Older population and cheaper prices

By Gwynne Dyer

LONDON (JP): In the long run, prices always go up, right? Wrong.

1999 is not over yet, but it is shaping up to be the first year in over half a century when global prices actually fell. Not only that, but the cost of living may be stable or falling for the next century. That would force us to re-think all our basic assumptions about money -- and our past experience will be no guide at all. It would be misleading, in fact.

Buying a house, for example, will cease to be an investment that is almost guaranteed to appreciate. Some houses, in the right neighborhoods, will rise in value, but others may fall. With the number of people in the crucial 21 - 35 age group falling in all the mature industrial countries, who is going to buy all those houses 10 or 15 years from now? And what applies to houses also applies to the multi-billion dollar loans to industry: if you cannot count on inflation to wipe out the debt eventually, then a bad investment decision stays bad forever.

This is not the way things have worked within living memory -- except in one country: Japan, where the inflationary era ended with the bursting of the "bubble" 10 years ago. Since then prices have been stable or falling, economic growth has crashed, and unemployment has soared (to 4.2 percent officially, but really much closer to 10 percent if you count all the "window people" who show up for work, sit by the window all day, and still get paid).

Some embittered Japanese expect the same thing to happen to the rest of the world, referring cynically to the U.S. economy as "bubble.com". Lots of people elsewhere in the world fear exactly that outcome, but they are not necessarily right: deflation is not always the same as economic stagnation or decline. Indeed, throughout the 19th century falling prices were accompanied by strong economic growth in both the United States and Britain.

What nobody realizes, after a lifetime of inflation, is that stable or falling prices are really the norm. We only have price data for the United States since 1800, but in England there are reliable data going back to the mid-1200s. They show only three periods of inflation.

The first was between 1520 and 1620 (roughly from Henry VIII's first divorce to the death of Shakespeare), when gold and silver flooding in from the Spanish conquests in the New World caused a fivefold rise in prices all over Europe. The second was during the Napoleonic Wars of 1792-1815, which the British government mostly financed by creating new debt, doubling prices in two decades. And the third began in 1940.

This last wave of inflation, ignited by the World War II, had a far bigger impact than either of the others. Prices in the United States went up 15-fold in the following six decades. In Britain, they went up 40 times. We think that is normal -- but only because we have been living in a time-warp.

The real normality is price stability, or even falling prices. And why would we be returning to normal now? Nobody really knows, but the likeliest culprits (or benefactors) are aging populations and the global market.

The global market, with more low-wage producers crowding into the market with every passing years, disciplines those who try to charge higher prices locally. It has not yet had a major impact on retail market (where price competition is already pretty effective), but it has transformed the wholesale market where most price rises usually start.

Even more important, perhaps, is the "aging" of the population in all the mature industrial countries. Older people tend to save more of their incomes, proportionately speaking, and they also tend to vote for governments that will preserve the value of their (more or less fixed) incomes by adopting anti-inflationary policies. It's not exactly surprising, therefore, that all the governments of the major English-speaking countries are running surpluses at the moment; they are responding to voter pressure.

These two changes in the environment are delivering us into a deflationary era which, on historical precedents, is likely to last for a long time. The trick, in this new environment, will be to avoid doing things that will cause our economies to go into a deep recession, particularly in the delicate transitional period.

That may be quite tricky, since nobody remembers what the rules of behavior in a deflationary economy are, but surely one rule must be: don't do what the Japanese did. That means, above all, not carrying hundreds of billions of dollars of bad bank debts for a decade. The end of inflation turns a lot of dodgy debt into outright bad debt, and banks have write it off as fast as possible: otherwise the whole system freezes up.

On the whole, everything should be all right for those economies that can persuade the consumers to keep on spending. But that means the consumers have to ignore the logical prospect that, in a deflationary economy, prices will be lower later.

Greed and impatience, it turns out, are even more important in a deflationary economy than an inflationary economy. If the consumers go on spending regardless, it will all be okay. Which is why the consumers in the English-speaking countries, famous for their propensity to spend up to and even beyond their incomes, may be the secret weapon of the Anglo-Saxon countries in the next decade, as we all learn to live with deflation.