Heads down in Japan as deflation rises
By David Pilling
Published: May 19 2003 10:06 | Last Updated: May 22 2003 13:10
The manila envelope, stiff with ice, lay beside an unopened carton of cold Japanese tea. On the front, in neat handwritten characters, were the words "cat money". Inside, were three crisp Y10,000 notes, worth $250.
Inquiries to the neighbours revealed that the previous residents of my new Tokyo home had regularly left money in the fridge to pay for emergency supplies of cat food when they were out of the country. House-sitters would simply raid the ice-box-cum-cash-dispenser.
Extrapolation based on one's own kitchen appliances is an unscientific business. Yet my discovery hinted at something more significant. The fridge - not so long ago a potent symbol of Japan's dash for first-world status - has in these leaner times become as good a place as any to stash your money.
As prices have fallen - by about 7 per cent since 1995 - the value of cash has appreciated. A savvy Japanese housewife who deposited Y100,000 in the refrigerator in 1995 would today find its purchasing power had risen to Y108,000. By contrast, if she had invested the same amount in the Nikkei stock market, it would have shrivelled to just Y43,000.
Similarly, in these deflationary times, in which interest rates are virtually nil, banks barely match refrigerators for rates of return. A typical interest rate on a savings account is 0.01 per cent. But customers who use services such as ATM withdrawals, for which profit-starved banks extract hefty charges, find their savings gradually whittled away. The Japanese, in other words, are paying banks to hold on to their cash.
Deflation gives the economy an almost fantastic quality. Since the mid-1990s, Japan's monetary authorities have furiously cranked up the printing presses in a futile effort to swamp deflation in a flurry of paper. According to Akio Mikuni, a sharp-witted economist, since 1995 cash in circulation has jumped from 8 per cent of gross domestic product to about 14 per cent, an increase of some $300bn. But the money has simply vanished into thin air.
Printing money should have stoked economic activity and inflation but prices have continued to fall. The explanation, says Mikuni, is that Japan's thrifty households - with a rational fear of what lies ahead - have simply stashed the money away. If he is right, then the cash equivalent to the annual output of Belgium has been stuffed into Japan's mattresses, its cupboards, its safe-deposit boxes and, judging by my experience, its refrigerators.
Deflation is an unfamiliar bogeyman. For 50 years, central banks have been preoccupied by inflation and its nasty cousin, hyperinflation. In the Nicaragua of the mid-1980s, I witnessed the havoc hyperinflation can cause. So debased had cash become that shop assistants in Managua learned to gauge the thickness of wedges of notes by sight, an expertise that saved them the bother of counting their worthless currency.
Yet, for all its associations with soup kitchens and dust bowls, deflation Japanese-style is a strangely invisible force. No visitor strolling through Tokyo's entertainment districts, dazzled by its lights and jostled by the free-spending well-dressed masses, could possibly imagine that one of the most-feared enemies of the 20th century was stalking the land.
Even the word has a shadowy existence. No Japanese term exists and in the uncompromising alphabet by which foreign sounds are rendered into Japanese, the country does not have deflation at all: it has defure (pronounced de-fu-leh). And so I went in search of this silent, hard-to-pronounce, enemy.
By the miracle of the bullet train, which rockets through mountain-bored tunnels at 200km an hour, Japan's Snow Country lies less than two hours from the capital. My search for defure sped me to Nagano, a mountainous region of rice paddies and ski-lodges, whose conservative reserve is a world away from the sharp-elbowed metropolis of Tokyo. I had come to see Takeshi Nakajima, a grey-haired man of 57. If things go badly, Nakajima may one day be known not as the father of Japanese deflation, but of something much worse - its deflationary spiral.
Nakajima is a kindly, polite man who has been a union leader for nearly 20 years. He has lively eyes and a habit of covering his teeth with his hand when he laughs. On the face of it, he doesn't have much to joke about. Head of the Nagano civil servants union, Nakajima has just given away up to one-tenth of his 28,000 members' pay. Over the next three years, the wages of rank-and-file civil servants will fall by between 5 and 10 per cent. "That's a month every year when we won't eat or drink," he dramatises.
