Sunday, 13 March 2011

Japan's Last Big One, Part 1

This is the first of a three parter on the impact and financial aftermath of the Great Kanto Earthquake of 1923. How did Japan's bureaucrats respond, what was short and longer-term financial and economic impact, and what were the longer-term costs. As you read these, bear in mind that a) Japan's goverment debt/GDP ratio is already 200%+, and MOF expects that by 2014 32% of all tax revenues will go on debt service, and b) only three weeks ago, the FSA was still thrashing out how to account for the roughly Y1.39tr in losses stemming from the collapse of the 'jusen' housing finance system in the 1990s.

The catastrophic Great Kanto Earthquake struck on 1 September 1923, leveling most of Tokyo and Yokohama. The casualty statistics are shocking: 91,000 killed, mostly in Tokyo and Yokohama; 13,000 missing; 52,000 injured; 69,000 houses lost or damaged. At the time it was estimated that 3.4 million people were directly effected – approximately 6% of the population.

The damage to national wealth was put at Y5,274 million, approximately 4% of total estimated national wealth of 1924, and 44% of 1923 GDP. Of that total, Y2,136 million worth of merchandise was lost and Y1,874 million worth of buildings, equivalent to 8.2% of the total building-stock. Perhaps we should be skeptical of these numbers: the Y2,136 million claimed as loss of merchandise and inventory seems an astonishingly high number (particularly when compared with the Y869 million lost in household goods), and suggests there was no shortage of people willing to inflate their losses in response to government relief actions.

(To compare: between December 1989 and September 1990, Japan’s stockmarkets lost Y270 trillion in value – an amount equivalent to roughly 60% of GDP.)

This estimate of losses does not, however, include the impact on the stockmarket. In the event, however, these seem to have been surprisingly light. The bond market reopened for business on October 16 (in IBJ’s banking hall), spot transactions started again in the ruins of the exchange on October 27, and futures trading restarted on November 15. But, buoyed by a Y13 million rehabilitation loan from IBJ, when TSE proper reopened on November 15, its shares, which had been quoted at Y121.9 on August 30, opened at Y107 – a loss of only 12%.

The government’s bureaucratic responses, and its immediate provision of liquidity were as one might expect. The government provided relief financing and, cut duties on the import of reconstruction materials. Not surprisingly, this resulted in a flood of speculative imports, which in turn blew out the trade deficit in 1924 to record proportions (6.7% of GDP), which in turn cut the gold reserves, drove the yen down from around 49 at beginning of 1923 to 38.5 by October. Such negative developments (from the point of view of a political leadership unwilling to abandon its gold-standard aspirations) constrained the government’s role in reconstruction.

More significant, in the longer term, was the government’s arrangements to contain the immediate economic and financial damage. On Sept 7, the government declared a 30 days moratorium on all obligations contracted before Sept 1 and payable during September, for all debtors having their residence or place of business in the stricken area. In addition, when that moratorium ran out, BOJ was empowered to rediscount all bills discounted by banks and maturing before Sept 1925, which were covered by the moratorium, with the government offering to indemnify BOJ for losses on these transactions up to Y100 million.

In other words, when the deadline for payment of a note issued or to be paid in the earthquake region came around, the note could be taken into a bank to be discounted. The bank would subsequently take the note to BOJ, which would rediscount the note stamping it with the words “Earthquake Bill.” In the event that the debt turned out to be bad, or simply not paid on time, the government would guarantee BOJ up to Y100 million.

Many companies were saved by this procedure, but at a cost to the financial system which was only revealed over time. And we'll turn to that in Part 11. . . .

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