Beware the Bugaboo.(deflation in Japan, United States economics)(Brief Article)

To hear the economists tell it, a specter haunts the globe: the downward spiral of prices called deflation. WHAT'S WRONG WITH LOW PRICES? most consumers will ask. Look at Japan: deflation there means that a McDonald's hamburger that used to cost $3 now goes for 55 cents. That's good, right? Not to the 46-year-old housewife, too embarrassed to give her name, who in 1990 paid $500,000 for a condo an hour from central Tokyo. It's worth $145,000 today.

Japan shows why deflation is scary. It's not scattered price dips and discounts for a few major items like oil and cars, of the kind the United States is now experiencing. It's a dangerous maelstrom, in which prices sink for just about everything, from haircuts to houses. Consumers know prices will only go down, so they wait to buy. Sales drop. Companies then cut wages or lay off workers. This discourages consumer spending even further, leading to yet more layoffs. America last saw deflation during the Great Depression, when prices fell by 26 percent. By the time they reached bottom, 25 percent of the labor force was out of work.

A half century later rising trade flows have made the global economy more vulnerable to a worldwide recession. That's what emerged earlier this year: what economists called a synchronized downturn in the United States, Germany and Japan. Now, a rare drop in the U.S. consumer price index has led some analysts to ask whether the United States is going the way of Japan, into a deflationary spiral.

Japan has fed this ill-founded fear by blaming its own deflation problem on China. Sure, China is exporting cheap steel and other products like mad, which drives down prices in other countries. In the first half of 2001 alone, the United States and other countries launched 22 investigations against China for dumping export goods at prices below the cost of production. Still, as troublesome as cheap imports can be, the effect on prices is limited to steel, textiles and other industries that compete directly with the Chinese. Such scattered pressure can't trigger a broad collapse in prices. Desmond Supple of Barclays Capital in Singapore dismisses Japan's attempt to blame deflation on China as "insane."

The notion that it is even possible to "export deflation" is an exaggeration of the power of globalization, for both good and ill. Major economies are far less vulnerable to world markets than is widely believed. Trade accounts for only about 10 percent of economic growth in Japan, Europe and the United States, says Paul Donovan, global economist with UBS Warburg in London. That's far too small a share to reverse inflation in the economy as a whole.

The only way to export deflation from Japan would be to slash the value of the yen, making all exports cheaper. Even that wouldn't produce global deflation, Donovan argues; it's impossible for every country to weaken its currency against all others at the same time. In the world of floating exchange rates, a product cheaper in one currency has to be costlier somewhere else. Europe is keeping a close eye on deflationary signs in Asia and North America, but the risks there are even more remote: Eurozone inflation was running at 2.4 percent in October. And no matter what happens in Japan, deflation is a domestic problem ...