Price destruction becomes a martial art
Tuesday 06 February 1996
One can explain the slowing in the US as a natural and inevitable pause after five years of solid growth.
One can explain the early German downturn, partly at least, by pointing to its tight monetary policy as the Bundesbank continued to correct (or over-correct) the inflationary forces generated by unification. But Germany did at least manage some recovery.
In Japan the experience is different in two respects: it is alone among the world's economies in that it has not really recovered at all; and it is experiencing falling prices. The searing effect of living with falling prices has been such that the expression "price destruction" has been coined to describe it.
Three measures of inflation - or rather price destruction - are shown in the graphs. The GDP deflator - the most representative of the three for it seeks to chart inflation in the whole economy - has been negative for a full year.
Long before that, back at the beginning of 1992, the wholesale price index went below zero, so the business community has had a full four years of coping with falling prices. Consumers, on the other hand, have only started to feel the benefit of this in the last few months, as the relatively inefficient distribution chain has offset the cuts in prices from the extremely efficient manufacturers.
Getting accustomed to a world of falling prices is quite difficult, as UK home owners have found. One obvious effect has been to make would- be borrowers even more cautious than they might otherwise be. Low interest rates do not therefore boost borrowing, as they might in an inflating economy. Commercial companies are under no pressure to invest; domestic consumers under no pressure to borrow either for consumption or house purchase. Further, low interest rates cut the income of savers and may on, balance, reduce overall demand.
Thus in real terms the latest figures for retail sales show them down 2.5 per cent year on year; household consumption is down 2.4 per cent; and department store sales are down 1.8 per cent. But those are in real terms. In nominal terms, the amount of money the retailers are taking in their tills is down even more.
This experience at the shops is paralleled in the economy as a whole. The real economy, the figures that the official world looks at, is up 0.2 per cent year on year. In nominal terms - the yen in your pocket,- the economy is down 0.4 per cent.
The importance of this is that debts are in nominal, not real, terms. So indebted companies are not seeing loans whittled away by inflation, but their real burden increase, even if the company can continue to service the debt. It is as though the whole economy has been struck with the British home-buyers' experience of negative equity. On a current basis, and helped by low interest rates, people can live on in their home, despite having negative equity. But the debt overhang not only stops them from being able to move; it also casts a cloud over their other spending decisions.
The corollary of this is the impact on the lender. If a debt is being serviced, there is no need for a bank to write it off. But the knowledge that the capital value of that debt, in real terms, is mounting every year, is a powerful inhibition on other lending decisions. Maybe borrower X can service Y loan; but what happens when the loan has to be repaid? Inevitably, would-be borrowers are loath to borrow yet more and banks are loath to lend to new customers. Result: the Japanese economy is paralysed, like our housing market.
So what will happen? As always, there is a spread of views, but it is perhaps most helpful to shoe-horn them into two categories. One is the slow haul back; the other, that things have to get worse before they can get better.
The slow-haul-back camp would point to a number of signs of recovery. These include the weaker yen; the change in capital investment from being negative to being flat; and a slight rise in certain categories of consumer spending, such as cars.
The things-get-worse camp would argue that even the present bouncing along the bottom cannot continue for domestic and external reasons. The domestic reasons include the large fiscal deficit, now already 4 per cent of GDP and projected to deteriorate further; falling employment and rising unemployment; low business confidence, particularly among small firms; and finally the still-unaddressed structural weaknesses of the Japanese economy.
Add to these woes the international concerns, particularly that the world's largest and third-largest economies seem to be turning down together. Recession in the US and Germany would be devastating to Japan.
So what is to be done? Even the more optimistic scenario is dispiriting. Within the Japanese business community there is a growing view that structural reform is the best way of squaring the circle.
Freeing up the labour market would do something about the rising problem of youth unemployment. Encouraging self-employment (which is still falling in Japan) and new business creation would help revitalise the service sector.
In other words, Japan needs, some members of the business community believe, to become more "Anglo-Saxon" in its economic policies.
They note that the United States's share of world manufactured exports has passed Japan's (11.9 per cent against 11.4 per cent).
They note the emphasis on profit rather than unprofitable growth. They note the transparency of financial markets and company accounting.
Finally they have been chilled by the increasing evidence of sclerosis in Germany, the European economy that most closely resembles their own.
Funny, just at the time when the German and Japanese models are coming to be admired by some sectors of the British populace, that both those countries are looking admiringly at the US, and even the UK? Meanwhile, we will have to learn from Japan about the martial art of price destruction.
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