The human obsession with economic growth has perhaps been best captured by E.B. White in an essay called A Report in January published in January, 1958. The essay is a part of a book titled Essays by E.B. White.
In this essay White writes: “The theory is that if you shoot forty thousand deer one year you aren’t getting ahead unless you shoot fifty thousand the next, but I suspect there comes a point where you have shot just exactly the right number of deer. Our whole economy hangs precariously on the assumption that the higher you go the better off you are, and that unless more stuff is produced in 1958 than was produced in 1957, more deer killed, more automatic dishwasher installed…more heads aching so they can get the fast fast fast relief from a pill, more automobiles sold, you are headed for trouble, living in danger and maybe in squalor.”
This obsession with economic growth has been at play in the aftermath of the financial crisis which broke out in September 2008, when the investment bank Lehman Brothers went bust. The central banks and governments all around the Western world unleashed an era of easy money, by printing money and maintaining low interest rates.
This was done in the hope of people borrowing and spending more. So, with interest rates remaining low, people were likely to buy more homes, more cars, more consumer goods and so on. And in the process there would be more economic growth.
Most central bankers did not want the Western world to turn into another Japan. Right through the eighties, the Japanese stock market and the real estate market had huge bubbles. These bubbles burst towards the end of the eighties. And it is widely believed by economists that the Japanese economy never recovered from this. It entered into an era of deflation (the opposite of inflation, when prices fall).
When the economy is in a deflationary scenario, people tend to postpone their purchases in the hope of getting a better deal. Once this starts to happen, the business earnings start to fall. This leads to businesses cutting costs by firing people among other things. All this impacts economic growth. Businesses cut prices further, in the hope of persuading more people to buy things. And so a deflationary cycle sustains itself.
This is something that Western central bankers wanted to avoid. And this led to the unleashing of an era of easy money, which continues. In fact, as Raghuram Rajan, the governor of the Reserve Bank of India, recently said in a speech: “The canonical example here is Japan, where many are persuaded that the key mistake it made was to slip into deflation, which has persisted and held back growth.”
There is a great fear that what has been happening in Japan will happen in large parts of the Western world as well, if central banks don’t act and flood their financial systems with money.
In fact, Andrew Hallande, the Chief Economist of the Bank of England recently suggested the elimination of paper money. This would allow central banks to impose negative interest rates (which some central banks have already tried in Europe). When there is a negative interest rate on deposits, the bank will charge people for depositing their money in a bank account. This will lead to people spending their money instead of keeping it in a bank account, where its value will fall because of a negative interest rate. The spending that follows because of negative interest rates will lead to economic growth.
This is only possible if there is ‘only’ digital money and no paper money. If banks apply negative interest rates as of now, people can simply withdraw that money in the form of paper money and keep it under their mattresses or wherever they want to. Hence, Hallande’s suggestion of only digital money to revive economic growth.
Such suggestions come from the fear of deflation. But the question is are things in Japan as bad as they are made out to be? James Rickards in his book The Death of Money, talks about a speech where he heard a former deputy finance minister of Japan, Eisuke Sakakibara, speak.
“He [i.e. Sakakibara] made the often-overlooked point that because of Japan’s declining population, real GDP per capita will grow faster than real aggregate GDP.”
What this basically means is that because of declining population in Japan, even if the overall Japanese economy does not grow or grows at a very slow pace, there will still be more economic growth per person in Japan.
As Rickards writes: “Far from a disaster story, a Japan that has deflation, depopulation, and declining nominal GDP can nevertheless produce robust real per capita GDP growth for its citizens. Combined with the accumulated wealth of the Japanese people the condition can result in well-to-do society even in the face of nominal growth that would cause most central bankers to flood the economy with money.”
In fact, Rajan made a similar point in his recent speech. As he said: “A closer look at the Japanese experience suggests that it is by no means clear that its growth has been slower than warranted let alone that deflation caused slow growth. It is true that after its devastating crisis in the early 1990s, Japan may have prolonged the slowdown by not taking early action to clean up its banking system or restructure over-indebted corporations. But once it took decisive action in the late 1990s and early 2000s, Japanese growth per capita or per worker looks comparable with other industrial countries.”
This becomes clear from the accompanying table:
In fact, one of the fears of deflation, as explained earlier, is that it leads to unemployment. Nevertheless that doesn’t seem to be the case in Japan. As Rajan said: “Japanese unemployment has averaged 4.5% between 2000-2014, compared to 6.4% in the US and 9.4% in the Euro area during the same period. In part, the Japanese have obtained wage flexibility by moving away from the old lifetime unemployment contracts for new hires to short term contracts. While not without social costs, such flexibility allows an economy to cope with sustained deflation”
So, it’s time that central bankers take a re-look at the entire Japanese experience and revise their views on the idea of deflation.
Meanwhile, Japan seems to be getting ready for more money printing. As they say, the more things change, the more they remain the same.
The column originally appeared on October 9, 2015 on The Daily Reckoning