Depression? : Japan case study

Sorry EdT, no Chinese crap for you here.

We keep hearing about calls for an exponential Great Depression from our usual MR conspiracy theorists, however I feel many do not understand the current situation we are in and how similar situations have occured in the past and how they can give us an idea of HOW we will get out of this mess.

Japan's 1990's deflation crisis

For the past decade, deflation has persisted in Japan. Deflation is the sustained decrease in the average of all prices of goods and services in the economy. Among all the countries since WWII, Japan has been suffering from deflation for the longest time. There have been many attempts in stopping deflation. Then why has Japan been under deflation for such a long time?

Deflation can be seen through various indicators:

• Lower housing prices
• Lower wages
• Increase in unemployement
• Lower commodity prices
• Lower profit margins
• Lower business profits
• Lower stock market

Japan's solution was to pour enormous amounts of money into the economy through various sources:

• Infrastructure spending
• Money printing
• 0% interest rate

Sounds familiar? The US is currently facing the problem and is using the same solution. Will it work? No.

Japan's real estate prices on average are still lower than in 1989, that is 20 years of economic contraction. Impressive isn't it?

Even through massive YEN printing, zip interest rate and enormous stimulus government spending, the YEN did not collapse. The sole power of the government to print money was not enough to counter the incredible forces of a deflationary market cycle.

The Yen crisis was strictly a trading imbalance issue. It did not face these current issues that we face today:

• Manufacturing oversupply
• Real estate over supply (16% vacancy rate on residential houses in the US)
• Commercial real estate oversupply

In order for the US to get out of this deep recession they actually need the USD to fall, midly, not abruptly. A slightly USD downfall would reestablish international trade and kick start the economy.

Reason for deflation
One reason for the deflation in Japan is the increased goods being imported from China and other Asian Countries. Since Japan imports more goods, the Net Exports (Exports �� Imports) has decreased significantly, creating a lower Aggregate Demand (AD) which leads to a recessionary gap; which drops the price level of goods and services and also causes unemployment. It is said that imports from China has accounted for a third of the increase in Japanese imports during 2004-2005 (OECD 2005). Since businesses are selling cheaper goods than when selling domestic goods, the total revenue of the company decreases and therefore in the long-run, the wages will go down as well. Therefore, consumption of goods and services will decline as well. Then, it will result in a decrease in company’s revenue, bringing down the wages again. This process will continue until some action is taken by the government or the FED.

Actions taken to end deflation
Monetary Policy has been used to stop deflation from continuing. Specifically, the Open Market Operations have been used. The Bank of Japan (BOJ) has been trying to increase Money Supply (MS) in order to increase AD. The first step BOJ takes is increasing the prices of Japanese Government Bonds (JGB). By doing this, bond owners will give up their bonds; resulting in the FED buying the JGB (We can see this buy looking at the Bonds Market). After doing this, the FED successfully should have increased the MS, which also brings down the interest rate (Money Supply and Demand Graph)....

But just possibly, Japan before and the United States now have something critical in common, and the United States will fall into the same trap that Japan did. The pundits have been wrong on forecasting the banking crisis too many times since August 2007 to be confident that anybody really can foretell where this story is leading.

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Il y a une chose que je ne comprends pas. En imprimant de la monaie on dilue sa valeur à travers plus d'unité, donc elle s'affaiblit et perd de sa valeur. Donc de cette façon l'équilibre de l'import/export devrait se rétablir. Je ne vois pas en quoi c'est la mauvaise voie?

Carbon_Blue_GT said:

Il y a une chose que je ne comprends pas. En imprimant de la monaie on dilue sa valeur à travers plus d'unité, donc elle s'affaiblit et perd de sa valeur. Donc de cette façon l'équilibre de l'import/export devrait se rétablir. Je ne vois pas en quoi c'est la mauvaise voie?

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Inflation.

Carbon_Blue_GT said:

Il y a une chose que je ne comprends pas. En imprimant de la monaie on dilue sa valeur à travers plus d'unité, donc elle s'affaiblit et perd de sa valeur. Donc de cette façon l'équilibre de l'import/export devrait se rétablir. Je ne vois pas en quoi c'est la mauvaise voie?

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Yes and no. In a sterile environment where paper money was the only type of money, you'd be right.

However we live in a far more complex monetary world where credit and virtual money amount to far more than paper money. Credit and virtual money is what got destroyed, over 40% of the world's wealth was destroyed in the last year alone. Even thought you did not notice, after all, your actual cash in your pocket didn't just catch on fire, but money in your investment funds vanished and credit dried up.

Printing money is one of the many tools government has to prompt up the economy. It is a fine balance and overshooting on money supply will indeed result in inflation. Hyperinflation will not happen unless the complete trust in the USD is lost, which I can't see happening as the USD is the sole beacon of hope for the rest of the world at the moment.

There is also a myth that inflation on its own is bad. Inflation, like anything, must be evaluated in context. We currently need inflation and all the governments in the whole word, even China's, are trying to set off a mild inflation trend to offset the massive losses incurred in the latest months.