Japan and the Effects of Deflation

Over the past year or so there have been numerous warnings about the dangers of deflation, usually coupled with the comment: “We don’t want to end up like Japan.” These concerns have diminished considerably given the uptick in economic activity, but the phenomenon of deflation turns out to be interesting in itself. At first thought, the notion of falling prices doesn’t seem like necessarily a bad thing, but a little further consideration brings focus to the problem. Falling prices, eventually, will be followed by falling wages. Once the notion that your salary is going to decline sets in, you will tend to be hesitant in making unnecessary purchases. Once the belief that prices will continue to drop becomes ingrained, there is little urgency in shopping for big-ticket items. Just exactly how bizarre this situation becomes can be illustrated by the decision to buy a home. The purchaser must go into the deal knowing that the value of the home will decrease, and the ability to make the mortgage payment will decline. So why do it? Taking out any kind of loan seems foolish in this situation. If so, how do you buy a car; how do you go to school; how do you start a family? Now consider what this does to the psyche when it continues for ten or twenty years. That has been the situation in Japan.



Data on the price history can be found at the Trading Economics site.

“Core consumer prices in Japan declined 0.4 percent on year in December, the Ministry of Internal Affairs and Communications said on January 28, falling for the 22nd consecutive month.”

“Overall consumer prices were flat on year following the 0.1 percent rise in November. On Month, CPI was unchanged at -0.3 percent.”

“Among the individual components, prices for education declined 13.0 percent on year, followed by furniture at -3.5 percent and recreation and clothing both down 0.8 percent.”

A number of articles have appeared recently that address the economic and social situation in Japan following many years of deflation. A recent New York Times article describes the mood in a Japan experiencing twenty years of deflation and diminished expectations as “resigned.” It is hard to see resignation as an indicator of a bright future.

“Just as inflation scarred a generation of Americans, deflation has left a deep imprint on the Japanese, breeding generational tensions and a culture of pessimism, fatalism and reduced expectations. While Japan remains in many ways a prosperous society, it faces an increasingly grim situation, particularly outside the relative economic vibrancy of Tokyo....”

“But perhaps the most noticeable impact here has been Japan’s crisis of confidence. Just two decades ago, this was a vibrant nation filled with energy and ambition, proud to the point of arrogance and eager to create a new economic order in Asia based on the yen. Today, those high-flying ambitions have been shelved, replaced by weariness and fear of the future, and an almost stifling air of resignation. Japan seems to have pulled into a shell, content to accept its slow fade from the global stage.”

“As living standards in this still wealthy nation slowly erode, a new frugality is apparent among a generation of young Japanese, who have known nothing but economic stagnation and deflation. They refuse to buy big-ticket items like cars or televisions, and fewer choose to study abroad in America.”

“Japan’s loss of gumption is most visible among its young men, who are widely derided as ‘herbivores’ for lacking their elders’ willingness to toil for endless hours at the office, or even to succeed in romance, which many here blame, only half jokingly, for their country’s shrinking birthrate. ‘The Japanese used to be called economic animals,’ said Mitsuo Ohashi, former chief executive officer of the chemicals giant Showa Denko. ‘But somewhere along the way, Japan lost its animal spirits’.”

As for what deflation does to the real estate market:

“The downsizing of Japan’s ambitions can be seen on the streets of Tokyo, where concrete ‘microhouses’ have become popular among younger Japanese who cannot afford even the famously cramped housing of their parents, or lack the job security to take out a traditional multidecade loan.”

“These matchbox-size homes stand on plots of land barely large enough to park a sport utility vehicle, yet have three stories of closet-size bedrooms, suitcase-size closets and a tiny kitchen that properly belongs on a submarine.”

“’This is how to own a house even when you are uneasy about the future, said Kimiyo Kondo, general manager at Zaus, a Tokyo-based company that builds microhouses.”

Businessweek included an article that provided the depressing assertion that the Japanese were becoming accustomed to deflation and were beginning to feel comfortable with it.

“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.”

“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.”

An article in The Economist provides some insight into why Japan seems unable to break out of this cycle. The first thought has to do with business decisions.

“JAPAN, one of the great exporting nations, usually runs a trade deficit with, of all places, Switzerland. Why? Ask Rolex. Japan also buys more from France and Italy than it sells there. Why? Bordeaux, Brie, mascarpone and Armani, to name a few expensive vices. In Japan such delicacies are mostly immune to deflation, while prices of everyday goods like cars, electronic goods and clothes tumble. Why then do Japanese firms continue to churn out the latter, even though margins are low? And could this help explain Japan’s persistent deflation problem?”

“These questions preoccupy Kosuke Motani, author of “The Real Face of Deflation”. In this book’s first seven months in print, 500,000 copies have been sold, including one to Naoto Kan, the prime minister. Mr Motani argues that deflation in Japan is not so much a monetary problem as a structural one linked to bad business decisions and demography.”

“If Japanese firms produced new types of luxury goods, he believes, they could unleash pent-up demand among Japan’s growing, and wealthy, ranks of old people and pay higher wages to Japan’s shrinking, and relatively poor, youth.”

Japan’s elderly also get blamed for the economic malaise. They control the majority of the country’s huge stash of savings ($18T). Much of these savings are needed to fund the borrowing the government must do in order to stimulate the economy to compensate for the fact the elderly are not spending: an interesting economic death spiral.

“Mr Motani....is fed up with the elderly hoarding their money. He says they do this because of a “King Lear” complex: they feel they will be deserted if they give too much away. And he favours tax reform to encourage them to bequeath their money to their grandchildren, rather than their children. One of the flipsides of longevity, he points out, is that the average age of those who inherit is a grand old 67.”

So the elderly are afraid to let loose of their savings and they live long enough that the inheritance eventually goes to children who are already elderly and similarly insecure.


Every country has a story to tell. Japan produces one of the most unusual.