Whenever economists want to scare us, they mention Japan. They note that since the collapse of its bubble 20-odd years ago, it has been caught in a cycle of hideous deflation that has left its population trapped in a living nightmare of unemployment and poverty. But look at Japan and there does seem to be a minor problem with the arguments.
It hasn't really suffered from that much price deflation in fact, over the last 15 years or so, Japan's consumer price index has been broadly stable. That's not terrible for ordinary people. It means their wages don't rise much, but it also means that their savings are worth much the same at the end of every year as they were at the beginning.
By contrast, here in the UK, we spend hours figuring out how much interest we have to get paid to make a real return on our savings (after inflation and the tax take) and usually find we can't.
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Put your money in a bank account in an inflationary economy with a progressive tax regime and you will almost invariably be poorer in real terms at the end of the year than you were at the beginning. This will force you assuming you want to retire to constantly demand higher pay (which is inflationary in itself) and to raise the levels of risk you take with your capital.
If prices were stable and your savings retained their value, would so many people feel the need to pour their money into property, into the stock market and into endless complicated investment products? Think about it like that and it is no wonder that the financial industry is so terrified of even very low inflation: without it, they'll find that the high-fee, volatile return service they provide is no longer quite so much in demand.
When I interviewed Adam Fergusson, the author of When Money Dies: The Nightmare of the Weimar Hyperinflation (which you must read immediately if you have not yet done so), he said that then as they still do now workers constantly went on strike demanding the wrong thing. They wanted higher wages so as to be able to maintain their living standards, but they should have been calling for the kind of stable prices that would have prevented their living standards falling in the first place.
This is not to say that things are fine in Japan. They are not. Unemployment is only just over 5% on official numbers (not bad, given the 10% the rest of us are heading towards) but there is a high level of hidden unemployment and nominal GDP growth has barely budged over the last 20 years.
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However, in spite of the global conviction that deflation is to blame, it isn't necessarily so. Look at GDP per worker in Japan and you'll see that, as Dylan Grice of Socit Genral points out, it has actually "outpaced that of the US over the last five and ten years". Is it possible then that the lousy overall GDP growth in Japan has nothing to do with deflation or what we might call stable prices and everything to do with its declining population? Is the country simply suffering from a "demographic compression", something no amount of government fiddling can get it out of?
Whatever the truth of these musings, lack of inflation remains the great fear of our central bankers. It might be nice for savers, but they don't drive the kind of GDP growth the authorities like to see. Borrowers, by investing and spending, do. And borrowers need inflation to help them pay back their debts.
How many 60-something people have you heard talking about how, when they borrowed £6,000 to buy their five-bedroom London house 30 years ago, "it seemed so much at the time?" Without inflation it still would. So, to encourage people to keep taking on debt, our central bankers need to keep inflation stoked.
This brings me, in a roundabout way, to the point I actually want to make this week: that deflation is good for gold prices. There has been some confusion in the market about why the gold price has soared, even as the risks of deflation have seemed to rise gold being the classic inflation hedge.
The answer to the conundrum, as analysts at Cross Border Capital point out, is that price deflation falling consumer prices tends to encourage the authorities to indulge in massive monetary inflation.
Note that the US is almost certain to restart QE relatively soon and that the UK is likely to follow. This might or might not make a difference to consumer prices but it will undermine the value of our paper currencies, making gold look like a pretty good alternative currency.
Those looking for a precedent for falling consumer inflation and rising gold prices need only look at the years between 1933 and 1940. Then, says Cross Border, the US government injected huge amounts of new money into the economy. Consumer prices fell and the gold price rose over 60%.
Deflation, as it turns out, is good for gold.
This article was first published in the Financial Times.
Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).
After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times
Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.
Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.
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