The previous two posts detailed the way in which the government tried, and failed, to finance the aftermath of the Great Kanto Earthquake of 1923 – a failure generated by an initial underestimate of the sheer size of the problem, and the unwillingness fully to acknowledge it long after the problem had become obvious. In the absence of effective government policies, the burden fell on the banking system which was unable to carry such a weight. As the banking system buckled under the pressure, the result was the financial and political implosion of the Japanese banking crisis of 1927, which ultimately discredited Japan’s democracy and opened the way for the aggressive nationalistic militarism of the 1930s and 1940s.
During the 1920s, Japan’s banking industry was in no fit state to trade through the bad debts haunting the money markets and the ‘earthquake bills’ which were cluttering up both their balance sheets, and, just as importantly, Bank of Japan’s balance sheet. In the aftermath of both the implosion of the post-war Bubble in 1920, many banks were already on shaky ground. Japan had lots of banks, mainly extremely small, local, and corrupt. In 1922 Japan had 1,794 ordinary banks in Japan, averaging less than three branches each, and averaging Y4.4 million in deposits (about Y21 billion in today’s money). This multiplicity of tiny banks came at a price – local banks tended to use local deposits for the benefit of the local power-broker’s business scheme. If and when those schemes went belly-up, the bank and its depositors would suffer.
As the Japanese economic historian Nakamura Takafusa wrote: “Companies . . . commonly went to great length to cook the books so that their assets and liabilities tables showed a profit even when the company was awash in red ink.” Banks aided and abetted these practices – hardly surprising considering that the companies were also likely to own the banks.
This underlying weakness was magnified by combination of the unacknowledged losses from the 1920 bust, the earthquake bills mess, and extended deflation. Increasingly, the banking system was quietly freezing in distress. Four years after the Great Earthquake, the cracks in the system could be hidden no longer.
By the beginning of 1927, the government was moving on two fronts to deal with the banking industry’s problems, addressing both the banks’ immediate financial problems, and also the regulatory and capital weaknesses obvious in the system. In April 1927 it introduced a new Banking Law, in an attempt to consolidate the industry and ensure its capital adequacy and operational probity.
But first, in January 1927 two bills were introduced into the Diet to deal with the recurrent problem of the roughly Y200 million in uncollectible outstanding Earthquake Bills. The first indemnified BOJ for Y100 million losses from uncollectible bills, and proposed issuing a Y100 million five year bond to do it. The second bill would allow the government to lend Y100 million in public bonds to banks still holding Earthquake Bills, whilst the debtors would be given 10 years to pay off, in instalments, the remaining bad debts.
This willingness to open the public purse to the banking system was political dynamite. The government faced accusations that it was bailing out mismanaged but politically well-connected banks and enterprises at the expense of the taxpayer. The opposition wanted to know which banks held the earthquake bills; the government refused to say. In the absence of disclosure, rumours abounded.
Quite a few centred on a trading company called Suzuki Shoten and the Tokyo office of the Bank of Taiwan – which, as its name suggests, was a note-issuing bank for Taiwan (at that time a Japanese colony). Together, these two became the ground zero of the 1927 banking crisis.
Founded in Kobe before World War One, Suzuki Shoten was a small trading company dealing mainly in Taiwanese products, and financed largely by Bank of Taiwan. Bankrolled by Bank of Taiwan, the company massively over-traded: indeed, at one point it was bigger even than Mitsui. Naturally, when the 1920s bust came, Suzuki found itself holding huge inventories at a time when prices were falling. Its vast profits disappeared into equally imposing losses, and Bank of Taiwan threw good money after bad. Naturally, Suzuki Shoten was responsible for a huge amount of “earthquake bills” after 1923. By April 1927, loans to Suzuki Shoten stood at Y396 million (at the time, Japan’s national budget came to Y1.5-1.6 billion). Its borrowings from Bank of Taiwan came to Y250 million, out of a total BOT loan book of Y720 million. By the time one adds Suzuki-affiliated manufacturing companies, the total owed by Suzuki to Bank of Taiwan was about Y350 million. In other words, about half Bank of Taiwan’s loan-book. This was not so much a disaster waiting to happen, but a disaster that had already happened.
The collapse of Bank of Taiwan triggered a fully-blown banking crisis which rapidly closed all banks in Tokyo and Osaka temporarily – a closure which literally bought time for Bank of Japan to run its printing presses sufficiently fast to meet the demand for banknotes as customers withdrew their deposits. The note issue doubled and Bank of Japan lending tripled in a matter of days. In an echo of its initial response to the earthquake, the government imposed a three-week moratorium on all financial obligations. But in the end, this was insufficient: 44 banks were bankrupted, representing the loss of deposits equivalent to around Y36 trillion today.
The political blow to Japan’s Taisho democracy was immense. Had Japan reflated massively after this financial catastrophe, the worst of the depression and indeed starvation of the 1930s might have been avoided. But the political damage was too deep – opening the way for something much worse. In June 1928, the Japanese Army in
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