Tax-challenged governors all over Japan are monitoring events in Nagano closely; so too are the academic economisrs. Some fear they could set Nagano, perhaps even the entire nation, on a destructive deflationary freefall, in which wages and prices chase each other ever downwards.
Nakajima knows what is being said. Only a little while ago, he was saying it himself. When Nagano's pudgy governor, Yasuo Tanaka, a household name in Japan, came to him saying the prefecture desperately needed to save money on wages, Nakajima gave him short shrift. His union took out advertisements in six local newspapers and canvassed the homes of 600,000 residents to explain why they thought pay cuts on this scale were suicidal. "But the people of Nagano were not interested in our arguments," Nakajima says. Nagano's private businesses are squeezing wages and bonuses in preference to the very un-Japanese - though increasingly common - practice of laying people off. Japan, which spread its postwar success with remarkable equanimity, is straining to do the same on the way down. Wage deflation is a way of all sinking together.
"We public servants must share the pain with our fellow citizens," Nakajima says, echoing the language of self-sacrifice that swept Junichiro Koizumi to the prime ministership two years ago. He hesitates. "It is true, I am still worried about starting something terrible, a deflationary spiral I think economists call it. But what can we do? The public expects us to make this sacrifice."
Governor Tanaka personally negotiated the deal with Nakajima and has become a national hero. An author best-known for Bump and Grind, his salacious diaries featuring his hectic sex life, Tanaka became the implausible governor of provincial Nagano in October 2000 on the uncatchy slogan of "No more dams". But the slick governor, whose personal penchant for Armani suits contrasts with his new-found image as Mr Austerity, is making a serious point. In a reflection of national policy, successive Nagano administrations have sought to tame deflation by spending lavishly on public works. About 13 per cent of the labour force works in construction, even more than the already extraordinary national figure of 10 per cent. As a result, says Tanaka, not only has half his picturesque prefecture been encased in concrete, but his government has been left with a formidable debt of $13.8bn.
At national level, huge government spending to compensate for lack of private investment has turned once-thrifty Japan into the most indebted country in the world. As with the nation, the flurry of spending has kept Nagano above water - but only just. At first glance, Nagano city looks typically prosperous, with sleek buildings of glass and concrete etched against the bright blue sky. Huge television screens flicker advertisements from the side of buildings. Jingles piped from shop-fronts exhort people to spend.
The only thing missing is shoppers. The main high street, leading towards the 1,500-year-old Zenkoji Temple, is deserted. The town's two biggest department stores, Daiei and Sogo, stand boarded-up, thick dust settling on the escalator handrails. A bank next to the abandoned Sogo is lined with posters asking a question befitting of the world's most rapidly ageing society with the lowest investment returns: "When you get your retirement money, will you be OK?" Soichiro Yoshida, a local businessman who led Nagano's successful bid for the 1998 Winter Olympics, and thus one of the city's cheerleaders, recalls driving along the main street recently. "There were no people, no cars, nothing," he says, throwing up his hands. "I looked at the traffic lights at the crossroads and thought: 'What do we need these for?'"
If you want to hear a cautionary tale of the bubble and its deflationary aftermath, meet Shigekazu Mitsuda, a Tokyo lawyer and possibly the only man in the world to have paid $125,000 for a single round of golf. Japan underwent a frenzy of golf-course construction in the 1970s and 1980s, led by developers who assumed that land prices were immune from the forces of Sir Isaac Newton. Mitsuda's mistake was to join the Hamano Golf Club, an 18-hole oasis of serenity in Chiba City, an upmarket suburb of Tokyo, for what seemed like the reasonable sum of $125,000. In those days, golf-club memberships were traded on the secondary market like bonds. But Mitsuda had time to play only one round before his club, like so many of Japan's 2,200 courses, collapsed under a mound of debts.
