------------ EH.NET BOOK REVIEW --------------  
Published by EH.NET (January 2007)  
  
Mark Metzler, _Lever of Empire: The International Gold Standard and   
the Crisis of Liberalism in Prewar Japan_. Berkeley: University of   
California Press, 2006. xxii + 370 pp. $50 (cloth), ISBN:   
0-520-24420-6.  
  
Reviewed for EH.NET by Eugene N. White, Department of Economics, Rutgers University.  
  
Drawing extensively on archival sources, University of Texas   
professor Mark Metzler provides a detailed history of Japan's   
experience with the gold standard. Japan's interwar quest to return   
to gold is instructive not only as a policy problem but also because   
it was a key issue in Japan's struggle over whether to join a liberal   
global economy or build a state-controlled empire.  
  
Following Germany's example after the Franco-Prussian War of   
extracting reparations to facilitate a move to the gold standard,   
Japan gained the needed reserves after the Sino-Japanese War of   
1894-1895 yielded an indemnity from China. Whether the gold standard   
offered a nation a seal of good housekeeping when it sought to borrow   
abroad is currently hotly debated. For Japan, Metzler shows that   
moving to gold was considered as vital to gaining access to Western   
capital markets. But empire and gold went hand in hand. To prevent   
Russian dominance of Korea, Britain signed an alliance with Japan in   
1902 that recognized Japanese interest in Korea, after which the   
British Foreign Office supported the sale of Japanese bonds in   
London. Japan had equal success on Wall Street, where a critical role   
was played by Jacob Schiff of Kuhn, Loeb who was eager to see   
anti-Semitic Russia (and the Morgan bank) defeated. As a result 40   
percent of the 1904-1905 Russo-Japanese war was funded with overseas   
borrowing.  
  
While conquest and the gold standard marched together up to this   
point, they now pulled Japan in opposite directions.   
Military-industrial interests wanted to increase government spending,   
while those committed to the gold standard pressed for balancing the   
budget and husbanding resources to pay the foreign debt. Metzler   
translates the two competing policies (sekkyoku seisaku and shí½¯í¹¯ku   
seisaku) as "positive" and "negative" policies, suggesting that they   
represented Keynesian and monetarist approaches. Better translations   
would be "active" and "passive" policy, which reflected the   
expansionary imperialist program and the "rules of the game" followed   
by a liberal state. Two dramatis personae occupied center stage in   
this battle: Inoue Junnosuke (finance minister and governor of the   
Bank of Japan) and Takahashi Korekiyo (vice governor of the Bank of   
Japan, finance minister and prime minister) who respectively   
campaigned for classic liberal and expansionary economic polices.  
  
By declaring war against Germany in 1914, Japan easily seized German   
concessions in China. Emboldened, Japan attempted to gain hegemony,   
issuing the infamous but unsuccessful "Twenty-One Demands" to the   
Chinese government. The war cost relatively little and created   
extraordinary export opportunities. The trade surplus led to an   
inrush of gold, producing a monetary expansion and inflation, and   
Japan only exited the gold standard after the U.S. embargoed gold   
exports in 1917.  
  
The worldwide postwar boom was amplified by "positive" policies   
pursued by finance minister Takahashi who saw an opportunity for   
Japan to catch up. The government floated new bonds to finance   
military spending, notably the anti-Bolshevik Siberian expedition.   
Warning about the dangers of a speculation boom, governor of the Bank   
of Japan Inoue, lobbied the cabinet to lift the gold embargo. When   
the Bank of Japan was permitted to raise interest rates in 1919, the   
boom came to a resounding end with a stock market crash and bank runs.  
  
The battered economy never truly recovered in the 1920s. A gold   
standard at the prewar parity was a distant goal because postwar   
deflation was insufficient. Although volatile, the yen was often 20%   
below its prewar value. A key problem that worsened with time was the   
Japanese military's political independence, which made budget cuts   
difficult. Fiscal policy was loose, but the Bank of Japan kept its   
key rate over 8% from 1919 to 1925. Chances of an early return to   
gold ended with the great 1923 Kantí½‚íµ¡rthquake that devastated Tokyo   
and Yokohama. The Bank of Japan provided massive credits to banks.   
Rolled over year after year, they added to the bad loans from the   
collapse of the postwar boom, undermining the solvency of the banking   
system.  
  
