Deflation Worsens in Japan

[JEast]

In the continuing battle of deflation versus inflation, this is a somewhat scary fact reported by the BBC.

 

Other figures released in Tokyo show core consumer prices fell by 2.2% in July from a year earlier, the fastest pace on record. And analysts expect prices to fall further.

 

http://news.bbc.co.uk/2/hi/business/8225885.stm

 

Maybe the bond traders have it right based on the very successful bond auctions recently and the talking heads have it wrong again.

 

 

Cheers

JEast

[scorpioncapital]

On an inflation-adjusted basis, Japan's stock market 20 years after the 'bubble' is down even more than 20 years after the Great Depression, with dividends, maybe even more. It is interesting to understand what happened to that country's stock market to product such a disastrous result but I have no idea.

[Parsad]

Yup, and they've thrown the book at this thing to stimulate the hell out of it.  Japanese corporations are flush with cash.  The consumer has been saving for the last twenty years.  The psychology had changed significantly with the consumer and corporate balance sheet strengthening, while the national balance sheet plummeted. 

 

Finally, they used to be the cheapest source of production 50 years ago, and then the most efficient 25 years ago, but the world has changed.  The cheapest source now is China, and the most efficient is South Korea.  Japan peaked twenty years ago, and is slowly finding out what it feels like to fall from the top of the food chain.  The U.S. is next unless it can continue to innovate.  That's what kept it on top against all these hungry competitors and it has to do so again.  Cheers! 

[Guest kawikaho]

I think people are comparing apples to oranges when it comes to Japan and the rest of the world -- save SE Asia.  You have to understand their society to understand why they've had all these problems.  The traditional Japanese or Asian person is frugal.  We've never been known for doing stupid things like running big personal credit imbalances, cashing out our RRSP or 401k to buy things, or not saving.  I've talked about this with my Asian friends a lot, and we all agree that you can't compare a white American with even an Asian American.  We usually have a completely different set of values.  And it's even worse in Asia.  You have a strong paternal family structure, strict guidelines for success in academics, and fiscal responsibility instilled in you at a young age.  It's quite a different story than what I see in America.  And Japan is EXPENSIVE to live.  You guys that have never been there don't know, but I don't see how people in Tokyo survive.  It's way worse than NYC, and I thought that place was expensive.  My ex-g.f. used to tell me how much it used cost for her family's utility bills in Tokyo, and I didn't believe her.  It's outrageous.  When you have a very high cost of living, declining economic prosperity, and a generally frugal population that's declining in age, you have a recipe that is Japan.  Just to show how frugal and different these guys are, they have the lowest birth rate out of any modern society.  Why?  Sociologists are trying to understand and study this phenomena, but I think it has to do with the high cost of living there.  They just can't afford to have kids, and even when they can, they only have one.  And they're naturally xenophobic, so they highly restrict immigration and potential growth.  I'm inclined to believe that Japan will create the most sophisticated robots (they've already done this, and has surpassed every other country and institution including MIT's robotic laboratories) to replace their bottomed out population as workers. 

 

I do not believe the U.S. is heading towards Japan.  Not in a million years.  I'm adamant against that notion.  If anything, I think we're heading towards Europe: socialist, backwards, slow, not competitive anymore.  Although, I think the US will pull out of this fine.  Innovative people will always make their way in a highly democratic capitalistic society. 

[scorpioncapital]

But why wouldn't these things lead to inflation instead of deflation? Wouldn't the currency become worthless as the government undertook more debt and asset prices would inflate in yen terms?

[20ppy]

I think it boils down to math.

 

Figuratively speaking, if the unit price of assets fell by 50% from the top, and the Japanese Government's stimuli accumulatively add up to be only about 5% in proportion to this unit price fall, then it means things are not stimulated enough

 

For example, (real data) a 2-bedroom condo unit in Toyko is now priced at $2.5 million US, that's about 50% off from its peak. The stimuli throws at this unit say $100,000 (not real, wild guess, but can't be anything near 2.5 million), it's still short by a large measure. So, stimuli do have limits when the asset bubble is too great. I am not sure about the current US case, bubble bursts vaporized about 20 to 30 trillion US dollars, will the US government's stimuli be enough? I don't know.

