U.S. may face deflation, a problem Japan understands too well
By Don Lee, Los Angeles Times
The White House prediction Friday that the deficit would hit a record
$1.47 trillion this year poured new fuel on the fiery argument over
whether the government should begin cutting back to avoid future
inflation or instead keep stimulating the economy to help the
But increasingly, economists and other analysts are expressing concern
that the United States could be edging closer to a different problem —
the kind of deflationary trap that cost Japan more than a decade of
growth and economic progress.
And as Tokyo's experience suggests, deflation can be at least as tough a
problem as the soaring prices of inflation or the financial pain of a
When deflation begins, prices fall. At first that seems like a good thing.
But soon, lower prices cut into business profits, and managers begin to
trim payrolls. That in turn undermines consumers' buying power, leading
to more pressure on profits, jobs and wages — as well as cutbacks in
expansion and in the purchase of new plants and equipment.
Also, consumers who are financially able to buy often wait for still
lower prices, adding to the deflationary trend.
All these factors feed on one another, setting off a downward spiral
that can be as hard to escape from as a stall in an airplane.
For now, the dominant theme of the nation's economic policy debate
remains centered on the comparative dangers of deficits and inflation.
However, economists across the political spectrum — here and abroad —
are talking more often about the potential for deflation.
So how likely is the problem?
The latest U.S. data are sobering: Consumer prices overall have declined
in each of the last three months, putting the inflation index in June
just 1.1% above a year earlier. The core inflation rate — a better gauge
of where prices are going because it excludes volatile energy and food
items — has dropped to a 44-year low of 0.9%.
That's well below the 1.5%-to-2% year-over-year inflation that the
Federal Reserve likes to see, and some Fed policymakers have raised
concerns about the rising risk of a broad decline in prices.
Private economists and financial experts have expressed much greater
"I think we have to take it seriously," said John Mauldin, president of
Millennium Wave Advisors in Dallas, who puts the probability of
deflation at more than 50%. Among the reasons he cites: a lot of unused
labor and production capacity, increased savings and the low speed at
which money is changing hands.
"It's a good bet that by some measures we'll be seeing deflation by some
time next year," Paul Krugman, the Nobel laureate economics professor,
said this month in his New York Times column. He went on to scold the
Fed for standing idle while the nation is "visibly sliding toward
But the Fed's chief, Ben Bernanke, appears to think deflation fears are
overblown. During his semiannual testimony to Congress last week, he
told senators that he didn't view deflation as a near-term risk.
In the Fed's latest forecast, core inflation is projected to stay at the
current pace this year, then gradually rise toward 1.5% in 2012.
Should deflation occur, the central bank has the tools to reverse it, he
said. But many question whether the Fed can do much more, given that it
already has pushed interest rates to historical lows and pumped more
than $1 trillion into the financial system.
Also, Bernanke said, America's economy is more vibrant and productive
than Japan's was, and its labor force isn't declining, whereas Japan's
has been for much of the last decade. Japan also was much slower in
addressing problems with its banking sector than the U.S., he said.
Japan's aging population and rigid business and political systems have
clearly contributed to the country's long economic malaise, which began
in the 1990s. But there are some notable similarities with America's
latest economic slump.
In both cases, real estate bubbles burst after years of rapid growth and
low unemployment, exposing poor loans and serious problems with
financial institutions and regulations.
In both countries, the crash led to a sharp fall in real estate prices
and financial markets and to soaring unemployment.
Yet the scope and economic fundamentals of the two crises are very
different, said Richard Katz, editor of the Oriental Economist Report, a
New York newsletter focusing on Japan and U.S.-Japan relations.
Commercial land prices in Japan's six largest cities soared 500% from
1981 to 1991, Katz said, and the bust took them down below 1981 levels.
The U.S. housing slump has been bad, but nowhere near that severe. And
whereas bad debts pervaded Japan's entire economy, Katz argued, the U.S.
recession wasn't the result of structural flaws but rather of excesses
in the financial system that came from deregulation and other policy
mistakes that he sees as correctable.
"The policymaking response in the U.S. is better, in part because of the
precedence of Japan," Katz said, noting that it took Japan's central
bank nearly nine years to do what the Fed in essence did 16 months:
bring short-term interest rates to zero.
But like Japan, some analysts suggest, the U.S. is heading into a long
period of stagnant growth, in large part because of high unemployment
and an overhang of debts that will restrain consumer spending — now at
70% of the nation's gross domestic product.
Those factors tend to hold down wages, putting more downward pressure on
prices. And once deflation sets in, consumers may hoard cash or try to
pay off their debts faster, fueling the downward spiral of spending and
Bernanke said bond-market measures and consumer surveys show little
change in expected inflation. "And that stability of inflation
expectations is one important factor that will keep inflation from
falling very much," he said.
Some economists remain skeptical, saying such expectations can turn very
quickly or conditions can change in stealthy ways.
"People don't see it coming," said John Makin, a visiting scholar at the
conservative American Enterprise Institute. He said he doesn't take much
stock in consumer surveys about inflation expectations because most
people have been ingrained to expect inflation in the future, not deflation.
Makin also thinks some price declines are indirect and not reflected in
government reports. Many online retailers now provide free shipping, and
more businesses are offering specials such as "buy two, get the third
free" — the functional equivalent of price cuts.
In one measure that Makin calls a "flashing red light," yields on
10-year Treasury bonds, which rise with inflation worries, have slipped
to less than 3% from 4% in April.
Among businesses, many restaurants are feeling the squeeze because
they're finding it tough to pass higher costs along to customers.
Prices for restaurant food rose 1.2% this June from June 2009, much
slower than the 3.8% rise during the year-earlier period. Meanwhile, the
purchasing cost for restaurant operators this June was up 4.7% from June
2009, said Hudson Riehle, chief economist at the National Restaurant Assn.
Charlotte Kubsh, a 55-year-old St. Louis-area homemaker, would not be
surprised that businesses have little power to raise prices. She said
her husband, who works for a trucking firm, didn't get a raise last year.
They've long been strong savers, she said, and with their income
seemingly frozen, they don't plan any big spending any time soon.