Mon, Mar 06, 2006 page11

• Japan's economy snaps out of deflation doldrums

  • AFP
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  In a country renowned for its jaw-dropping prices, it was obvious something was amiss with the world's second largest economy when "¥100" shops started cropping up across Japan.

  The equivalent of the US' "dollar stores," they quickly filled the space vacated by failed businesses.

  More than a decade since Japan's asset bubble burst, ¥100 (US$0.86) no longer buys what it used to -- now it buys even more than eight years ago.

  Before the excesses of the 1980s came to an abrupt end, inflation had been the biggest fear on economists' minds.

  Then came a different specter in Japan -- deflation -- death by a thousand price cuts that pushed the economy into a decade of stagnation.

  Falling prices may sound like good news for consumers, but with the value of their homes and other assets falling and little prospect of a pay rise, few were rushing out to buy luxuries.

  Besides, if the price of that television was going to be lower in a month's time, why bother buying now?

  "At the height of the bubble people used to go to expensive and luxurious restaurants, to drink a lot of tremendously expensive champagne," recalled Noriko Hama, an economics professor at Doshisha University in Kyoto.

  Things began to change in the second half of the 1990s.

  "Instead of luxurious restaurants we had to eat cheap motsu nabe [a simple dish of tripe and vegetables]," Hama said.

  "Lifestyles became much more modest, looking for cheap bargains. Deflation penetrated society," she said.

  Company profits slumped. Unemployment doubled. Before long parks were dotted with the blue tarpaulins of the growing number of homeless. Government debt soared and soon Japan had a credit rating lower than Botswana.

  From 1997 to last year, consumer prices in Japan fell by 2.6 percent on average excluding perishable goods, returning to the levels of the early 1990s.

  Bank lending started to shrink and companies stopped borrowing. The banking industry was crippled by a mountain of bad debts and is only just emerging from its long crisis after a series of government bailouts and industry mergers.

  "The Japanese economy was suffering from the Luciano Pavarotti syndrome," Hama said.

  "It was far too large for its own good and needed to downsize. Industries had no need to borrow and no capacity for it because they had already borrowed too much," she added.

  In 1999, with the aim of ending the deflationary spiral, the Bank of Japan adopted a policy of zero interest rates.

  When this failed to solve the problem, it began flooding the banking system with virtually free cash in 2001, an unprecedented measure called "quantitative easing" aimed at encouraging borrowing and stimulating growth.

  After almost eight years of deflation, Japan finally appears to have kicked the habit after consumer prices jumped by 0.5 percent in January, the third straight monthly rise and the biggest since 1998.

  This week the Bank of Japan will meet to consider scrapping its ultra-loose monetary policy.

  Some analysts think a move will come on Thursday. Others expect it in next month. But few doubt a change is almost here, and interest rate rises are expected to follow by the end of the year.

  Now another concern is emerging -- how the Japanese will cope with an end to years of virtually free credit.

  Public debt alone now stands at a staggering 160 percent of Japan's annual economic output, after the government spent trillions of yen trying to kick-start the economy.

  Following its long slump, however, the economy appears to have finally snapped out of its deflationary doldrums with annualized growth of 5.5 percent in the fourth quarter of last year.

  "The Japanese economy has shrunk enough that it can start to grow once more. The next really interesting question is: what happens to the Japanese economy once interest rates start to behave in a normal fashion?", Hama said.

  "Everybody, even the government, has forgotten about interest rates, and about what it is to be exposed to interest rates risks when you take loans. I think they will learn this with a lot of pain," she warned.
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