Sustainability of Public Debt: Evidence from Pre-World War II JapanOn Wednesday, September 12,  The Center on Japanese Economy and Business cosponsored the Weatherhead East Asian Institute (WEAI) Brown Bag Lecture by Professor Masato Shizume, Professor, Kobe University. The causes of the Japanese public finance trouble could have deep roots in the past, dating back to policies adopted in the thirties: this is the original result of the research led by Professor Mosato Shizume, from the Kobe University in Japan. Seventy years ago, lack of fiscal discipline led to serious borrowing problems; how the country got out of this trap can be a precious advice concerning the current situation. The act of birth of modern state finance was the reform of land tax, by the mid1880s; the first real exposure on the international markets was the debt issuing for the war with Russia, in 1904. International investors trusted Japan counting on its adherence to the Gold standard, but by the end of the conflict, the amount of debt was so high that foreign banks questioned whether it was repayable: the price of government bonds dropped.The answer of the policymaker was limiting public spending within the range of maintaining gold parity. Such an action was possible only through an agreement with the army, which was a keeper of a large portion of the spending quotas.As the gold standard was suspended in 1917, the financial market reacted negatively. The country then suffered yen instability combined with a terrible earthquake in 1923. In 1924, Japanese bonds sold in London and New York to finance the war and the earthquake damages were labeled by Japanese as the “bonds of national disgrace” because investors demanded a star yield of 7. Japan managed to return to the gold standard in 1930. It had to further cut state spending, but the choice was rewarded by a successful bond issuing at a yield of 6.2. Yet, the storm was knocking at Japan’s door: the war with China in 1931 led to uncontrollable army expenditures, and at the same time Britain left the gold standard, making Japan’s exit the only reasonable choice. The Keynesian measures of Finance Minister Korekiyo Takahashi led to a complete loss of fiscal discipline and the underwriting of government bonds by the central bank became an instrument of easy credit. Takahashi was assassinated in 1936, a short time after he had started to reduce spending.  Inability to defend the conditions for sustainable debt levels were virtually lost even before the Keynesian policies and inflation began to skyrocket in the 1940s. Fiscal discipline is key to maintaining a sound financial situation, and Japan was able to achieve this as long as the external constraints of the Gold Standard and international market pressure were present. These constraints even helped contain the budgetary disaster of the war with Russia. As the control mechanisms faded away, Japans did not find its path towards fiscal self-discipline, but rather superfluous military spending for the war in China made the situation collapse.Contemporary Japan relies on a stable constitution, limited military spending; and has a creditable public finance act. The solution to garnering new financial credibility is to apply the rules with discipline, or even better, self-discipline.