Deflation: The tie that binds

John de Boer (University of Tokyo & GLOCOM Platform)

Most foreign news media, in particular those based in the U.S., praised Koizumi's recent cabinet reshuffle. The New York Times, the Washington Post, the International Herald Tribune and the Associated Press all seemed happy with Hakuo Yanagisawa's (financial services minister) removal and the merging of his responsibilities under Heizo Takenaka's (minister of the economy) portfolio. Nevertheless, the estimation is that the economic situation in Japan remains gloomy with the threat of deflation looming in everybody's mind. In fact, fear continues to spread in the U.S. that their economy is headed in the same direction. Although most economists in the U.S. claim that there are more differences than similarities between the bursting of the 'bubble' in the U.S. and that of Japan ten years ago concerns continue to linger.

After PM Koizumi announced his cabinet reshuffle, the Washington Post carried a story entitled, "In Japan, A sign of change" (October 1). They assessed Koizumi's new cabinet as one that was capable of pushing through tough measures. In particular, the Washington Post welcomed Yanagisawa's removal stating that his intransigence relating to the use of public funds to bail out banks had caused "impatient hand-wringing from key Bush administration advisers, who feared that inaction could lead to a financial crisis in the world's second largest economy". The hope is that U.S. concerns will also be reflected in the comprehensive plan on how to deal with bad loans, scheduled to be introduced by Takenaka at the end of the month. The U.S. government and its media wants Koizumi to press through with reforms and let companies fail instead of propping them up to protect jobs (Eric Talmadge, the Associated Press, October 1; Washington Post, October 1).

One other worry overseas relates to deflation. Ken Belson of the NYT headlined with an article on October 2, which reported on the "gloomy" outlook as forecasted in last month's Tankan survey. He reported that 8,500 company executives think that the country will slip back into recession if no new impetus is given to Japan's main source of growth: exports to the US and Asia. He also highlighted the fact that a combination of lower corporate capital spending, almost non-existent consumer spending and the threat of rising oil prices (Iraq attack) could make conditions even tighter.

While the U.S. remains cautious about the possible effect that another recession in Japan will have on their economy, an ever present concern is that the U.S. will follow the path Japan took ten years ago. David Leonhardt's article comparing the burst of the bubble in Japan with that of the U.S. was featured in both the International Herald Tribune and the New York Times last week. There he led off with the following statement, "few policymakers or economists expect the U.S. to fall into the same trap as Japan because the U.S. bubble never reached the same size as Japan's and U.S. financial and political systems appear more flexible. Still, many signs suggest that the U.S. could suffer a post-bubble hangover that lingers for at least a few years" (NYT, October 2; IHT, October 3). The conclusion reached by Leonhardt was captured in a statement made by the chief economist at ITG/Hoenig, Robert Barbera, who claimed that, "the US has a very defensible system, but we got too giddy and we had a bubble. ... The immediate future is pedestrian".

Indeed, there are many differences between both economies. For example, as Leonhardt mentioned, in the US equity markets dominate corporate finance which tend to pull their money from failing companies relatively early while in Japan, banks dominate, which have traditionally tried to avoid foreclosures. However, in both cases deflation seems to be the knot that binds. Deflation has already taken root in Japan with land and stock prices falling between 70-90% over the past ten years and no matter how optimistic U.S. economists may be about the systemic differences between the U.S. and Japan, they cannot neglect that a similar phenomena is being experienced in the United States.

Articles:

• David Leonhardt, "Will US follow Japan downhill?", International Herald Tribune, 3 October 2002
• David Leonhardt, "Japan & US: Bubble, Bubble, Toil and Trouble", The New York Times, 2 October 2002
• Ken Belson, "Japan's Executives Fear Economy is Slipping Again", The New York Times, 2 October 2002
• Eric Talmadge, "Japan Bank Czar to Tackle $325 B Debt", The Associated Press, 1 October, 2002
• "In Japan, A Sign of Change", The Washington Post, 1 October, 2002