Japan’s Latest Export: Deflation


The Bank of Japan's announcement last Friday of additional "quantitative and qualitative easing" to stimulate its economy sent many equity markets racing towards multi-year highs.  The enormous monetary stimulus (~16% of GDP/year) was also accompanied by news that the country's pension assets would be more equities-oriented.  The primary objective: shake the  deflationary pressures that are returning after the consumption tax increase and help cement inflation expectations.  One of the most noteworthy impacts of this policy announcement was the chaos it produced in currency markets.  The Yen plunged against the dollar.  A mere two years ago, it only took 80 Yen to buy one dollar.  Today it will cost you ~114 Yen.

So What?  In addition to impacting export competitiveness, currency moves also reallocate inflation and deflation pressures.  The Yen is no exception, and the recent depreciation will have meaningful implications for Europe, the United States, and the entire world economy.  To illustrate the dynamics, let's use a simple example.  Suppose that imported beef costs $5/pound and the price has remained constant over the past two years.  Two years ago, the cost was 400 Yen/pound.  Today, that same beef costs 670 yen/pound...meaning that a weaker currency translated into higher import costs.  Further suppose that Japanese yellowtail costs 800 Yen/pound and has remained so for the last two years.  This means that foreigners buying this fish will now pay ~US$7/pound versus the prior US$10/pound.  Because of the falling Yen, Japan is now importing inflation and exporting deflation.

This has big ramifications for Europe, which is already suffering from falling prices and is trying to generate inflation.  Japan exporting deflation to Europe does not help.  Might the ECB have to amplify its already loud efforts?  It also has major implications for the United States, where imported deflation may allow the Fed to be looser for longer, possibly even driving US asset markets towards bubbly levels. Lastly, consider the fact that 13 OECD countries have negative CPI readings and that another 8 are below 1%.  Add to these deflationary pressures recent advances in robotics, the North American energy revolution, excess capacity in China, and demographic headwinds in most large economies.  Now sprinkle a healthy serving of debt across most economies.  Might this toxic cocktail be foreshadowing toxic wealth-destroying debt-deflation dynamics?

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