Dr. Simon Bytheway has made two major career mistakes in life: First, he teaches Japanese finance students an uncomfortable truth -- that their country’s economic preeminence derives in large part from the influence of western culture. His second career mistake was to specialize in research pertaining to the gold standard, something which his Keynesian academic colleagues told him would consign him to the sidelines of the discipline.
It is to these career errors that we owe the existence of a brilliant treatise in economic history, Investing Japan (Harvard University Asia Center, 2014). This rigorously documented treatise demonstrates that the gold standard is behind the rapid rise from the feudal backwaters to a modern economic and military superpower in a matter of a decade or two.
How is this possible? How can something as simple as a stable monetary unit do for Japan what almost 1,200 years of the regime failed to do prior to that? It does it by creating the preconditions for the transfer of knowledge. Knowledge follows investment: foreign capital comes accompanied by foreign knowledge. But when a nation debases its currency, it sends a message to the world: keep your financial and your intellectual wealth away from here; you’ll lose it when the time comes to cash-out. The most a weak currency country can hope to pick-up is the short-term usage of some hot-money flows and its best and brightest young minds driven out of careers in technology and towards financial hedging. But a hard currency country implicitly sends out a different message: send your money; send your experts; build your factories here; teach us what you know, and the wealth you create here will come back to you multiplied and in a currency which holds its value.
That’s how Japan did it, and though it has forgotten that lesson, other countries mired in rice paddies can learn from its experience. Stable currency, as George Gilder taught us, is the stable carrier, the channel through which knowledge flows. The more stable the carrier, the greater the bandwidth.
Perhaps the decision to focus on the study of the gold standard wasn’t such a career mistake after all.
Dr. Bytheway (Simon) and I spoke for about two hours, and although that probably seems a bit long, it’s a short period in which to cover a quarter millennium of economic history of one of the wealthiest nations of modern times. You can listen to the whole thing here and learn not just about the gold standard and the rise of Japan, but about the role of western culture, and Christianity, and also about how the US twice led the Japanese away from the gold standard and into economic and political crisis. The interview references a video representation of the economic rise and fall of Japan which you can find here.
A partial transcript is below (edited for clarification). We pick up the conversation in the context of Japanese fascism…
JERRY: I've always thought of the fascist age of the 1930s as a revolutionary age, but a revolution from above, rather than a revolution from below. A kind of a revolution of the elites against the old restraints. The golden handcuffs I think is what Keynes called them, of say a metals-based monetary standard.
Let's go back, since we're talking about the gold standard. This is I'd say almost one of the… There's really three or four key ideas in the book Investing Japan. But half of this book seems to me to be about one key idea, which is the central importance of the adoption of the gold standard, beginning in the Meiji restoration, championed by Matsukata... And that that gold standard then becomes the means through which the Japanese economic miracle and modernization occurs. So let's zoom in on that.
First of all, who was Matsukata?
SIMON: Matsukata was a man that we, surprisingly, still don't know that much about. He used to describe himself as a samurai from Satsuma. And Satsuma was that part of Southern Japan that initiated the Meiji restoration. So he was one of those young revolutionaries that we're talking about.
And initially through the military, he became like a regional governor. And from there he became of what he's most known as, as a minister of finance.
And he served as a minister of finance for a very long time. And when he became the minister of finance he introduced deflation. And at the moment, we often said that the Japanese economy is in deflation, and it's something within a percentile of some portion of a percent. But he introduced deflation at about twenty percent.
JERRY: When was Matsukata's deflation?
SIMON: 1885. And he was a seasoned oligarch, and he served as, not only as minister of finance, but sometimes he was twice prime minister as well.
JERRY: If you look at our data chart, I'm at 1870 now, and then I push play and, boom, you definitely see a downturn around that time. There's a contraction. So you have a deflationary contraction, but then what? What happens after that deflationary contraction?
SIMON: Well, what he does by inducing that deflation is he puts the Japanese government on a very steady footing for economic growth. So he's sometimes seen as a champion -- the first champion of privatization. But he privatizes aspects of the Japanese government that he felt the government shouldn't be involved in. So he sells off, like, coal mines and things like that. But most of the stuff he sold off wasn't huge. But he also privatized some silk works. But the mining was the really big thing. There was some nineteen or so industries that he privatized.
But in doing that, he also introduced taxes, and so he was providing a kind of fiscal base. And what he wanted was for Japanese money to be convertible, and at first it had to be made convertible to silver. And so by 1885, or so, Japanese paper money is convertible to silver; he changed that fairly quickly.
