Central Banks and Gold

How Tokyo, London, and New York Shaped the Modern World

Simon James Bytheway, Mark D. Metzler

• Publisher: Cornell University Press
• Year: 2016
• Print ISBN: 9781501704949
• eBook ISBN: 9781501706509
• Topic: History
• Subtopic: Economic History
• Index: History

In recent decades, Tokyo, London, and New York have been the sites of credit bubbles of historically unprecedented magnitude. Central bankers have enjoyed almost unparalleled power and autonomy. They have cooperated to construct and preserve towering structures of debt, reshaping relations of power and ownership around the world. In Central Banks and Gold, Simon James Bytheway and Mark Metzler explore how this financialized form of globalism took shape a century ago, when Tokyo joined London and New York as a major financial center.As revealed here for the first time, close cooperation between central banks began along an unexpected axis, between London and Tokyo, around the year 1900, with the Bank of England's secret use of large Bank of Japan funds to intervene in the London markets. Central-bank cooperation became multilateral during World War I—the moment when Japan first emerged as a creditor country. In 1919 and 1920, as Japan, Great Britain, and the United States adopted deflation policies, the results of cooperation were realized in the world's first globally coordinated program of monetary policy. It was also in 1920 that Wall Street bankers moved to establish closer ties with Tokyo. Bytheway and Metzler tell the story of how the first age of central-bank power and pride ended in the disaster of the Great Depression, when a rush for gold brought the system crashing down. In all of this, we see also the quiet but surprisingly central place of Japan. We see it again today, in the way that Japan has unwillingly led the world into a new age of post-bubble economics.

1

THE BEGINNINGS OF CENTRAL BANK COOPERATION

Tokyo and London, 1895–1914

Anxiety about the national gold reserve was in no way abated.… Almost the whole civilized world was on the gold basis, so that, through the international banks, claims might be made on London from any, or all, of half a dozen or more financial centres. A centre so new, remote and incalculable as Tokio now kept very large balances in London.

JOHN CLAPHAM, The Bank of England, 1944

Cooperation between the Bank of Japan and the Bank of England, as revealed in hitherto obscure archival records, constitutes the first historical example we know of close, regularized cooperation between national central banks. The story starts with the Japanese receipt, in London, of an immense monetary indemnity from China, as an outcome of Japan’s victory in the Sino-Japanese War of 1894–95. The indemnity funds were received by the Bank of Japan, at the Bank of England. Using these funds as a reserve, the Japanese government established a British-style gold standard in 1897. Interwoven with this story are the conclusion of the Anglo-Japanese military alliance of 1902 and the issuance, in London, of massive loans to the Japanese government for the war with Russia in 1904 and 1905. The Bank of England made use of Japanese funds to an extraordinary degree during this pivotal period. These operations helped it to maintain its own position at the foundation of Britain’s globalized credit structure.

A detailed view of this connection is made possible by examining the governor’s daily accounts at the Bank of England, which were not made available to outside researchers until almost a century after the events in question.¹ Even these records are cryptic, as explained below, with the enormous newly opened Bank of Japan accounts being labeled simply “A” and “B,” without being otherwise named in the account books. These procedures testify to the great political and financial sensitivity of these accounts. A newly constructed data series based on these accounts is presented here and in appendix A at the end of the book.

The first decade of this central-bank connection was punctuated by wars, including Britain’s war in the Transvaal and Japan’s war with Russia in northeastern China. This period was punctuated also by financial disturbances, the greatest of which were the financial bubbles of 1906 and the panic of 1907. During these years, the Bank of Japan assisted the Bank of England with enforcing its official discount rate and thereby reinforced the preeminent standing of the pound sterling in international finance. What were the motives and nature of the mutual assistance between the Bank of England and the Bank of Japan? What was the significance of the Bank of Japan’s “overseas specie reserve,” which supported Japan’s gold-standard currency system? And what was the role played by the Bank of Japan in lending short-term funds to the Bank of England?

