Deflation is the word That Dare Not Speak Its Name. In a 2002 speech (before he became Fed chair), Ben Bernanke even titled his talk, Making Sure “It” Doesn’t Happen Here. “It” meaning, of course, “deflation.”(1)
When we inquire why deflation is so awful a condition that it’s name dare not be spoken, we hear a lot of stammering from central bankers. That’s because the US has experienced so little deflation over the last eight decades that it isn’t at all obvious that it should be undesirable. The only examples economists can cite are the very brief period of deflation at the beginning of the Great Depression (a silly example, as I pointed out in my last post) and, of course, Japan’s “Lost Decades.”
But before we debug the Politically Correct view of Japan since 1990, let’s put the Japanese experience in perspective by looking back at the early United States. From the beginning of the Industrial Revolution – which also marked the beginning of the USA – up to about World War I, America experienced its most rapid period of economic growth. Human wealth and human welfare grew faster in the century following the launch of the Industrial Revolution than it had since the species arose.
And what happened to the value of money during the 19th century? It rose! While the emerging market that was the US grew explosively, the pervasive economic condition was deflation. (Except for a brief period during the Civil War.) In other words, the next time we hear a central banker suggest that “deflation” is a synonym for “economic stagnation,” we can roll our eyes. Today we can only lust after such extraordinary growth and deflation.
True, economists will argue that deflation in the 19th century was so-called “good” deflation, caused by spectacular increases in human productivity. But – hello – that’s precisely my point: there is good deflation and bad deflation, just as there is good inflation and bad inflation.
And so to Japan. In the 1980s, as everyone knows but has probably forgotten, extremely low interest in Japan rates led to massive borrowing, which led in turn to gigantic bubbles in the real estate and stock markets. If you happened to a real estate or stock investor, this was terrific (for awhile).(2) But for the rest of the Japanese population it was a disaster. Prices rose massively across-the-board and soon nobody could afford to rent an apartment or buy a home. Nobody could afford to eat out, and the prices of even ordinary consumer items rose out of sight.
Eventually, the Japanese raised interest rates sharply and the bubbles burst in spectacular fashion, leading to a colossal collapse in the stock and real estate markets. Prices now fell across-the-board, a process we call “deflation.” How bad was it? It was flat-out terrific. Suddenly, people could rent apartments, buy homes, go out to eat.
In addition to the price collapse deriving directly from the burst bubbles, high prices during those bubbles had led to intense pressure to open up the insular Japanese economy to outside competition. And while that process proceeded (in typical Japanese fashion) slowly and spottily, where it took root it blossomed.
Consider the phenomenon of the “100 Yen Shops,” the equivalent of our dollar stores. The first store opened in 1991, right after the bubbles blew up, and there are now more than 1,300 of them. Before they opened, Japanese housewives could buy a terrific egg beater guaranteed to last five generations for 1,000 yen. Afterward, they could buy a perfectly serviceable egg beater for – right – 100 yen, and everybody did. A utilitarian suit for a salaryman could be had for less than US$75.
One of the best stories is about McDonalds, which was still trying to establish itself in Japan. As deflation set in and McDonalds’ costs declined, the firm at first tried to maintain its retail prices (and growing profit margins). But volume began to fall off rapidly, so, in desperation, McDonalds cut the price of its hamburgers in half, to 52 cents. Volume shot up 500%.
People who imagine that, as a result of deflation, Japan is a depressed, moribund place obviously haven’t been there. Japan is a spectacularly wealthy, vibrant society. Here are just a few factoids:
* Since the bubbles burst, Japan’s average life expectancy has grown by more than 4 years, to 83, or 4.8 years longer than Americans live.
* Of the 50 cities in the world with the fastest Internet service, 38 are in Japan. (3 are in the US).
* Since the end of 1989, the yen has risen against the US dollar, the British pound and even the Swiss franc.
* Unemployment in Japan is at 3.7%. (Eat your heart out, US.)
* Japan’s current account surplus, measured before Abenomics, was over JPY 580 billion. The US hasn’t had a consistent surplus since Ike was President.(3)
And if deflation was so terrible for Japan, how come its competitors weren’t able to catch up and pass it over the past twenty years? Japan remains the second largest developed economy in the world, way, way ahead of Germany, France, the UK, Italy, and so on.
Granted, all isn’t well in Japan, not because of deflation per se, but because the Japanese allowed deflation to persist for way too long. In other words, the Japanese made precisely the same mistake as the US Fed, but in the opposite direction. More on this in my next – and, I promise, last – post on this subject.
(1) See http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm. I quoted from this speech in Part 1 of this series of posts on deflation.
(2) As a random example of the silliness of the real estate bubble in Japan, at the peak the land beneath the Emperor’s Palace in Tokyo was more valuable than all of California. See Jennifer McNulty, New Book by UCSC Economist Examines Japan’s “Bubble Economy,” October 13, 1997, referring to Michael M. Hutchison’s The Political Economy of Japanese Monetary Policy.
(3) Most of these examples are taken from a piece in the New York Times, The Myth of Japan’s Failure, by Eamonn Fingleton, January 6, 2012.
Next up: (On Deflation (Part 4))
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