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Price-cutting in Japan points to repeat of deflation misery

June 26, 2009 | 12:30 am

Japan, which showed the world how awful a sustained bout of deflation can be, may be heading back into that vortex.

The country’s main index of consumer prices dropped 1.1% in May from a year earlier, the biggest decline since 2002, the government said Friday.

Oil is part of the explanation here: Because crude prices have fallen so far from their peaks a year ago, they’re exerting unusual downward pressure on inflation rates. In the U.S. the consumer price index, including food and energy costs, was down 1.3% in May from a year earlier, the biggest drop since 1950.

Japanretail But excluding food and energy the U.S. CPI was up 1.8% in May from a year earlier. In Japan, by contrast, the CPI ex-food and energy was down 0.5% in the same period, signaling more widespread price cutting.

Japan is much more sensitive to the risk of true deflation, which is a broad-based decline in prices that can feed on itself and have a severe debilitating effect on an economy.

From Bloomberg in Tokyo:

"Profits fall, then wages come down, then consumers stop shopping," said Junko Nishioka, chief Japan economist at RBS Securities Japan Ltd. in Tokyo. "And because people aren’t shopping, companies lower prices. That’s the process that we’re starting to see. It isn’t easy to break out of."

Consumers, whose spending accounts for more than half of the economy, may delay purchases if they expect goods to get cheaper. That would erode profits and force companies to cut wages, which have already slid for 11 months.

Finance Minister Kaoru Yosano said an "extreme" slump in demand and production are causing the drop. "We continue to monitor developments in prices and need to carefully manage the economy to avoid a deflationary spiral," he said.

As Japan struggled in the aftermath of its real estate and banking system crashes of the early 1990s, the economy stagnated in the late 1990s and early 2000s.

That brought on deflation: Japan’s consumer price index fell every year from 1998 to 2002, was unchanged in 2003, then declined again in 2004. The index began to move modestly higher in 2005.

The policy responses of the Obama administration and Federal Reserve to last year’s economic and credit catastrophes have in large part been aimed at keeping the U.S. from falling into a similar deflationary cycle.

The Fed wants to believe it’s winning the battle, as I noted in this post on Wednesday. But many economists say the risk of sustained Japan-style deflation in the U.S. remains high.

-- Tom Petruno

Photo: Shopping in Tokyo. Credit: Toshiyuki Aizawa / Bloomberg News