 

I do have a puzzling question, anybody knows why WB is so sure that US just won't have deflation in our life time? I don't doubt him, but I can't seem to understand why. Do you think he assumes that the US Government will throw more and more stimuli until it overwhelms the losses?

 

[hyten1]

i personally think there will be minimally flat prices or slight deflation.

 

everything i see prices are falling, real estate, stocks, car prices, restaurants coming up with cheaper menus, clothing. the biggest thing is wages, there is so much slack in our economy. i dont see how govs few trillion will compensate for all this.

 

however i am not 100% convince yet as well. things that make me think otherwise are theoritically the gov can print as much money as they can if they really want inflation i dont see how they cant create it, just print 5 trill, or 10 trillion whatever they want/need.

 

but all the typically signs i see prices falling.

 

[jasonw1]

Japan is a special situation, I can't think of any other country which has prolonged deflation (20 years) in the modern world (last 100 years), while you can find plenty examples where inflation runs wild.

 

As we discussed in thread on WEB's recent article on NY times, inflation is a natural tendency for any goverment to have. It started with Romans when they were still using gold as currency, they would scratch some gold off the gold coins collected as tax, for example the original 1 ounce coin now only contains 0.95 ounce of gold, but they would put the gold coin back to circulation as if it's still whole, and combine the 0.05 ounce of gold together to make additional new gold coins. If the Romans can create more money with gold coin as currency, it's just too easy for modern goverment to do something like this. And why not? I would say all governments would like to spend a little more than what they actually have, inflation also creates an illusion that things are progressing, citizens would feel pretty good when their wages and asset prices go up 3% a year, not many people would care so much that it's 2.5% inflation and 0.5% real growth, politicians and policy makers around the world are quick to figure out this is an easy way to keep things looking good on paper.

 

Now why Japan is such an exception? I've been puzzled by the prolonged deflation in Japan for quite a while, I haven't seen any explaination which I can understand and it makes sense. A few factors I think are unique to Japan and probably caused this long deflation:

 

1) the asset bubble (RE and stock) in Japan was at a different scale than the bubble in US. It's way worse than US, at the high of it, the RE value of Tokyo was more than the RE value of whole US. Stocks were having triple digit PE on average, in short, as pointed out by 20ppy, it just become too big of bubble to be overcountered by inflation, even you run 7% inflation (it would be really hard to run 7% without cauing mass fear and runaway inflation), you can only inflate ~400% in 20 years, which isn't enough for the bubbles they have. 

http://en.wikipedia.org/wiki/Japanese_asset_price_bubble

 

2) Japan would be the last country having the incentive and will to run high inflation like 7%. Why? It's a country of net saver and creditor, it's a country where older people are respected and dominated policy, mass inflation will impact the savers (older people) most, and they don't want to see their national fortune vaporate just so easily. Culture and pride also have some effect as well.

 

I don't think US would repeat Japan, for the exact same two reasons: housing at 4-5 times of annual household income is still one of the most affordable in the world, stocks by most standards are at "fair boring" prices. We mostly have an inventory excess and over-leverage problem, but not a huge asset bubble at this point. And as a net debtor and little savings, US doesn't have much resistence to inflate, as matter of fact, all the smart policy makers know it's in the best interest of US to inflate, the burden of the trillions of foreign and public debt just become so much easier to handle. The trick is to do it gradually without scaring off debt holders (both foreigh and domestic) and crashing USD and US treasury.

 

[JEast]

As I mentioned at the beginning, it is a continuing battle of deflation versus inflation. In my neck of the woods, I still see prices going down from real estate, car prices, restaurants, to even groceries running sales. Though I have the money, I also still find myself looking at Ebay and Craigslist on occasion.

 

In the short run, the government can print all the money in the world, but in Irving Fisher's terms if there is no velocity to that money, there will be no inflation as people are either becoming prudent or paying off debt. Competition is tough and business is trying to keep sales up, but its difficult and margins are going down though the market has been going up.

