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Japan’s multi-year deflation battle may be entering its most dangerous phase yet: contagion.
The economic version of the pandemic upending nations everywhere might not be existential. But it does mean the specter of Japan-like funks around Asia can’t be downplayed.
Not with Malaysia, Singapore, Taiwan, Thailand and others suddenly registering consumer price declines.
Or South Korea, Asia’s No 4 economy, which is on the verge of negative prices. China, in the meantime, has been grappling with wholesale price deflation all year.
Obviously, Covid-19 is the immediate thread connecting all these weak-pricing-power stories. But Japan’s failure to extricate the inflation genie from the proverbial bottle after 20 years of trying predates the coronavirus, and offers the rest of Asia a kind of “Deflation 101” guide.
Sadly, Tokyo is not heeding the lessons from its own falling-price nightmare.
Granted, Japan is not formally back in the red, yet. Consumer prices are, however, flatlining. Since April, they averaged only 0.2% at best. The collapse in top-line growth, employment, exports, business confidence and household sentiment leave little doubt of where Japanese prices are headed from here.
But even in the heady days of, say, 2018 when Tokyo was turning in 2.5% quarterly growth rates, inflation was never anywhere near the 2% target. That, despite the most aggressive monetary easing modern that history has ever seen.
The problem, of course, is that Japan has been treating the symptoms of economic funk, not the forces causing it. And it still is.
The Japanese conundrum
Deflation is an overall decrease in price levels, pushing the inflation rate negative. It’s generally a dreadful sign of plunging demand. And it’s a problem that can be harder to rectify than inflation. Falling prices tend to beget more gloom about the future, exacerbating the trend.
All the adulation being heaped Shinzo Abe’s way as Japan’s prime minister steps down ignores how much of the “deflationary mindset” he promised to change lives on. Japan’s gross domestic product, in the meantime, is smaller now than it was back in 2012 when “Abenomics” was being rolled out.
The mistake Japan made, and has been making since 1999, is thinking of deflation as the problem, not a side effect.
The underlying ailment is the crippling belief that the next five to 10 years will be less prosperous than the previous five or 10. Seeing China surpass Japan in GDP terms in 2010 was an added psychological blow.
But the biggest lesson from Japan is that Milton Friedman, the father of monetarism, was only half right. If the Nobel laureate were still alive, Japan would have him back at the drawing board.
Friedman argued that inflation and deflation were “always and everywhere” monetary phenomena. Not so in Japan, which has been holding rates at, or near, zero for 21 years without generating stable inflation.
Since 2013, Bank of Japan Governor Haruhiko Kuroda proved massive monetary easing alone cannot reflate an unbalanced economy.
In Japan’s case, demographics are the major spoiler. An aging and shrinking population has less need for buying new homes, cars, electronics and apparel than 20-somethings.
Kuroda’s predecessor, Masaaki Shirakawa, predicted exactly this outcome back in 2013.
Shirakawa argued, rightly, that massive deregulation was needed to jolt Japan’s rigid economy and incentivize new investment, generating growth and the confidence to take risks that generate new wealth.
It’s not only Japan
Herein lies the real lesson for other economies around Asia flirting with deflation problems of their own.
Thailand, for example, is seeing consumer prices drop at a 1.2% rate year-on-year. The Bank of Thailand says it’s studying large-scale asset purchases akin to what the BOJ has done. It is also mulling ways to control the level of government bond yields to support economic activity.
The biggest headwind is a strong currency. The baht is among Asia’s best-performing currencies this year thanks to a sizable current-account surplus. That is crimping exports and a tourism industry already hitting a Covid-19 wall. Taken together, these two sectors account for 70% of Thai GDP.
The answer for Thailand, though, is not more monetary easing. Last month, the BOT left its policy rate at 0.5%, meaning it doesn’t have much conventional stimulus left in the toolbox.
More importantly, Bangkok needs to reduce bureaucracy, improve the ease of doing business, curb corruption and invest more in education and training to enliven economic spirits.
That, and “improving the effectiveness of its current policies or implementing targeted measures to curb” currency strength, says economist Krystal Tan of Australia & New Zealand Banking Group.
Malaysia is seeing consumer prices drop at a 1% rate, year on year. That has former finance minister Lim Guan Eng urging the government to step up stimulus efforts to “prevent deflation” and crack a cycle that’s hard to break.
He’s not calling on the central bank to ease, but on Prime Minister Muhyiddin Yassin to accelerate fiscal responses.
“Failure to do so will cause greater hardship and even bankruptcy as many will struggle to serve their borrowings, either for cars, homes or business purposes,” Lim says.
Prices in Singapore are falling at a 0.5% clip as the city-states export engine seizes up.
For more than a decade now, Singapore has dragged its feet on diversifying its economy, moving upmarket into higher-value-added niche industries. That means increasing the roles of biotechnology, energy, health care, logistics and software.
Efforts have been gradual and unimaginative, holding back Singapore’s innovative game.
But when economists like Brian Tan of Barclays Bank says “demand-pull inflation pressures should remain soft through the rest of this year,” they may be eyeing an overly optimistic scenario as coronavirus fallout intensifies.
The government needs to generate growth from the supply-side via deregulation, not only more central bank cash.
South Korea, in the meantime, is on the cusp of negative prices. The central bank expects inflation of 0.4% for this year. That doesn’t offer a lot of cushioning if second waves of Covid-19 slam global growth.
And these risks up the odds that the Bank of Korea might dabble with quantitative easing.
Yet structural reforms that shift economic power away from giant family-owned conglomerates to smaller enterprises would do more to boost jobs, wages and confidence. Creating more economic energy from the ground up would do more to juice growth and stabilize prices than BOK largess.
China is experiencing factory price deflation, though there are signs the situation is stabilizing.
The producer price index fell 2.4% in July from a year earlier, compared to a 3% drop in June. Industrial activity in Asia’s biggest economy, it’s worth noting, is gradually climbing back to pre-Covid levels.
Why deflation is tricky
Deflation isn’t a simple phenomenon.
Over the last two decades, Japanese households grew used to stable-to-lower prices. In high-tax, stagnant-wage Japan, sliding costs acted like a stealth tax cut. These issues actually increased household spending power.
Naturally, fears of losing that benefit in 2013 left many households feeling conflicted. And they left many even more uncertain about the future and less inclined to spend.
Even so, the forces thrusting deflation upon all too many Asian economies are as ominous as they are dangerous. They require urgent and cooperative action by governments and central banks alike.
They also offer an essential realization: That Japan’s Deflation 101 course offers as many examples of what not to do as real pointers.