The Bank of Japan’s Foreign Specie Reserve Held in the Bank of England

On cessation of the Sino-Japanese War, the imperial Chinese government agreed to pay the Japanese government an indemnity of 200 million kuping (Treasury) taels, equivalent to 7.5 million kilograms of silver. A further treaty yielded an additional payment of 30 million kuping taels to the Japanese government.² Matsukata Masayoshi, Japan’s veteran minister of finance, recognized the magnitude of the opportunity provided by the Chinese indemnity as early as May 1895 and petitioned the prime minister concerning the “method and process of payment.” Matsukata’s bold proposal was that all Chinese indemnity payments be paid in London in pounds sterling, directly convertible to gold, thereby creating the gold reserve necessary for Japan’s adoption of the gold standard.³ On October 6, 1895, the Chinese government agreed with the Japanese request: regardless of how the Chinese government financed the indemnity, it agreed to make all payments in London, using English currency. Accordingly, the Chinese government was to pay £32.9 million; to this, £4.9 million was added for the retrocession of the Liaodong Peninsula, and a further £82,000 to subsidize the Japanese occupation of the port of Weihaiwei. The total Chinese payment to Japan was thus calculated to be £37.9 million.⁴ It can hardly be overstated: the Bank of Japan’s overseas specie reserves originated in the payment of these indemnities. Forced to resort to foreign loans to pay for these huge indemnities, the Chinese government turned first to a Franco-Russian bank syndicate.

On July 25, 1895, even before these arrangements were finalized, an account was opened at the Bank of England with the name “Russian Finance Minister,” through the agency of the bankers Hottinguer and Company of Paris. On October 31, 1895, the bulk of the funds in this account, some £11 million, were transferred to another Bank of England account named “Chinese Minister,” and then transferred into a “Japanese Minister” account as the initial indemnity payment. When the first check was drawn, for the first quarter-payment of the indemnity and ancillaries, it totaled £11,008,857 (often misquoted as being for £32 million or £38 million). It was reputedly, up until that time, the largest bank check to be processed in world history.⁵ “On taking charge of this large amount of money belonging to Japan in the Autumn of 1895,” as the governor of the Bank of England explained to the chancellor of the exchequer a year later, “we made no special stipulations, presuming that the nature of the operation was a temporary one.”⁶

On March 12, 1896, the balance of the “Russian Finance Minister” account was again transferred to the “Japanese Minister” account, via the account of the “Chinese Minister.” From this point on, however, a newly formed Anglo-German syndicate, on behalf of the Chinese government, refinanced the Franco-Russian loans and made all further indemnity payments.⁷ The Anglo-German syndicate’s aggressive takeover and refinancing of the Franco-Russian advance illustrates the way that finance and diplomacy so often converge.⁸ The syndicate was led by the Hongkong and Shanghai Bank (the future HSBC) and the Deutsch-Asiatische Bank, which was itself owned by a consortium of German banks. Together they floated two £16 million loans for the Chinese government on the London financial market, the first at 5 percent in March 1896, and a second at 4.5 percent in March 1898.⁹ The Bank of England was more deeply involved at this point, via its guarantee of the bonds. As a further outcome of this profitable arrangement, the Hongkong and Shanghai Bank also became the British government’s chief financial agent in China.¹⁰ The bulk of the indemnity was thus financed or refinanced in London. The Anglo-German syndicate included the Reichsbank, Germany’s central bank, and the Disconto-Gesellschaft as a junior partner; they assisted by floating two loans worth £5.1 million each on the Berlin financial market in May 1896 and May 1898. The participation of the Reichsbank is significant, as it marked a starting point for the Bank of Japan to develop relations with the German central bank.¹¹

