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Notes From the Rabbit Hole

Embrace Deflation - It's the Cure, Not the Problem

By Mike Shedlock

July 29, 2009

Concern over Japanese deflation is increasing. Please consider Japan Succumbs to Deflation as Consumer Prices Fall Record 1.1%.

Japan’s consumer prices fell at a record pace in May, adding to the risk that deflation will become entrenched and hamper a rebound from the nation’s worst postwar recession.

Prices excluding fresh food slid 1.1 percent from a year earlier after dropping 0.1 percent in the preceding two months, the statistics bureau said today in Tokyo. It was the sharpest decrease since comparable figures were first compiled in 1971.

Bank of Japan Governor Masaaki Shirakawa said last week that price declines will accelerate through the middle of the fiscal year as demand slackens and crude oil continues to trade lower than last year’s record. Retailers including Aeon Co. are cutting prices to attract customers as falling wages and the worsening job outlook damp spending.

“Profits fall, then wages come down, then consumers stop shopping,” said Junko Nishioka, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. “And because people aren’t shopping, companies lower prices. That’s the process that we’re starting to see. It isn’t easy to break out of.”

“With demand deteriorating, companies are finding it more difficult to sell goods and services and are turning to discounting,” said Azusa Kato, an economist at BNP Paribas in Tokyo.

Some 47 percent of 775 Japanese retailers surveyed by the Nikkei newspaper plan to lower prices in the year ending March 2010 to spur sales, up from 9 percent a year earlier. Aeon, Japan’s second-largest retailer, this week started a discount campaign for confectionary, drinks and mayonnaise.

Consumers, whose spending accounts for more than half of the economy, may delay purchases if they expect goods to get cheaper. That would erode profits and force companies to cut wages, which have already slid for 11 months. Japan only escaped from a decade of deflation in 2005.

Japanese Deflation Deepens

As Japanese deflation deepens, Japanese Bonds Complete 2nd Weekly Gain.

Japan’s bonds gained for a second week as a government report showed consumer prices fell at a record pace, adding to signs deflation will hamper the economic recovery and boost the value of the fixed payments of debt.

Ten-year yields touched the lowest in almost three months after the statistics bureau said yesterday prices excluding fresh food fell 1.1 percent in May from a year ago.

“The drop in consumer prices may accelerate to about 2 percent in the summer,” said Yuichi Kodama, chief economist in Tokyo at Meiji Yasuda Life Insurance Co., Japan’s third-largest life insurer. “The 10-year yield may decline to 1.3 percent or below as the market needs to prepare for deeper deflation.”

An “extreme” slump in demand and production are causing the drop in prices, Finance Minister Kaoru Yosano said yesterday. “We continue to monitor developments in prices and need to carefully manage the economy to avoid a deflationary spiral.”

The Organization for Economic Cooperation and Development this week urged the Bank of Japan to keep pumping cash into the economy “until underlying inflation is firmly positive.” Since it cut the key interest rate to 0.1 percent in December, the central bank has been buying corporate debt and increased government bond purchases from lenders to revive growth.

Japan Fighting Deflation For Decades

Notice the misguided advice by the OECD about pumping cash into the economy. Japan has been doing this for 15 years and all they have to show for it is massive national debt and bridges to nowhere.

Will Deflation Derail A Japanese Recovery?

Jun Saito, a top Japanese economist says Deflation May Derail Japan Recovery.

Deflation “will exert a significant amount of downward pressure on the recovery,” Jun Saito, an adviser to Economic and Fiscal Policy Minister Kaoru Yosano, said in an interview yesterday in Tokyo. “An increase in deflationary expectations will raise real interest rates and that will restrain business investment.”

“Declining prices will mean lower profits, less investment and wage cuts that will weaken consumer spending further,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co.

According to Saito, who quantifies the risk of deflation by using government data and figures from the International Monetary Fund, the risk of persistent price declines climbed to the highest level since 2003 and almost doubled since last year.

“I think there’s a risk we may slip back into deflation,” Saito said, adding that he defines it as a sustained decline in prices.

Japanese companies cut spending at the fastest pace in 54 years in the three months ended March 31. Wages have dropped for 11 months and households reduced spending for a record 14th month in April.

Falling prices are a blow to households who borrow money because it makes it harder to repay debt, Saito said. Consumers will cut back spending if entrenched price declines push up their borrowing costs, he added.

Deflation Misinformation

There is so much misinformation in the above articles it's hard to know where to begin. For starters, inflation and deflation are monetary measures not price measures. However, let's talk about prices for a change.

The idea that "Falling prices are a blow to households who borrow money because it makes it harder to repay debt" is preposterous. When prices fall, consumers have more money and they can pay off debts faster, provided of course they have a job. Falling prices reward the fiscally prudent, which is the way it should be.

Falling home prices do encourage more mortgage walk-aways which is another matter. However, home prices must drop to the point of affordability before a recovery in housing can begin, so even falling home prices are desirable. The sooner home prices fall to the point of affordability, the better of everyone will be.

In general, falling prices are good for consumer balance sheets. Imagine the problems we would have if prices were soaring with the unemployment rate approaching 10%.

Profits are falling along with prices because demand is returning to some sense of normalcy that businesses did not plan for. In the meantime, cash strapped consumers spent recklessly for decades and need to save. They are. Proof is easy to find: US Savings Rate Hits 6.9%, Highest In 15 Years.

This saving is not bad for business as Keynesian clowns believe. Savings provides capital for businesses to expand. For more on this as well as a rebuttal to the ridiculous concept callled "Paradox of Thrift", please see Families Start Saving; Does This Aggravate The Nation's Woes?.

The only reason it appears that savings is bad is after decades of loose credit and monetary expansion by the Fed the world is awash in overcapacity. Now is payback time for misguided Fed polices and reckless consumer spending.

This recession and a rising savings rate are both necessary ingredients to restore fiscal sanity. Deflation should not be feared; deflation should be embraced. What should be feared is the reckless expansion of consumer and corporate credit made possible by Fed policies under both Greenspan and Bernanke. Deflation is not the problem, it is the cure for those reckless policies.

Ironically both Greenspan and Bernanke encouraged Japan to write off bad debts as the means to return to normalcy. However Bernanke Suffers From Selective Memory Loss and cannot follow his own advice.

Addendum:
The Fed likes to portray itself as being an "inflation fighter" when the ONLY source of inflation is the Fed itself. Because of rising productivity over time, the natural state of affairs is actually deflation.

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