In the January 19, 2010, The Wall Street Journal Alison Tudor along with Kenneth McCallum ("Rating Agency Knocks Japan's Outlook") described how Standard & Poor’s warned Japan of a downgrade, unless “policy makers can reverse [the] deflationary spiral”. It reads that, “Investors began to raise questions about the sustainability of government debt”.
Uh.. Wait, What? Why are we knocking Japan? In my opinion, they are doing a better job with their economy then the US is with ours.
So why do I think this? Well, contrary to common belief I do not think their deflation or debt is a problem at all. I also think their economy is a lot more natural then ours, and because of that, a lot healthier too.
First I will touch on deflation, then government debt will follow in the next post:
The Japanese economy is much like the United State's so I will refer to our economy instead of Japan’s to analyze the economic style.
Why does deflation have to be bad? Everyone is always painting deflation as a bad, horrible, retched force -why?
Deflation is natural. It is the natural force that follows inflation, this can be seen in any 10 year graph of the Dow Jones Industrial Average (the one represented below is from the wsj.com website). These fluctuations between inflation and deflation are commonly recognized as the business cycle.
The business cycle explains that the economy is always pushing itself towards a neutral, or beginning point. For the sake of this article, we will call this beginning point: point zero (zero).
The economy is the product of all past inflationary and deflationary changes:
Economy = (inflation - deflation)
So, with the natural (beginning) point of the economy being zero:
(Inflation - Deflation) = 0 or 0 - 0 = 0
In looking at the Dow Jones decade chart it can be seen that the market inflated upwards. Let’s say it inflated 5 points.
5 - 0 = 5
Here the economy inflated away from its natural point of zero -To remedy this, it deflated.
5 - 5 = 0 ...The business cycle did its job and equalized the economy. This is a very simple idea that is understood and counted on by many investors.
But What About The Big Picture?
If we look at the Dow Jones Chart dating back to the 1900s (around its inception), we can see that from the 1900s to the 1930s the economy inflated and deflated many times but always ended up around the same point. This changed after the 1930s though when the economy began an upward trend.
After the Great Depression (around 1930) the government stepped up its control over the economy through various bills, acts, and boards. The goal was to keep another large depression from happening again and to keep the economy growing (inflating). The government found a way to manipulate the natural cycle of the economy so that it worked in their favor. They turned deflation into an always losing villain and inflation into the hero that always prevailed in the end (hence, our current view that deflation is bad).
If we take a look at the economy equation again, with government manipulation now considered, we would find something like:
(80,000 - 0) = 80,000
For the economy to equalize itself it would have to deflate by 80,000, but the government suppresses this natural force. It is important to understand that as inflation grows to new heights, its deflationary counter force grows stronger. How long can the government keep a force that grows stronger the longer it is suppressed from breaking through and bringing the economy back to its natural state?
It seems to me that inflation is the power hungry villain here and deflation is the honest, dignified, man that might (will?) prevail in the end.
The question needs to be asked, would you rather an economy that is higher then nature intended and backed by man made elements -therefore making it prone to failure? or would you rather an economy thats natural and backed by natural elements -therefore giving it a more solid base (less prone to failure)?
**The US is still manipulating their economy to inflate it every year, Japan is letting its economy fall back into an un-manipulated (natural) economy.
..more on the government debt in my next post
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