, which had been closed since the end of the war, were reopened in order to stimulate the flow of capital into industry and to increase security investment.10 With industry in need of long-term capital and with an enormous quantity of formerly Zaibatsu-held securities to be disposed of to new investors through the government’s Securities Coordinating Liquidation Commission and the “Holding Company Liquidation Commission,” it was felt to be important to attempt to create much wider public acceptance of the concept of security ownership.
7. To direct the flow of bank credit into useful productive and economic channels, and to determine credit policy, a Credit Control Board was established, modeled along the lines of the U.S. Board of Governors of the Federal Reserve System, thereby providing a sort of directorate for formulation of monetary policy. In the field of taxation Mr. Dodge made no recommendations, since he did not wish to prejudge and thereby prejudice the work of the Shoup Tax Mission. He did, however, indicate informally to the Japanese government that it would have to maximize tax revenues, and he rejected a government request for an immediate reduction of tax rates.11
Japan’s spiraling postwar inflation was brought to a temporary halt by the work of the Dodge Mission. The effectiveness of its stabilization program was seen in the decline of the consumer price index from a high of 142.5 in May 1949 (1948 = 100) to a low of 118.2 in June 1950. The Bank of Japan note issue was actually lower in March 1950 (311.3 billion yen) than in March 1949 (312.5 billion yen). The Japanese complained of tight money, stagnant output, rising unemployment, and an increase in small business failures, but a government review noted: “The price-fall brought benefits to the consumers. Family expenditures and the real consumption level for the urban populaton was 17 percent higher in the April-June quarter of 1950 than in the same quarter of 1949.”12
The outbreak of hostilities in Korea in June 1950 brought a halt to the stabilization program and led to an export boom, shortages of materials, and further inflation in Japan. The United States began its program of “special procurement” in Japan of supplies and equipment for United Nations forces in Korea, and Japanese exports rose sharply, by 60 percent, from April-June 1950 to October-December 1950. Thus in the second half of 1950 a $9 million export surplus was recorded, the first since the end of World War II, whereas the first half of 1950 had witnessed a $162 million import surplus. By June 1951 the cumulative total of special procurement reached $315 million. Between June 1950 and March 1951 Japanese export prices increased by 90 percent. In the year following the outbreak of the Korean War, Japanese wholesale prices rose 52 percent, far surpassing rates of increase in other countries, e.g., 17 percent in the United States and 22 percent in the United Kingdom. Industrial production in Japan exceeded the prewar level for the first time in October 1950, and by April 1951 it was 52 percent higher than in April 1950.
The Korean war boom began to ebb throughout the world from April 1951 on, and the international price level dropped. The Japanese price level, however, failed to record any comparable decline. In fact, wholesale prices in Japan rose slightly between 1951 and 1952. Several factors were responsible for this. For one thing, the profits of the Korean boom were plowed back into Japanese industry as an investment boom carried the rate of net capital formation in Japan to a new postwar high. Thus the prices of metals, machinery and equipment, and other investment goods continued to rise. Because Japanese prices remained so far above world levels, certain Japanese export industries such as textiles were hard hit; in order to assist these industries the government undertook certain financial measures, such as the establishment of the Japanese Export-Import Bank in 1951, and increased government investment. The Japan Development Bank was established in May 1951 with its total capital supplied by the government. These events, when coupled with the expansion of bank loans to the prosperous capital goods industries, had the total effect of increasing the money supply and thus maintaining inflationary pressures.13
At the time of his last official visit to Japan in late 1951, Mr. Dodge issued a very frank and critical statement which did not further endear him to the Japanese public. It read, in part, as follows:
At present, Japan is suffering from a plague of false legends, which include some dangerous delusions. A few of these are:
1. That Japan is a “special case” not affected by economic events that are affecting most other nations, when, as a nation dependent on imports, it is sure to be one of the first and most deeply affected.
