Lost in Deflation

I remember as a kid seeing images of Japan via TV and the movies. It was different, wonderful, fascinating, otherworldly. It seemed like a fantasy-land of smells and colors, moving parts, robots attending to your every needs and an army of business suits churning out really cool stuff.

Fast forward to today and it wasn’t until a series of articles regarding Japan’s steady decline that I realized this once magical place has ceased to exist in my psyche, yet I don’t remember when it stopped – it just appears less and less cool/innovative everyday.

During the 1980’s Japan rode speculative stock and property bubbles that actually challenged American dominance. At the end of the 80’s and early 90’s the bubble popped which initiated this slow and almost anonymous (outside of Japan) decline. Productivity growth began to slow, the working age population started to shrink, and the Japan as we knew it commenced down the road of flashy to subdued.

Here’s where it get’s creepy for Americans – one reason for the prolonged failure was the lack of an aggressive response to deal quickly with bad loans clogging Japanese banks. Rather than forcing them into liquidation, inefficient companies were propped up and government policy mistakes essentially aggravated the situation causing the crisis to linger.

All this meant less capital to lend to upstart firms. So, instead of encouraging less saving and more spending during this time, the opposite occurred which has resulted in deflation. When corporations hold back on investments, banks sit on their cash, and consumers won’t consume due to future uncertainties, this is deflation. A wicked cycle thus ensues with prices falling further, consumers continuing to tighten their pockets, and companies cutting back spending even more.

Japan is now mired in a culture of pessimism, fatalism and reduced expectations. There are these things called microhouses that have been springing up in large cities. They are like matchbox houses rising three stories with rooms the size of closets. Young people and families are flocking to these low-cost options because they are too afraid to take out home loans. Confidence has been replaced with resignation leaving many Japanese 60 years and up dumbfounded at the responses of their sons and daughters. It’s almost as if they are complete foreigners sharing nothing in common with their once-proud parents.

A natural preoccupation from the West would be are we facing the same potential fate amidst our own debt and property bubble bursts? Scary, yes, but the same, no. The West has a greater tolerance for capitalism’s creative destruction. Policy, in general, responds accordingly. While Japanese policy maker’s spent heavily on things like creating jobs and big public works projects, key changes, such as structural changes, were placed on the back-burner. The service sector, an increasingly vital component of any country in today’s globalized economy, is heavily regulated, protected from foreign competition, and thus, lags behind. Unlike Japan’s great manufacturing sector, the service sector was unable to capture the benefits from the IT revolution which has placed the country in a perilous position.

Of course, there are many lights breaking through the cracks in Japan’s proverbial tunnel. The private sector is by all accounts composed of brilliant thinkers, and policy decisions cannot get much worse. But more than anything, the cultural shift of a once proud nation to a citizenry now afraid of risk-taking and new investment is most worrisome. The evils of deflation are real and not very pretty.

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