Learning From Japan's Deflation Trap

by: Alex Filonov

Maybe we are all looking at the wrong things? Maybe we are not in the Great Depression 2.0, but in something new?

Let's take a look at Japan. The usual explanation of the current Japanese nightmare (21 years of depression and deflation and counting) is that the real estate and stock markets were grossly overpriced in 1989 and then there was no next idiot to buy either. But usually depressions of this kind end in 6-10 years. The explanation for this 20 year-long depression is that the Japanese, instead of fixing the problem, tried to hold a brave face and sweep problems under the carpet. This is partially true, there are still companies with lifetime employment, banks which should have been closed and companies which should've gone bankrupt long time ago.

But there is one thing that nobody is talking about. It's not exactly an economic issue, its' more political. One feature of Japanese society is that it has a very low birth rate. The population is actually shrinking and immigration practically doesn't exist. Add to that a high life expectancy and you get a society with a very high proportion of people who don't work and live on pension and some kind of savings or fixed income. What's most important for these people? Price stability. Deflation is even better. And when you have a significant and politically active part of population interested in deflation, what do you get? Politicians might not declare deflation as their real goal, they might even talk about fixing the budget, prudent money policy, something else. But in reality the senior population will vote for deflation.

I understand that nothing is simple in politics. And currently Japan prints money and the government borrows at a scary rate. But they spent the 1990s doing practically nothing and that lost time was very expensive.

You'd think other countries would take Japan as an object lesson. Yeah, right! On the last G8 forum what was the main theme? Recession? Deflation? Hell, no! They talked about austerity measures and cutting budget deficits. Especially Europeans. Why? Because the demographics of Europe aren't much better than in Japan. Birth rates are low, populations are shrinking. Immigration helps somewhat, but immigrants don't vote, not until they are naturalized.

It can't happen in US, right? Our country is younger, the birth rate is at least covering deaths, immigration is much bigger than in Europe. But our government in its infinite wisdom is going to shrink budget deficit by reducing spending and increasing taxes. Remember, young people are much less politically active and immigrants don't vote until naturalized. The population is mostly happy to hear about austerity measures. Some are unhappy about rising taxes, but they don't want the deficit to increase, they'd just prefer to cut spending. Six of one, half dozen of other. Cutting the deficit decreases money mass in circulation; it's actually a deflationary measure.

Unfortunately, modern economies just don't work in deflation. They shrink. To support an increasing population of pensioners, we need the economy to grow. So the deflationist policies are leading us to a trap: the economy shrinks, but the fixed income people increase their incomes. Such a situation is not sustainable.

I'm hope I'm wrong. I hope that austerity policies are just a fashion based on false belief that "prudent" economies work better. There is no proof for that. Prudent economies lead to depressions. But this is a belief, almost a religion, and when you try to speak to zealots, it's useless. It's even worse if the zealots really win from advocated policies. Working people lose, because of high unemployment and non-existent wage raises, but why would most politically active people care if they win?