2. That granting progressively larger amounts of commercial bank credit for capital purposes can be substituted for the normal processes of capital accumulation, without creating current credit shortages and the possibility of later difficulties.
3. That increased production without a parallel increase in exports represents sound progress.
4. That large amounts of foreign investment capital can be attracted to Japan under circumstances which do not offer political and financial stability.
5. That any use of foreign exchange will automatically replace itself.
6. That the projects most needed to protect and ensure the future of Japan, in terms of reducing the need to import and increasing the ability to export, can be done last instead of first.
7. That any future trade with Communist China will have the same advantages as it had before the war.
8. That the Korea wind-fall will be followed by another equally good or even better fair wind.
9. That in view of Japan’s progress and the unusual external sources of it, substantial amounts of foreign aid will be obtained as easily in the future as in the past.
10. That inflation is a temporary phenomenon instead of a continuing pressure in an economy short of domestic supplies of raw materials, and that inflation easily can be offset by increased production under these circumstances.
11. That the recent excessive increase in domestic prices has been caused solely by the increase in import prices.
12. That a nation that must export to live can afford to price itself out of its export markets with a domestic inflation.
13. That a rapid and excessive increase in domestic prices is inflation anywhere else in the world but not in Japan.
14. That there is anything but trouble ahead in an attempt to chase inflationary price increases with stop-gap measures which merely feed the fires of inflation.
15. That every difficulty caused by excessive debt, speculative purchasing and similar acts of bad management always is the fault of others, it is not the inevitable result of the previous mistakes of the individuals concerned, and should be borne by the government or the consumers.
The progress and the present favorable status of Japan has been the result of a series of extremely fortunate external circumstances, which cannot be expected to be repeated and continued indefinitely.14
The more important trends in the Japanese economy from March 1949 through March 1952 may be seen in Table VI-1. The March 1950 column shows the impact of the Dodge stabilization program; the March 1951 column clearly indicates the effect of the Korean boom; and the March 1952 column shows the adjustment to lower rates of increase as the boom tapered off. Clearly the so-called postKorean “slump” in Japan was nothing more than a slowdown in the rate of increase. During 1952 the Japanese economy marked time, leveling off on a kind of plateau established by the preceding Korea boom.
|Source: Economic Survey of Japan (1951-52), Economic Stabilization Agency, Tokyo, July 1952, p. 31.|
In 1953, however, Japan developed a genuine home consumption boom. Two things were strikingly manifest during 1953—a rise in the national economic level and a marked deterioration of the trade balance. The domestic boom in 1953 saw the industrial production index (1934-36 = 100) reach a new peak—161—for the whole year. In December 1953 it stood at 172.6, a 24 percent increase over 1952. Wholesale prices remained firm, however, increasing by about 3 percent between March 1953 and March 1954, but declining slightly thereafter, as the following figures indicate:
The increase in output was accompanied by a marked expansion of bank credit, particularly to finance imports. Total money supply rose by 174 billion yen, or 14 percent. National income rose to 30 percent above prewar. Allowing for population increase, per capita income, like consumption, exceeded the prewar level (by 6 percent) for the first time. At 360 yen to the dollar, the Japanese national income worked out to $160 per capita, one-eleventh of the U.S. figure and about one-fifth of the West German. Farm income increased despite the fact that output fell 20 percent. The increase in income was due to an increase in rice prices paid by the government. Income taxes were reduced at the beginning of the year. Business investment in plant and equipment rose 27 percent over the previous year.
