In 1945 Japan was undergoing devastating bombing attacks by the U.S. Air Force. Fire bombings of Tokyo killed as many as 140 thousand Japanese in one night. A submarine blockade of Japan cut off supplies of food, fuel and everything else. Yet the Japanese government showed no indication of surrender.

Despite the obvious inevitability of defeat the Japanese were defending to the death islands on the path of an American invasion of the main Japanese islands. The capture of Iwo Jima cost over 6800 American lives and 19000 Japanese lives. The capture of Okinawa cost over 7600 American lives and 110,000 Japanese lives. There was every reason to believe the conquest of the main islands would be far more costly in American and Japanese lives. It took the dropping of an atomic bomb on Hiroshima on August 7th to startle the Japanese government. Even then there were leaders in the Japanese government that thought the U.S. had only one bomb. Therefore a second bomb was dropped on Nagasaki on August 9th. On August 9th the Soviet Union declared war on Japan. Although Japan had seen death tolls equal to those of the nuclear weapons before and not surrendered the prospect of all the major cities being destroyed by nuclear weapons was too much and the government agreed to an unconditional surrender on August 14th of 1945. The Emperor Hirohito announced the surrender to the Japanese people in a radio broadcast.

General Douglas MacArthur was chosen to be the Supreme Commander of the Allied Powers (SCAP), the authority that was to govern Japan for the immediate future. MacArthur put together a team of American officers to fulfill that responsibility. MacArthur himself was a political conservative but many if not most of the people working for him at SCAP were liberal Democrats dedicated to the principles of Franklin Roosevelt's New Deal. The New Deal was a variety of the economic system called Corporatism. One major tenet of the New Deal was the recognition of labor unions and the notion of collective bargaining to settle management-labor differences such as in wages, work hours or working conditions. More generally the New Deal allowed for private enterprise only under the guidance of the government.

MacArthur's priority was to carryout a political revolution that would establish constitutional democratic government for Japan. Economic stability and recovery were of secondary consideration. The economy of Japan was in terrible shape. There were shortages of all essentials such as food and housing. The functioning Japanese government had little in the way of financial resources. The tax system was not operative and the public had little to tax. The U.S. government provided food supplies to the Japanese government which sold them to raise funds for its operation. The government dealt with its deficits by printing up money. This of course led to inflation.

Meanwhile SCAP was concentrating on political changes. It persecuted the top leadership of the wartime government and hanged about twenty of them including the prime minister, Tojo. SCAP also forced over two hundred thousand top administrators out of business as well as out government. In particular SCAP sought to break up the large, conglomerate, family-owned firms known as Zaibatsu, literally financial cliques. These firms, such as Mitsui and Mitsubishi, were thought to be guilty of supporting the militarist government.

MacArthur did not however want the Emperor Hirohito prosecuted. MacArthur realized that the prestige of the emperor could be utilized in promoting the objectives of SCAP. The announcement of the surrender of Japan by Hirohito had affectively ended all resistance in Japan. Moreover MacArthur was not opposed to the institution of royalty in a society. When MacArthur took command of the governance of Japan he did not contact the emperor but instead waited for the emperor to contact him. In September the emperor sent a message to MacArthur asking if he might come to see MacArthur. The emperor arrived at SCAP prepared to give deference to MacArthur but MacArthur made a point of walking to the emperor to let him and all observers know that MacArthur considered that he and the emperor were meeting as equals. MacArthur's treatment of the emperor proved wise when later he was able to obtain the emperor's support for the measures SCAP was promoting, such as the new constitution.

