It’s a question few in Tokyo want to ask: What happens if deflation returns to Japan?
In reality, it’s too late to ask; Asia’s biggest economy already may be experiencing renewed deflation. It’s not of the kind that crippled Japan in the late 1990s, yet its return to the negative-price column has important implications for global growth and interest rates.
That isn’t the spin you heard last week when Prime Minister Shinzo Abe met with President George W. Bush in Washington. Those kinds of chats have gotten easier for Japanese leaders now that Japan is growing again. Abe’s message has been that his country’s recovery is taking care of itself.
Consumer prices in March told a different story. Excluding fresh food, they declined 0.3% from a year earlier, falling for a second straight month. Put in perspective, price trends aren’t disastrous.
The economy is stable, corporate profits and property prices are up and, as we heard from Standard & Poor’s last week, Japan is cutting borrowing and its banks are in good health. S&P raised Japan’s debt ratings one level to AA, the third-highest grade.
What’s more, said Huw McKay, senior international economist at Westpac Banking Corp. in Sydney, “There’s a big difference between demand-deficient deflation that Japan was afflicted by in the late 1990s and this good deflation, which is driven by competitiveness and productivity gains that aren’t being fully compensated for by increases in wages.”
It’s an important point. The days when Japan risked a deflationary spiral are over, though the rise of low-cost China and the forces of globalization are closing in on the economy. Even as corporate profits improve and businesses increase employment, wages are stagnating. That has kept Japan’s long-awaited revival from inspiring households to spend more.
Amid all this, though, there are some troubling signs in Tokyo, ones underlined last week by economic and fiscal policy minister Hiroko Ota. She said the latest inflation news “doesn’t change my view that the end of deflation is in sight from a macroeconomic perspective.”
The problem isn’t that Ota is among those who remain in denial; it’s that economic officials still don’t seem to realize that deflation isn’t Japan’s illness, but a symptom of it.
Until consumers have confidence that Japan’s 1% or 2% growth will approach 4%, see their wages increasing and believe the national pension system is stable, they will save more than they consume. It’s that simple. Consumer doubts about the outlook are prolonging deflation. It’s a cart-and-horse issue and one with which officials continue to grapple.
The disconnect between growth and weak consumer-price trends means the Bank of Japan is on hold indefinitely. Since raising the overnight-lending rate to 0.50 % in February, Bank of Japan (BOJ) governor Toshihiko Fukui has watched prices ease further and further. On 27 April, the central bank said inflation will accelerate next year. Of course, that’s what it said last year about 2007.
Currency traders also have watched the yen slide to a record low versus the euro and go nowhere versus the dollar this year. The latest inflation report, coupled with a 0.6% drop in industrial production in March, didn’t help the yen’s prospects. “This data looks a bit nasty from the BOJ’s point of view,” said Richard Jerram, Tokyo-based chief Japan economist at Macquarie Securities Ltd. What would the return of Japanese deflation mean for the global economy?
For one thing, it means the so-called yen-carry trade remains alive and well. In recent months, those who had borrowed cheaply in yen and invested that money in higher-returning assets elsewhere were concerned the yen would rise, spoiling what has been a sure-bet trade.
The weak-price environment and the view in markets that the finance ministry will fight any rise in the yen means borrowing in Japan may remain a popular practice. That’s good news for those holding Australian or New Zealand dollars, both of which have been major beneficiaries of the carry trade. For another, optimism that Japan would offset a potential slowdown in the US may be overdone.
That’s not so problematic for Asia considering how fast China and India are growing. Together, said T.J. Bond, Merrill Lynch & Co.’s Hong Kong-based chief Asia economist, China and India now constitute 21.4% of global gross domestic product—greater than the US economy’s 19.7% share, based on purchasing-power parity.
Yet a more vibrant Japan would add stability not only to Asia, but also to the global economy.
Sadly, Abe is far less focused on the economy than his predecessor, Junichiro Koizumi. Abe became prime minister seven months ago figuring he could concentrate on other things, Richard Katz, editor of the Oriental Economist newsletter, said. So far, Abe’s priorities have been to strengthen Japan’s foreign policy, revise the constitution and tweak the education system to instill patriotism in youngsters.
True, Japan’s economic upgrades are still filtering through the economy. Recent corporate takeover attempts and investigations of company scandals show how much Japan has changed over the last decade.
“But additional reforms are still needed,” Katz argued.
Without those changes, deflation could once again become the norm in an economy thought to be moving beyond it. That’s hardly in the global economy’s best interest.