The other side of the picture was the largest imbalance in trade that Japan had yet encountered. Exports were only $1.3 billion while imports rose to $2.6 billion. The result was a balance of payments deficit of some $300 million, despite special procurement and allied expenditures in Japan of $809 million. While most accounts of Japan’s trade difficulties in 1953 place the blame on the fact that Japan overpriced its exports in world markets, the basic explanation seems to lie with imports. Exports were about the same in 1953 as in the previous year. Imports, however, were almost $500 million higher, owing to (a) the sharp increase in domestic consumption, and (b) a 20 percent decline in the rice crop. Since the surplus the previous year had exceeded $300 million, this shift in 1953 represented a worsening of Japan’s balance of payments position by some $600 million. Japan’s foreign exchange reserves, which had reached a peak of over a billion dollars in 1952, dropped sharply to about $700 million. This drain on scarce foreign exchange was accompanied by an overextension of bank credit and heavy borrowings by commercial banks from the Bank of Japan. Credit expansion exceeded the increase in deposits. Commercial bank borrowings from the Bank of Japan increased by 76 billion yen in 1953 compared with only 9 billion yen in 1952.15 The ratio of loans to deposits, which had averaged 69.2 percent in 1934-36, rose to 98.7 percent in 1953. Prices, which had been relatively stable during the first half of the year, began to rise again during the second half.
|—indicates net repayments.|
|a Internal capital surveyed by Economic Planning Agency.|
|Source: Bank of Japan, Tokyo.|
This resurgence of inflationary pressures and deterioration in Japan’s balance of payments, together with the alarming loss of foreign exchange, led to action by the monetary and fiscal authorities. With considerable political courage the Yoshida Government moved to resort to the classic remedy of tight money.16 In October 1953 the Bank of Japan began to tighten import financing. It raised money rates three times between October 1953 and March 1954—from 7.0 percent at the beginning of 1953 to 8.5 percent by mid-1954.17 At the same time the government cut back its budget sharply, reducing public investment by 17 percent. Planned expenditures by the Japan Development Bank, the nation’s largest long-term lending agency, were cut 23 percent below the 1953 level. Foreign exchange allocations, effective April 1, 1954, sharply slashed allotments to importers of nonessential goods.
The curtailment of credit is reflected in the decline in the amount of industrial funds which the banks furnished to industry, as well as in the decrease in new stock and bond issues. As may be seen in Table VI-2, the total supply of industrial funds fell from 1,065 billion yen to 613 billion, with bank loans declining from 513.6 billion yen to 211.9 billion. On the other hand, deposits rose by 446 billion yen as consumers turned from their 1953 spending spree to increased savings in 1954. Thus the increase in deposits and the decrease in the use of funds for industrial and import purposes gave the commercial banks a plentiful supply of funds, which they used in part to repay their Bank of Japan loans.18 Such loans, which had exceeded 400 billion yen in early 1954, fell to half that figure a year later, and by March 1956 were down to a nominal 27 billion yen. This was central bank credit curtailment on a major scale.
The proclivity of the Japanese economy to inflation was checked during 1954 and 1955, as the following Bank of Japan wholesale price index shows:
|Source: Economic Statistics of Japan for 1956.|
The remarkable stability of the Japanese price level in the two years following the imposition of the tight money program may be seen in Table VI-3. The impact of the program began to be felt in March 1954. Wholesale prices reached a peak in February and then fell off until August.19 The reduction was not great—about 6 percent—and the price index turned up slightly during the last half of the year. Japan’s trade position improved significantly as imports declined and exports rose, owing to (a) the decline in export prices, (b) the greater attention which producers paid to the export market in view of the decline in domestic demand, and (c) the easing of import restrictions on Japanese goods by sterling area countries. Despite a decline in special procurement receipts, which fell from $809 million in 1953 to $596 million in 1954, a small surplus (about $100 million) was achieved in the balance of payments for the calendar year 1954, in contrast with the previous year’s huge deficit. Foreign exchange reserves climbed back to approximately $950 million. Japanese exports in 1954 reached a new postwar peak. Despite small business failures, industrial production held up, as Table VI-4 indicates. Counterbalancing this, however, was the fact that 1954 was the first year in the postwar decade that industrial output failed to expand. The index (1934-36 = 100) was 168.5 in December 1954, as against 172.6 in December 1953.
