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     Apr 7, 2010
Japan caught in deflation conundrum
By Christopher Johnson

TOKYO - If you live in Southeast Asia and need cheap clothing, come to Tokyo and check out these prices: 700 yen (US$7.45) for jeans, 1,000 yen for women's boots, and 7,800 yen for men's suits - about a third of what they cost a decade ago, when Japanese used to go to Bangkok and Hong Kong to shop.

For 12 straight months, prices in Japan have been falling, the country's Statistics Bureau said last week, and land prices are roughly half what they were 20 years ago. Prices fell by 1.2% in February from a year earlier. The finance minister and Bank of Japan board members are promising to stem the price slide, and many financial analysts are warning that further "de-flay" could delay any economic recovery.

Declining prices can encourage consumers, expecting further price falls, to delay purchases. That hits company turnover and


profits, prompting further price cuts and factory lay-offs to stem costs - further eroding overall consumer purchasing power and sales. Government income from sales and other taxes is also hit in the downward price spiral.

Yet Eisuke Sakakibara, famous as "Mr Yen" when he was a top bureaucrat at the Ministry of Finance in the 1990s, argues that Japan's deflation is not necessarily a bad thing. "We aren't in a deflationary spiral. I do not think mild deflation in Japan is a bad thing," he said at a forum of financial analysts last week in Tokyo. "We should enjoy mild deflation, rather than ponder it as a disease."

Sakakibara says deflation is due to economic integration, as intra-regional trade in East Asia reaches 57% of all the region's trade. "If you import cheap goods from China, then naturally prices will come down, compared to the conventional prices we're used to in Japan. It's very difficult to avoid deflation by monetary policies, when it's because of structural changes. Relatively slow deflation is something given."

Yet many others strongly disagree, saying deflation will further dampen economic growth and lead to an eternally greater burden of debt compared with what the country produces, or gross domestic product (GDP).

"Deflation is a bad thing. People don't want to spend money, that is the big problem," says Masaaki Kanno, a former senior official of the Bank of Japan, currently chief economist at JP Morgan in Tokyo. "Now deflation and the economy are affecting each other. It's not easy to see what is the egg and what is the chicken. Without ending deflation, the government's target of 3% growth is impossible."

The Japanese economy grew by 0.9% in the final three months of last year, or 3.8% on an annualized basis.

"Deflation corrodes the health of your economy long term," says Richard Jerram, head of Asian economics for Macquarie Capital Securities in Tokyo. "Non-manufacturing companies are more pessimistic than they were a year ago. Deflation means it's impossible to fix the fiscal problems in the economy without some nominal growth. If you have persistent deflation for the next five to 10 years, public finances are going to crash."

As prices and wages fall, many Japanese are putting off purchases of appliances or cars, since they might be cheaper next year. Yet when chatting in supermarkets about "de-flay" (deflation) and "in-flay" (inflation), many Japanese say they are kowaii (afraid). After seeing prices spiral too high in the 1980s and subsequently decline, they still don't reflect the real worth of things.

Tokyo consumers, who tend to rent apartments, even when they cost $1,000 for a tiny living space in the suburbs, rather than own homes, are all for cheaper food, clothing and housing in a city where urban parking spots fetch between US$200 to $600 a month. Many feel that prices still have a long way to fall toward "normal" levels.

Things haven't been normal since the early 1980s, when the Japanese currency stood at 300 yen to the US dollar (compared with 93 this week). Back then, a spartan room in a seaside village bed-and-breakfast (minshuku), at 3,000 yen per person, equated to $40 total for a family of four; a fair rate, not unlike a decent motel in America. Since workers could easily afford a 900 yen lunch special of pork on rice with miso soup, thousands of mom-and-pop shops sprouted up to serve them, fostering a culture of full employment, which attracted thousands of foreign workers.

