We Are Not Japan (Deflationists of America, RELAX, a deflationary spiral is not likely)

Federal Reserve Chairman Ben Bernanke clearly worries about a deflationary spiral. That explains, in part, his push for and vigorous defense of so-called quantitative easing. St. Louis Federal Reserve President James Bullard has also expressed deflation concerns, as has Eric Rosengren, president of Boston’s Federal Reserve Bank. Smart Money magazine, in its October issue, published poll results showing that 40 percent of respondents are worried about deflation, with one of its columnists writing that the “latest scare for already nervous investors … is deflation.”

It is true that price-level measures have indeed been subdued. The Consumer Price Index (CPI) showed a one-tenth of a percent increase for September and a two-tenth percent increase for October. In the past, this has generally been good news, lauded as successful anti-inflationary policy creating a relatively stable price level. Today it is interpreted as something nefarious.

The deflation chorus frequently invokes the image of a deflationary Japan, a former economic success story gone awry. While Japan’s problems for two decades have been real, fears of a Japanese-style deflation in the United States are excessive and, if continued or magnified, likely to generate negative sentiments that bias both private behavior and public policy. Simply put, we are not Japan—we have enormous demographic, cultural, and policy differences. For several significant reasons, deflation is very unlikely.

First, the Federal Reserve’s efforts to keep the economy afloat have resulted in the banking system holding roughly $1 trillion in excess reserves. As banks start lending again, these could yield major future increases in the money supply, placing upward, not downward, pressures on price levels.

Second, the business community has enormous cash stockpiles that will eventually turn into spending and investing. U.S. nonfinancial corporations, for example, have almost $2 trillion in cash, the highest amount in more than 50 years. Formerly spendthrift American households have, at least temporarily, changed their ways, and sit on $8 trillion in cash or near-cash. Hedge funds, too, have raised their already relatively large cash holdings, by roughly 20 percent over the past four months alone.

Inflation’s traditional cause is too many dollars chasing too few goods. As balance sheets and cash holdings improve, we could—and eventually will—see the revival of considerable spending, although it is hard to estimate exactly when this will happen. Let us not delude ourselves into believing that John Q. Public’s recent conversion to penny-pinching is a complete change in personality. More likely, it is a reasoned response to adverse conditions, with reversion to the mean to be expected in improved times.

Third, there are some serious measurement issues involving price-level calculations. Many mainstream economists generally view a CPI increase of 1 percentage point to be masking 1- to 2-percent deflation, since quality improvements are alleged to be inadequately reflected in the official numbers. This popular view, however, ignores widespread quality deterioration, particularly in the service sectors. Very few Americans have not suffered inordinate waiting times and the “press one, press two, please hold” routine when calling their banks, insurance companies, and doctor’s offices. While airline “pat-downs” are a hot current complaint, problems like longer waiting times, closer seats, less leg room, and delayed take-offs and arrivals all escape the CPI. In the medical field alone, a 2006 survey found that the average wait to get a dermatologist appointment was 38 days, while in Boston it was 73 days. Persistent overbooking also means longer time in the office waiting for a doctor. If such degradation outweighs quality advances—a strong possibility, in my view—real inflation may be higher, not lower, than the price indices suggest.

There are also technical measurement issues, as Nobel Prize winner Vernon Smith pointed out. In 1983, the Bureau of Labor Statistics substituted “rent-equivalent” for the direct costs of owner-occupied homes, an adjustment which yielded a minor CPI understatement of inflation through 1996. Between 1999 and 2006, however, the price-to-rent ratio increased more than 50 percent, leaving “an important component of inflation remaining outside the index. In 2004 alone, the price-rent ratio increased 12.3 percent.” Smith calculated that if “home-ownership costs were included in the CPI, inflation would have been 6.2 percent instead of 3.3 percent.” Here again, we may be a lot further from deflation than official numbers suggest.

