Monday, January 31, 2011

BW: Japan Learns to Live with Deflation

Quite amusing to see the dogma differences in Germany vs the Europe.  Due to the Weimar experience, any tendency to high(er) inflation is met with horror overseas, whereas the exact opposite happens hear when a whiff of deflation is in the air, due to the Great Depression era.  Meanwhile, the country with the oldest records of inflation (Great Britain) ruled the world during a period that inflation and deflation took turns... unfortunately, central banks are run with their countries specific dogma, and there is no changing that.  A couple years ago we highlighted a well thought out piece stating that the deflation genie is being sold as the bogeyman [Aug 18, 2009: Deflation Theory is a Lemon We've All Been Sold] due to the belief once you experience deflation there is no escaping it ala what Japan has experienced.   Even if one subscribes to that view (which is highly simplistic) there is an interesting story in BusinessWeek showing that many Japanese have adjusted, or indeed embraced, deflation in prices of good - especially since wages have held up ok - in many cases cost of goods have fallen far quicker than wages.  (hence their purchasing power goes farther)  Of course as a nation of debtors, versus the Japanese people which has a very high savings rate, deflation is a more difficult concept in the States since we cannot inflate away our debts (i.e. give people who we owe money to, devalued currency).

My take of course is large swathes of the country needs deflation in price of goods because they have fallen off the track in terms of wage growth (non college educated men make as much now, inflation adjusted, as they did in the 1970s while cost of goods/services have skyrocketed_).  Hence to combat that people have turned to borrowing - whether credit card or house ATM.  When the buck stopped on those 2 avenues, in has come the government and we're in the last stage - the government ATM.    [May 25, 2010: 1 in 5.5 Dollars of American Income Now Via Government; All time High So we'll continue with the same wage pressures across society with a government and central bank intent on an inflationary warpath - which in the long run will cause ever more stress for those with stagnant incomes, and in a self reinforcing pattern require the government to hand out even more money to keep people on the gerbil wheel.  It's quite circular really.

Of course I am not calling for a 25 year cycle of deflation, but certainly once an adjustment period was over people would have a much better match of incomes to cost of goods.  Indeed, to use housing as a simple example if the average American would only be forced to spend 22-25% of income for a roof over head, rather than 33-45%+, life would be far more comfortable and heck, they might be able to consume due to savings rather than government handout, or indeed save money for the long run.  The increasing amount of Americans on fixed income (or no income!) would fare better as well.  But I'm a rogue economic thinker in terms of inflation v deflation, in a country where ever higher inflation is a "great" thing.

Via BW:

  • Ben Bernanke has been lecturing on deflation's perils since he joined the Federal Reserve in 2002 and has often held up Japan as Exhibit A.  There's something curious about the way the deflation syndrome has played out in Japan, though. The Japanese don't feel that threatened anymore. "Everyone knew deflation was bad for jobs and bad for the economy, but gradually households and companies just got used to it," says Martin Schulz, a senior economist at Tokyo's Fujitsu Research Institute.
  • Deflation—the steady drop in prices of goods, wages, and services—has many ill effects. Households are stuck paying off mortgages, car loans, and other debt even as their take-home pay has declined. Also, as housing values fall, consumers have smaller nest eggs for retirement. Companies, meanwhile, are unable to raise prices, which puts pressure on profits.
  • Yet the Japanese have discovered the benefits of deflation as well. Monthly pay dropped to an average 315,294 yen ($3,800) in 2009, the lowest level since the government began tracking wage data in 1990. "It's not like I'm promised any pay raises," says Momoko Noguchi. The 24-year-old Tokyo resident gets by on two part-time jobs by shopping for everything from nail polish to dinner plates at her local 100-yen outlet (the Japanese equivalent of an American dollar store), and she pays 400 yen or less for lunch. "I hope prices keep falling." Four out of five Japanese say higher costs would be "unfavorable," according to a central bank survey.
  • Faced with consumers such as Noguchi, companies in Japan have actually accelerated deflation. Retailers "have poured a lot of energy into offering products that are cheap but still have high value," says Naozumi Nishimura, an analyst at TIW in Tokyo. "We're seeing some good effects from that."
  • Price cutting by companies has helped Japanese consumers adjust to deflation. The average household owns 1.4 cars and 2.4 color TVs, about a quarter more than in 1990, a Cabinet Office survey shows. Deflation has helped home buyers, too, by forcing prices down from their peaks in 1990: According to calculations based on yearly Land Ministry data, Japan's residential land prices have dropped by an average of 2.9 percent a year over the past two decades.
  • All told, the proportion of people content with their standard of living was 63.9 percent last year, compared with 63.1 percent in 1989, a government report said.
  • In Japan, where 23 percent of the population is over 65, a sudden rebound in prices would hurt pensioners and retirees especially hard. "It's amazing what you can buy with 100 yen now. We didn't have 100-yen stores before," says Sachiko Enokida, 80, who lives on her bimonthly pension checks from the government. "I would hate for things to get expensive again."

Now for the counterpoint - and once again this assumes once deflation is embedded it never goes away.
  • So is deflation a blessing in disguise? Not to analysts such as Richard Jerram, head of Asian economics at Macquarie Securities . He points out that as businesses cut prices to compete, it becomes harder to borrow and invest. "It's extremely corrosive," he says. Deflation, adds Jerram, will steadily sap Japan's nominal growth and deprive the government of tax revenue. 
  • Eventually, Japan may no longer be able to finance its borrowing. The country will then either have to default on debt that's about twice the size of the economy or devalue its currency to reduce the real value of liabilities. "That's the unavoidable endgame," says Jerram, who has analyzed the Japanese economy since 1987. "As long as it's in the future, everybody can pretend it's someone else's problem."

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