Deflation has returned with a vengeance in Japan.
And we’re not talking about some short-term dip in prices either.
The Bank of Japan is forecasting that prices in Japan will fall by 1.5% this year, by 1% in 2010, and by 0.7% in 2011.
So much for any recovery in the Japanese economy.
Deflation is indeed a symptom of the woes in the Japanese economy. It’s created by excess capacity that drives down prices since companies are willing to cut prices to keep factories running at even partial capacity. It’s a sign that Japan’s export-based economy is getting killed in competition with cheaper Asian exporters such as China and Korea. And it indicates that Japanese companies facing slow demand aren’t investing in new capacity or hiring more workers.
But a period of prolonged deflation like Japan has suffered during long patches of the last decade and looks like it will suffer again for an extended period as the country moves from the “00s” to the “teens,” isn’t just a reflection of an economy’s woes. Deflation in this setting itself creates problems. For example, once consumers and CEOs become convinced that prices will keep falling they have a built in excuse for putting off buying decisions. Everything will be cheaper in the future, right?
In addition, if prices are falling, low risk investments paying seemingly ridiculously low interest rates become reasonable choices. If you’re money is safe, it will appreciate in value as prices fall even if the yield is 0%. This discourages risk-taking and saddles the country with a vast pile of under-performing investments—a problem for a rapidly aging country such as Japan facing huge future expenditures.
What does all this mean to a U.S. investor?
It means that the U.S. dollar carry trade has a chance to unwind without sinking the prices of all the assets that traders purchased with the cheap dollars that they borrowed. When the dollar was a reliably falling currency with benchmark interest rates set by the Federal Reserve near 0%, traders borrowed dollars (essentially going short the dollar) and bought gold, commodities, commodity stocks, and shares on emerging stock markets.
That trade has started to unwind as the dollar has stabilized on prospects that the U.S. economy is moving toward sustained growth in 2010 and that raised the prospects that traders would have to sell off those assets to pay back their dollar loans. (Nobody wanted to hold onto those loans if the dollar was rising in price because nobody wanted to pay back a loan in the future with more expensive dollars.)
That’s why on so many trading days lately as the dollar climbed, commodity and emerging stock market prices all fell.
But with the Japanese economy locked into what seems to be a period of reliable deflation, traders have an alternative to their dollar loans. They can buy dollars and repay their loans and then borrow to replace those loans in yen.
With the return of deflation in Japan and the return to a depreciating yen, the financial markets seem to have entered a new phase, one in which the dollar can climb and commodity and stock prices can too. That shift will be the subject of my next post.
Anybody looked at the Baltic Dry index or LME copper warehouse levels lately? Looks to me like commodity prices may be headed further down.
Forget the Fed, BudAngus. They’re no longer in control of anything, except the media talking heads.
How does FED policy fit into the picture? Doesn’t it ensure we willl have signigicant inflation in the near future?
twoyrfixed I have been thinking about the same thing through this whole bailout mess and such. People use to say that Japan got their decade of problems (looks more like two decades so far, as I see it), because the government wouldn’t let their companies fail (save face problem). The point being that you needed to let the mistakes be torn down so only the good survive. Well it for the last two year it seems to me the US can’t point that finger any more.
Purewater, if you want to see what is wrong with Japan’s economy you have to remember that before their bubble/colapse, the big fear in the US was that Japan was going to own the US, because they were so strong, now look in comparison.
The US can decide any time to have zero unemployement, just one problem, that means the government “creating” the jobs. The problem with that is governments only make jobs that at BEST, infrastructure for companies that make real money for the economy, and are mostly a negative number in any GDP. So unless you are going to have a self contained country like the Soviet Union, you had better maximize the part of the economy that increases your GDP. In other words deflation caused by more effecient process is good, defation caused by people refusing to buy your products isn’t.
I wonder how this will affect the price of gold?
I wonder how this will affect the price of gold, as well as the price per share of gold mining companies like Kinross or Goldcorp?
The Soviet Union had low unemployment as well. Not sure unemployment says much about the strength of an economy in all cases. The US also had virtually record low unemployment a few years ago as well. That wasn’t a sign of a vibrant, sustainable economy either.
If Japan’s economy is so awful how come they have such a low unemployment rate?
Jim,
Wasn’t the start of Japan’s long, and it seems never ending nightmare, the inabilty of their Government to let Real Estate assets fall to their correct value? Haven’t we embarked on the same course? If so, are we really so different from Japan that our 10-20 year future isn’t pre-ordained?
could present some interseting oppurtunities.
Does this mean a next leg up for the commodity “super cycle ?”
OMG!