Finally, the dollar has lost almost 30 percent of its value against gold over the past year. Gold is a traditional inflation hedge, suggesting that while Bernanke apparently fears deflation, the market’s concerns are the opposite. In a related vein, another factor likely to spur more inflation rather than deflation is the price of oil, which has been steadily rising and will likely continue to do so, for two reasons. The economic reason is that a recovering global economy will raise the demand for oil, putting upward pressure on its price. The second reason is that oil, traditionally priced in dollars, has generally risen in cost as the dollar depreciates.

This worm can turn very quickly. Indeed, in late June the Swiss National Bank suggested that deflation risks have just about disappeared in their country and inflation has been inching upwards, expected to rise 2.2 percent in 2012 and 3.1 percent in 2013. While their unemployment rate is much lower than ours, America’s real economy will one day recover and inflation threats could, as in Switzerland, easily reappear.

The likelihood of deflation is further dampened by the position of the dollar. In the future, the dollar no doubt will fall relative to a number of Asian currencies, particularly China’s. And on August 20, the dollar began a decline against the euro. While that trend has been interrupted, a successful resolution of the Greek crisis will likely continue that decline. A reduced currency value will raise the cost of imports, again inflating rather than deflating average American prices. Allan Meltzer, the dean of American monetary economists, noted in July that there have been just seven periods of deflation in the last 97 years. “Only one, 1929-33 brought the country close to disaster.” The others were mild—the last being 1960-1961, a slowdown whose recovery looked like most other recoveries. The end is not near!

Finally, a small bit of deflation is no more problematic than an equivalent modest inflation, say 1 to 1.5 percent each year. Such inflation rates barely gain notice and hardly distort economic calculations. A deflation of similar magnitude would be similarly uneventful. Further, a little deflation should evoke smiles from those no longer in the labor force. While wage recipients enjoy productivity gains via higher pay, retirees and stay-at-homes are left out of generalized productivity advances because they no longer earn wages. With modest deflation, however, they can share in society’s productivity gains via lower prices and experience a modest rise in the purchasing power of their savings.

American policy makers must understand that false fears about extreme deflation can lead to negative business and investor expectations as well as ill-advised public policy.

-- Donald Losman is professor of economics at the Industrial College of the Armed Forces, National Defense University. The views expressed are solely his own.

Over here:

http://www.businessinsider.com/similarities-between-us-and-japan-2010-12

They are giving reasons why America Is Turning Into Japan Or WORSE

The resemblance between two of the greatest financial stock market bubbles in history cannot be easily dismissed. Japan’s financial bubble (peaking in late 1989) and the U.S. stock market bubble (peaking in early 2000) compare with some of the greatest bubbles in history such the tulip bulb craze, the British East India Company collapse and the South Sea bubble.

The Nikkei quadrupled in five years to peak at 39,000 the last day of 1989. It collapsed into a two- decade period of down-trending volatility that reached historic proportions before winding up around 10,000 presently (75% below the high).

The U.S. market rose 3 1/2 times in the four years leading to the high of 2000. The P/E ratios for U.S companies broke out of an average trading range of 8-10 at major bottoms and 20-23 at major tops for the prior 80 years, before more than doubling to close to 50 times earnings for the major averages and 200-400 times earnings for many high tech and dot com companies-—and this excludes many companies with no earnings at all.

In fact, Japan’s stock market in 1989 was the only other major market that could be compared to it in terms of irrationality. In the same vein, the Japanese real estate market was the only major market that could be compared to the real estate bubble in the U.S. six years after the bursting of our stock market. In fact, Japan’s real estate bust was probably worse than the U.S. since the ground under the Imperial Palace was estimated to be worth almost as much as all the land in California at the time.

Let’s take a look at the similarities of the busts in both nations following the respective peaks of their cycles. We believe you will be amazed at just how similar our credit crisis was to Japan’s.

