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Part
1: Learning by doing
By
Richard Hanson
 TOKYO - Worried about deflation these
days? Thinking about the
weather doesn't help a
bit.
If you live in Tokyo, this is the season
when numbing high-summer heat stealthily, almost in
wink, replaces the moldy damp of a lowly rainy season on
most of Japan's archipelago. Mother Nature's summer
options to bring on temporary relief are limited to the
odd typhoon, usually accompanied by destruction and a
costly cleanup.
There is no fooling with Mother
Nature. Man-made deflation, however, which has ravaged
Japan for the past decade, just may be succumbing to
man-made fixes, according to policy makers who decided
to turn conventional deflation-fighting wisdom on its
ear way back in March 2001.
Deflation is not
dead by any means. Prices in Japan are still falling.
But the much-hyped fear of a shrinking economy being
sucked further into a deflationary spiral has receded.
That may sound out of sync with common fears of
deflation. Spiraling deflation was used as a stick to
scare politicians as recently as this March as the Diet
(parliament) debated the passage of the an austere
national budget prepared by Prime Minister Junichiro
Koizumi's cabinet.
The budget was aimed at
multiple threats to the economy, with the huge problems
of mounting government debt and the stability of a
banking system uppermost in the public's mind. Falling
prices of goods and shrinking values of such assets as
securities and property were also high priorities. The
government strategy to battle falling prices was to
provide super-easy money.
That was the core of
the revolutionary policies rolled out a year earlier,
which in effect slashed the interest rate charged on
very short-term money borrowed by banks from the Bank of
Japan (BOJ), the country's central bank, to zero
percent.
Within the BOJ influential policy
makers created a new chapter in central banking. Yutaka
Yamaguchi, a career official serving as deputy governor
of the central bank, led the charge. Yamaguchi saw Japan
at risk to erratic foreign-exchange movements and other
shocks while the economy was mired in recession.
The danger of cutting the starting point for
lending money to zero was considered but discounted. In
central banking, monetary policy is eased and tightened
by raising or lowering interest rates. Setting interest
rates at zero was called "quantitative easing" since the
price of money was zero. In crude terms, this meant
shoveling money into the banks, regardless of whether
they were lending it to customers.
In the
very-short-call money market the rate quickly declined
to 0.001 percent - very near zero. The rate on one-year
government bonds slipped to 0.01 percent. Since last
summer, the yield on long-term government bonds has
stayed at the historically low level of 1.3-1.5 percent
per annum.
Talk about quantity? BOJ's Yamaguchi
admits it is hard to appreciate the numbers. The banks,
as a result of borrowing at zero cost, raised their
balances with the central bank to 15 trillion yen. They
are legally obliged to hold only 4 trillion yen in
reserves with BOJ. That means Japanese financial
institutions hold excess money, or liquidity, of 11
trillion yen without earning any interest (the ordinary
bank depositor is in the same boat as a result of
slashed savings-account interest rates).
Apart
from the extraordinary period of World War II, there is
more money sloshing around - versus the size of the
economy - than at any time in the past century. This was
new territory for the central bank. Yamaguchi describes
it as "learning by doing". If thinkers at the BOJ are
correct, the policies may be leading Japan into a phase
where the benefits of deflation outweigh some of its
evils.
Despite long periods of poor to negative
economic growth in the 1990s, Japan has remained an
expensive place to live. This is especially true in
terms of the price of services and the cost of
government. Despite a decade of deflation, Tokyo and
Osaka still consistently rank at the top of the list of
high-cost cities to live in around the world.
The question is whether Japan's approach to the
monetary threat of deflation can be translated into
economic growth. There is comfort among policy makers
that Japan has not suffered the worst that deflation can
offer. This is small comfort indeed.
There is
little chance that Japan's economy will speed up.
Negative growth is likely to return after the positive
performance in the gross domestic product (GDP) seen in
the first quarter of this year, and other signs of a
cyclical recovery.
This depended largely on a
healthy US economy. Japanese consumers are not poised to
buy on a large scale. They have less money and are less
willing to spend it. The reality is that it seems about
half the world is depending on the other half to show
enough economic growth to boost themselves out of a
slump. This is evident in Japan's hopes for economic
growth in the United States to continue to stimulate its
exports, as it has recently. Don't bet on it.
Japan sees no actual solution to its own ongoing
threat of deflation for the foreseeable future (a
concept that has shortened in duration a lot in recent
years). Yamaguchi is committed to continue the current
zero-interest easing framework until CPI (Consumer Price
Index) inflation "stably registers zero or a
year-on-year increase".
Japan's wildly
speculative hyper-inflated economy of the late 1980s
collapsed starting in 1990. The hangover of that
inflationary binge was not recognized as the most
destructive case of deflation among the advanced
industrial countries for several years. By luck, Japan
followed an uncharted (and unplanned) path, says
Yamaguchi. In retrospect, this was a "gradualist"
approach to deflation.
That could be an
important lesson for other countries in Asia and
elsewhere that face what could be a global tilt toward
deflation in consumer prices in the near future.
At the end of last year in East Asia, Taiwan,
Hong Kong, Singapore, Malaysia and mainland China
recorded negative CPI figures, notes Yamaguchi, along
with all but two of the Group of Seven industrialized
countries, Germany and Canada. Japan's latest Whole
Price Index fell one percent from a year earlier - the
21st monthly fall in a row.
What Japan has still
left to ponder is how its policy makers helped create
the problems they are still sorting out. There was a
time when asset inflation seemed the way to unbound
riches. After all, it was the collapse of the bubble
economy of the late 1980s - and the failure to act
quickly in the 1990s - that created the monster of
deflation in the first place.
Next: Uncharted
territory: Bubble to deflation bust
(©2002
Asia Times Online Co, Ltd. All rights reserved. Please
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