After Britain's return to gold in 1925, the government hoped to   
follow and began a retrenchment in 1926. The costs of an appreciating   
yen proved to be very high, wounding export industries. When the   
finance minister moved to clean up the banking system, a storm   
erupted in Parliament over the disclosure of weak banks. Rumors   
swirled, setting off a severe panic in 1927, in which 36 banks with   
9% of deposits closed. The government fell, and Takahasi returned to   
the finance ministry, where he halted retrenchment and allowed the   
yen to depreciate.  
  
Yet by 1929, a new government concluded that a restoration of the   
gold standard was necessary as Japan's foreign loans were coming due   
and needed to be refinanced. Assistance came from the House of Morgan   
led by Thomas Lamont. An enthusiastic supporter of (some would say,   
apologist for) Japan, Lamont demanded a "thorough-going" deflation   
and an end to the government's "extravagance." He supported Inoue for   
whom a return to gold was a matter of honor. The government began an   
extraordinary campaign, exhorting people to give up unneeded   
luxuries; and a propaganda pamphlet was distributed to almost every   
household. Movies and popular songs promoted the government's plan.   
The "Retrenchment Ditty," a movie theme song, entreated the public:   
Let's retrench, let's retrenchŠ..  
  
        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.  
  
In spite of the 1929 stock market crash a Morgan-led group of banks   
provided a $25 million loan (to which London added £5 million) for a   
cushion of reserves that enabled Japan to lift the gold embargo on   
January 11, 1930. An overvalued yen caused gold to flow out, yielding   
a 25% decline in prices. The effects were wrenching. Wage cuts spread   
across industry, followed by strikes and rising unemployment.   
Indebted farmers began to fail when world rice and silk prices   
collapsed. Panics hit the Tokyo stock exchange in April and September   
1930.  
  
Whatever control the government had over the military was lost in   
1931 when faked Chinese sabotage on the South Manchurian Railway   
allowed the army to attack China. After Britain abandoned gold in   
September 1931, a run on the yen began. Inoue tried to stop it by   
raising interest rates. For his efforts to restrain military   
spending, he was assassinated in 1932 by a member of the right-wing   
Blood Pledge Corps. Back at the finance ministry, Takahashi took the   
yen off gold in December 1931. Budget deficits were financed with   
money creation; but when inflation picked up, he tried to cut the   
military budget in 1936. Wrathful ultranationalist officers shot and   
hacked the 82-year-old finance minister to death in his bed. Gearing   
up for war, the army's general staff drafted a five-year plan in 1937   
that buried what remained of the liberal economy.  
  
Metzler's book provides a solid, nuanced and depressing account of   
the failure of the interwar gold standard in Japan. One can only   
speculate that had Japan returned to gold at less than its prewar   
value, the country could have avoided the wrenching deflation that   
radicalized the public and produced allies for the fanatics promoting   
imperial expansion.  
  
  
Eugene N. White is professor of economics at Rutgers University and a   
NBER research associate. His most recent publication is "Bubbles and   
Busts: The 1990s in the Mirror of the 1920s," in G. Toniolo and P.   
Rhode, editors, _The Global Economy in the 1990s: A Long-run   
Perspective_ (Cambridge University Press, 2006). He is currently   
writing on war finance and the microstructure of the NYSE and the   
Paris Bourse.  
  
Copyright (c) 2007 by EH.Net. All rights reserved. This work may be   
copied for non-profit educational uses if proper credit is given to   
the author and the list. For other permission, please contact the   
EH.Net Administrator ([log in to unmask]; Telephone: 513-529-2229).   
Published by EH.Net (January 2007). All EH.Net reviews are archived   
at http://www.eh.net/BookReview.  
  
-------------- FOOTER TO EH.NET BOOK REVIEW  --------------  
EH.Net-Review mailing list  
[log in to unmask]  
http://eh.net/mailman/listinfo/eh.net-review