It could have been worse. "I only joined the club in Heisei 9," says Mitsuda, using the imperial calendar in which Japan officially records the passage of time. "That [1997] was just before Hamano went bankrupt. If I had joined during the bubble years, it could have cost three-quarters of a million dollars."
Mitsuda, sitting in a crowded office overlooking the haphazard clutter of buildings that make up the Tokyo skyline, explains that "people believed strongly that asset values, including membership fees, would never go down. It was the myth of land. This became an article of faith for the Japanese people." But like the price of houses, land, industrial property, shares and almost every other asset - save cash and gold - Hamano's membership fees landed with a thud. Membership now goes for $1,600.
Deflation has produced another unexpected twist. Mitsuda was one of many who objected to his golf club being sold to a US investment bank. He offered his legal services to the club, which recently secured victory in the courts. The members have ousted the former management and now run their club as a co-operative. It could be the first rebellion in a nationwide plaid-trouser revolution.
From the flat roof of the Hiraki shoe warehouse in Kobe, central Japan, you can look down on the small town of Ikuno at the end of the valley, as if deposited by some ancient glacier. This was once a mining town, sustained by silver. But in 1973, like Japan's economic miracle, the silver ran out. Since then, Ikuno's population has dwindled from 15,000 to 5,000. Just a few months ago, Hiraki closed a heel-making factory in Ikuno, bringing to an end its shoe-manufacturing activities anywhere on the Japanese archipelago.
But Hiraki hasn't stopped selling footwear. Three times a week, ships from China dock at Kobe's ultra-modern port built on an artificial island, and 40-foot containers are winched on to the back of trucks bound for Ikuno. Here they are stored in a six-storey warehouse, the size of several football pitches, in row after endless row. In this way, every year an astounding 10m pairs of shoes are shipped to mail-order customers throughout Japan.
Hyperinflation has a way of unhinging prices. So, apparently does deflation. In a country where teenage girls happily hand over hundreds of dollars for a Louis Vuitton bag and a cinema ticket costs $20, Hiraki's well-made canvas shoes go for 75 cents. Put another way, for the price of my train ticket from Tokyo to Kobe, I could have bought myself 444 pairs of trainers. Similarly, the country is now home to the 49 cent McDonald's hamburger, Ronald's cheapest offering anywhere.
How can things be made so cheaply? To hire a factory worker in Japan costs $100 a day. In Taiwan, Hiraki pays $40. In China, the going rate is $3. Makoto Nozaki, the company's president, is sensitive to suggestions he might be sucking in Chinese deflation through his warehouse. "Prices are going down and down, it's true. But is this deflation?" he asks. "We are giving people what they want - good-quality shoes at cheap prices. That's what we should be doing."
Debate has raged about the effects of cheap labour, with many Japanese blaming China for the "hollowing out" of domestic industry. But Robert Feldman, chief economist at Morgan Stanley in Japan, says that - in so far as China is responsible for deflation - this is a good thing. He calculates that price falls from imported goods have boosted the average purchasing power of a Japanese household by up to 6 percentage points. This, he says, has freed up spending for other things, such as glitzy mobile phones, the mass purchase of which has sparked an entire industry in just the sort of high-tech enclave Japan should occupy.
Many Japanese economists wonder why everybody is so worried about deflation. Aren't lower prices just what everyone was screaming for just a decade ago? The Bank of Japan was ridiculed a few years ago when it began to postulate the possibility of "good deflation". It has since dropped the notion. But secretly, there are many central bankers who still hold to this view.
In a bank in central Tokyo, a robot is noiselessly moving through the vaults. It is searching for one of thousands of safe-deposit boxes stacked from floor to ceiling. When it finds the right one, the size of a cigar-case, it extends a mechanical arm and delivers it through a tiny hole to a customer waiting in a small, sealed room. The robot and the box are made by Kumahira, Japan's best-known manufacturer of security systems. Kumahira has also had to rebuild from the devastation of war. Its main factory, a wooden building on the outskirts of Hiroshima, was burned to the ground on August 6 1945 when the Enola Gay dropped its terrible payload. Similarly, Japan also makes the 49 cent McDonald's hamburger, Ronald's cheapest offering anywhere.