After the fact—in the form of the Chinese indemnity—capital funds raised in European markets thus paid Japan’s expenses in the Sino-Japanese War of 1894–95. The Chinese were left with the bill. For China also, this marked a turning point. Before this time, the external debt of the Chinese government was quite small. But now, as Charles Addis of the Hongkong and Shanghai Bank noted, China was having to borrow some £40 million to pay the indemnity. The annual debt service would henceforth cost the Chinese government about £3 million per year—and “that sum would nearly absorb all her maritime [customs] revenues, of which formerly six tenths were used in the provinces, four-tenths for the imperial exchequer.”¹² The implication of Addis’s statement, concerning the fiscal aggravation this might cause in the provinces especially, was prescient. By 1910, the Qing government was facing a comprehensive fiscal crisis, which created the conditions for its overthrow in the revolution of 1911.¹³ Alto gether, between October 1895 and May 1898, the Japanese government received in London a total of thirteen indemnity payments through the auspices of the Franco-Russian and then the Anglo-German financiers.

We have seen how the funds were raised. How were they received? First, in whose name would the Japanese account be held? In initial negotiations between the Bank of England and the Yokohama Specie Bank (YSB, Japan’s parastatal foreign exchange bank), the Bank of England had refused to countenance the opening of an account for the Japanese bank.¹⁴ By October 31, 1895, however, Bank of England objections to opening a Japanese account had obviously been overruled, presumably at the very highest levels of the British government. Nevertheless, it would take almost another six months for the Yokohama Specie Bank’s negotiators (primarily Nakai Yoshigusu, but also Takahashi Korekiyo and others) to find a way around the Bank of England’s intransigence.¹⁵ In this context, it is notable that the Bank of Japan in 1897 requested to send two trainees to the Bank of England, and the request was brusquely turned down. These trainees were Inoue Junnosuke and Hijikata Hisaakira, who interned instead at Parr’s Bank in London; both would serve in turn as governors of the Bank of Japan in the 1920s.¹⁶

In the end, Nakai Yoshigusu asked the Bank of England to open an account for Japan’s central bank, the Bank of Japan, instead of for the Yokohama Specie Bank. Thus, on April 16, 1896, the account was retitled as “Bank of Japan,” though it continued to be administered by the Yokohama Specie Bank as the London agents of the Bank of Japan. This account was the central reservoir of the Bank of Japan’s overseas specie reserve; it was without doubt the most important account the Bank of Japan held at another bank.

Arguably, the Bank of Japan account was also the most important central bank account held by the Bank of England in the two decades prior to the First World War. In fact, for a time in late 1896, the Japanese account alone was equivalent to more than half of the Bank of England’s entire gold reserve (see table 1.1). On May 18, 1896, the Bank of Japan account was split into two accounts: a normal “A” account held by the Bank of Japan head office, and a special “B” account, held by the Bank of Japan as its own convertible banknote reserve.¹⁷

Thus, the division of the Bank of Japan account into “A” and “B” accounts seems initially to have reflected the dual use of the indemnity payments as both a source of funds for foreign exchange and as an overseas specie reserve supporting the convertibility of the Bank of Japan’s own banknotes.¹⁸ This was a preparatory step in the establishment of the yen on a gold-standard basis; that happened on October 1, 1897, meaning that Bank of Japan notes were now convertible into gold rather than into silver as formerly. Later, in the early 1920s, when the Bank of Japan deposited a large $20 million and then $40 million fund at the Federal Reserve Bank of New York, it asked again for the same kind of dual account.¹⁹ All of this suggests that the dual account arrangement had a particular significance or orthodoxy in Japan’s international finances. But these “overseas specie reserves” were not something that Bank of Japan or Japanese Ministry of Finance officials discussed in public, and much concerning these arrangements remains obscure.²⁰

