Japan Exporting Deflation Reveals Meaning of Bernanke's Economic Nightmare
Deflation is so entrenched in Japan that companies are exporting it.
Fast Retailing Co., Asia’s biggest clothing chain, whose Uniqlo brand offers 790-yen ($9.50) fleeces, will open 44 stores overseas this fiscal year, compared with 36 in Japan. Aeon Co., which boosted sales with its low-cost Topvalu-brand products, plans to spend 207.5 billion yen over three years opening stores in China and Southeast Asia. Japan’s biggest 100-yen chain, Daiso Industries Co., has outlets in more than 20 countries.
Their advantage may be Japan’s disadvantage. Prices in Japan as measured by the gross domestic product deflator have declined almost without interruption since 1994. That has muted the effect of falling wages and provides a cautionary tale for Federal Reserve Chairman Ben S. Bernanke, who has been lecturing on deflation’s perils as a central banker since 2002.
“Retailers like Uniqlo were able to ride the wave of deflation and grow,” said Yoshimasa Maruyama, a senior economist at Itochu Corp. in Tokyo. “To win these pricing wars at home, companies had to keep cutting workers’ pay, and that’s spiraled down with prices falling and then falling some more, with deflation never ending.”
Sales at closely held, Hiroshima-based Daiso, which has branches in countries such as Indonesia, Singapore and Bahrain, reached a record 341 billion yen in the year through March. Aeon had 94 outlets in Malaysia, Thailand and China as of August. Fast Retailing plans to open at least 200 U.S stores by 2020.
No Cheap Products
“Because of the recession, customers are becoming more value-conscious, but they don’t want a cheap product,” Shin Odake, chief executive officer of Uniqlo’s U.S. unit, said in an interview with Bloomberg Television last month. “They want to make sure they get good quality.”
While an attempt by Fast Retailing to move away from its low-cost model and compete with fashion chains like Inditex SA’s Zara caused its shares to slump 26 percent last year, the stock has still returned 66 percent over three years. That compares with a 28 percent decline in total returns from the benchmark Topix stock index.
Fast Retailing Chief Executive Officer Tadashi Yanai said in March that overseas sales may overtake domestic revenue within four years.
Building in Asia
“Retailers that have been closest to consumers have poured a lot of energy into offering products that are cheap but still have high value and we’re seeing some good effects from that,” said Naozumi Nishimura, an analyst at TIW Inc. in Tokyo who has a “neutral plus” rating on Aeon.
The success of the companies in Japan has helped consumers adjust to deflation. The average household owns 1.4 cars and 2.4 color televisions, about a quarter more than in 1990, a Cabinet Office survey shows. The proportion of people content with their standard of living was 63.9 percent last year, compared with 63.1 percent in 1989, a government report said.
“Everyone knew deflation was bad for jobs and bad for the economy, but gradually, households and companies just got used to it,” said Martin Schulz, a former Bank of Japan researcher and now senior economist in Tokyo at Fujitsu Research Institute. “The risk is that it takes hold in the U.S. as well.”
U.S. consumer costs for goods and services, excluding food and fuel, climbed at the slowest pace since records began in 1959, the Commerce Department reported on Dec. 22.
“The Japanese have seen their wages stagnate, so the only thing that increases their real income is lower prices,” said Schulz. “Companies don’t expect markets to expand anytime soon since this is an aging society, so the smart policy for businesses in Japan has been to focus on how to cut prices.”
Monthly pay dropped to an average 315,294 yen in 2009, the lowest level since the government started tracking the data in 1990. Four out of five Japanese say higher costs would be “unfavorable,” according to a central bank survey.
“It’s not like I’m promised any pay raises,” said Momoko Noguchi, 24, who has watched Japan’s consumer prices fall for more than half her life. Noguchi has two part-time jobs, gets everything from nail polish to dining plates at her local 100- yen ($1.20) store and pays 400 yen or less for lunch. “I hope prices keep falling.”
As part of a strategy begun in 2004 to reverse a seven-year decline in same-store sales, McDonald’s Holdings Co. (Japan), a unit of Oak Brook, Illinois-based McDonald’s Corp., created a 100 yen menu in 2005, cutting the cost of its cheeseburger, pancakes and ice cream. The chain’s 100-yen hamburger sold for 210 yen in 1990. McDonald’s Japan shares have returned 17 percent in the past three years.