 

I heard a talking head the other day say that the Russell 2000 Growth had a P/E of over 100 now. Maybe a little misleading, but still a curiosity to make one think.

 

Side note: kawikaho, A few years ago I read a very nice book that addresses your point very well. "The Geography of Thought: How Asians and Westerners Think Differently."

 

 

Cheers

JEast

[Guest Broxburnboy]

As I mentioned at the beginning, it is a continuing battle of deflation versus inflation. In my neck of the woods, I still see prices going down from real estate, car prices, restaurants, to even groceries running sales. Though I have the money, I also still find myself looking at Ebay and Craigslist on occasion.

 

In the short run, the government can print all the money in the world, but in Irving Fisher's terms if there is no velocity to that money, there will be no inflation as people are either becoming prudent or paying off debt. Competition is tough and business is trying to keep sales up, but its difficult and margins are going down though the market has been going up.

 

I heard a talking head the other day say that the Russell 2000 Growth had a P/E of over 100 now. Maybe a little misleading, but still a curiosity to make one think.

 

Side note: kawikaho, A few years ago I read a very nice book that addresses your point very well. "The Geography of Thought: How Asians and Westerners Think Differently."

 

 

Cheers

JEast

 

Some good points here, but there is a difference between demand destruction causing falling prices for specific assets (housing etc.) and monetary deflation causing the general level of prices to drop.

Although velocity of money has lessened, the supply of money is increasing dramatically. In a monetary deflationary environment, consumers can sit on their fiat money with no penalty, but in the current environment the incentives are all encouraging consumers to spend. No one in authority seems to have noticed however, that the US consumer is broke.

Savings earn interest at below the rate of inflation therefore discouraging savings. Once we have reached bottom on the credit implosion, prices will begin to rise and consumers will be forced to spend their dollars. The danger is of course that the sheer volume of the newly minted money circulating at a higher velocity will drive prices up too fast (high price inflation) or create a panic selling of US dollars (rapid devaluation).

 

[scorpioncapital]

"It's a country of net saver and creditor, it's a country where older people are respected and dominated policy"

 

I'm wondering if an analysis has been done how many people had a significant amount of wealth in the stock market in Japan at the peak in 1989. Maybe as you mention, the citizens did not participate in that bubble that much compared to the US market, so they would not have a big incentive to want all that inflation. Of course, there was also a real estate bubble as well.

[bargainman]

In the recent youtube video of Buffet in the furniture store, he pointed out something relevant I think.  He said the US is creating some reasonable number (I think it was 1.3 million?) households a year.  There is currently an oversupply of housing since we were building 2 million a year for a while due to artificial demand.  But a few things will happen. The growth in households will eventually catch up with the oversupply, and people who are deferring purchases will eventually push that demand higher in the future.  I think with Japan, not only was the population aging like in the US today, but population was stagnant if I remember correctly.  Also they have a very stringent immigration policy from what I've heard, so growth from that angle didn't help things.  So not only was the RE bubble worse and the stock market more inflated, population isn't going up and it's getting older...

[bookie71]

One article that I read some time ago suggested that part of the problem is that Japan has a much larger percentage of an aging population.  I'm not sure if that is a factor but I haven't seen that noted.

[Cardboard]

"In the short run, the government can print all the money in the world, but in Irving Fisher's terms if there is no velocity to that money, there will be no inflation as people are either becoming prudent or paying off debt."

 

This velocity of money is an interesting concept, but I wonder if it will be dismissed some day like so many economic theories.

 

Consider this example: If company XYZ split its stock 2 for 1, its share price will be cut in half and it does not take a lot of trading or velocity for it to happen.

 

If tomorrow morning we have twice has many U.S. dollars in circulation, shouldn't the price of everything priced in dollars doubles without any real growth in the economy and without much transactions? The pie is just divided differently, no?

 

I believe that the key problem with currencies is that we never really know for sure what is in circulation at any given point contrarily to shares outstanding of a stock. You have M1, M2, M3, but no decisive number anywhere. So the mechanism of pricing discovery becomes a much longer process leading to the possibility of not enough to overdone.

