Based on an article for Trust magazine – Summer 2013
Japan’s pre-war experience of deflation and reflation has several lessons for us today.
The first is not to be nihilistic about the potential for policy to make a difference. If the political will is there, reflation can gain traction with surprising speed.
The second is that successful reflation means a bull market in risk assets. As of 1931 Japanese stock prices were 70% below the 1918 high – a slump comparable to the gruelling bear market Japan has endured since 1990. Within two years of the turn to reflation, stock prices doubled and never looked back.
The third lesson concerns the necessity of a credible exit strategy, preferably expressed in clear numerical terms, rather than depending on the judgement of a single individual. Stimulus that becomes structurally embedded – whether in military spending or lavish systems of welfare – leads to disaster.
The fourth lesson is that conventional wisdom can be not just wrong, but dangerously so – especially when benign political ideals become intertwined with wrong-headed economic policies.
The commitment of Japan’s liberal elite to the deflationary gold standard created the conditions for militarism and national destruction. The commitment of today’s European elites to the deflationary euro may end up torpedoing the “ever closer union” that is their holy grail.
—————————————————————————————–
Japan is getting interesting again – thanks to “Abenomics” the reflationary policy package associated with Prime Minister Shinzo Abe.
Abenomics has a precedent – the policies of Korekiyo Takahashi, Japanese finance minister between 1931 and 1936.
According to Ben Bernanke, who is a scholar of the period, Takahashi “brilliantly rescued Japan from the global depression.” According to Hugh Patrick, the doyen of Japanese economic studies, Takahashi put together “one of the most brilliant and highly successful combinations of fiscal, monetary and foreign exchange policies the world has ever seen.”
So who was Korekiyo Takahashi? It is worth examining this remarkable man in detail, not least because senior figures in Japan’s current administration claim to be copying his approach.
Viscount Takahashi (pre-war Japan had a British-style honours system, subsequently abolished by the US occupation authorities) is sometimes referred to as Japan’s Keynes. However he was not a scholar or a trained economist. According to Richard J. Smethurst , author of a superb biography, he probably had no formal education at all!
Takahashi was born in 1854, when Japan was still a closed country under the rule of the moribund Tokugawa shogunate. He was the illegitimate son of a painter and a fishmonger’s sixteen year old daughter. Within days of his birth, he was put out to adoption with the family of a foot-soldier, the lowest rank of samurai.
Unlike commoners, foot-soldiers were allowed to have surnames. The adoptive father’s name was Takahashi.
On the brink of the Meiji Restoration, which kicked off Japan’s headlong rush to modernization, foreign traders and financiers flocked to the treaty port of Yokohama. At the age of ten Takahashi was sent to work as a houseboy at a British bank, where he quickly absorbed English and became comfortable with foreigners, as well as getting into trouble for drinking and gambling.
Two years later he travelled to California to further his English, only to be tricked by his homestay family and sold into indentured servitude as a grape-picker.
Bought out of the contract by friends, he returned to Tokyo. At the age of fifteen he was given a secure teaching position at a government school but “succumbed to the demon sake” and quit to live with a geisha. Perhaps it was this experience that inspired the Keynesian parable that he published sixty years later, just before he put his reflationary programme into practice.
“If a man goes to a geisha house and calls a geisha, eats luxurious food and spends 2000 yen, we disapprove morally. But if we analyse how that money is used, we find that the part that paid for food helps support the chef’s salary and the part used to buy fish, meat and vegetables then wets the pockets of farmers and fishermen. The farmers, fishermen and merchants who receive the money then buy food, clothes and shelter… From the individual’s point of view it would be good to save his 2000 yen, but when seen from the vantage point of the national economy spending is better.”
Takahashi’s first acquaintance with Japan’s elite financial circles came when he was given a job as a translator at the Ministry of Finance – where he shocked his co-workers by ordering in sake from a restaurant and drinking it at his desk.
In keeping with the turbulence of the times, Takahashi continued to move from responsible government jobs – he was Japan’s first patent commissioner and more or less wrote the laws on intellectual property – to dodgier areas of activity. He speculated in the silver market, set himself up as an unscrupulous stockbroker and led a group of brawling, hard-drinking Japanese miners to the high Andes. The silver mine he had purchased contained little silver and Takahashi ended up effectively bankrupt and living in a back-alley tenement in Tokyo.
Again, he was rescued by his connections and given a job at the Bank of Japan
Takahashi’s economic ideas were well formed by this stage. At a time when Keynes himself was still a schoolboy at Eton, Takahashi rose to the vice-governorship and implemented policies that, in the judgement of Richard Smethurst, were “more Keynesian than Keynes.”
Smethurst adds that Takahashi was both a Keynesian and a Hayekian at the same time. He believed that the government’s role was to create the conditions for growth, not to direct the allocation of capital within the economy. In particular he was opposed to increasing the share of military spending and maintained that Japan’s prosperity was best secured within the framework of the Anglo-American world order.
These ideas, consistently held throughout his career, ultimately cost him his life.
Takahashi’s experience and ease with foreigners made him invaluable to the new Meiji government. Proof of his talents came with the outbreak of the Russo-Japanese war in 1904. During extended stays in New York and London, Takahashi single-handedly negotiated a series of bond issues that allowed capital-short Japan to buy modern British warships and weaponry. His counterparties included Lord Rothschild, the American banker Jacob Schiff and the Scottish banker Alexander Allan Shand whom he had served as a houseboy back in Yokohama.
