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Posted by Larry Doyle on December 27, 2009 7:52 AM |

Although the American consumer is much more accustomed to inflation and the threat of inflation, I am increasingly convinced that the threat of deflation remains the greater challenge. This battle between macroeconomic deflationary forces versus governmental supported inflationary programs is THE ultimate issue facing our economy in 2010 and beyond.

We hear very little about deflation from Bernanke, Geithner, or other central bankers here in the United States. Why not? If they were to even bring attention to it, I think they would cause a stir and legitimize the underlying deflationary forces at work in our economy.  What do we hear? Continuous platitudes about how inflation is under control. Remember that the primary mandate of the Federal Reserve is to work to achieve stable prices. How is it going about that currently? Massive federal programs including ballooning the Fed’s balance sheet to prop the economy and prices from the weight of deflationary forces. How and why have these deflationary forces developed? Excessive debt throughout large sectors of our economy.

What other country has run up enormous debts and played the ‘extend and pretend’ game in terms of not acknowledging losses on loans and other forms of debt? Japan. What is Japan experiencing currently? Increasingly entrenched deflationary pressures. The Wall Street Journal highlights these pressures in writing, Japan’s Consumers, Businesses Try to Adapt to Falling Prices:

Consumer prices in Japan fell in November for the ninth month in a row, the government said Friday, a worsening trend that is shifting consumer spending and imperiling a nascent recovery in the world’s second-largest economy.

[tokyo prices]The effect can be seen in the behavior of consumers like Tokyo housewife Yoshiko Sunabe. Shopping this week at an electronics superstore, Mrs. Sunabe, 64 years old, dithered over which washing machine to buy, bewildered by the numerous special offers. “Ten years ago my washing machine cost over 100,000 yen, now they are so much less…. It’s so confusing,” said Mrs. Sunabe.

Japan’s consumer price index fell 1.7% in November from a year earlier, the government said Friday. The drop suggests Japan faces a lengthening spell of deflation, which began to plague its economy in the latter half of the 1990s and undermined economic growth until around 2006. Deflation — a decline in the general level of prices for goods and services — undermines corporate profits, leading to cutbacks and layoffs, and keeps consumers on the fence waiting for new bargains.

Such effects could bring to an end Japan’s two consecutive quarters of economic growth, which has been driven largely by demand from other countries for its electronics, cars and other exports.

Prices have dropped broadly. Domestic durables prices have dropped 23% over the past three years; children’s clothing has fallen 7.1%; fruit has dropped 8% and beverages have dropped 4%. Food overall has risen 2.6% over the past three years but fallen 0.5% in the past year.

Japanese companies are trying to cope by finding profitable ways to sell to increasingly thrifty consumers.

Japan’s economy, the 2nd largest in the world after the United States but soon to be surpassed by China, is faced not only with massive debts but also an aging population. The similarities between Japan of the last 20 years and the United States of today are striking.

The deflation versus inflation debate will be a long running and challenging travail on our economic landscape. We would be foolish to discount the potential for serious deflation.


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