 

Cardboard

[Guest kawikaho]

You guys should watch part 4 of the Ascent of Money series.  Halfway through the video it talks about the the inflation equation and socialism.  It talks about Japan and Chile.  Pretty serendipitous.  There was an interesting point made: 20 years after Chile was democratized and open to free trade and the markets, its stock market returned 18x for approximately 15.5% CAGR.  Jim Rogers has said that the best places for oppty is after a war.  Sri Lanka, perhaps?

[oldye]

"In the short run, the government can print all the money in the world, but in Irving Fisher's terms if there is no velocity to that money, there will be no inflation as people are either becoming prudent or paying off debt."

 

This velocity of money is an interesting concept, but I wonder if it will be dismissed some day like so many economic theories.

 

Consider this example: If company XYZ split its stock 2 for 1, its share price will be cut in half and it does not take a lot of trading or velocity for it to happen.

 

If tomorrow morning we have twice has many U.S. dollars in circulation, shouldn't the price of everything priced in dollars doubles without any real growth in the economy and without much transactions? The pie is just divided differently, no?

 

I believe that the key problem with currencies is that we never really know for sure what is in circulation at any given point contrarily to shares outstanding of a stock. You have M1, M2, M3, but no decisive number anywhere. So the mechanism of pricing discovery becomes a much longer process leading to the possibility of not enough to overdone.

 

Cardboard

 

I'm not sure we're talking about the same thing but the velocity of money isn't an economic theory, it simply the amount of times money changes hands over the course of the year.  You take money supply x velocity and you get GDP :). 

[ERICOPOLY]

If tomorrow morning we have twice has many U.S. dollars in circulation, shouldn't the price of everything priced in dollars doubles without any real growth in the economy and without much transactions? The pie is just divided differently, no?

 

Let's follow that through with a real example:

 

Is my house going to double in price simply because of Bernanke's quantitative easing doubling the quantity of dollars? 

 

 

Here is what I think: 

 

In order for the house to double in price, the buyer needs to be able to afford twice as much right?

 

Okay, have incomes doubled?  No.  So there is not twice the dollars chasing my house.  The number of dollars chasing my house has not changed, in fact there are likely fewer dollars chasing my house because there are more unemployed people and people who are earning smaller paychecks.

 

So, the price of housing is not set by the total number of dollars that Bernanke doubled via his policies.

 

Rather, the price of housing is set by what the buyer can afford -- and in this recession he can afford less.  Screw the quantitative easing causing inflation -- that house's price isn't going to budge until the buyer can afford to make it budge, and that means that his supply of dollars needs to double, which isn't happening.

 

Wages need to spiral upwards before that home price goes up.  That's not what we have... we have rising unemployment and wages are certainly not skyrocketing.

 

Where is the money?  If it's not in the consumer's hand, the price won't go up.

 

Anyways, that's just an example.  Other things priced in the economy might behave differently.  So far though I can't figure how quantitative easing is going to raise prices unless those consumers get their grubby hands on it... but the quantitative easing program hasn't done that.  There's been cash for clunkers, but that's about it.

 

 

[Packer16]

If tomorrow morning we have twice has many U.S. dollars in circulation, shouldn't the price of everything priced in dollars doubles without any real growth in the economy and without much transactions? The pie is just divided differently, no?

 

This would be true if everything is held constant (same supply and demand) but it is not. Today the demand is trending downward as unemployment is increasing.  If demand does increase, the supply would increase as their few barriers to build houses in most parts of the country.  So on average there is a downward bias in home prices (except in those areas where building is restricted).

 

Packer

[Guest Broxburnboy]

In order to understand these issues, we need to look at them from an accounting viewpoint.

 

We have two main statements - the balance sheet and the income statement. The former is a statement of assets and liabilites, the latter a statement of cash flows. The balance sheet is a tally of net worth and the income statement a measure of whether that net worth is increasing or decreasing. Debt sits on your balance sheet as a liability and the interest payments impact your monthly income statements.

