Japan Tips Ever Deeper Into Deflation
By Staff News & Analysis - September 30, 2009

Japan is sliding into the deepest deflation since the Second World War, forcing the new-broom Democrats to abandon their strong yen policy within weeks of taking office. The country's core inflation fell a record 2.4% in September, a steeper drop than at any time during its Lost Decade. A surging yen is twisting the knife further. The currency has risen 22% against the euro, 27% against the dollar, and 43% against sterling since mid-2007. Hirohisa Fujii (pictured left), finance minister, ditched his non-intervention policy yesterday, saying Tokyo would "take necessary steps" to prevent disorderly currency moves. Yen strength is asphyxiating Japanese exporters and feeding a self-reinforcing spiral of lower prices and wages. This 1930s process increases the real burden of debts. Corporate debt alone is 180% of GDP. – Telegraph

Dominant Social Theme: The danger of price deflation.

Free-Market Analysis: First Spain and now Japan. The Telegraph is charting deflationary trends in one industrial economy after another. The problem in Spain apparently is that EU central bank demands make it impossible for Spain to print enough money to cushion its increasingly grim recession. The problem in Japan is different, according to the Telegraph (our favorite mainstream financial newspaper). Japan needs to continue to export to keep its economy humming. But somehow according to the Telegraph's analysis, the yen continues to climb in value against other currencies, which means lower prices and lower wages.

Of course, savvy Daily Bell readers may remember yesterday's column on Spain, where we pointed out that price deflation was not a central banking matter once the bubble bursts. In our humble opinion, price deflation (and monetary contraction in general) is part of the process of a fiat money disintegration. The bigger the bubble, the more uncontrollable the monetary aftermath.

For those at the Telegraph, it may be fairly simple. Pump enough fiat into the economy and the fall will be cushioned. If Japan and Spain face deflation, it must be because monetary policy is lacking and the will to print money is flagging. Not so fast. Economic malaise in a fiat crisis aftermath may be inevitable BECAUSE of the efforts of central bankers to re-inflate.

Re-inflation, to the degree that additional money does circulate, accomplishes perhaps three things. First of all it freezes mal-investment and makes it impossible to purge large ruined entities. Second, additional private capital is fooled into fueling these ruined companies because they seem stabilized. Third, it is very likely that small entrepreneurial companies are prevented from gaining additional funds because the large stabilized (but ruined) companies are still gaining the lion's share of capitalization.

From where is growth to come? It must come from companies with new ideas and new business models. But capital is still being diverted to old, bankrupt firms and banks themselves are in a non-lending panic – banks large and small will NOT lend in the aftermath of a crisis as grave as this one.

So new ventures are kaput. Real business shrinks. People are thrown out of work. Prices drop. Wages spiral downhill. Money does not circulate as it should (creating real deflation), but in our opinion this is NOT a monetary phenomenon but a real-economy one. Sure, if central banks tighten they can make a bad situation worse, but it is PARADOXICALLY the very loosening that is being called for by mainstream economists and financial writers that causes the deflation that they fear.

Here's some more from the Telegraph article:

Junko Nishioka from RBS said a yen near ¥90 to dollar has broken through the "break-even rate" for manufacturers such as Toyota, Honda, and Sony. "Exporters face the possibility of exchange losses," he said.

The crisis engulfing the world's second economy is remarkable. Profits fell 53% in the second quarter. Total cash earnings have dropped 7.1% this year. Tax revenues have plunged 27%. While the economy is no longer in recession,

GDP has shrunk by 8% from its peak and exports are down 36% (in yen).

Andy Xie, a leading consultant in Asia, said Japan's Democrats have been handed a poisoned chalice. "The bursting of the global credit bubble in 2008 brought down Japan's export machine. Of all OECD countries, Japan's looks most like a depression."

It is Japan's misfortune that the yen tends to rise in times of turmoil as its own citizens repatriate savings. But other complex forces are also at work. The fall in rates to near zero in the West has closed the yield gap.

We can see once again that deflation seems a monetary phenomenon. Not so fast. Fiat currencies around the world are in a race to the bottom and right now the yen has the misfortune of being one of the strongest among the weak. But as we pointed out yesterday, and now have pointed out again today, a monetary analysis of deflation – and price deflation –is simplistic. It is likely, at least in part, a function of the very re-inflationary strategies that central banks pursue after such a currency shock as the world has experienced.

After Thoughts

Central banking doesn't work. Bankers and politicians in general have only one answer to currency issuance – print more. They rarely print less, and anyway what is less? Does anyone know what the true volume of money is or should be? Of course not. Only the market can decide, which is why we need a market-based gold and silver monetary standard. Then money could become a medium of exchange once more instead of an instrument of policy and a weapon of mass destruction.

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