War costs an immense amount of money.

How, then, did Japan finance its military in the early Showa period?

The Manchurian Incident of September 18, 1931, prompted the Japanese government to allocate a large sum to its Chinese policies.

While the initial amount to be expended was earmarked at 1.46 billion yen, it was eventually increased to 2.02 billion yen.

That was a sharp addition of 0.52 billion yen (34.2%) from the budget of fiscal 1931, which mainly came from Manchurian Incident spending of 0.29 billion yen and public construction projects of 0.16 billion yen.

The government issued national bonds in order to compensate for the lacking funds as it was difficult to raise taxes further.

Government bonds were issued as debt drastically rose from 0.03 billion yen (the substantial amount was 0.12 billion yen) in 1931 to 0.7 billion yen or 34% in 1932, which was a huge increase of financial dependence on national debt from 2% in 1931 and around 3% from 1927 to 1929.

Finance Minister Korekiyo Takahashi tried to resolve this fiscal crisis by underwriting national bonds by the Bank of Japan as an interim solution.

Finance Minister Takahashi initially expected that the financial balance could be recovered quickly by decreasing spending as tax revenue increased because of economic recovery from the depression.

However, contrary to his expectations, the amount of government expenses kept rising because of military spending.

As a solution, Finance Minister Takahashi proposed to decrease government debt in the draft budget of fiscal 1935 by reducing military spending, which caused friction with the military.

Military officers angrily set him as a target for assassination and killed him in what is named the February 26 Incident of 1936.

The next Finance Minister Eiichi Baba, in the Kouki Hirota administration, presented a bill that the Diet approved titled, "Law of Switching Budgetary Items in the Special Account in order to Compensate for Financial Resources of the General Account Expenditure of 1936." Subsequently, the Senjuro Hayashi administration enacted "the Law of Reserves Financed by the Special Account to Compensate for Financial Resources for the General Account Expenditure" (Law No. 9 of March 30, 1937).

With this law, the government adopted a tentative policy of allocating money to a special account that could be used for projects involving telecommunications, the imperial railways, the Guandong (Kwantung) Bureau, the Korea-Governor's General Office, the Taiwan-Governor's General Office, the Colonial Government of Karafuto (Sakhalin), and the Territorial Government of South Seas Islands.

The Japanese government manipulated the budget in this manner by pumping financial resources of the special account into the general account to compensate for a lack of money in it as debt was issued in parallel.

The Special Account Act for Extraordinary Military Budget (Law No. 85) was passed to support functions of the Sino-Japanese War on September 10, 1937, and it set the Japanese wartime fiscal policy on route to be more dependent on government debt.

The general account's budget was set annually (from April 1 to March 31) while the special account for extraordinary military budget was based on the entire wartime period from start to end, covering from 1937 to 1945.

The special account for extraordinary military budget was formulated fifteen times and also frequently appended as requested, and it was more flexible than the general account in terms of its switching of budgetary items.

The amount of the account was increased from about two billion yen in 1937 to approximately 73.5 billion yen in 1944.

It was better financed than the general account and its value increased quickly.

The financial resources for this budget were not taxpayer money but mostly government debt, which could be issued without consent from the Diet for the purpose of war spending.

When consent for a proposal was needed for the extraordinary military budget by the Diet, it usually took a couple of days and fell under twelve days in most cases (one and half month is the longest in an exceptional case).

In an extreme case, it took only one day to present and pass a draft budget both in the House of Peers and the House of Representatives, and the budget was promulgated the following day.

Such hasty draft budgets were passed as originally proposed and never modified in the Diet.

The Ministry of Finance drafted expenditure proposals roughly calculated from spending estimates within the limits of the assigned budget in each quarter.

Those draft spending proposals were presented with statements of reasons to the Minister of Finance and adopted in the Cabinet meetings.

After those were approved by the Emperor (as the fixed amount by the Emperor), the government could officially start the spending procedure.

Although the budget was supposed to be implemented based on the fixed amount approved by the Emperor, abovementioned procedures contributed to the budget often going over.

The total amount of the budget expenditure from the Sino-Japanese War to the Pacific War was 155,397,218,000 yen, 145 times as much in relative values to that of the Sino-Japanese War of 1894 and 30 times the Russo-Japanese War.

