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Amid talk and analysis of a lost American decade driven by dollar devaluation and its myriad symptoms, including nosebleed gasoline prices, horrifying misallocations of capital, housing booms and moderations, bank failures and subpar stock-market performance, there’s been renewed discussion about Japan’s (NYSE:EWJ) two lost decades.And with increased talk about what depressed Japan’s economy, there have materialised arguments that say Japan’s (NYSE:EWJ) economic decline was and is entirely mythical.
In truth, Japan’s decline was very real, and while there are definitely some similarities that will be laid out in this piece, it should be said first that opposite a lost American decade authored by inflation, Japan’s was a function of deflation. For Japan’s struggles being a function of deflation, we need to first look inward because the deflation was very much the doing of the U.S. political class.
To understand what happened in Japan we must first go back to 1985. Back then Japan’s economic success very much bothered the gasping U.S. auto industry (there’s a pattern here)(NYSE:GM)(NYSE:TM)(NYSE:F), and deluded by the false belief that a weak yen was the source of Japan’s export success to the United States (from 1971-1985 the yen had already strengthened from 360/dollar to 250/USD), a renewed desire among protectionist politicians to force an even stronger yen on Japan took hold.
Specifically, the 1985 Plaza Accord was foisted on Japan’s economy, during which it was agreed that “some further orderly appreciation of the main non-dollar currencies against the dollar is desirable.” Japan in particular complied, and thus began its deflation.
Over the ensuing 15 years the yen tripled in value against gold (NYSE:GLD), the tripling in price an actual deflation. More modernly, pretend Keynesians who don’t understand their guiding light’s economics like to say that deflation is a decline in economic growth, but in reality, deflation is a massive rise in the value of a currency that forces down all prices while wiping out debtors and profits.
Some will doubtless point out (as this writer has many times) that falling prices are a good thing, and that they by definition materialise in advanced economies. That’s certainly true, but there’s a difference between falling prices which result from enhanced productivity, and those that occur due to a currency-driven decline in the price level.
Apple (NASDAQ:AAPL), Dell (NASDAQ:DELL) and Microsoft (NASDAQ:MSFT) to name but three make it their business to continuously bring down consumer costs. But that is not deflation. If the prices of some goods are falling, that simply means other prices must be rising as the range of goods demanded by consumers expands thanks to the previously expensive eventually retailing cheaply.
Much as a weak currency pushes up the broad price level, deflation pushes it down. It wreaks havoc on commerce simply because nominal prices must eventually account for the rising currency, but if debts were taken on when the currency was weaker, the falling prices make debt service more difficult.
To put it more simply, imagine taking out a $1 million loan to buy barrels of oil (NYSE:USO) at $100 in order to sell them at oil’s current price of $112/barrel. If the price stays the same there’s a nice return, but if the dollar’s value strengthens such that the price of oil falls below $100, the near-term deflation wipes out any nominal profits on the investment, and if it strengthens substantially, the investor is out a lot of money.
Japan (NYSE:EWJ) suffered a real deflation whereby a rising yen forced down all prices. For those not in debt this was a Godsend, but for those heavy on debt the deflation not only erased profits, but it effectively made Japanese companies insolvent.
Longer term, no rational person would seek to borrow growth capital if the rising value of the currency is going to increase the real cost of the debt. Think back to the oil example. So in Japan’s case, an ever-rising yen brought great harm to its firms holding lots of debt, plus it necessarily made entrepreneurs more gun-shy than they otherwise would be about borrowing given certainty that their debts would increase in real terms on a daily basis.
Japan’s deflation was real, and it laid a wet blanket on growth.
And just as inflation – meaning a devaluation of money – leads to a great deal of capital misallocation toward hard, commoditized assets least vulnerable in a nominal sense to devaluation, so does deflation drive misallocations the other way. If this is doubted, think back to all the Internet firms (Webvan, eToys, Globe.com) that received capital in abundance in the late ’90s when the dollar deflated as evidenced by the greenback crushing gold and all other commodities.
The difference then, is that rather than try to paper over a rush to metaphysical assets aided greatly by deflationary monetary error, the Internet firms that were improperly allocated capital were allowed to fail, and in failing, their assets were quickly released to better managers with a stated objective to manage them better. There’s a reason the 2000-2001 U.S. recession was brief, and it had to do with the markets being allowed to cleanse the system of bad business concepts quickly.
In Japan, that wasn’t the case. In a prelude to our own unwillingness stateside in 2008 to allow the economy to rid itself of poor economic practices made briefly economic by our lurch to devaluationist policy this past decade, Japan’s economic authorities would not allow the markets to force liquidation of the myriad banks and businesses that a rising yen had for a time made more attractive to investors.
Japan’s lost decades were just that for it suffering an extended monetary error hatched by protectionist politicians in the U.S., and then things were made worse by an aversion to failure that disallowed the release of precious human, financial and mechanical capital to higher uses. The lessons for the U.S, as we subsidise the failures made possible by a weak dollar with bailouts, and an ever weaker dollar, are many.
Moving to production, one supporter of the view that Japan hasn’t been lost makes the false argument that “economic growth” is “the production of goods and services.” By that logic bailing out General Motors (NYSE:GM) was a good thing, not to mention that the economies of pre-1977 China and the former Soviet Union produced lots of goods and services.
Of course the problem with such a definition of economic growth is that it does not consider the return on capital expended to “produce goods and services.” Japanese business doubtless produced a great deal during its lost decades, but not in a way that impressed the markets.
Indeed, the biggest problem with the increasingly popular view suggesting Japan’s struggles have been mythical has to do with the performance of the Nikkei. After hitting an all-time high of 39,000 in the late ’80s, it’s been down since, and presently sits around 9,600.
Credible arguments can be made about stock markets perhaps being wrong for a time, but can they really be wrong for over two decades? Logic tells us not. Japan suffered the double whammy of deflationary policy in concert with a governmental aversion to failure that sets its economic growth back immeasurably.
The Nikkei is the scoreboard in this regard, so while individuals of all stripes can debate the merits and demerits of Japan’s modern economy, Japan’s stock index tells the real tale. With it down 76% since the late ’80s, any lingering doubts about whether Japan’s economy actually suffered two lost decades should be put to bed for good.