[I thought this piece was especially interesting in light of the frequent questions on survivalist boards, "Are we headed for inflation or deflation." --Andre]

Headline: Japan Is Shackled by Deflation, Blocking Its Hope for Recovery

Source: New York Times, 12 Mar 2001

URL: http://www.nytimes.com/2001/03/12/business/12DEFL.html

TOKYO, Monday — As Japan shows signs of falling back into recession, behind many of its woes lies deflation, a rare but devastating drop in the prices of goods and services that is starting to feed on itself. Deflation is chipping away at asset values, increasing credit risks, pinching wages and salaries, and preventing the economy from generating any sustained growth after a decade of stagnation.

Stocks are trading at the same prices of 15 years ago, and land values in major cities, which back many of the loans made by Japanese banks, have fallen 65 percent from their peak in 1991.

Excluding fresh foods, prices in Japan dropped 1.1 percent last year, the greatest decline since World War II. In Tokyo, core prices fell a stunning 0.4 percent last month alone, the 18th month that prices have fallen. "A crisis of pernicious deflation, which could destroy people's lives, is looming," declared the Yomiuri Shimbun, the most conservative of Japan's major daily newspapers, in a front page editorial last week.

Although today's reported 0.8 percent rise in gross domestic product for the final quarter of last year slightly exceeded expectations, Japan has recently been hit by a rash of bad news. "The economic outlook has worsened more quickly than we anticipated," Kazuo Ueda, a member of the policy board at the Bank of Japan, said in an interview late last week. And with growth slowing in the United States and elsewhere, many experts fear that another slump in Japan, the second-largest economy on the globe, spells big trouble for the rest of the world.

Just last week, the government reported that household spending in January was actually at a lower level than a year earlier. It disclosed that machinery orders, an important indicator of investment, fell nearly 12 percent in January from the previous month. And Finance Minister Kiichi Miyazawa, shocked Tokyo on Thursday when he told Parliament that the government's books were close to a "catastrophic situation."

Over the weekend, Prime Minister Yoshiro Mori met with senior members of his party to signal his intention to step down next month, and Japan's leaders are now preoccupied with their inability to find a new prime minister.

The human costs of deflation are meanwhile becoming more visible. When Hitoshi Matsushita started pondering his impending retirement seven years ago, his first concern was putting a roof over his head. "I was living in company housing," he said. "I thought buying a place would be convenient for my future."

In 1994, prices for housing had already started to decline after Japan's bubble economy had burst. The 76 million yen, or about $636,000 at current exchange rates, that Mr. Matsushita paid for his apartment looked like a bargain.

But real estate prices have continued to fall, leaving the home now worth at most 40 million yen — and Mr. Matsushita still owes the bank 30 million yen. "I can only work until I'm 70, and at that point, I guess my life will crash," said Mr. Matsushita, who is now 66. "Right now, I'm desperate."

Paradoxically, deflation was welcomed not so long ago in a country where prices are so much higher than anywhere else. It was also regarded as a sign that Japan was finally opening its doors to international competition. Many still see it as a force for accelerating economic modernization. One result is a heated debate over whether deflation is good.

Examples of falling prices and greater competition abound. Consumers are all but stampeding to Starbucks outlets here, where a tall caffe latte sells for 320 yen, a bargain compared with prices at the dying kissaten, traditional Japanese coffee shops infamous for selling thimble- size cups of coffee for more than twice that amount.

Then there is Uniqlo, a chain of Gap-like apparel stores that is perhaps the most popular store in Japan at the moment. Importing most of its products from China, Uniqlo is putting enormous pressure on its competitors here. "I have a Bally's leather briefcase, a Burberry's leather briefcase and a Coach doctor's bag, but I switched to a nylon brief case from Uniqlo because it is much easier to use, very functional, and most of all, it was only 2,900 yen," said Koki Konishi, an executive at a car company, who also buys boxer shorts there at two for 900 yen, or $7.63, and T-shirts, three for 1,000 yen ($8.47).

