Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Inflating and Deflating Japan.

Herbert Hoover

Survivors of the Great World Depression of the Thirties need no convincing about the catastrophe of deflation, but even they would have trouble defining it. Deflation is, well, something that was caused by the 1929 stock market crash, or maybe it was Herbert Hoover's fault, or maybe Hitler's fault. It is enough to know it was bad, that it's all over, and that it is on page six of the newspapers, below the fold. Unfortunately, it has returned again to crush the poor Japanese for the past fifteen years, but still, no one seems willing to say what causes deflation, or what will cure it. So, let's venture.

World Depression

The world acts as though it believes the following one-liner: The main cause of deflation is inflation. Merely keep inflation under control, and you will then avoid deflation, as well as the awkward need to know what to do about it. The main proof of this fragile argument lies in the fact that America has somehow avoided serious recession for almost twenty years by relying on "inflation targeting". It's a little uncomfortable to notice that the main proof that inflation is the only cause of deflation rests on the fact that we have had no recessions during the time we had no inflation. When central bankers are confronted with the lack of logic in that position, they appear distinctly uncomfortable. It may be correct that only inflation can cause deflation, but the proofs are unsatisfying.

Rock, Paper, Scissors

So let's retreat to a little safer ground. Let's say that massive shifts of currency can topple the stability of any government or national economy; inflation is the main cause of massive currency movements. However, it's like the old children's game of paper, rock, and scissors; you can't be sure in advance whether you want diversification, strength, or flexibility. Stability rests on long term financial commitments, like long-term bonds, or mortgages, insurance, or pension schemes. But maybe you don't want strength, you might want agility. Then, if you are in a position to anticipate currency disruption, you will shift from long-term to short-term. Panic like that undermines the people who are locked to thirty-year commitments but may not have thirty years to ride them out. The value of a national currency is tied to shifts in interest rates; that's the same thing, one within borders and the other across borders, like pushing on a balloon.


If you think government action can rescue a real panic, look at Japan. The Japanese sold good cars and cameras, acquiring a lot of foreign currency. That should have caused their own currency to increase in value, but instead, the Japanese just printed more of it to maintain the low international price of cars and cameras. All that resulting loose cash, confined within their borders, caused serious inflation of Japanese real estate and stock market prices; when this inflation shifted around, it capsized their boat. Long-term debts defaulted, eventually bringing the banks down with them.

Perhaps the Chinese have learned a lesson from Japan's experience, but don't count on it.

Originally published: Thursday, June 22, 2006; most-recently modified: Wednesday, May 22, 2019