Japan Learns to Live With Deflation (If Only Analysts Could Figure Out How)

by: Michael Shedlock

In Japan, wages are lower, but so are prices for goods and services, even food. Japan's companies are devising ways to profit from deflation, says Bloomberg writer Aki Ito in Japan Learns to Live with Deflation.

Ben Bernanke has been lecturing on deflation's perils since he joined the Federal Reserve in 2002 and has often held up Japan as Exhibit A.

There's something curious about the way the deflation syndrome has played out in Japan, though. The Japanese don't feel that threatened anymore. "Everyone knew deflation was bad for jobs and bad for the economy, but gradually households and companies just got used to it," says Martin Schulz, a senior economist at Tokyo's Fujitsu Research Institute.

Deflation - the steady drop in prices of goods, wages and services - has many ill effects. Households are stuck paying off mortgages, car loans and other debt even as their take-home pay has declined. Also, as housing values fall, consumers have smaller nest eggs for retirement. Companies, meanwhile, are unable to raise prices, which puts pressure on profits.

Yet the Japanese have discovered the benefits of deflation as well. Monthly pay dropped to an average 315,294 yen ($3,800) in 2009, the lowest level since the government began tracking wage data in 1990. "It's not like I'm promised any pay raises," says Momoko Noguchi. The 24-year-old Tokyo resident gets by on two part-time jobs by shopping for everything from nail polish to dinner plates at her local 100-yen outlet (the Japanese equivalent of an American dollar store), and she pays 400 yen or less for lunch. "I hope prices keep falling." Four out of five Japanese say higher costs would be "unfavorable," according to a central bank survey.

To help reverse a seven-year decline in same-store sales, McDonald's Holdings Japan, a unit of McDonald's (NYSE:MCD), introduced a 100-yen menu in 2005. The chain's 100-yen hamburger sold for 210 yen in 1990. "We wanted our customers to know that we've changed," says Kazuyuki Hagiwara, Tokyo-based senior marketing manager at the company. Since the debut of the lower-priced menu, same-store sales have climbed every year. McDonald's Japan shares have returned 17% in the past three years.

Price cutting by companies has helped Japanese consumers adjust to deflation. The average household owns 1.4 cars and 2.4 color TVs, about a quarter more than in 1990, a Cabinet Office survey shows. Deflation has helped home buyers, too, by forcing prices down from their peaks in 1990: According to calculations based on yearly Land Ministry data, Japan's residential land prices have dropped by an average of 2.9% a year over the past two decades.

So is deflation a blessing in disguise? Not to analysts such as Richard Jerram, head of Asian economics at Macquarie Securities. He points out that as businesses cut prices to compete, it becomes harder to borrow and invest. "It's extremely corrosive," he says. Deflation, adds Jerram, will steadily sap Japan's nominal growth and deprive the government of tax revenue. Eventually, Japan may no longer be able to finance its borrowing. The country will then either have to default on debt that's about twice the size of the economy or devalue its currency to reduce the real value of liabilities. "That's the unavoidable endgame," says Jerram, who has analyzed the Japanese economy since 1987. "As long as it's in the future, everybody can pretend it's someone else's problem."

The bottom line: Although deflation ultimately poses a serious threat to Japan, ordinary consumers are benefiting from lower prices.

Erroneous Conclusions

It is painful to watch someone gather the facts then jump to the wrong conclusions.

Even worse than Ito's fallacious "bottom line" conclusion is the thought process from Richard Jerram at Macquarie Securities, supportive of that conclusion.

It would help if Jerram thought for 15 seconds (about the right things) before yapping nonsense. Japan is in debt to the tune of 200% of GDP because it squandered massive Japanese savings over the course of decades, in a foolish and futile fight against deflation.

Japan would not be at risk of default and would instead be sitting on a mountain of cash instead of a mountain of debt had it not squandered money building bridges to nowhere in a battle that should not have been fought, and clearly was not winnable in the first place.

Moreover, if prices are falling, they are falling for the government as well (at least they should be). Therein lies the problem. Governments want ever increasing amounts of revenue to support huge untenable and needlessly growing bureaucracies, regardless of what prices and wages are doing.

That is what saps a country's strength. Yet, Jerram comes to the amazing conclusion that inability to collect higher taxes saps a country's strength.

The last time I checked, Toyota (NYSE:TM), Subaru (OTC:SBUOF), Nissan (OTCPK:NSANY), Mitsubishi, Mazda (OTCPK:MZDAF) and Honda (NYSE:HMC) were still in business and doing fine. So are Sony (NYSE:SNE), Panasonic (PC), Kyocera (NYSE:KYO), Nippon, etc.

Since Ito never explained his bottom line, "Although deflation ultimately poses a serious threat to Japan, ordinary consumers are benefiting from lower prices," I suspect it came from listening to Keynesian clowns like Jerram who has studied this problem for 24 years and failed to learn a damn thing.

The fact of the matter is there is nothing corrosive about deflation per se. Indeed falling prices and rising lifestyles as a result of increasing productivity should be expected.

However, there is something corrosive about going deep into debt that cannot be paid back. That is the situation Japan finds itself in today (primarily because the government listened to Keynesian and Monetarist clowns who insisted that deflation was something that needed to be fought).

Of course the U.S. (led by Bernanke), Europe (with its sovereign debt crisis), and Australia, Canada and China (with their housing bubbles) are in the same sorry condition.

What cannot be paid back won't. That is the message of Japan. That is the message of Greece and Ireland. That is the message in the U.S. That is the message in Australia, Canada and China.

With so many messages and with savers wanting lower prices (please see Hello Ben Bernanke, Meet "Stephanie"), how the hell can people like Ito and Jerram get it 180 degrees wrong?