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Solution to deflation won't be found by copying Japan

"We know so little about it. We will lean over backward to make sure we contain deflationary forces."

Alan Greenspan, chairman of the US Federal Reserve

When Shizuma Tokifuji bought his Tokyo condominium in 1999, he thought he was buying close to the bottom of a real estate market that had lost two-thirds of its value since 1991. He was wrong.

The 56-year-old father of three sold his home last week for US$85,000 less than he had paid. Tokifuji is just one victim of an economic nightmare called deflation, a general drop in consumer prices that has contributed to Japan's three recessions since a property and stock market bubble burst in the early 1990s.

Four central bank governors in a decade have failed to halt falling prices, making it hard for companies to repay debt and contributing to the Nikkei 225 Stock Index's 77 percent plunge since 1989.

With prices starting to fall in the US and Germany, Federal Reserve chairman Alan Greenspan and European Central Bank president Wim Duisenberg will find few remedies in Japan.

"I don't see any quick fix that would kill this deflation monster," said Tokifuji, who retired after having a stroke. He sold his home to pay for his youngest son's college tuition.

Japanese are now looking to Bank of Japan Governor Toshihiko Fukui, who marks his first 100 days in office on Friday, to free the world's second-biggest economy from the yoke of deflation. Fukui has few options left.

Japan cut short-term interest rates to zero for the second time in March 2001 and has tripled monthly purchases of bonds from banks to ?1.2 trillion (US$10.2 billion) to drive down long-term interest rates.

"We at the Bank of Japan stand on the front line of the war against deflation," Fukui said this month. "However, we have used up the greatest weapon in a central bank's arsenal, that is interest rates, which have all declined to virtually zero in our short-term markets."

All that extra money hasn't helped the economy grow because banks, buckling under ?52.4 trillion in bad loans, haven't increased the amount of new lending in six years. Companies are focused on repaying debt to avoid bankruptcy.

The lesson for Greenspan and Duisenberg, who oversees 12 countries sharing the euro, including Germany, is to stop deflation before it starts.

Falling prices cut company sales, making it harder to repay debt, as consumers shelve spending plans with the expectation prices will keep dropping.

"The most important lesson from Japan is that when there is a risk of deflation, it's highly desirable to address it early," Anne Krueger, IMF deputy managing director, said in Tokyo this month. "Once it gets entrenched, it's much more difficult to get rid of."

US consumer prices in April fell for the first time since 2001 and the index was unchanged last month, tempered by a drop in energy prices.

While the core consumer price index -- excluding energy and food costs -- rose 0.3 percent, prices still aren't rising fast enough to eliminate the threat of deflation.

"Implicit in deflation is not what's happening to the current level of prices, but what markets expect about the future pattern of prices," Greenspan said by video link at the International Monetary Conference in Berlin this month.

While the Fed has battled inflation, it lacks experience in handling deflation, and seeks a "wider firebreak" to prevent it, Greenspan said.

"We know so little about it. We will lean over backward to make sure we contain deflationary forces," he said.
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