Consumer Hopes Deflated by Japan’s Economic Woes

Noriko Kanbayashi and her husband tried to buy a condominium in the early 1990s only to lose out repeatedly to other buyers. Finally in 1993, a small three-bedroom opened up and they grabbed it, even though its $415,000 price tag severely stretched their budget and locked them into a 30-year mortgage.

Eight years later and a world apart, their investment is worth half what they paid for it, leaving Kanbayashi furious at the banks for allowing her family to get into such trouble and at the government for ignoring the broader debt problem.

“How come we are made to suffer so much?” Kanbayashi said. “In 20 years’ time, our house won’t be worth anything.”

Like a cancer, deflation is eating away at the world’s second-largest economy. Japan is the only advanced nation since World War II to experience such serious price declines, leaving policymakers in uncharted economic territory. Japan’s deflation has become a drag on global growth at a time when the U.S. economy is down and American exporters could benefit from a more vibrant trade partner.

Wholesale prices in this country have dropped steadily over the last three years, and retail prices excluding fresh food fell by 1.1% last year, their biggest drop since 1945. Land prices have declined for nine straight years and Japanese stock prices are languishing at mid-1980s levels.

This is hitting people where it hurts. The average family in Japan saw its net worth decline by 18.4% to $350,000 from 1994 to 1999 largely because of falling land prices. In the same period, Americans were riding a great wave of wealth, as the U.S. stock market more than tripled. U.S. policies have helped protect Americans from a debilitating deflation.

At first blush, lower prices in the land of the $120 melon would seem like a cause for celebration. And in some areas they have benefited consumers. Those in a position to buy real estate now, for instance, can expect to get more in a better neighborhood for less. Many imported consumer goods have fallen sharply.

“Prices have definitely come down in Japan, especially food and clothing,” said Keiko Sato, a 51-year-old Tokyo homemaker, as she emerged from a “100-Yen Store” that sells everything from dinnerware to children’s chairs for 80 cents an item. “It’s a huge change from 10 years ago.”

The problem, however, is that incomes often fall faster than prices as companies reduce bonuses and overtime, leaving consumers further behind. In fact, deflation has eroded Japan’s overall standard of living.

Sato said her husband’s auto-repair business has fallen off by 30%. To make ends meet, he now rents rather than buys tools and she scours leaflets for bargains, turns off lights and scrimps on dining out.

“We used to be able to save a little,” she said. “Now I feel like we’re barely above water.”

In a bid to reflate the economy, politicians and bureaucrats have tried to nudge, bribe and browbeat consumers into spending more, without much luck. While pervasive gloom is part of the problem, deflation also gives people a strong incentive to keep their wallets shut.

“It tends to discourage consumers from spending now, since the value of their money will increase later,” said Haruhiko Kuroda, Japan’s vice minister of international finance.

Furthermore, an older, less productive population that always has been good at saving is increasingly intent on socking its yen away for retirement as government and corporate pension plans have become less solvent. This demographic will continue to haunt Japan for years to come.

Most Americans have an implicit understanding of inflation, but deflation is harder to grasp. One approach is to think of inflation in reverse.

Thus, while inflation left untended can lead to nasty hyperinflation, deflation run amok can give way to a similarly nasty deflationary spiral. It occurs when lower wages prompt people to buy less, leading to lower corporate earnings, which in turn lead to lower wages and more layoffs, completing the cycle and further undermining the economy. Economists see little imminent danger of this doomsday scenario.

But deflation is taking giant bites out of Japan’s financial system. As money in effect becomes more valuable, the debts owed to banks by companies and individuals become increasingly burdensome. Three years after Japan injected tens of billions of dollars into its troubled banking system, many banks and corporations are in deep trouble again as deflation and new bad loans further erode their balance sheets.

“In talking about these core problems, we’re confronted with some very tight deadlines and heavy pressure,” said Mitsuru Taniuchi, an economic planner in the cabinet office. “Companies already have very heavy debt burdens and deflation increases that burden.”

