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Consider Japan

Chapter VI

. . . But Tight Money

The monetary policy of the Bank of Japan provides a fascinating study for the visiting foreign economist, like almost everything else in this land. It is very difficult to decide whether the policy’s undoubted effectiveness has been the result of the Bank’s extraordinary success in making the brilliant best of a bad job, or whether the bad job itself (as represented by the highly unorthodox nature of the Japanese commercial banking system) has paradoxically made monetary control very much easier. For various historical reasons (of which the failure of the cheque system to develop quickly under Japanese conditions is one) commercial banking business in Japan is profitable only if the big city banks operate at levels of illiquidity that would drive an English or American banker into a state of permanent neurosis. When window dressing (which is considerable) is removed, the city banks’ real cash ratio against deposits is only about 2 or 3 per cent, and they hold virtually no other genuinely liquid assets at all (compare the British commercial banks’ conventional liquidity ratio of 30 per cent). The other 97 or 98 per cent of their deposited money is out on loan, without many of the usual conventional bankers’ distinctions about lending only for short-term requirements; a very large part of Japan’s massive investment boom in fixed capital equipment has been financed by commercial bank loans.

The result of this “overloan position” is that the city banks periodically find themselves in a desperate need to raise liquid funds from somewhere, either in order to meet emergencies or else simply in order to increase their lending further. They can do this in two ways. They can borrow some emergency funds from each other (or from rural and other savings institutions) on the so-called call loan market, interest rates on which can sometimes reach fantastic heights; at one stage during the last balance of payments crisis and credit squeeze call money was being borrowed by the big city banks at over 20 per cent. The other source, nominally as a lender of last resort but really as the main engine of capital creation during a boom, is the Bank of Japan. The Bank’s process of credit creation went forward particularly heavily during the early years of Japanese recovery, so that Japanese bankers themselves admitted – and visiting American bankers reported back with horror – that “the commercial banks in the early nineteen-fifties became merely a channel through which the central bank fed industry with investment funds.” It was this “overloan” position that Mr Dodge referred to with indignation when he castigated (as mentioned in Chapter 1) the illusion “that granting progressively larger amounts of commercial bank credit for capital purposes can be substituted for the normal processes of capital accumulation.”

Nevertheless, the fact remains that it was substituted and that it has worked. Looking round the shining new factories of Japan – a country that actually had the greater part of its previous industrial capacity destroyed in the war of only seventeen years ago – nobody can doubt that. Moreover, paradoxical though this may seem, the consequence of the central Bank’s unorthodoxy during this period has been its rebirth as one of the most powerful central banking organisations in the world. Because the commercial bankers have to come begging to it when they want new funds to increase their lending further, the entire credit structure of Japan now seems to the visiting foreigner to lie snugly under the Bank of Japan’s control.

The Bank itself would deny this; its position of absolute power, as lender of last resort, over the credit situation does sometimes mean that it cannot use that power to quite the extent that its exasperation with some aspects of the boomu might make it wish to do. It cannot very well turn away big banks who ask it for funds if the result would be to cause a massive financial crash of Overend Gurney proportions. But in banking, as in international diplomacy, an authority that possesses an unusable thermonuclear deterrent does not necessarily thereby become less able than an unarmed country to make its wishes felt.

The control by the Bank of Japan is exercised in various ways. The one “orthodox” weapon is Bank rate, this summer at 7.3 per cent, which it is certainly able to make effective; most of Japan’s other (very high.) interest rates are tied to it, and Japanese businesses’ heavy dependence on borrowing means that they are very susceptible to changes in borrowing rates. A second and more controversial weapon is the so-called “window operation.” The Bank of Japan holds regular consultations with the commercial banks, reviews the likely trend of advances of each bank for perhaps a month ahead, and warns individual banks (or, at times of balance of payments crises, warns all big city banks) that they should please start to restrain their advances; if necessary it will even suggest an “overall loan level” for the big banks as a whole. Finally, although the Bank will not generally in the last resort refuse to lend to any big bank, it does levy penalty rates on what it regards as its ultimate margin of less desirable loans to the commercial banks. As part of the same process the Bank of Japan will offer favourable discount rates on particular types of lending paper – especially, to the annoyance of competing British exporters, it will help indirectly to subsidise Japanese exports in this way.

The commercial banks in turn also have a schedule of penalty rates which they levy on those who borrow from them, according to the status of the borrower concerned. And when they have to cut back lending, they have no hesitation about putting pressure on borrowers whose position they regard as unsound. The small local banks, who lend mostly to smaller local firms, will do the same thing when a credit squeeze makes it more profitable for them to use some of their funds in other ways (perhaps, for example, to lend call money to the big city banks at very high interest rates). The consequence is that tight money during credit squeezes can lead to bankruptcies of small firms in Japan. The figures for dishonoured bills (52,470 in January of 1962) are one economic indicator that is regularly watched. So is the number of bankruptcies (firms with debts exceeding £10,000) – which was 202 in January of 1962, close to the last peak of July, 1957. But at the same time as reporting this, the Japanese press also reported that the Government seemed to be more intent than in previous crises to temper the wind to the smaller shorn lambs.

The more closely one studies the history of the Japanese economy in the last decade, the more one becomes convinced that success in economic policy nowadays springs from a policy of favouring the forward – looking and most prospering and efficient firms, and beating the less efficient ones into the ground. The fact that control through monetary policy in Japan has – until this last year (1962) – generally worked in this direction may not be a sign of great social and humanitarian virtue (see the following chapter on “After the Zaibatsu”); but it has been of enormous economic utility. Your correspondent became convinced that there are two important lessons for Britain here.

First, the general British method, during the crises of the last decade, of restraining demand by tough budgets and tax regulators has automatically laid its main restraining power on the growth industries, while the opposite Japanese method has worked the other way round. Growth industries, by definition, are those that will be given the biggest impetus to expand their production when the next few hundred million pounds’ worth of marginal demand is pumped into the economy; so, of course, they are also those that suffer most severely when the next few hundred million pounds’ worth of marginal demand is siphoned out of the economy by means of a restrictive budget. By contrast, the Japanese method of pumping in extra demand through stimulatory budgets, and then using monetary policy and high interest rates as a rationing device, has caused restriction to impinge mainly on those whom the banks regard as the worst business risks. The rationed capital has become available only to those who can use it most profitably – except when political considerations intervene and gum the process up.

Secondly, the British have got used to saying that a policy of expansionary budgets and high interest rates will penalise investment at the expense of stimulating consumption. Japanese experience surely proves this to be nonsense. Japan (where industrial borrowing in recent years has cost about 10 per cent) has recently been devoting nearly 40 per cent of its gross national product to total investment. Britain, on the same basis of comparison, has devoted less than 20 per cent. The truth is that it is a spirit of dynamism among thrusting growth industries that nowadays serves to impel an economy along the high road of expanding investment. A policy of stimulatory budgets provides the oats that beckon the horse forward, while a policy of high interest rates provides the reins to guide the horse and also (at least in Japan) helps to provide the high savings (and, sometimes, at appropriate moments of the trade cycle, also the temporary increase of borrowing from abroad) which make the continuance of heavy investment possible. A policy of low interest rates relaxes the reins so that the horse will find it easier to rush forward faster if it wishes, but this is not much use when, because of a lack of expansion of marginal demand, the horse itself is standing still.