The results were spectacular – the sinking of the Russian fleet in the Battle of Tsushima and the first victory of an Asian power over Europeans since the Mongols laid siege to Vienna. Later Admiral Togo would tell the workers at Barr and Stroud in Glasgow, “You won the Battle of Tsushima for me.” In recognition of the role of finance, the Japanese government bestowed imperial decorations on Schiff, Lord Revelstoke (John Baring) and others.
Takahashi was in and out of public office through the first two decades of the new century. He was prime minister once, minister of finance five times and is the only governor of the Bank of Japan to have his portrait featured on a banknote. Throughout this period he argued for counter-cyclical growth policies, decentralization and a broad distribution of income. This pitted him against conventional opinion which favoured austerity and tight money and held that frivolous consumption weakened the Japanese economy.
The leader of the austerity faction was Junnosuke Inoue, a sophisticated, highly-educated Anglophile who rose effortlessly to the upper echelons of the financial bureaucracy. According to Lever of Empire, Mark Metzler’s wonderfully readable account of Japan’s pre-war monetary politics, “for Inoue it was almost as if recession was the natural state of narrow, constricted Japan.”
The contrast in temperament and background with Takahashi could not have been more pronounced. The two men started off on good terms, but grew apart ideologically in the 1920s when the economy, in Inoue’s own words, fell “from the summit of Mount Fuji to the bottom of Lake Biwa.”
Inoue welcomed the long deflationary stagnation that followed, which he believed was necessary to “tighten up people’s lax attitude.” As governor of the Bank of Japan, he hiked the official discount rate to 8.3%, where it stayed for five years, despite falling prices.
In 1929, the year in which Takahashi published his geisha house analogy, Inoue was lamenting that “luxurious living and the worsening of people’s thought” had only got worse. This was despite the fact that over the previous decade consumer prices had fallen 15% and wholesale prices 35%.
Like Britain, Japan had been forced off the gold standard by the First World War. Now, with disastrous timing, it was about to follow Britain back on. In preparation the government launched a massive austerity propaganda drive, which included movies, lectures, books and popular songs, such as the Retrenchment Ditty –
It’s the time, it’s the season,
All together, hand in hand (yes!)
Let’s retrench, let’s retrench…
You give up salt, I’ll give up tea (isn’t it so?)
Lifting the gold embargo (that’s right, absolutely!)
Until the joyful lifting of the embargo
The outcome was decidedly unjoyful. Lifting the embargo, necessary for a return to the gold standard, meant allowing the free flow of gold in and out of the country. A net outflow of gold was equivalent to contraction of the domestic money supply, which would inevitably lead to economic shrinkage. That is exactly what happened – on a huge scale.
In 1930 the economy went into free-fall. Nominal GDP plunged 20% in two years, unemployment surged and rural areas were devastated by falling prices. Brokers set up offices in hard-pressed north-eastern villages to arrange the sale of farmers’ daughters to houses of prostitution in the big cities.
The government fell, and shortly after Inoue himself was murdered by a right-wing terrorist enraged by the contrast between rural misery and plutocratic high living.
His personal disaster was to have identified himself so totally with the conventional wisdom of the times, which was strongly pro-austerity and pro-deflation. Japan’s disaster, and the world’s disaster, was that liberalism and democracy had become similarly identified.
With the failure of liberal austerity, the empowerment of violent radicalism became irreversible.
Metzler sums up as follows – “Inoue was tragically loyal to the ideas and forms of the liberal world order. By pushing the logic of that order to its full conclusion, he also helped to destroy it.”
By this time Takahashi had retired from public life to tend his bonsai, but he answered the call of duty and embarked on his last and most celebrated stint as minister of finance.
He immediately took Japan off the gold standard and closed the public deficit through bond issuance, not cuts in expenditure which had been the norm until then. He instructed the Bank of Japan to underwrite the bonds and feed them out into the market when conditions were propitious.
In contemporary terms, Takahashi depreciated the currency and combined fiscal stimulus with open-ended quantitative easing – all on a grand scale.
The result was a rapid return to growth and a stabilization of the debt-to-GDP ratio as government revenues soared. Under Takahashi-nomics, nominal output grew 70% between 1931 and 1936, while consumer prices rose just 18%.
But there was to be no happy ending, either for Takahashi or Japan. So successful was the reflationary programme that within five years it was time to implement an exit strategy. Takahashi, a strong advocate of civilian control of the military, had been critical of the Japanese army’s unbridled adventurism in China. It was clear that military expenditure would bear the brunt of his imminent fiscal squeeze, a prospect that was anathema to the hard right.
Early one snowy morning in February 1936, a group of fanatical army officers staged a coup d’etat in central Tokyo. A detachment of one hundred soldiers marched the short distance from their Roppongi base, now the site of the Ritz-Carlton Hotel, to Takahashi’s residence in Aoyama. They burst in on him as he slept and shot and hacked him to death. It is a tribute to Takahashi’s stature that he was a prime assassination candidate at the age of eighty one.
The coup was soon crushed, but the nationalists were now dominant and Takahashi’s successor immediately doubled the military budget. Hyper-inflation and war were the inevitable result. As Richard Smethurst notes, “Takahashi was Japan’s last barrier to militarism.”
The rest, as they say, is history.
As for Takahashi himself, he may well have the last laugh. If Abenomics succeeds and if other countries follow suit, a humbly-born Japanese brought up in the Tokugawa era will have a powerful influence on the shaping of our world today.
References –
From Foot Soldier to Finance Minister, Takahashi Korekiyo, Japan’s Keynes, Richard J. Smethurst, 2007, Harvard University Asia Center
Lever of Empire; the International Gold Standard and the Crisis of Liberalism in Prewar Japan , Mark Metzler, 2006, University of California Press.
Photographs by Mark Pearson