After the 1985 Plaza Accord, major powers intervened in currency markets to weaken the dollar and strengthen the yen. The goal, echoed in present-day international pressures on China, was to open Japan to more imports and slow down its export juggernaut. The yen quickly doubled in value, and property values skyrocketed, to 50 times their 1950s levels in some cases. Even the cramped wooden house where this correspondent lived in the Osaka area in 1989 was worth $1 million at that time.

Expecting Japanese to get wealthier, businesses jacked up their prices to absurd levels, and Japanese kept buying $60 bottles of wine and $100 melons because they feared prices would rise further. But when the bubble burst, and the stock market benchmark index, the Nikkei 225, shrank from 39,000 to 9,000 in the 1990s, prices didn't fall accordingly. Many landlords, farmers, and suppliers stubbornly held their prices firm, believing consumer demand would recover - which it never did.

Today, even amid Japan's worst downturn since the war, minshuku owners still expect a family of four to pay 12,000 yen, despite 25 years of wear and chronic vacancy as city-folk stay home instead of taking weekend breaks.

Any sudden jump in economic growth might not boost prices. During the export boom of 2006, Japanese corporations channeled record profits toward research rather than into rewards for their workers. Employees felt betrayed, and refrained from buying their own company's products. Since wages on average were still 10% lower than 1997 levels, household spending continued to drop.

Suburban property values, meanwhile, have fallen to half of their 1990 peak. Even though home prices are less "stupid" than before - as many Japanese say - many younger workers are either afraid of losing their jobs, or are waiting for prices to sink to a lower bottom. China's boom can't help, because Chinese can't build cheap houses and bring them to Japan.

Given Japan's declining population, policymakers are faced with tough choices on how to turn things around. The Bank of Japan last month doubled a credit program for commercial lenders to 20 trillion yen. Governor Masaaki Shirakawa said he hoped the move would lower borrowing costs and spur growth and prices. Former BoJ official Kanno says the central bank should lead the way out of deflation.

"The BoJ is responsible for ending deflation," he says. "They shouldn't wait for the government. Discussing inflation targeting is simply a waste of time. People's price expectations will not be affected by higher inflation targets."

Kanno says spending 40 trillion to 50 trillion yen might trigger inflation but wouldn't be sustainable and would increase debt servicing costs. "All the best policies are going to have short-term pain to get the best long-term results. Without taking these risks, Japan will fall into a trap which we can't find an exit. The government should let people know how bad deflation is. Japanese journalists don't want to tell the truth to the Japanese public. The current public pension system will not be sustained."

While agreeing with many of Kanno's points, Macquarie Capital's Jerram doubts whether the central bank can fight deflation on its own.

"Deflation everywhere else is a monetary phenomenon, but Japan sees itself as unique, because deflation is due to deregulation," says Jerram, who has been monitoring Japan for two decades. "The tolerance of deflation is extremely unorthodox. The United States for example will take extreme measures to avoid going into the deflation hole. The problem with tolerating it is, you wake up one day and feel the need to do something about it. Japan is in such a deep hole, that a little bit of fiddling around the edges, such as what the Bank of Japan is doing, is not going to make that much of a difference."

Jerram says the politicians should take action instead of telling the BOJ to try harder. "I think the government doesn't understand it well enough. To be fair to them, they just took office six months ago, and they're starting to see how bad things are. You need to tell the public that the last 10 to 15 years have been a terrible mistake. It's a question of whether you want a crisis now or a crisis later."

One solution, he says, is to set short-term interest rates at minus 3 or 4%. "The idea that nothing can be done is a fantasy. If you fight deflation, it appears to hurt pensioners and lower income workers, but it might be better in the long term."

Yet Sakakibara warns that extreme measures could make things worse.

"Just because prices are coming down doesn't mean Japan is in a recession. We just had a recovery combined with deflation. We shouldn't worry about deflation too much," says Sakakibara, now a professor at Waseda University. "Taking actions to solve deflation might have some undesirable side-effect. We need to really worry when deflation comes with a recession."

Tokyo-based journalist Christopher Johnson (www.globalite.posterous.com) is author of Siamese Dreams and an upcoming novel set in Japan

(Copyright 2010 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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