|Sources: 1937 to 1951, Monthly Bulletin of Statistics, United Nations, May 1952; 1951 to 1955, ibid., June 1956; 1956, ibid., May 1957.|
|Sources: Economic Statistics of Japan, Bank of Japan, Tokyo; Economic Statistics Monthly, Bank of Japan, Tokyo; Monthly Bulletin of Statistics, United Nations; International Financial Statistics, International Monetary Fund.|
On the other hand, the Bank of Japan note issue at the end of 1954 was below the previous year-end total. This was the first instance in 23 years (since the depression in 1931) that the annual year-end bank note issue total had declined—a significant achievement of the tight money policy. As Table VI-5 shows, total money supply was held at about the previous year’s level.
|Sources: Statistical Yearbook, 1956, United Nations, and Monthly Bulletin of Statistics, United Nations, May 1957.|
The policy of monetary restraint continued through 1955. The Mitsui Bank noted:
It can be said that extraordinary was the diminution of the Bank of Japan loans in 1955 when city banks paid back some ¥400,000 million of their borrowings from the Central Bank during a single year. The balance of the Bank of Japan’s loans was reduced from the peak of ¥418,700 million as of September 6, 1954 to ¥31,900 million as of December 31, 1955.20
The Japanese economy moved forward rapidly in 1955. The Bank of Japan observed:
As regards the Japanese economy brisk business activities, worthy of being expressed in such a phrase as “an inflationless prosperity” or a “quantitative boom,” were prevalent during the year 1955; whereas in 1954 the economy assumed a conspicuously deflationary appearance owing to the direct and full impact of the policy of financial retrenchment.21
Japan’s balance of payments showed real improvement, excess foreign exchange receipts for the year 1955 reaching $494 million, a marked increase over the 1954 surplus of $100 million. Foreign exchange reserves rose to a new high of $1.4 billion. Spurred by a substantial expansion of exports, industrial activity rose sharply, and this, coupled with a bumper rice crop, brought widespread economic gains.
Despite this improvement in the economy, the continued enforcement of the tight money policy kept domestic investment and consumer demand at relatively restrained levels, while it stimulated exports and operated to restrain any increase in commodity prices (see Table VI-6). The price level in 1955 was almost stabilized with only small fluctuations. Prices reached a low point in July (146.7), rose slightly through October (155.0), and then declined again to 152.5 in December.
The improvement in economic conditions brought further benefits in the money and banking situation. Owing mainly to the substantial excess disbursements from the Foreign Exchange Fund and the Food Control Special Account, reflecting both the gain in exports and the bumper rice crop, Treasury accounts showed an excess disbursement of 288 billion yen during 1955. As a result the money market eased, since the demand for funds was moderate. Bank deposits rose by 731 billion yen during fiscal 1955, the banks repaid their loans to the central bank, and their so-called “overloaned” condition was bettered. The ratio of loans to deposits fell to 83.5 percent. Since the tight money policy placed emphasis on the restriction of excessive imports, all Bank of Japan preferential arrangements for import financing were either curtailed or abolished. In August, the Bank of Japan’s interest rate policy was revised to make the official rate more effective, to improve the Bank’s credit control mechanism, and to rectify what had been an extremely distorted interest rate system.22
|a M=market price; Q=quoted price; E=export price.|
|Source: Bank of Japan, Tokyo.|
|Sources and Notes:|
|a From Bank of Japan.|
|b From Statistics Bureau.|
|c From Economic Planning Agency.|
|d From Ministry of Labor.|
|e From Ministry of International Trade and Industry.|
|f From Ministry of Finance. Based on customs house returns; figures for 1946 cover the period September 1945-December 1946; import value in yen for 1951 is converted into dollars at the rate of 360 yen per dollar.|
Thus from the last quarter of 1953 through 1955 Japan pursued a classic tight money policy with extremely effective and successful economic results. One can agree fully with the Bank of Japan’s comment that: “As a result of the implementation of the tight money policy, the economy and money and banking in this country have been remarkably improved, with capital accumulation accelerated, general demand for funds being sluggish and the price level stabilized.”
