After delays caused by depressions, earthquake, and a financial crisis, the yen is briefly put on the gold standard. The government abandons the gold standard in 1932 and expands the money supply through mandatory loans and credits from private and state banks. A competitive devaluation helps exports.
Currency controls are imposed, and limited foreign currency makes financing imports of raw materials a major bottleneck. The state also controls business and investment through permits and loans. The war exacerbates shortages, leading to price and wage freezes.
The ruined economy coupled with expansionary fiscal and monetary policies means that too much money is chasing too few goods, leading to high inflation. Unsuccessful fixes include an asset freeze in February 1946 and price controls in March.
The Dodge Plan, introduced by the United States in 1949, slashes inflation by curbing the money supply and the budget, fixing exchange rates, and boosting exports. The yen is pegged at 360=1$ for the next two decades, which gives Japan a further advantage in competitive exports.
Monetary policy aims to address trade deficits and shape the economy through loans to power, shipbuilding, coal, and steel firms. The Central Bank's "window guidance" informally restricts the money supply. Policies also encourage high savings but low interest rates, and the main source of funds for corporations shifts from the Bank of Japan to private savings channeled through the state.
This high-growth era sees trade deficits end and credit crunches result. An improving trade balance leads to international calls to liberalize trade and financial controls. Membership in the International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) demands financial and currency liberalization. The undervalued yen is allowed to appreciate slightly in '71.
Like many currencies, the yen is allowed to float in 1973, but the government continues to intervene in currency markets to ensure competitive exports. Relaxation of tight investment controls leads primarily to more overseas investment, as firms seek raw materials, energy, and inexpensive labor. Post-shock inflation is brought under control by conservative monetary policies.
The strong yen leads to a surge in investment abroad, particularly in wealthy countries. Investments in U.S. car plants, for instance, are meant to deal with import restrictions and reduced competitiveness resulting from the high yen. The Foreign Exchange and Foreign Control Law officially frees external transactions from government control. As in trade, however, informal state control continues.
Accords with the United States lead to appreciation of the yen and further liberalization of capital controls, mainly on domestic instruments like CDs and Treasury bills. By 1988, capital controls are no longer the issue, but rather the enormous imbalance in capital flows themselves, as Japan becomes the world's largest net creditor, buying Van Goghs, Hollywood studios, and land in Australia.
The bubble bursts as stock and land prices go into free fall, leaving banks with massive bad debt. The problem is exacerbated by loan decisions based on bureaucratic influence or business ties rather than on how good the investments are. The falling yen and interest rates, and increased government spending, are not enough to revive the economy.
"Big Bang" liberalization in foreign exchange, banking, securities, and insurance tries to revive Tokyo as a financial center and improve investment opportunities. Two big banks are nationalized, and others are recapitalized. High public spending continues, and the Central Bank briefly institutes a zero interest rate in 1999. But a mild recovery is hurt by the global slump.
The economy cannot find its way out of the doldrums; when the dollar falls against the yen in late 2002 on fears of global instability and war in Iraq, the government is suspected of selling yen to stop its rate from rising and hurting exports. The stock market hovers at decade-low levels, and the banks remain under threat of collapse.
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