The real worry behind falling consumer prices

GETTING peppered all over with questions about the economy and even requests for investment advice was how one colleague described the encounter I too recently had with a big group of boisterous 17 and 18-year-old students from the eastern part of Singapore.

The Straits Times School team organised a national current affairs competition billed as the Big Quiz for junior colleges and I gamely accepted their invitation to speak to students before the second quiz round, held at Victoria Junior College.

It was the first time that I had given a talk to junior college students since I left teaching 28 years ago, and I emerged unscathed from it. As I told a school principal friend afterwards, I was amazed by the broad range of issues which they raised. It is a reflection of how well-informed youngsters must be nowadays, compared to nearly 40 years ago when I was their age.

It certainly makes a teacher's life more challenging when having to cope with these inquisitive young minds. But woe betide the speaker who comes ill-prepared as his ignorance will be quickly laid bare by them.

One question I was asked, was for my views on deflation in Japan - not exactly a topic I expected a 17-year-old to ask.

As I subsequently read in the papers about consumer prices falling again last month - the 17th straight month of decline - and the tepid retail sales in February despite the Chinese New Year festivities, I was reminded of the reply which I gave, and its relevance in the local context.

Where Japan leads, the rest of us may follow. Many Asian countries have, after all, borrowed heavily from the Japanese blue-print on how to industrialise their economies. As such, post-industrial Japan makes an interesting model to study on what may possibly befall us too.

Compared to Singapore, deflation in Japan is an even bigger problem. It is no longer measured in months or even years but in decades - with economists referring to the past 20 years as the country's lost decades, grappling with an ailment which saps at its economic vitality.

Before looking at Japan, one question to ask: Just why are falling consumer prices so fearful? At the risk of simplification, the classic explanation is that this causes consumers to delay their purchases and force prices to fall still further.

That prompts firms to cut production and wages which, in turn, weakens demand still further. And when that fails to work, they may even resort to layoffs and closing down their factories to stay in business.

This will, in turn, increase the economic uncertainties and make people even more reluctant to spend.

Now, taken to extremes, it may even cause an economy to collapse.

But even before that happens, investors will be selling their shares because of falling share prices and stowing away their money at home.

That happens to be the case in Japan where the Nikkei-225 Index has more than halved in value in the past 27 years after peaking at 38,916 in 1989. The Tokyo real estate market fared even worse. By some estimates, it had fallen about 80 per cent in value from its peak in the same period.

Yet, this is despite various attempts to stimulate the Japanese economy - the latest being made in the past three years with the Bank of Japan printing trillions of yen each month and buying Japanese stocks in a big way - so much so that it is now purportedly among the top 10th shareholders in 90 per cent of the Nikkei-225 component stocks.

The downward trajectory of the benchmark Straits Times Index in the past few years suggests that we may be headed down this slippery slope if we are not careful.

The STI had peaked at 3,850 in 2007 and currently trades at about 2,895, about one-quarter below its peak.

But as I related to my audience, the manner in which many articles are written about Japan's economy are so full of doom and gloom that you would associate the country with being close to economic collapse.

In fact, nothing is further from the truth.

If you have been to Japan, as I did recently, you will find the bullet trains zipping to their destinations right on the dot, the streets spotlessly clean and people enjoying a far higher standard of living than in many European countries.

"Whose lost decade are the economists referring to?" you may ask yourself, as I did when I was enjoying a set lunch with free flow of coffee at an upmarket Ginza restaurant which cost only 1,800 yen ($22). This was a fraction of what I would have to pay for a similar meal in Singapore.

In fact, for an economy where banks pay next-to-nothing on deposits, Japanese savers are having a remarkably wonderful time - because stagnant or falling prices mean that their yen can stretch further - and many of them are retirees.

True, deflation has caused Japan's economic growth to snarl to almost a standstill and made its net debt as a share of GDP one of the highest among developed countries in order to pay for rising pensions and healthcare costs.

But on the flipside, Japan is one of the world's biggest creditor nations with over US$3.3 trillion of foreign assets. Most of the debts issued by the Japanese government are snapped up by Japanese savers who are more than happy to roll them over when repayment is due because falling prices mean that they get a real positive return even when nominal interest rates are close to zero.

So, what is the catch? Japan is a wonderful country for the aged. But life has become much harder for young people seeking good jobs, with many of them finding themselves staring at the prospects of years of stagnant wages which is one of the effects of deflation.

That may sap their incentive to forge ahead in life. It also makes them more risk-averse, as companies with exposure to the domestic economy, focus on paying down debts and deal with falling prices, rather than try to expand their businesses. And if you are a young ambitious Japanese, what do you do?

Some of them may leave Japan and look for greener pastures elsewhere.

As it is, one of my nieces married a Japanese who is quite happy to settle down in Singapore and find a job here. Their two children go to the local school and my cousin - their maternal grandmother - is beside herself with joy to have them by her side.

When I asked my niece how her Japanese in-laws felt about the arrangement, she shrugged her shoulders.

I suppose that for my niece and her husband, it is better to stay in vibrant Singapore where they can still get decent jobs and enjoy good career prospects, rather than in Japan where the phenomenon of deflation has become so deep-rooted that it defies every attempt by the Japanese government to root it out.

Sure, the effects of deflation in Japan are masked by an estimated eye-popping US$17 trillion of savings which its people had accumulated during the boom years.

This has enabled them to continue to spend lavishly and pass on their wealth to their children even though Japan's economy is not growing.

But as its population ages further, even this massive cashhoard will be used up at some point, as more and more people retire and have to rely on their nestegg for their living expenses.

What happens then?

What I had outlined is a serious economic lesson for 17-year-olds. But it is a very real problem which their generation will have to grapple with in the years ahead, as we cope with our own challenge of slow growth and possibly prolonged stretches of stagnating prices while our population ages.

engyeow@sph.com.sg