After reading through the breif summary of what went on in the article here on mises.org (linked to by Fred above) I was thinking a little bit about the parallels between the US and Japan myself. I should note, before I embark on the long explanation below, that one of the main things I’m trying to understand is why recessions are “deflationary by definition” as I so often hear.
Now, presuming that article linked to in Fred’s post is accurate, it sounds like the Japanese applied Keynesian economics to the letter… and Bernake was hired knowing full well that his first name is Helicopter so it would seem likely that more or less the same economic policy will be followed in the US if faced with (as now seems likely) a similar situation. However, as you point out, there are certainly important differences between the two countries and situations. The one that seems the most obvious is that Japan is a net exporter (and if I’m not mistaken this was also the case prior to and during the 1990s). As such, and as you also noted, their recession was perhaps softened by strong exports to the US market. The US, on the other hand, has the largest current account deficit in the world so is most certainly a net importer. Although stagnation and deflation were the order of the day in Japan - there’s no immediate reason to expect that this would be the case in the US.
If I’m not mistaken in my reasoning, on the back of weak economic data and Bernake continuing to lower interest rates the dollar is likely to weaken and, since the US is a net importer a weaker dollar would have a net inflationary effect on prices, even during a recession. To see what effects we could expect the sinking dollar to have on prices, we need to know what proportion of the products/services that are consumed US are imported. A country that makes one hundred apples, exports 1 of them and imports 2 of them has a trade deficit of 1 apple but the cost of apples in that country certainly isn’t determined primarily by the cost of the 1 apple they’re importing. So to see what effect a lower dollar might have on prices in the US we need to know what the current account deficit represents as a proportion of the US GDP… and that figure turns out (if you believe the official figures, which I think are a bit bent personally) to be around 5.43%.
According to the Austrian theory however, only the costs of higher order goods will fall. The cost of consumer goods will rise (since these have seen a lack of investment, the money for that investment having been artifically shifted away to higher order goods during the inflationary boom that led to the recession). So the approach I took in the third paragraph above of lumping all imports/exports together and taking these as a percentage of the GDP simply won’t do. We need to know much more about the nature of the goods that the US imports and exports. If it’s importing primarily higher order goods and exporting primarily lower order goods then imports could be drastically reduced (as a result of much lower demand for these higher order goods) and exports could also be reduced to compensate for the increased demand for lower order consumer goods… without requiring the usual delay that would be necessary to wait for production in lower order consumer goods to get back to where it should have been (at least to satisfy internal demands). However if it’s exporting primairly higher order goods and importing primarily lower order goods then the inflation situation could be much worse since it’s likely that a US recession would not have very positive effects on international market and so demand for those higher order goods could well drop internationally, countering hopes that a low US dollar might stimulate exports. Additionally, the things that will be needed most (lower order consumer goods) would then not only be in greater demand but, due to the lower dollar, these would be harder to obtain! If this is the case then imports/exports would play a much greater role in determining whether or not to expect inflation or deflation in the wake of a US recession.
What then are US imports and exports made up of? So as not to compare apples to oranges, I’ll use the same source for the industry composition as I used for the figures on the Current Account Deficit and the GDP, which is https://www.cia.gov/library/publications/the-world-factbook/geos/us.html. According to that page exports are:
“agricultural products (soybeans, fruit, corn) 9.2%, industrial supplies (organic chemicals) 26.8%, capital goods (transistors, aircraft, motor vehicle parts, computers, telecommunications equipment) 49.0%, consumer goods (automobiles, medicines) 15.0% (2003)”
So exports are 50% capital goods and 26% industrial supplies - which appear (to this amateur) to be mostly higher order goods - and only 15% consumer goods.
Imports are:
"agricultural products 4.9%, industrial supplies 32.9% (crude oil 8.2%), capital goods 30.4% (computers, telecommunications equipment, motor vehicle parts, office machines, electric power machinery), consumer goods 31.8% (automobiles, clothing, medicines, furniture, toys) (2003) "
Imports then are 31% consumer goods and 8.2% crude oil. Capital goods only account for 30% of imports where they accounted for 50% of exports.
So although the makeup of the imports and exports does’n’t spell for a worst case scenario, on the balance of things it looks like the US is definitely exporting more higher order goods than lower order consumer goods and is importing more lower order consumer goods than higher order capital goods… which would indicate to me that the import/export situation is likely to contribute to rising prices somewhat more than we had initially expected simply looking at the trade deficit as a percentage of the GDP.
However I never cease to hear economists and investment parroting the mantra that “recessions are deflationary by definition”… and I never quite understand the reasoning of this (which was one of the reasons I was so interested in Japan). Although I realize that all of the figures I’ve used above have been approximations and guesses, presuming the reasoning above isn’t completely false it certainly looks like imports will push US inflation upwards, even in a recession. So if we want to believe that the coming recession will be deflationary then we’d have to presume that the cost of goods that are made and consumed in the US will drop considerably, not only to counter the effects of rising imports but to produce the recessionary deflation that everyone is harping on about.
The cost of goods is determined primarily by the costs of capital and labour. The cost of capital is often tied to interest rates which are already extremely low and indeed every time they’re lowered prices seem to go “mysteriously” up - not that mysterious really since you have more dollars chasing fewer goods. So it doesn’t look like the famouse decrease in prices will be coming from lower capital costs. Which leads me to the conclusion that the decrease in prices will only be achieved if wages in the US absoutely plummet (since they have to make up for all the losses that none of the other factors seem to be contributing).
However even if wages plummet (and that’s not good news), would this produce the so called deflation that is apparently synonymous with recessions? If the Fed is not raising interest rates by selling assets back to the market (taking money out of the economy) then what is expected to precipitate the decrease in the overall money supply (and thus the number of dollars chasing all the available goods)? In a recession, GDP is negative, so the quantity of goods in the market is decreasing… meaning money supply would need to contract at an even greater rate than the GDP if we were to hope for deflation. Perhaps it’s assumed that commercial banks will voluntarily increased their reserves? This seems to be the only way that I can see of hoping for a real monetary contraction and thus a decrease in prices, if the Fed is going to maintain (as has the Bank of Japan) low interest rates.
I realize the quantity theory of money also incorporates that famous “velocity” of money that Keynes was talking about. However as far as I’m aware, now that we have the data 80 years after Keynes postulated this theory, contrary to his initial expectations it appears that the velocity of money remains more or less constant and prices are determined by in large by the quantity of money in circulation - the real effects of the velocity of money are only very marginal. So once again, I simply don’t see where this deflation is supposed to come from?
Does anyone have an explanation for this? I’m confused as hell.