Deflation phobia has broken out again. James Bullard, president of the Federal Reserve Bank of St. Louis, grumbled in San Diego about inflation expectations being too low and threatened to print more money, while QEx mongers are once again pointing at the Japanese “deflation spiral” as a horrid event that we have to avoid at all cost.
In 1996, seven years after the Japanese bubble burst, I arrived in Tokyo for the first time and saw a shockingly expensive country (though the exchange rate was good, $1 = ¥110). It wasn’t just me. One day, I was looking at Italian wines at a department store. The bottle of Chianti Classico in my hand was a global brand that sold for $8 in the U.S. In Tokyo, it was $53. I sucked in air and put it back down. As I drifted away, another gaijin wandered along and picked up the same bottle. He grunted in Italian. We started talking. Turns out, that Chianti cost less than $4 in Rome.
Item after item. Plain white T-shirts made in Japan, $30. Rent for a dingy 200 sq. ft. apartment in a lousy area, $1,500 a month (plus 3 months key money, plus 2 months deposit, plus 1 month rent up front, for a total upfront payment of $9,000). Public transportation, food, fuel, hotels (except love hotels), coffee, you name it. Everything was shockingly expensive.
There were reasons. During the bubble, pricing didn’t matter. The more expensive an item was, the better it sold. The insular Japanese market was protected by insurmountable administrative barriers. When a company was actually able to import something, it wasn’t to offer a better deal, but to offer a prestige product at a premium. A jungle of regulations, restrictions, knotty transportation issues, inefficiencies, and other hurdles made doing business expensive. But during the bubble, it didn’t matter because everyone was making money, and everything kept going up.
In 1989, the hot air began to hiss out of real estate and equities. A lot of money went up in smoke. Buyers lost their exuberance. Attitudes changed. People began to look for cheaper alternatives. Some businesses figured out that they could gain market share by lowering prices. Price competition started. Import restrictions were softened. Certain aspects of the economy were deregulated in tiny and still incomplete micro steps. Year after year, the Japanese market became more competitive. Pressure to lower prices filtered into supply chains and made them efficient and cost conscious.
Now the $53 bottle of Chianti costs $8, and a Chinese-made T-shirt cost $5. Rents have come down, and new apartments are bigger and nicer. Food is cheaper, and so are meals at restaurants. Unemployment is under 5%. Wages have come down too, but not much. Infrastructure has improved. Subway and train lines have been added, extended, or four-tracked, and rush-hour trains are less crowded. Trees have been planted. Tokyo is cleaner and greener. Savers and bond investors haven’t gotten ripped off by inflation. Reason has returned to Japanese prices.
In the U.S., too, the bubbles in equities, real estate, and credit blew up. But none of the other conditions that contributed to deflation in Japan exists in the US.
The massive U.S. trade deficit is proof that protectionism à la Japanese hasn’t occurred in the U.S. (well, there are bizarre exceptions, like sugar). Price pressures from overseas have become even stronger during the process of globalization. Supply chains are highly efficient and integrated worldwide. In the US, that bottle of Chianti cannot drop from $53 to $8 because it already costs $8. Plus, China and other developing nations have begun to ship their red-hot inflation to the U.S.
Alas, in one category, the deflationistas have been right all along: real wages. Down nearly 9% since their peak in 1999. It is one of the reasons for the current economic malaise. Worse, without increases in real wages, servicing the growing mountain of debt will become ever more difficult.
Yet in its twisted way, the Fed favors deflation in real wages, inflation in goods and services, and negative real yields. Financial repression at its best. And while we may occasionally get a highly welcome quarter or two of deflation in goods and services, the conditions in the U.S. are unlike the conditions in Japan, and long-term deflation in goods and services is not in the cards.