During 1956, however, signs of inflationary pressures began to re-emerge in Japan, as indeed they did in most other leading industrial countries. The increased liquidity of the banks, and the decline in interest rates, led to renewed borrowing. The Industrial Bank, the Development Bank, and the People’s Finance Corporation lowered their interest rates and expanded loans for long-term development projects. The foreign exchange allocation for imports was sharply increased. Wholesale prices rose steadily throughout 1956, exceeding by midyear the previous peak of February 1954, attained before the tight money policy became effective.23
Wholesale commodity prices rose 8.7 percent during 1956, in contrast with a dip of 0.2 percent during the previous year. Monetary pressures back of the price rise were clearly apparent. Loans made by all banks during the year amounted to 869.9 billion yen, approximately triple the 1955 figure of 283.9 billion yen. The note issue rose by 111 billion yen, more than twice the previous year’s increase, and bank deposits rose by more than one trillion yen24 (see Table VI-7). Most significant of all was the expansion of credit by the central bank. Bank of Japan loans rose by 108 billion yen in 1956, compared with a decrease of 211 billion yen in 1955.25 Since the Bank of Japan also absorbed 36.1 billion yen of short-term government securities sold by financial institutions in 1956—in contrast with its sale to financial institutions of 39.9 billion yen of shortterm governments in 1955—the total change in central bank credit was an increase of 144 billion yen in 1956 compared with a decrease of 251 billion yen in 1955.26
With industrial production in Japan up 22 percent over the previous year, bottlenecks, particularly in electric power and coal supply, began to appear in the economy in late 1956 and early 1957. When the draft of the budget was submitted to the Diet, calling for a large tax reduction and a marked increase in expenditures, thus prospectively contributing to the inflationary pressures through fiscal policy,27 the Policy Board of the Bank of Japan moved on two occasions in the spring of 1957 to raise the Bank’s discount rate, finally bringing it up to 8.39 percent.28 Masamichi Yamagiwa, Governor of the Bank of Japan, said the intent of the action was threefold: to force an increase in loan rates by commercial banks, thus making credit more costly; to slow the rate of capital investment; and to reverse the growing deficit in Japan’s foreign trade.29
Nihon Keizai reported:
The Bank of Japan, on April 26, 1957, sent for leading executives of the nine big Tokyo banks including Fuji, Mitsubishi, Dai-Ichi, Mitsui, Kangyo, Kyowa, Kogyo, Long-Term Credit, and Tokyo, and strongly entreated them through the chief of the Bank’s Business Department to the effect that, the present rapidly deteriorating balance of payments situation forbids the Bank to go on increasing its advances, and therefore, banks hereafter are advised and expected to extend new credits only in so far as could be financed by collection of their loans. This was taken as the manifestation of a firm attitude on the part of the Bank of Japan not to approve of any increase in the outstanding bank loans in the future. It is certain that the Bank’s policy of curbing credit mostly through suasion at the Bank’s counter, would be further strengthened.30
The Financial System Research Council released the draft of a plan to establish legal reserve requirements for commercial banks, a move which would also limit credit expansion.31
In June the Bank of Japan ordered the nine leading commercial banks to cut their proposed lending by 50 percent. In July, the Bank of Japan ordered the nine banks to hold their volume of new loans to the limit of funds they received in repayments. Bankers said that this was the first time that the central bank had ever issued such an order. Both private enterprise and government were persuaded to reduce their investment plans by 15 percent. As a means of curbing imports, the amount of deposit required as security for importing goods was raised, and 5 percent in cash had to be deposited with the Bank of Japan. Both the Bank of Japan and the commercial banks lowered rates on discounts and advances on export bills.32
Despite these measures, Nihon Keizai reported:
The banking results for the first half of the business year 1957 (April-Sept.) of all banks of the country, as made public by the Bank of Japan, show a huge increase in loans during the period of ¥420,500 million, which nearly equals the extraordinary gain in the same period last year of ¥461,300 million. Although stringent monetary policy was put into effect since May last, it has not yet had sufficient influence upon industrial activities during the period and demands for funds continued enormous.33
In his opening speech before the three-day conference of branch managers of the Bank of Japan, on October 3, 1957, Governor Yamagiwa indicated his determination to continue the tight money policy as long as necessary. He said the effects of the stringency had begun to be felt in distribution but not in production.34 Loans amounting to $125 million and $175 million were obtained from the International Monetary Fund and from the U.S. Export-Import Bank to mitigate the expected further decline in foreign exchange reserves.
