Sunday, April 14, 2013

Japan's inflation cavalry arrives too late

Published in The Tennessean, Sunday, April 14, 2013 and at FORBES with archives.

by Richard J. Grant

Throughout history, inflation’s advocates always found some reason for governments to create new money. We receive most of our incomes as money and we calculate our wealth in terms of money. When any one of us receives more money, that person rightly feels wealthier. But it does not follow that the existence of more money in general would make us all wealthier.

It is true that as we have grown wealthier, historically the quantity of money has tended to grow along with that wealth. The biggest deviations from this tendency have occurred during periods of fiat-money inflation or debasement of the coinage. In each case, the consequent monetary depreciation resulted from government officials trying to get something for nothing. The newly printed money, or the new coins minted from diluted alloy, was directed toward the special purposes of the government officials and their supporters.

The stimulus to those activities favored by the availability of the newly created money is always temporary and never without side effects. Such newly created money never enters the economy evenly. It increases demand for some goods and services relative to others and redirects resources accordingly.

The injection of new money, especially through the credit markets, will temporarily reduce interest rates. But it does not necessarily reduce people’s time preference, which means that it does not by itself make people more willing to save. Neither does the induced reduction in interest rates reflect any such spontaneous willingness.

An increase in the money supply is not the same as an increased willingness to supply capital. An expansion of credit in the present does not assure the continuous availability of such credit in the future.

When governments arbitrarily alter the general value of our currency (whether up or down), they deprive us of a reliable measure of the relative values of the goods and services that we trade. This is especially apparent when comparing the values of present goods and investments with future goods.

This makes inflation a harmful and inappropriate method to compensate for the effects of poor fiscal and regulatory policies. But this is how inflation has been used in the United States and around the world.

It is not even obvious that inflation is a good cure for a preceding deflation, though it can truncate some of the unhappy price adjustments.

Japan experienced de facto deflation from the mid-1980s through the 1990s. Since then, the yen has trended lower against gold. For the past dozen years, even though Japanese consumer prices periodically fell, the yen-gold price did not signal deflation.

During the same period, the yen trended horizontally against the US dollar with wide, but smooth, fluctuations. That trend broke during the US financial crisis. The Fed weakened the dollar and the yen moved relatively higher, surpassing a 15-year high by the end of 2010. This (relatively deflationary) uptrend continued until about September 2012 when the Japanese government very credibly signaled its intention to inflate the yen.

After a period of deflation, it can take many years for the price effects fully to work their way through the economy. A reflation of the currency, such as that indicated by the yen-gold price during the past dozen years, would remove much of the impetus for the deflation-induced price adjustments. Reflation can never put things back the way they were, because changes in relative prices would already have caused real adjustments in economic activity.

With the yen-gold price now at record highs, perhaps the Japanese government should loosely peg its exchange rate to the dollar and focus on improving its fiscal and regulatory policies.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears fortnightly on Sundays. E-mail messages received at:

Follow on Twitter @richardjgrant1

Copyright © Richard J Grant 2013