And then he realized that Japan needs a central bank. Earlier Japanese oligarchs had preferred something like the American national banking system, but Matsukata is very much a champion, very much argues that Japan needs a central bank, something like the Bank of England, or the Reichsbank in Germany.
JERRY: So this is not central banking in the sense of the modern idea of fiat central banking; this is Bank of England classical gold standard central banking that he is sailing towards. He had taken Japan from a paper standard to a silver standard, but as of the time of the national bank, not yet to a gold standard.
SIMON: Yeah. But his plans were always there. So he does that, so he reorganizes the fiscal basis of government, and he establishes a central bank that functions. And he wants to put Japan on the gold standard, because Japan's main trading partners, particularly he imports from gold standard countries. And to be on depreciating silver standard, while you're trying to import technology from gold countries, was a huge liability.
So what Japan needs is the gold. And as you know, the way they got their gold is taken from that Prussian example, after the Franco-Prussian War. Prussian extract this huge indemnity from the French in gold. And that becomes the basis of the German gold standard.
Well, Japan has its first war with China, the Sino-Japanese War of 1894-'95. And from that victory they received a huge indemnity. China was initially prepared to pay that in silver; I mean, China was a silver economy. But what Matsukata suggested -- even though he was actually out of power at this time, what he suggested to the prime minister, was that rather than paying China in silver, they should pay the indemnity in England, at the Bank of England, pay it in English pounds because he knew that China would have to raise a loan. They wouldn't have the money to -- they wouldn't be able to afford to pay that huge indemnity without taking loans, and the loans would have to go through Europe anyway.
So that became the means of Japan having the gold to adopt a gold standard.
JERRY: So, basically, the gold was always in London, but you're just changing the label on it.
SIMON: I mean, just think of it from a British perspective. I mean, all you've done is create a balance -- you've created two balances.
SIMON: One, you receive a large amount of monies from the Chinese, but this is essentially raised through loans. So you have the Chinese in your pockets as debtors. And then you have this huge Japanese credit. But you've done this without actually physically moving any gold, without there being any shipping costs, any insurance costs, any kind of risk at all.
JERRY: And you just pocket the spread. The London banks just pocket the spread. Good deal for them.
SIMON: Yeah. Well, it was the Bank of England, so it was not so much like a private transaction; it all happened at the Bank of England. So this is you know, I mean, that's the advantage of being a capital of capital, isn't it?
JERRY: It is. So you said something interesting. You said that you have a depreciating silver standard. So I suppose I'm kind of reading between the lines here on the book, "Investing Japan" a little bit, but if I'm to invest in Japan, whether it's foreign direct investment, or whether it's lending or equity investment -- not a lot of equity investment I guess.
SIMON: Yes.
JERRY: So almost all of it was lending, maybe a little bit of foreign domestic investment; you have a couple of chapters on that. One of my concerns, I mean aside from the issue of whether or not there will be a positive return in the currency that I've invested into, there is also the issue of whether I lose that positive return by depreciation of that currency, when I cash back out.
SIMON: Absolutely.
JERRY: And if silver supplies are increasing, as they were in the late 1800s, and in addition--
SIMON: Yeah, from 1861 the silver price against gold has always depreciated, yeah, with a few jumps, but--
JERRY: Partly because the silver supply increases, but partly because as the nations of the world are going off the silver standard, then the real price of silver is also declining, so if you're a silver-based currency, you'll have trouble attracting foreign capital at a time like that.
SIMON: Yeah, absolutely. Absolutely.
JERRY: I mean, maybe not as much trouble if you were a purely paper currency, but certainly more trouble than if you're a gold currency.
SIMON: Yeah. I mean, this is something that people just can't fathom now. But when Japan adopts the gold standard, it fixes its exchange rate in terms of all other gold currency -- you know, in all other gold currencies. What that meant was that if you invested in Japan, that you would know exactly what the exchange rate would be, not just next month or next year, but in four, five, ten years. And under the classical gold standard, exchange rates really didn't move that much. I mean, even the March Revolution in Russia in 1917, the ruble hardly moved. So the kind of, you know, the kind of daily fluctuations we see now were very rarely experienced under the classical gold standard.
So that stability meant that people could invest with confidence. And also, it removed the ill effects caused by speculation, pure speculation, because of the great confidence that the yen would maintain its stated value in the future.
JERRY: Well, right, enormous amounts of manpower in the modern world go into hedging against currency.
SIMON: Yes. Yes.
JERRY: I mean, not just hedging against the decline of, you know, all currencies against say a gold standard, but their relative decline, and trying to guess which one will decline faster and hedging against that. I mean, it just adds drag, financial drag to all international transactions.