SCAP called for Japanese authorities to write a new constitution. The old constitution which had been adopted in the Meiji Era was modeled on the Prussian constitution and gave all the real authority to the bureaucracy. The government authorities made inconsequential modifications to the old constitution and MacArthur gave up on them making any real changes. Instead he formed a group within SCAP and assigned them to formulating a new Japanese constitution in six days. None of the members of the group had a background in constitutional law. Nevertheless the group came up with a draft that emphasized civil rights. The group formulated the role of the emperor as the symbol of the state and the unity of the Japanese people. MacArthur himself wrote a clause in which Japan renounced military action even in self-defense. MacArthur then pressured the ruling party to promote the legal acceptance of the draft as the constitution of Japan. The conservative ruling party was not in favor of the draft but the emperor supported the draft and there was widespread public support. Everyone knew that it was an American product but most accepted it anyway. MacArthur threatened the ruling party that if it did not ratify the draft then he would call for a public referendum on the draft constitution. If it passed in a referendum after the ruling party declined to pass it then the ruling party would lose face.

One of the most important reforms promoted by SCAP was that of land reform. Many Japanese farmers worked on land owned by the aristocratic families. MacArthur forced the Japanese government to buy up land low pre-inflation prices and sell it to the farmers who worked it on easy terms. The land owners were compensated in bonds to be paid off at some future time (30 years) in fixed Yen amounts. When Japan went through high inflation the land owners found the real value of their compensation decrease to next to nothing. This greatly reduced the social power of the aristocratic landowning class. Some alleged that this financial arrangement and the subsequent inflation was a scheme of the Ministry of Finance to destroy the power of a rival power group, the wealthy, aristocratic landowners.

SCAP decided to release the people the militarist government had put into prison. This included the communist party members. More conservative Japanese were appalled at this move, feeling that it was comparable to putting poison into the Japanese social system.

SCAP also legalized and supported labor unions. This included the right of labor unions to engage in strikes. This was in keeping with the New Deal mentality of the lower level members of SCAP. The labor unions organized very quickly and quickly achieved a membership of over six million. The unions soon were exercising their right to strike. The communists who had been released from prison soon captured the leadership positions in the unions and the labor movement.

With the communists capturing leadership of the labor unions and leading parades featuring red flags it was very plausible that Japan would soon be a communist country. This is not what SCAP had intended. When the labor unions called for a nation-wide general strike in February of 1947 to overthrow the government, SCAP panicked. Douglas MacArthur prohibited the general strike. Labor leaders felt SCAP had snatched national control from their hands.

SCAP eliminated the censors that had restricted public expressions in art and politics. This resulted in a flowering of artistic expression and political dissent. The noted Japanese movie director, Akira Kurosawa, started his career at this time.

However economic conditions were appalling with high unemployment, inflation, and food shortages due to poor harvests and general chaos.

SCAP then embarked upon what was called the reverse course. That is to say, SCAP began to undo some of its policies which it had promoted in the interest of democratization and replaced them with policies intended to promote economic recovery. SCAP started with a list of 325 firms to be dissolved; this was reduced to 100 and finally to nine. The reverse course was in part instigated by General William Draper, a former Wall Street financier, who was sent to Japan to persuade MacArthur to build up the Japanese economy. Another factor was the political victory of Republican Party candidates in the 1946 Congressional election that gave Republicans control of Congress. New Dealers were no longer in the ascendance and this extended to SCAP. A division between the conservative Republican and the New Deal Democrats within SCAP became known to the Japanese authorities and they sought to exploit it for their own objectives. In 1948 the Liberal Party of Yoshida Shigeru won control of the Diet, the Japanese legislature. (Remember that outside of the U.S. liberal means what conservative means in the U.S. Social democrat is the term used outside of the U.S. for what is called liberal in the U.S.)

The new economic recovery program of SCAP included the reformation of the firms which had been the zaibatsu, only time without the monopolies and special privileges they had enjoyed. The new versions of the zaibatsu were called keiretsu, literally business associations.

An important influence on economic policy was Joseph Draper, a former Detroit banker, who came to Japan and made policy recommendations.

Joseph Dodge's Nine Point Program (1949)
• 1. Balance budget
• 2. Strengthen tax program
• 3. Limit credit expansion to economic recovery
• 4. Wage stabilization
• 5. Price controls
• 6. Foreign trade and exchange controls
• 7. Rationing
• 8. Increase production
• 9. Improve food collection program
• (10. Eliminate multiple exchange rate system and set the single exchange rate at 360 Yen to the dollar)