Given Japan's aging population, stable or even slightly declining prices are seen by many as desirable because they preserve the value of the savings of the elderly. Deposits held in postal savings accounts nominally earn a scant 0.11 percent a year, but deflation has lifted the real return by almost 2 percentage points over two years. "The older a society is, the more anti-inflation it is because higher savings balances are hurt by inflation," said Vincent J. Truglia, co- head of the sovereign risk unit group at Moody's Investors Service.

Citing just such cases, the Bank of Japan has long been deflation's biggest cheerleader. The bank's governor, Masaru Hayami, insists that this particular variety is "good deflation," with suppliers of goods and services able to offer more for less.

But outside the central bank, many economists and even some top government experts warn that Japan risks being sucked into a dangerous deflationary spiral that may only worsen as companies are forced to cut prices and wages repeatedly. "We have gone beyond the point where the deflation we are seeing can be attributed to globalization and greater competition," said Takatoshi Ito, deputy vice minister for international affairs at the Ministry of Finance. "Deflation is now the mirror image of falling demand, and that's not good deflation."

Critics of the central bank say that Japanese consumers have no reason to spend despite lower prices. Not only has the value of their homes plummeted, but unemployment is at a postwar peak of 4.9 percent and is expected to climb more. "If incomes don't rise in nominal terms — and they aren't — you are having to run faster to meet your mortgage obligations," said Jesper Koll, chief economist at Merrill Lynch in Tokyo. "And it is not just Mrs. Watanabe who is feeling strapped. Every sector here, whether we talk about the banks, corporations, households or the government is highly leveraged."

Even though prices are falling, many incomes are falling faster. Corporate earnings rose 28 percent last year, leading economists to predict a 5.5 percent increase in winter bonuses. Instead, bonuses shrank by half a percent, as companies spent their hard-earned cash to offset their increasingly painful debts. A number of economists, however, argue that Japan needs more deflation as a form of shock therapy: fewer debts, greater efficiency and a reallocation of labor, they say, is precisely the bitter medicine the economy must swallow. "If deflation continues, inevitably it will put further downward pressure on wages, and if wages are cut, then prices will have to fall, too," said Tadashi Nakamae, an outspoken economist who runs his own consulting firm. "I think Japan needs to accept that. Later, it will be offset by higher growth."

The question is whether Japan can tolerate the pain of waiting patiently for such benefits of deflation to appear. Already, textile manufacturers are urging the government to curb the imports that underpin Uniqlo's success. Meanwhile, officials at the Ministry of Finance, which once supported the Bank of Japan's monetary policy, are growing increasingly worried about deflation's devastating impact on the national budget. They are pushing the Bank of Japan to lower its already low interest rates, print more money, buy government bonds, do anything short of dropping bank notes out of helicopters to combat deflation.

And even Mr. Hayami, the top central banker, has begun suggesting that, if the economy continues to deteriorate, the bank may abandon its staunch resistance to buying government bonds to expand the money supply. That may come too late, however, to prevent a very grim future for Mr. Matsushita and his family, along with millions of Japanese who owe more on their homes than they are worth.

He and others in his apartment complex have sued the government, which owns it and had dropped the price of unsold units to dispose of them. But they will have a hard time proving their case, for they are victims less of bureaucratic bungling than of powerful market forces.

Mr. Matshushita had planned to use 50,000 shares of Yamaichi Securities stock he accumulated during three decades of work to pay down his 63 million yen mortgage. At one point, his stake was worth 1.5 billion yen, about $13 million. But Yamaichi went bust, shattering his dreams of a leisurely old age. Now Mr. Matsushita works as a security guard at night and part-time in a convenience store during the day. "I might sell this place, and if I'm lucky, I might then have 10 million yen in hand to rent a little house in the country and live off of my pension money," he said. "My living standard will go down, but I still have some hope."

-- Andre Weltman (aweltman@state.pa.us), March 12, 2001