In Manchuria and Korea, where the company had followed in the reckless boot-steps of Japan's imperial army, its assets were confiscated. Many of its Manchurian workers were dragged off to Siberian labour camps.
Now, thanks to deflation, Kumahira's business is booming again. Last year, sales of safe-deposit boxes nearly tripled to 110,000. It estimates there are now an astonishing 2m safes dotted around Japan. Masahito Kumahira, the company's 60-year-old president, is loath to make any connection between his company's success and Japan's difficulties. Yet there is an obvious link. Fearful of the shaky financial system, the public has been withdrawing trillions of yen from regular bank accounts and frantically stuffing them into Kumahira's boxes instead. Ironically, the most popular location for such boxes is the banks themselves. In Japan, banks are regressing from sophisticated institutions that increase the value of money by lending it to business, into giant warehouses for the safe-keeping of paper currency. Kumahira's robots are a cost-effective way of chaperoning customers in and out of the cash-lined vaults.
My fridge aside, this is where most of Japan's missing $300bn has vanished. "Some customers complain that they can't fit Y100m ($830,000) in the boxes," Kumahira says in an indication of the quantities of cash people are stashing away. "We also get a lot of inquiries from people asking whether our boxes are strong enough to hold gold bars," he says, referring to soaring purchases of the ultimate in safe-haven investments.
Kumahira is not surprised to hear of my feline treasure trove. He has heard of people keeping money in the refrigerator, though he says the habit has been imported from the US. As a manufacturer of safes, he cannot condone the practice. "With our products, even if the house comes crashing down, your money will be safe."
Seven years after deflation began, the house has not come crashing down. But no one really knows what deflation is or where it is leading the economy. These relatively gentle price falls do not seem the unmitigated disaster of the 1930s. There are, indeed, obvious benefits to consumers for whom "luxuries" like domestic travel, apples and international telephone calls have become more affordable.
Yet there is something enervating, slightly unnerving, about living in an economy that is shrinking rather than growing, even if wages and prices are falling in tandem. The huge debts that have piled up as prices have fallen are for now easily repayable. But in the long run, many economists bet they will be eradicated in the traditional way: either through hyperinflation or default.
Comparisons with the horrific weapons that fell on Hiroshima and Nagasaki should not be made lightly. But if the bursting of Japan's economic bubble was a nuclear bomb, deflation could turn out to be the radiation that follows. Invisible and poorly understood, radiation ended up wrecking lives after the initial explosion itself. In economic terms, defure may prove to have the same impact.
David Pilling is the FT's Tokyo bureau chief
What is deflation?
Deflation is no longer an exotic economic disease from a far-off land (Japan) about which the rest of the world knows little. Just last week the US Federal Reserve warned it was ready to do whatever was necessary to head off the prospect of falling prices. A day later the European Central Bank, famed for its near obsession with inflation, changed its policy to take into account the dangers of its opposite.
Deflation is a generalised fall in prices, which has been happening in Japan since about 1995. It is usually thought to be bad because it pushes borrowers further into debt as a proportion of shrinking income. It can turn into a deflationary spiral: a company will try to cut wages to compensate for the lower prices it can charge for its goods - but if all companies do this, consumers have less money to spend on goods and services, forcing another round of price and wage cuts, and so on. That happened in the 1930s. Historically, however, deflation has not always been bad. In the 1880s, US prices fell but this was the result of an agricultural boom.
Some argue that the same thing is happening in Japan; as it becomes more integrated into the global economy, its famously high prices are being eroded. Others warn that, while consumers may be enjoying the benefit of lower prices now, the overall cost to the Japanese economy will be disastrous.
Western central bankers believe the Bank of Japan was too slow to react after the bubble burst at the start of the 1990s. By the time interest rates were brought down to zero, prices were falling continuously. The central bank had lost its power to affect prices by setting interest rates.
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