Tuesday, March 16, 2010

Aging Japan / Keynesian theory / Inflation or Deflation

Andy Xie writes yesterday about the impact an aging population has on an economy, using Japan as the study case. In this article, he describes the point-of-view (POV) decisions people make. In other words, seniors have a POV that will be different than that of someone two generations younger. The impact will have economic implications that simply cannot be swayed when the numbers of people in the less productive older labor population are greater than the younger and physically productive working labor population. Most of his article addresses issues building over many years. The title of his article is "Our Next Economic Plague: Japan Disease" and includes a brief critique of Keynesianism because it is being promoted in Japan too. He says "Keynesianism is a prescription for a short-term economic hiccup. It's like a painkiller, not a cure. It tries to minimize output loss during a down cycle. It doesn't mean much for an economy in the long run. Without Keynesian stimulus, an economy is supposed to adjust properly. Using Keynesianism to explain or cure long term economic problems is just plain wrong." Using Keynesian theory makes for good policy when politicians are running for re-election, and after the election they can resume partisan games that produce token repairs to the damage brought on by Keynesian policies, like unlimited government borrowing and money printing.

There is one other aspect to Andy Xie's article that is germane to today's crisis. He mentions the economic conditions in Japan are currently deflationary, brought on by government borrowing, just like we see here in the US and across the Atlantic ocean. As long as the borrowing is tolerated deflation persists. At some point, there will be an end to the debt tolerance and that is the time when we'll observe a change from deflation to inflation. The force or forces that bring the change on are not known. It could be a bond market crisis or simply loss of tolerance where interest rates need to rise in order to attract buyers (the so-called bond vigilante's). It could be the result of a populist movement creating an opportunity for a free market action or several other possibilities. The point is, inflation is going to be an unwanted guest in our world, and we don't know when it will arrive or how long it will stay. All we can do is keep our eyes open to warning signs like bond market spreads and currency exchange rates for starters. In the meantime, we won't be getting any younger. Scanner