Japan and Deflation

According to many, Japan has essentially been in a recession for the last 20 years or so.  Some of the "experts" say that Japan has been in deflation mode and we (meaning the U.S. government and Fed) need to make sure that it doesn't happen here.  There are a lot of myths to sort through here.

First, Japan has not really been in deflation mode, whether you define it in terms of the money supply or prices.  The central bank of Japan has inflated the money supply, but not anything like the Fed has inflated in the last couple of years.  Japan has had a few years with very minor decreases in the overall price level, but there have been many years with minor increases too.  Basically, the price level has been fairly flat over the last two decades.  Even in terms of prices, there hasn't been any significant deflation.

The Japanese people tend to save more and spend less than the American people.  This means that the velocity of money is lower as money changes hands less frequently.  This keeps prices down.  This explains why there has been some monetary inflation while prices have stayed relatively flat.

Of course, the biggest myth is that deflation causes recessions and depressions.  While deflation (prices or monetary) could be an effect from a recession, it doesn't cause it any more than a wet sidewalk causes rain.  Price deflation is actually a good thing for people as their money buys more, even if wages are going down.  In a free market economy (including a free market in money), there would be a tendency for prices to gradually fall.  This would represent an increase in technology and production which would allow people to buy more with their money.

There is one thing that is amazing about the Japan situation.  The debt to GDP is around 200%.  This is by far the highest of any first world country.  The debt to GDP in the U.S., as bad as it is, has not hit 100% yet.  The really amazing thing is that with such high government debt, that interest rates have remained as low as they have.  It just goes to show that human action is all that matters.  It seems that it would be irrational for people to buy bonds at really low rates when the debt is so astoundingly high.  But it doesn't matter what you and I think.  It matters what everyone else thinks and does.  There are obviously investors who think that bonds are a good investment despite the low rates.  I can't argue with the market.

If the Japanese government does not stop its Keynesian ways, rates will eventually go up.  But they have stayed low for 20 years, so maybe they will stay low for another 20 years.  It isn't likely, but anything is possible.

The people of Japan have a lower standard of living than Americans.  The Japanese government is ripping off the people of Japan as all governments do.  But the Japanese people tend to be hard workers and good savers.  Americans could learn a few lessons from the Japanese people on this.  The Japanese people could learn a few lessons about free market economics.  For the amount of productivity and investment by the Japanese, their standard of living should be much higher than it is.