Deadly Deflation

Recently, I decided to get rid of my old DVDs, since I watched movies mainly online for the last couple of years. Shifting through dusted DVDs with movies from the 1990s like ‘Rising Sun’ (Sean Connery), or ‘Die Hard’ (Bruce Willis) reminded me, that in many Hollywood movies from that time, there was lot of talk about Japans coming cultural and economic dominance over the US.

Japan was in fact a powerful economic force in the late 1980’s and early 1990’s. The stockmarket had one direction only – up. The Nikkei-Index reached 40000 points at the end of 1989. Real estate prices in Tokyo overtook the values in New York by far. The japanese way of production called ‘kaizen’ was superior compared to european or american standards.

Then japanese investors from Sony, Matsushita or Mitsubishi began to buy american icons like the Rockefeller Center in Manhattan or the Hollywood studios Columbia and Universal. That made the americans nervous. Nothing, it seems at that time, could stop Japan from becoming the number 1 economic force globally very soon.

As we know today, Japan didn’t make it. Instead the land of the rising sun went the other way and for the last 25 years had severe economic problems. The main reason for the japanese malaise: Deflation.

In 1990 the Bank of Japan (BoJ) was aware of the bubble in real estate and asset prices like stocks. To contain the risk of a crash the BoJ opted for higher interest rates and this decision set up Japans path into deflation.

Deflation means prices of goods and services are sinking. Prima vista something that sounds not to bad. But deflation is a brutal, dangerous, even deadly spiral. Consumers, in anticipation of further sinking prices, wait to spend their money for goods. Companies for that reason have no incentive to invest in new products or pay higher salaries. Au contraire, they fire employees and close factories as the demand for goods is constantly sinking by domestic consumers.

To boost at least the exports, the BoJ then lowered interest again and again and flooded the market with cheap money to get a lower Yen vs the Dollar. With the result that imports (mainly oil which is priced in US Dollars) became more expensive for japanese consumers and therefore they would spend even less for domestic goods. The deadly spiral of deflation took another turn for the worse and companies closed even more factories and fired even more employees.

Finally, the economic issue became a social issue. Many japanese consumers, who bought real estate with a mortgage during the boom in the 80’s, were so highly indebted, that suicides in Nippon were rising up to 70 per day.
Its very hard for a country to get out of a deflation. Japan tried everything (low interest rate, tax reform, economic deregulation, social support for families) but was unsuccessfull for a quarter of a century in the fight against deflation.

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The example of Japan is also a warning for all these current projections about China becoming the world’s dominant economic superpower very soon. China has still a very long way to go and this way is packed with heavy obstacles hard to come by without an accident. More on China in the next chapter:  http://www.theleader.ro/chinas-real-numbers/