Japan has witnessed periods of protracted deflation before, as have other countries, but not in a long time. Prices fell by 3% to 4% annually here from 1881 to 1885; by 30% to40% in total during 1930-31; and by a couple of percent in 1949-50.

But experience may offer relatively few lessons. In the first two cases, Japan turned itself around by expanding rapidly into steel, shipbuilding and other emerging industries. And in the third, the Korean War came along, followed by Japan’s aggressive move into consumer goods.

“Now Japan is a mature economy, so it’s difficult to find new growth areas,” said Hideaki Miyajima, professor of economic history at Waseda University.

Japan also had a much easier time in decades past laying off workers and letting small inefficient companies fail, which helped reduce excess capacity and channel people and capital into more promising activities. Today social taboos make this much more difficult.

The laws of economics do not protect Americans from deflation, but U.S. policymakers have been more willing to administer bitter medicine to protect the economy. Weak corporations are allowed to fold. Corporate restructurings are commonplace. Accounting standards are enforced. And immigration has helped to balance demographics.

Advice is cheap, particularly for economists, and Japan’s unique plight has attracted great interest and much kibitzing from around the world. That said, Japan’s reluctance to act decisively years ago has whittled down its options.

Under growing foreign and domestic pressure, the central bank recently returned to a zero-interest rate policy. Free money may defy conventional wisdom, especially for pensioners on fixed incomes who now receive $2 a year interest for every $10,000 they deposit at their local bank. But creating as much of an easy money policy as possible is seen as the first step in taming deflation.

Beyond that, some economists believe Japan should flood the markets with so much money that it effectively forces inflation to take root. This is more controversial, however. If done the wrong way--by giving politicians direct access to government coffers, for instance--it risks a collapse in government finances at a time Japanese government debt is already at record levels.

Another perceived solution is to weaken the yen, which raises import prices and may boost domestic price levels as well. But this would hurt Asian competitors, while Japanese private capital hoarding tends to limit how far the currency would fall anyway.

But all of these are technical solutions, not fundamental changes in how Japan’s economic and social systems work. Massive immigration, for example, has strengthened the U.S. economy in the last century, but in Japan such an option is not culturally acceptable.

One thing is for sure. Ordinary citizens ultimately will foot the bill. Millions of hard-working people are trapped in a real estate black hole. Bank refinancing and bad debt disposal almost certainly will spell more taxes, pain and sacrifice ahead for Japan’s declining population of older, less productive workers.

Many Japanese now find themselves trapped in homes they can’t afford to live in and can’t afford to leave. Cultural tradition and strong feelings of responsibility discourage most from declaring personal bankruptcy or handing over the keys to the bank.

“Even if they owe more than it’s worth, most people keep trying to pay it back,” said Norihiro Nitta, head of the Japan Debtors Assn., a counseling group.

A sharp rise in suicides and loan shark activities finally persuaded Japan to enact a more lenient personal bankruptcy law, which went into effect April 1, but it’s still too early to tell whether this will ease the pressure.

“This is a huge social problem right now,” said Makoto Takahara, a bankruptcy attorney. “The snow ball is getting bigger and bigger.”

Kanbayashi, with her three-bedroom condo in a Tokyo suburb, doesn’t care much about deflation’s theoretical underpinnings, but she cares a great deal about the frustration it has caused her family.

Land prices have dropped sharply but real estate taxes and mortgage payments haven’t, she said. And politicians show little sympathy for millions of people buried under mountains of debt.

“The situation in Japan is horrible,” she said. “Prices just seem to be going down, never up. I just hope we can sell some day.”

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Hisako Ueno in The Times’ Tokyo Bureau contributed to this report.

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Deflation Eats Away at Land Values

Average percentage change in Japanese land prices each year, in all categories (residential, commercial, etc.)

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2001est.: -4.9%

Source: Ministry of Land, Infrastructure, and Transport