* Our Total Debt/GDP ratio is ten years behind theirs

* Our Government Debt/GDP is ten years behind theirs

* The private debt in Japan was the driving force for the secular deflationary bear market. The private debt in the U.S. that was the driving force for the secular deflationary bear market was largely in the household sector. The household debt as a percentage of GDP was approximately 50% for the three decades of the 1960s, 1970s, and 1980s. This was before the households decided that they wanted more house or homes and more goods and services than they could afford. Consequently, household debt rose to 100% of GDP by 2008.

* Both Stock Markets Did Extremely Well Prior to the Financial Crisis

* Both Countries Are not Producing Jobs With Each Attempt at Recovery

* Both Countries Are Caught in a Liquidity Trap

* The inflation rate of the U.S. has not gone negative yet, but it took Japan ten years to go negative. Japan’s core inflation actually went up from ‘89 to ‘92 (1% to 2.5%) before going into negative territory in 1998. It has yet to recover from negative territory, fluctuating between negative 1% to flat. The U.S. core inflation rate declined from 3% in 2006 to 1% now, but has never reached the deflation of Japan.

* We understand that Japan didn’t start their quantitative easing (QE) for 7 years after the peak, but if the U.S. peaked in 2000, it also didn’t start QE or any other fiscal stimulus until 8 years later. The Fed did lower interest rates in mid 2003 to 1% from 6%, but that clearly only postponed the inevitable bailouts by creating a housing bubble that eventually made the stimulus response much more difficult.

* America’s global scope makes it harder to grow our way out

* Japan’s bubble was more broadly based since it consisted of both residential and commercial real estate as well as the stock market, while the U.S. was mostly based upon residential real estate and the stock market. Of course, we are not sure of the end result of our commercial real estate market. There will be a substantial amount of refinancing coming due over the next couple of years and this could be a major problem if we go into a double dip.

* Saving Rate in Japan was much Higher than the U.S., which might make our problems even worse then theirs.

* Japan had much lower household debt than the U.S., and the U.S. had much lower corporate debt than Japan. It is therefore the household debt that has to be deleveraged in the U.S. (and that is taking place right now-with household debt down about $1 trillion from the peak of $14.5 trillion)

* U.S. Finances Its Deficits Abroad While Japan Has Surpluses and Finances Domestically

* America spends an incredible amount on defense. The amount of money the U.S. spends on defense dwarfs Japan as well as virtually any country on the planet. Our military budget totals close $750 billion and that is greater than every other country combined.

* NOW HERE”S ONE PROBLEM THAT IS LESS SEVERE: Demographics
Because of Japan’s restrictive immigration policies and low birth rates, their aging population is greater than the U.S. In fact, the Japanese have an older population with presently 25% over the age of 65. The U.S. has about half of Japan’s population over 65 at 12.5%. An older population is a deterrent to production and productivity. It also requires fewer and fewer workers to support more and more retirees. So, even though the U.S. and Europe have an aging population that restricts growth, their problem is only half the problem in Japan.

* Entitlements — we’re a little better than Japan.

The entitlements problem with the U.S. could not possibly be as bad in Japan. After all, the U.S. has anywhere from $62 trillion (Peterson Institute estimate) to over $100 trillion of unfunded liabilities (Congressional Budget Office estimate), depending upon which estimate you want to use. But even at $62 trillion we are in a tremendous hole. Japan has a population that is aging faster than the U.S. and has a national health care plan, but has health care costs per person less than one-half that of the U.S. This could be the most significant difference between the two countries and could be the factor that would make the difficulty of the U.S. escaping from our deflationary secular bear market before Japan’s two decades almost impossible.

* Both Japan and the United States have shown incredible innovative talent over the past. Japan looked like it was going to take over the world in the late 1980s with many innovations and manufacturing capabilities (especially in automobiles). Then they got greedy and borrowed and spent money they didn’t have. U.S. innovation has also been amazing with the development of microprocessors, computers, biotechnology, wireless communications, the internet and smart phones. It is also true, however, that much of our growth over the past two decades has been propelled by excessive debt, growth of paper wealth, construction of un-needed capacity and building millions of homes that people could not afford.

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