Official deflation

Japan officially saw its first spark of deflation in July 1994 when the CPI turned negative on a year over year basis.

“Japan’s prices remained relatively static as they staggered through a couple of recovery plans,” Pressler notes.

By 1997, the Japanese economy appeared to be out of recession and the Japanese government decided everything was stable.

“They raised the national consumption tax from 3 percent to 5 percent on April 1, 1997 and it turned out to be a horrible April Fool’s Day trick,” Pressler says.

It became known as the “False Dawn,” as the economy plummeted into its second recession of the decade, which lasted from April 1997-July 1999.

In 1998, Prime Minister Keizo Obuchi instituted a bank recapitalization plan “that had some teeth,” according to Pressler.

“Part of it accepted that some major banks and major manufacturers would fail and it eventually got them back on track in 2000,” he says.

Unfortunately, that was just in time for the technology bubble to burst and the global equity markets to enter a bear market. Japan entered its third recession in August 2000, which lasted until April 2003 amid weaker U.S. demand for Japanese exports.

Deflation had artificially dissipated in 1997 in the wake of the tax hike, Pressler notes, because taxes are part of CPI. However, by 1998 deflation was back again.

“From 1994 to 2006 you had 12 years of static or negative prices, with the exception of tax-induced bursts,” Pressler says.

Goldstein downplays any similarities between the U.S. and Japan’s deflationary episode.

“It’s a different story,” he says. “They were an export-driven economy, and had few natural resources. That cannot happen here.”

What are the takeaways from Japan’s decade-long battle with deflation?

“Really [determine] what is too big to fail,” Pressler says. “In the early 90s, Japan had pretty easy qualifiers. They would bail out companies and they usually had minimal accountability enforced. Bankruptcy is a powerful change for the betterment of an economy. There is a place for that. Short-term it is hazardous, but it does help clear a path.”

Perhaps the U.S. officials need to take a close look at this aspect of Japan’s struggle.

“They let Lehman and Indy Mac go,” Pressler says. “I think that is a good thing. There needs to be a line drawn and it needs to be a high standard. If it is left as an ambiguous term, everyone thinks they will qualify and that is very dangerous.

” What other lessons could be learned from the Japanese debacle?

“Strict accountability for the recipients of government funds,” Pressler says. “The money should come with so many strings attached that anyone who takes the funds will have an incentive to change.”

It was the failure of these two rules that prolonged Japan’s crisis into a lost decade, Pressler says. Going forward, only time will tell if U.S. politicians will be able to learn from these lessons and implement different and better solutions.

Currently, Pressler believes the U.S. is failing on accountability.

“When you are handing someone a 12 digit check, you should demand 12 digits of reform,” he says. “With some companies, it’s been a little more than a get-out-of-jail-free card.”
Finally, once the U.S. economy does begin to stabilize, Pressler says “we have to be sure the financial system can handle a little slowdown if we raise taxes or interest rates. We don’t want to experience what Japan did in 1997 with the False Dawn.”