Turning to the “A” and “B” accounts themselves, the first thing we notice is the enormity of their initial sizes (see table 1.1). The significance of the Bank of Japan’s two accounts was not lost on the Bank of England; indeed, Bank of England officials in their daily account books entered the “A” and “B” balances in red ink under the bank’s own account totals. For example, on June 1, 1896, following the big Chinese indemnity loan in London in March, the combined balances of the two accounts totaled over £20 million. This sum was equivalent to 53 percent of the Bank of England’s entire gold reserve. Japan’s balance at the Bank of England was also significantly higher than the value of all the other (British) bank balances held at the BoE at that time. On December 18, 1896, the Bank of England’s governor A. E. Sandeman wrote to Chancellor of the Exchequer E. W. Hamilton to explain that after the bank received the large Japanese funds in the autumn of 1895, “numerous transactions have since taken place, and lately the Japanese Government have withdrawn a certain amount in gold for export.” The Japanese had done this “in a very discreet manner,” he said, “but, should these withdrawals assume large proportions, and become generally known, they might easily create alarm at a time like the present,” when the financial markets were “in a very sensitive condition.” The governor concluded that “unless some arrangement can be come to with the depositors,” the money market would be seriously imperiled.²¹ By January 1, 1897, the Bank of Japan’s account balances were equivalent to 64 percent of the Bank of England’s gold reserves, and were equivalent to 72 percent of total (British) bank balances held at the BoE. Clearly there was a need for the British government to accommodate Japanese finances, for while Sandeman refrained from discussing it in public, London’s streets buzzed with rumors of Japan’s “enormous (£11, £32, or £38 million!?) account” and how its withdrawal threatened the gold standard and the finances of Great Britain and the empire.²²

It is therefore striking that the great bulk of the Bank of Japan’s account does in fact appear to have been paid out in quick order. According to the Bank of England’s daily accounts, there were no withdrawals from the Bank of Japan’s accounts during 1895, but during 1896, £8,084,779 was withdrawn. The Japanese then withdrew almost double that amount, £15,459,576, during the twelve months of 1897.²³ Accordingly, the special “B” (convertible bank note reserve) account was closed at the request of the Bank of Japan on November 8, 1897. Japanese withdrawals continued, and after 1900, the Bank of England temporarily ceased to specially note the Bank of Japan’s “A” account underneath its own daily account totals.

How did the agents of the Bank of Japan manage to move these enormous funds without disrupting London’s financial market? The direct export of gold from the Bank of England to the Bank of Japan could have caused financial panic and had the potential to destabilize the British economy. The Yokohama Specie Bank therefore scoured the world’s financial markets to purchase bills of exchange payable in Japan from late 1895 to early 1903. In this way, funds were remitted to Japan, while in London demand for bills of exchange, payable in Japan, did not seem unusually large. In the midst of these operations, during 1897, the Bank of Japan discreetly withdrew £6,018,048 from the “B” account for use as its convertible bank note reserve, in the lead-up to the adoption of the gold standard on October 1, 1897.²⁴ Simultaneously, the Yokohama Specie Bank went to great lengths to reduce the discounting in London of trade bills for imports to Japan, in order to discourage the Japanese import trade and ameliorate Japan’s trade deficit with Great Britain.²⁵

Table 1.1 summarizes the course of the Bank of Japan’s accounts at the Bank of England over their first four years. In 1900, the Japanese balances were withdrawn from the...

Table of contents

• List of Tables and Figures
• Preface
• Acknowledgments
• Abbreviations
• Note on Conventions
• Introduction: Bases of Credit
• 1. The Beginnings of Central Bank Cooperation: Tokyo and London, 1895–1914
• 2. World War and Globalization
• 3. Japan Emerges as an International Creditor, 1915–1918
• 4. Postwar Alignment
• 5. Wall Street Discovers Japan, Spring 1920
• 6. Putting the Program into Action, 1920–1928
• 7. Making a Market: London and Gold in the 1920s
• 8. The Rush for Gold
• Conclusion: Private Networks and the Public Interest
• Appendix: Reference Material
• Notes
• References
• Index