“We wanted our customers to know that we’ve changed, so we needed to attract a lot of people,” said Kazuyuki Hagiwara, Tokyo-based senior manager of marketing at the company.
Since the cut, same-store sales have increased every year, boosting net income to 12.8 billion yen in 2009, the most since the company went public.
What looked good to consumers and discount retailers is forcing most other businesses to cut prices to compete, reducing wages and making it hard for them to borrow and invest.
“It’s extremely corrosive,” said Richard Jerram, Singapore-based head of Asian economics at Macquarie Securities Ltd. “The problem is, it’s not a spectacular problem in any given month or quarter.”
Deflation will steadily sap nominal growth, depriving the government of revenue, until one day Japan will no longer be able to finance its borrowing, Jerram said. The country will either default on a debt of about twice the size of the economy or debase its currency to reduce the real value of liabilities.
“That’s the unavoidable endgame,” said Jerram, who has analyzed the Japanese economy since 1987. “As long as it’s in the future, everybody can pretend it’s someone else’s problem.”
Japan’s real GDP has grown at an average 0.6 percent pace in the past 10 years, compared with 1.8 percent in the U.S.
U.S. inflation is lower than policy makers’ long-term forecast. The Fed’s preferred price gauge, which strips out food and energy, rose at a record-low 0.5 percent annual pace, the Dec. 22 Commerce Department report showed.
As a scholar of the Great Depression, Bernanke is no stranger to the dangers of deflation. Months after he was appointed as Fed governor in 2002, he outlined steps the central bank could take beyond traditional rate cuts to avoid it.
During a visit shortly afterward to Tokyo, he urged his Japanese counterparts to work with the Finance Ministry to buy more government bonds to keep interest rates low and cut taxes to spur consumer spending.
“At stake is not only the economic health of your country but also, to a significant degree, the prosperity of the rest of the world,” he said.
Now, the Fed is expanding record monetary stimulus to prevent the U.S. from going through its own lost decade. On Nov. 3, the Fed announced it will buy $600 billion in Treasuries to support the U.S. recovery. That is 10 times the size of the Bank of Japan’s latest 5 trillion yen fund to purchase government bonds and riskier assets such as real estate investment trusts.
To be sure, Robert Feldman, head of economic research at Morgan Stanley in Tokyo, says the younger American population and the Fed’s mandate to counter unemployment would require the bank to act in a more aggressive way than has the Bank of Japan. U.S. central bankers said in minutes of the Nov. 2-3 meeting that the securities purchases would help protect against the “small probability” deflation would take hold.
Retirees on Savings
For Japan, with the fastest-aging population in the developed world, a sudden rebound in prices would hurt pensioners and retirees living off savings.
“It’s amazing what you can buy with 100 yen now, we didn’t have 100-yen stores before,” said Sachiko Enokida, 80, who lives on her bimonthly pension checks from the government and has witnessed inflation’s ups and downs since the 1940s. “After the war, we all thought this was going to be the last year before we starved. Then things really boomed and people were buying apartments like crazy and you saw wealth everywhere. I would hate for things to get expensive again.”
With almost one fourth of the population over 65 years old, Japan chose to stay in deflation, said Feldman. That turned cash into an investment, as money left in bank deposits gained in purchasing power the longer it stayed there. Today, Japanese households keep 56 percent of their financial assets in cash, compared with 14 percent in the U.S.
“The factors that produced and permitted deflationary policy seem likely to persist,” Feldman said in a report.
Meanwhile, consumers continue to enjoy lower prices. Golfers pay 26,800 yen to play on the weekend with a caddy at Oak Hills Country Club, a course 90 minutes’ drive from central Tokyo designed by Robert Trent Jones Jr. Twenty years ago, the fee was about 40,000 yen, said Katsutoshi Ohira, acting manager.
“I don’t think I can expect any meaningfully big pay raises going ahead,” said Satoshi Miyazaki, 34, who works for an advertising company in Tokyo. “Since I’m paying for things out of my limited salary, lower prices have been a great help.”
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