The asset, in this case a house, sits on your balance sheet. If we use mark to market accounting, the asset is valued at its current market value. If we use depreciated book value (usually the more conservative measure), we get a different valuation.

In the last few years prior to the housing implosion, home prices had skyrocketed for several reasons... low interest rates and interest tax credits which have a positive impact on monthly cash flows and increase the ability to take on more debt.

The extra money in the market in turn drove up home prices and those lenders who were allowing assets to be valued at mark to market were justified in extending even more credit based on higher notional values of homes. A classic leveraged bubble, created in this case by well meaning incentives and easy, cheap (almost free) money. No one asked the question

If money is almost free, is it actually worth anything?

On the other side of the money supply/demand dynamic the Federal reserve made more available to lending institutions to satisfy the demand so created. Monetary inflation increased and the velocity was high, the purchasing power of the US dollar was thought to be intact because the mark to market values of the collateral was "real".

Not only was the home bubble inflated by this logic, but also the derivatives bubble, which now sit on bank balance sheets

as "toxic assets"... whose value is "frozen" for accounting purposes, because to unfreeze them and mark them at a any true value, would send the balance sheets into negative territory and force the banks out of business.

So it sits... most new money being created and borrowed by government is going to try to relieve the banks of these "toxic assets", so they can start lending again.

If this can be accomplished we will then have a flood of money unleashed into the economy and the arithmetic of monetary inflation will be operative. The intent is to then "mop up" the excess liquidity through yet unspecified means... but higher interest rates and higher taxes are surely part of the equation.

[Cardboard]

I like the balance sheet/income statement thinking. I don't know why it is so easy to apply and to understand for individuals and companies, but when it comes to a country then people start talking about other things and concepts. At some point it will matter. Either the debt will be exchanged for assets or the debt will be "restructured" by issuing more equity or currency: devaluation.

 

The issue could also be fixed via the income statement by out growing the debt with income. However for that to happen, more taxation does not work since it is just dollars moved from one pocket to another and large real GDP growth seems unlikely considering current demographics.

 

A great number of U.S. households did not manage their finances properly and now it is the governement doing the same thing and somehow it will end up being just fine because they're bigger? You can't just sweep that whole debt issue underneat the government rug, keep spending like mad and never see real consequences for the country. Also, to "mop up" the excess liquidity simply cannot be done without slamming the brakes on a fragile economy.

 

Cardboard

[Guest Broxburnboy]

More on household balance sheets and other related topics:

 

http://www.counterpunch.com/whitney08282009.html

 

 

 

[JEast]

Nice "counterpunch" article.

 

Not to beat this subject over everyone's head, but noticed this article today in the WSJ about -- Bottled-Water Price War Heats Up as Demand Falls.

 

"It used to be $6.99 for a 24-pack, then $5.99," said Michael Bellas, chief executive of New York consulting firm Beverage Marketing Corp. "But $2.49? That's the lowest I've seen."

 

http://online.wsj.com/article/SB125167502443470973.html

 

I have always been curious about the sometimes obsession with designer bottle water and the price people were willing to pay for it over the years. Possibly connected to the social proof and commitment mental models (i.e. $5 for a cup of Starbucks coffee) and now the social proof is fading as we all become a little more frugal.

 

 

Cheers

JEast

 

[Guest kawikaho]

http://www.zerohedge.com/sites/default/files/images/SeanMaloneRiseFallDollarLarge.jpg

 

Maybe deflation has to do with the value of the dollar.  Haha.  If that's the case, then looks like we've had deflation of the dollar for the past 70 years!  BTW, I'm being facetious here.

[Guest kawikaho]

This is another reason why Japan is in another category much different than here:

 

http://www.greenbiz.com/blog/2009/09/03/japans-obsession-perfection-may-be-thwarting-sustainability

 

I also forgot that Japan penalizes people for driving older cars.  I'm sure eventually this will change and prices for new cars will drop to compete with all the cars people are holding on to.  Like I said, Japan was extremely expensive to live in, and it's now just really expensive.  It will head towards expensive, and one day, it won't be that bad to live there.  :-)  Deflation.