As in 1953, it was again the sharply deteriorating balance of payments position in the spring of 1957 which caused the monetary authorities to take vigorous action. The decline in the balance of payments position resulted from very rapid industrial expansion in 1956, particularly in the field of capital goods, which caused imports to rise much faster than exports, thereby depleting foreign exchange reserves rapidly and drastically.
The extent of the rise in capital investment in Japan during the last half of 1956 and the first half of 1957 may be seen from the following:35
The consequence of this surge in buying new equipment was a remarkable increase in imports. While exports rose 12 percent during the first six months of 1957 as compared with the same period in 1956, imports jumped by 67 percent. The resulting deficit of $399 million in the balance of payments brought foreign exchange reserves well below what is considered an adequate level. For the first eight months of 1957, the deficit in international payments amounted to $570 million, well in excess of a third of Japan’s total foreign exchange reserves at their 1956 peak.36 The policy of restraint took hold during the latter half of 1957 and the payments deficit for the year was reduced slightly to $533 million.
The sharp deterioration in Japan’s foreign exchange position during the last half of 1956 and the first half of 1957 may be seen from the following:
|Source: Foreign Exchange Statistics, Bank of Japan, December 1957.|
1. The figures of national income are based on the estimates for the respective fiscal years made by the Economic Planning Agency.
2. The figures of national taxes, including payments of monopoly (inclusive of alcohol monopoly profits), relate to the settled account for the years through F.Y. 1956, and to the budget for F.Y. 1957.
3. The figures of local taxes, which do not include allocation tax and shared tax, relate to the settled account for the years through F.Y. 1956 and to the estimates of revenue for F.Y. 1957.
|Source: Ministry of Finance, Tokyo.|
The sharp increase in output for domestic use and the rise in prices began once again to reduce Japan’s international competitive power. Its prices rose relative to those of its principal international competitors. For example, Japanese cotton yarn, which was 10 percent lower than the Italian product at the beginning of 1956, was 5 percent higher by the end of the year. Japanese electrolytic copper, which was priced the same as the Belgian product at the beginning of 1956, was 23 percent higher by the end of the year.
In the face of these economic developments the stringent monetary measures undertaken were clearly justified and essential. What was foolhardy from an economic point of view, though politically understandable, was the largest tax relief measure since the war, representing a saving of up to 50 percent for the average salaried man. Whether a reduction of income taxes, amounting to 125 billion yen, is justifiable at a time when the government is increasing its expenditures, when the economy is operating at a strained level, and when the central bank is attempting, by monetary policy, to contain inflation, can be questioned, especially since the burden of taxes has been falling steadily in Japan since 194937 (see Table VI-8).
Clearly, Japan cannot hope to expand its volume of exports significantly—which it must do if industrial output is to continue to grow without balance of payments difficulties—unless the prices of its exports are held in check. This can, of course, be achieved only with political courage, and at considerable hazard, as Mr. Yoshida learned. The reluctance of Japanese politicians to press the issue firmly is not surprising. Yet Japan’s great dependence on foreign trade and its extensive trading relationships in the world economy clearly point to the need for checking inflation and reducing costs and prices. Monetary and fiscal policy, when employed together, are very useful tools for this purpose. It is discouraging, therefore, to see them working so often in Japan at cross purposes.