The Fumimaro Konoye administration made revisions of the accounting system in July 1940, by which the budget for war had to be passed more urgently than any other items drawn up by the Ministry of Finance as well as the ministries of War and Navy.

The budgetary items were to be merged thoroughly among the ministries concerned so that the budget could be more easily processed.

The management and implementation procedures of the national fund were simplified and made flexible enough to include items involving advanced payment or rough estimates.

In order to facilitate more munition productions, the procurement procedure of necessary materials was changed to be completed by no-bid contracts or provision of national property for free of charge.

In this sense, the budget was not to be altered by the Diet or financial authorities, but rather it was to be implemented by decision and management by the heads of the ministries concerned.

The Diet had just nominal authority over the budget but could not influence its accounting procedures particularly from fiscal 1942 to 1945.

As the war conditions grew worse and military spending ballooned, the government had to issue more national bonds.

Even though the government debt had been once issued and underwritten by the Bank of Japan, it needed to have been circulated into the civil bond market in order to prevent the price from going into hyperinflation.

The government attempted to ease the limit of issuing Bank of Japan notes, keeping the interest rate low, and encouraging people to accumulate more savings while adopting financial and legal measures favoring the purchase of national bonds so that the government debt could be issued and used more flexibly.

Among those measures, the movement to encourage savings was promoted under administrative guidance.

On April 19, 1938, the National Savings Promotion Bureau was established as an affiliate organization of the Ministry of Finance, and local branches of the National Savings Promotion Bureau were set up and administered by local authorities of the Ministry of Home Affairs.

Those organizations were taken over by the Imperial Rule Assistance Association which administered the movement at the top and extended the network of savings unions among the people with the guidance of local leaders, heads of neighborhood associations, and chiefs of savings unions.

In addition, the movement was also involved with commercial banks, savings banks, trust companies, mutual loan companies, credit unions, commercial unions, and industrial unions for deposits, savings, money trusts, and mutual loans.

Post offices were also committed to campaigns for postal life insurance.

Each unit of central organizations, prefectures, counties, municipalities, neighborhood associations and financial institutions worked to achieve goals in the savings movement.

After the end of the war, on February 27, 1946, the Kijuro Shidehara administration promulgated the "Termination of the Special Account for Extraordinary Military Budget" based upon the "Directive Issued by the Acceptance of the Potsdam Declaration" (Imperial Decree No. 542 of 1945, promulgated and enacted on September 20, 1945).

As a result, the surplus and deficit of the budget were transferred to the general account.

With this measure, the final accounting of the revenue and the expense of the special account for extraordinary military budget was adjusted and presented to the 92nd Imperial Diet session on March 8, 1947.

According to the final accounting, the total amount of revenue was 173,306,154,239 yen.

Of that figure, the expenditure was 155,397,218,352 yen so there was a surplus of 17,908,935,886 yen.

Defaulting upon wartime government debt significantly damaged corporate financial prospects.

The government promulgated the Financial Institution Reconstruction and Readjustment Act (Law No. 39 of 1946) and the Corporate Reconstruction and Readjustment Act (Law No. 40 of October 19, 1946) in order to support companies.

However, the government blocked deposits of people and used them as financial resources for reconstruction of private financial corporations (the second blocked deposits).

The Diet also passed the Public Finance Act, which, in Article 5, prohibited the Bank of Japan to underwrite government debt in principle while stating that national bonds should be consumed basically in the market.

It reflected a lesson from the war that once the Bank of Japan began to supply a large amount of money to the government by underwriting government debt, it lost its discipline for fiscal balance and could not stop issuing excessive notes that cause hyperinflation.

That is why advanced countries such as Japan have institutional restraints that the central bank cannot underwrite government debt.

However, the Bank of Japan still possesses government bonds as a result of financial adjustments and refinances to those bonds, which reach maturity of the period of redemption within the amount approved by the Diet, based upon a proviso of Article 5 in the Public Finance Act.

This practice of refinance has been reimplemented in accordance with prior decisions of the Policy Board of the Bank of Japan every fiscal year.

(Takeshi Sakuma, Researcher at JACAR)
(*This essay is based on the author's own opinions and does not represent the official views of the center.)