Will Japan's Policy of Massive Inflation Lead to Prosperity?

Paul Krugman thinks Japan's inflation is good news. I beg to differ. My thoughts are more along the lines of David Howden. In his new essay "Japan's Easy Money Tsunami" Howden explains that the ultimate consequences of monetary inflation are always the same: decreased purchasing power of money and the business cycle:

However happy people have been about higher stock prices, eventually the economic effects will be harmful; indeed the recent stock price crashes foreshadow still more troubles to come.

He notes that Mises had the analysis correct way back in 1912.

We're Not Japan, but We Can Hope

In this short video clip from Bloomberg TV, their "single best chart" of the day shows that our so-called recovery is the worst since the 1940s and even worse than Japan's lost decade thus far.




Such is what is wrought when liquidation of malinvestment via the market process is hampered.

BBC on Japan and the Broken Window Falacy

Steve Fritzinger of the BBC agrees with me about the fallacious notion that Japan's natural  and nuclear disaster will result in economic expansion in Japan. In his outstanding commentary on Business Daily Fritzinger gets it right as he cites Frederic Bastiat's explanation of the broken window fallacy. He makes the following insights:

• Larry Summers' claim that spending on rebuilding will boost the economy is akin to the claim that a family can improve their economic situation by burning down their house.
• It is a big mistake to equate GDP with economic wealth.
• Krugman's hope that such spending could get Japan out of an alleged liquidity trap is crazy.

You can listen to the entire program by clicking here. The commentary begins at 12:17 in the program.

Will Japan's Earthquake Be an Economic Boon?

Larry Summers thinks so (HT: Jeff Tucker). It is so sad that, almost like clockwork (to use a timeworn cliche in pointing to another timeworn economic cliche), some economist who has drunk too deeply at the fount of Keynesianism, has already asserted that, because of Japan's earthquake, their economy will receive a short term boost.

How in the world will the destruction of massive amounts of capital and durable consumer goods grow an economy, one may be excused for asking. The answer from Larry Summers and Keynesians like him, is that the Japanese will now have to spend more to rebuild, which will result in a boost to GDP. Of course, however, as I point out to my students, spending does not necessarily equal economic well being. I have already explained on this blog that we should be careful not to confuse GDP with the economy. Instead of spending a lot of yen to rebuild a home. It would be better to still have the home and still have the yen that could be directed to purchasing additional goods that could be used to satisfy even more ends. GDP measures spending as a flow of income, it does not measure wealth.

Summers cites as support for his case, the aftermath of the Kobe earthquake that hit Japan in 1995. It turns out that, according to SG Cross Asset Research, the data reveal that Summers' claim is wrong.

There was a significant decrease in industrial production due to the Kobe earthquake. No matter what certain "experts" say, we cannot achieve prosperity, even in the short-term, by breaking things.

Ritenour Talking about Japan, the Federal Reserve, and Macroeconomic Policy

Saturday I was privileged to be a guest on the Glen Meakem Program discussing my op-ed "The Lessons of Japan" (do not inflate and do not increase government spending); the Federal Reserve (abolish it), quantitative easing (bad idea), and fiscal policy (cut government spending).  You can listen to a podcast of the program by clicking here. My section of the show begins at 41:11.

The Lessons of Japan

My latest op-ed, "The Lessons of Japan," was published by The Center for Vision and Values at Grove City College. It discusses the deflation bogey as a justification for QE2 in light of Ben Bernake's recent appearence on 60 Minutes and explains the real lesson to be learned from the Japanese lost decade(s). As I see it,

The true lesson to be learned is that after an inflationary boom turns into the inevitable bust, trying to fix the mess by fiscal stimulus, monetary inflation, and bank bailouts is a fool’s game.

Time to Put the Japan Deflationary Depression Canard to Rest

Doug French has a very timely post responding to a New York Times piece documenting Japan's descent from "Dynamic to Disheartened" all supposedly due to a prolonged deflationary spiral following their inflationary boom of the 1980s.

