June 23 (Bloomberg) -- When Shizuma Tokifuji bought his Tokyo condominium in 1999, he thought he was buying close to the bottom of a real estate market that had lost two-thirds of its value since 1991. He was wrong. The 56-year-old father of three sold his home last week for $85,000 less than he had paid. Tokifuji is just one victim of an economic nightmare called deflation, a general drop in consumer prices that has contributed to Japan's three recessions since a property and stock market bubble burst in the early 1990s.
Four central bank governors in a decade have failed to halt falling prices, making it hard for companies to repay debt and contributing to the Nikkei 225 Stock Index's 77 percent plunge since 1989. With prices starting to fall in the U.S. and Germany, Federal Reserve Chairman Alan Greenspan and European Central Bank President Wim Duisenberg will find few remedies in Japan. ``I don't see any quick fix that would kill this deflation monster,'' said Tokifuji, who retired after having a stroke. He sold his home to pay for his youngest son's college tuition. Japanese are now looking to Bank of Japan Governor Toshihiko Fukui, who marks his first 100 days in office on Friday, to free the world's second-biggest economy from the yoke of deflation. Fukui has few options left. Japan cut short-term interest rates to zero for the second time in March 2001 and has tripled monthly purchases of bonds from banks to 1.2 trillion yen ($10.2 billion) to drive down long-term interest rates.
Avoiding Bankruptcy
``We at the Bank of Japan stand on the front line of the war against deflation,'' Fukui said this month. ``However, we have used up the greatest weapon in a central bank's arsenal, that is interest rates, which have all declined to virtually zero in our short-term markets.'' All that extra money hasn't helped the economy grow because banks, buckling under 52.4 trillion yen in bad loans, haven't increased the amount of new lending in six years. Companies are focused on repaying debt to avoid bankruptcy. The lesson for Greenspan and Duisenberg, who oversees 12 countries sharing the euro, including Germany, is to stop deflation before it starts. Falling prices cut company sales, making it harder to repay debt, as consumers shelve spending plans with the expectation prices will keep dropping. ``The most important lesson from Japan is that when there is a risk of deflation, it's highly desirable to address it early,'' Anne Krueger, International Monetary Fund deputy managing director, said in Tokyo this month. ``Once it gets entrenched, it's much more difficult to get rid of.''
`Wider Firebreak'
U.S. consumer prices in April fell for the first time since 2001 and the index was unchanged in May, tempered by a drop in energy prices. While the core consumer price index -- excluding energy and food costs -- rose 0.3 percent, prices still aren't rising fast enough to eliminate the threat of deflation. ``Implicit in deflation is not what's happening to the current level of prices, but what markets expect about the future pattern of prices,'' Greenspan said by video link at the International Monetary Conference in Berlin this month. While the Fed has battled inflation, it lacks experience in handling deflation, and seeks a ``wider firebreak'' to prevent it, Greenspan said. ``We know so little about it. We will lean over backward to make sure we contain deflationary forces.'' Germany faces a ``high risk'' of slowing economic growth because of falling prices, the IMF said in a report released May 18. German producer prices dropped the most in 10 months in May as energy costs fell. The consumer inflation rate of 0.7 percent in May was the lowest in 3 1/2 years and below the 1 percent European Central Bank Chief Economist Otmar Issing has described as a ``danger zone'' of deflation. European inflation slowed to less than 2 percent for the first time in 11 months in May as the euro's increase against the dollar made imports cheaper and a stagnating economy deterred companies from raising prices, a European Union report said last week.
Asset-Price Bubble
The Bank of Japan helped cause an asset-price bubble by not raising interest rates until just seven months before the Nikkei stock index hit a record high of 38,915 in December 1989. Property prices almost doubled in the 10 preceding years. It raised the benchmark rate from 2.5 percent to 6 percent between May 1989 and August 1990, slowing an economy that had already begun to slump. Land prices have fallen 74 percent in Tokyo and 45 percent nationwide since 1991. Japanese companies and small investors found they were sitting on ever-dwindling asset values, for which they had borrowed too much. Again, the central bank reacted too slowly as the economy fell into its second-longest recession from March 1991 to October 1993. The bank cut its discount rate from 6 percent in August 1990 to 0.5 percent in September 1995. Finally, in February 1999, it reduced borrowing costs to zero. The Bank of Japan's rate cuts in the early 1990s ``in retrospect proved to be too slow,'' Federal Reserve Vice Chairman Roger Ferguson said in New York this month.
`On the Brink'
The central bank, unable to reduce rates further, released more cash into the economy to spark growth. It has tripled purchases of government bonds from commercial banks the past three years and increased reserves it makes available to lenders sixfold to 30 trillion yen. Even so, the economy is smaller now than it was in 1996, before any adjustment for inflation. The Federal Reserve may lower its benchmark overnight lending rate by a quarter point to 1 percent on June 25, according to a Bloomberg News survey of 22 firms that trade with the Fed. That would be the lowest since 1958 and the 13th cut since January 2001. The European Central Bank on June 5 cut its rate by half a point to 2 percent, the lowest in the region since at least 1948.
``The most pressing question is whether Germany is on the brink of deflation and if it is facing a Japanese-style scenario,'' European Central Bank council member Ernst Welteke said this month in Berlin. Germany's economy shrank 0.2 percent in the first quarter. The economies of Italy and the Netherlands also contracted. The U.S. economy will probably grow 2.4 percent this year, the Blue Chip Economic Indicators survey showed this month, compared with 3.6 percent in 2002.
Hardest Hit
``The U.S., like many other countries, has spent the last 40 to 50 years worrying about inflation,'' Federal Reserve Governor Ben Bernanke said in Tokyo in May. ``But it's just as important or more important to worry about deflation.'' In Japan, construction companies such as Kajima Corp., the nation's biggest, have been hardest hit as property prices tumble and the government cuts the trillions of yen it spends on roads, bridges and other public works. The construction industry, which employs about 10 percent of Japan's 65 million workers, helped fuel the postwar economic boom. ``It's asset deflation that kills us,'' said Takashi Monma, corporate planning manager at Kajima, which plans to cut 1,300 jobs to trim its 594 billion yen of debt.
Kajima, which helped build four World Cup soccer stadiums when Japan hosted the tournament in 2002, expects a loss of 5 billion yen this year. An average 50 companies have gone bust every day since consumer prices began falling in 1998. Personal bankruptcies hit a record 214,634 cases last year as the unemployment rate reached a record 5.5 percent in August. Wages have fallen for two years.
Mac Attack
Deflation is even hitting Big Macs. McDonald's, which has 3 million Japanese customers a day, has cut burger prices by 55 percent to as low as 59 yen the past three years to attract sales. The policy backfired. McDonald's Holdings Co. Japan Ltd. reported its first annual loss in 30 years in 2002 and it stock price has fallen by more than half since it sold shares to the public in July 2001.
Meanwhile, the Bank of Japan under then Governor Masaru Hayami in November began buying shares from commercial lenders to help them cut stock investment losses. It plans to buy corporate debt to make it easier for small companies to borrow, hopefully halting deflation. Until then, Japan's 127 million people must live with deflation, something retiree Tokifuji says he is working on. He and his wife have moved to their hometown of Yanai-shi, 580 miles west of Tokyo, where some of the 33,675 residents barter for food. ``I spend my days fishing and trade them for vegetables,'' said Tokifuji. ``There's no deflation in barter.'' //www.bloomberg.com