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Japan's Deflation: A Great Case Study For The U.S.
GDP growth can happen even amidst a deflationary collapse.

By Jason Farkas
Wed, 06 Jan 2010 18:45:00 ET
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(Editor's Note: This article originally appeared in Jason Farkas' November 23 "Weekly Insight" column of EWI's intensive Currency Specialty Service. -- What are Specialty Services?)
 
Imagine the disappointment the Japanese faced in the 1990s. Their 1980s boom created enough wealth to buy landmarks like Rockefeller Center and Pebble Beach. But the 1990s turned inflation into deflation. Stimulus packages and bailouts failed to prop up Japan's property market and to prevent the deflationary collapse.
 
Now the United States government is trying to do the same thing.
 
One argument inflationists make is that the U.S. can’t have deflation because it will simply print enough money to counteract it. But the Japanese tried that and failed, but interestingly, it did succeed in holding up one economic statistic -- the GDP number. Even as Japan's stock and real estate bubbles imploded (commercial properties fell by 87%!), Japan's GDP continued to press higher, as seen in the chart. (Source: Richard Koo, Chief Economist, Nomura Research Institute.)
 
 
Why did GDP continue to grow amidst the deflationary collapse? First, the rest of the world was still growing, so Japanese exporters still had customers. Second, as my recent Weekly Insight pointed out, GDP is a crude instrument that measures only money spent and not the source of the spending. One reason the Japanese kept thinking their economy was on the verge of improving was the mistaken belief that GDP is a measure of economic performance. It's not!
 
The ivory-tower idea that the U.S. can create inflation via the printing press has the real-world example of Japan as a case study against it. In fact, Japanese 3-month yields have been below 1% since 1995, which shows that deflation can persist for a long time despite the supposedly inflationary policies such as low interest rates, quantitative easing and budget deficits.
 
Many argue that the U.S. is not like Japan. That is true! Japan was in a much better position to fight off deflation than the U.S. is presently, based on these factors:
 
  1. Japan had a large export sector that benefited from a weak currency. The U.S. doesn’t.
  2. Japan had a high savings rate going into the bust. The U.S. doesn’t.
  3. Japan had a current account surplus. The U.S. has a current account deficit of about $2 billion per day. This means that the U.S. needs to import $60+B every month. 

If Bob Prechter's forecast for continued weakness in stocks and economy comes true, the Fed, Congress and the President will have a good reason to try and inflate at all costs. However, similar to Japan's experience, although the printing and spending may hold up GDP, it won't necessarily hold up assets and save the U.S. economy from sliding into a full-blown depression.


Jason FarkasA chance reading of a book on technical analysis and the Austrian school of economics eventually led Jason Farkas, CMT, to Elliott Wave International. Prior to joining EWI Jason worked for 14 years as a futures, options and equity trader. Jason has been tutored by some of the best investment minds, including legendary trader Dick Diamond. Jason's Weekly Insights appear every Friday in EWI's intensive Currency and Interest Rates Specialty Services. (What are Specialty Services?)

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