Most of the following is from a comment in reference to an earlier post about the similarities between the U.S. policy response to the credit crunch ushering in the Great Recession and Japan's response to their downturn in the early 1990s. I think the issue so important, however, that it deserves its own post.

The author of the NYT piece about Japan's loss of vigor asserts:

For nearly a generation now, the nation has been trapped in low growth and a corrosive downward spiral of prices, known as deflation, in the process shriveling from an economic Godzilla to little more than an afterthought in the global economy.

Later the author writes:

The classic explanation of the evils of deflation is that it makes individuals and businesses less willing to use money, because the rational way to act when prices are falling is to hold onto cash, which gains in value. But in Japan, nearly a generation of deflation has had a much deeper effect, subconsciously coloring how the Japanese view the world. It has bred a deep pessimism about the future and a fear of taking risks that make people instinctively reluctant to spend or invest, driving down demand — and prices — even further.

The misery and human costs however are not the result of deflation. They are the direct result of Japan's failure to allow the liquidation process to occur. The Japanese government has kept unprofitably invested capital in place with fiscal and monetary stimulus as well as central bank policy that continues to keep bad debt frozen on the books of zombie banks.

Recessions as the necessary consequence of capital consumption via malinvestment resulting from artificially low interest rates. In both Japan and the US, entrepreneurs were led astray by central bank credit expansion to undertake too much investment at higher stages of production and not enough investment at lower stages. The end result is that a large number of investment projects were begun at stages farther away from the consumption that were simply not sustainable. These projects must be liquidated if we do not want to continue to consume capital and make the situation even worse over time. Recession is the beginning of the necessary restructuring of capital toward its most highly valued uses.

Additionally, whatever the cause of the misery in Japan, it is not due to deflation. The claim that there has been a generation of deflation in Japan is simply wrong. As French notes, in 1989 the annual CPI in Japan was at 91.3. In 2009, it was 100.3. There have been ups and down along the way, but prices are higher now than they were in 1989. The monetary base of Japan is now more than 244 times what it was in July of 1991. M1 in Japan almost trippled from 1990 to 2002 and then increased every year after until 2009. In no way can this be construed as deflation.

We should also not forget that liquidation does not have to cause prolonged misery. That is the lesson of the recession of 1920-21 that followed the inflation of the war years. Historian Tom Woods documents that during 1920 unemployment increased from 4% to 12% and GDP fell by 17%. Warren Harding's response was to cut government spending, cut taxes, and reduce the national debt and the Federal Reserve did not act to inflate in an attempt to forestall deflation. Unemployment was back down to 6.7 by the end of 1922 and fell to 2.4% in 1923. The reason we did not have two decades of misery following the recession of 1920-21 is that the government by-and-large allowed the malinvestment to be liquidated and for the necessary capital restructuring to commence.

Responding to Economic Recession: Like Japan, Like the United States

Last week, markets zoomed upon receiving the news that Japan was committed to "quantitative easing" or what we used to simply call inflation. What should give everyone pause is the reminder that we've been through this all before. 

In a very accessible article, "U.S. Recession Policies: Nothing New Under the (Rising) Sun" in the Fall 2009 issue of The Intercollegiate Review, Benjamin Powell expertly compares and contrasts the response of Japan to their earlier recession that led to the infamous "lost decade."

Powell documents that the central banks of both Japan in the late 1980s and the U.S. in the 2000s increased the money supply and greatly lowered interest rates. In both situations housing and stock bubbles were inflated and then burst leaving a plethora of economic devastation in their wake. He uses Austrian business cycle theory to rightly identify the massive capital malinvestment that is at the root of the economic problems of both Japan and the United States.

Powell notes that the response in the U.S. has been both monetary and fiscal stimulus. He does an expert job explaining why it was just this sort of monetary and fiscal intervention that prolonged Japan's recover into what became known as the lost decade. Powell's article is an excellent piece of economic history documenting how not to recover from the Great Recession.