SIMON: Yeah. And particularly if you're a small capital-poor country like Japan was. You don't have all that talent and all that capital being used permanently for hedging, rather than being employed in industry, rather than making productive investments.
JERRY: So Japan went on the gold standard, what was it, 1897, is that right?
SIMON: Exactly.
JERRY: I'm going to look at our data here for a moment. I'm looking at 1897. So we have another one of those small deflationary drops, you know, just a little bit of a contraction around then.
SIMON: Well, there was a war that was just after the war with China. So the first Sino-Japanese War of 1894-'95. So you had tremendous expenditure. After the war you had inflation, and then you had a kind of bust. So it was a little bit of that kind of cycle as well, yeah.
JERRY: When did the war end?
SIMON: 1895.
JERRY: All right. So they come out of '95; they've inflated their currency to pay for their -- to pay for the war, I assume, right. Or did they really keep to a strict silver standard?
SIMON: They were just on the silver standard, yeah.
JERRY: Okay. But you can be on the gold and silver standard and cheat a little too, sometimes, so that's why I ask.
SIMON: You know, they didn't make any monetary adjustments at that time. They weren't able to, because it was more important to be trusted and have credit with their -- with their trading partners, all the countries they traded with. It was more important to keep that kind of trust, to develop that trust than to, at that stage, play games with deflating the yen. They didn't need to deflate the yen anyway, because it was on silver, and silver was deflating.
JERRY: It's almost like having a fiat currency. Everyone's dumping silver, silver prices are dropping, so you have a kind of an inherent expansionary monetary policy and you could still remain on the metal standard, right?
SIMON: Yeah. And for Japanese producers, this is the time that Japanese capitalism is really kicking into gear, but only first gear. It's really sort of moving into gear. This was a great time for Japanese industrialists, and proto-industrialists, because their goods were increasingly becoming more competitive throughout the globe.
JERRY: Because it's basically competitive devaluation?
SIMON: Yes. Because as silver devaluated the costs of prices they attached to their exports decreased also.
JERRY: So I think what I'm hearing is that the depreciating silver standard was okay if you want to -- for Japan to sell more of the stuff that it already knew how to sell. But if it wanted to become a global economic player, absorb knowledge, know-how, not just academic knowledge, but tacit knowledge, you know, to sort of become an innovative technologically forward-looking country, it had to give up that depreciating currency power, and it needed to make the sacrifice of adopting a deflationary gold standard, even if it lost its ability to stimulate in the short run, because then instead of just goosing exports, you're selling more silk, right -- maybe selling more rice or whatever, it could actually launch whole new industries if it could attract that foreign capital, and the gold standard allowed it to do that. Do I have that right?
SIMON: Yes. And in a sense, by having huge amount of capital stored at the Bank of London, and at other European banks at this stage, you're engendering financial cooperation, and that's what very much Chapter 5's about... or Chapter 4, actually. But they're creating a situation where there is a strong financial connection. Maybe the earliest examples of central bank cooperation between the Bank of Japan and the Bank of England. And this financial cooperation precedes a formal alliance, and the Anglo-Japanese alliance happened in 1902.
And then just two years after that, you had the Russo-Japanese War, and that's fought by the Japanese navy. At that stage, they had fourteen battleships. Thirteen of those were made outside of Japan. And of those thirteen that were made outside of Japan, I think eleven of them were British. So you needed a gold standard if you were going to buy rifles, railway carriages, battleships, all those kinds of things. It was very important that you get off that depreciating silver standard. Otherwise, you're never going to be able to take on Russia.
JERRY: I see. One of the things I noticed, you have a great deal of extremely detailed research in this book. And I don't want to scare someone away from the book -- because one can just skip the tables if one wants to, and read the story. But I didn't skip the tables.
I looked at the financing transactions, the basically, floating bonds on the global market, mostly Britain, the British market, but France to some degree, and then later American. Not long after the gold standard, you see a significant drop in interest rates. Not right away, but the Japanese cost of capital, after a short adjustment period, which I think is basically just a matter of them not knowing how to negotiate yet in the global markets. You know, they're not borrowing at seven, eight, nine percent anymore. All of a sudden, they're borrowing at six, five, even four percent with the change in the gold standard. Do I have that story right?
SIMON: Yeah. I'm glad that you picked up on that. That's so important.
The way it was described at the time -- I'm just trying to think which page it is. I actually caught it, and a guy described it as like turning on a switch. That's exactly one of the reasons why a country would adopt the gold standard, because by doing that it's, one: a greater trust, and people could safely invest in it. And, of course, interest rates would be much lower. And that's exactly what happened.
