September 9th, 2011
by Doug Short
Here is a series of real (inflation-adjusted) monthly close charts of the Nikkei 225 and the S&P 500 since 1970 with their respective annualized rates of inflation shown below. This series also includes an overlay chart with the two index peaks aligned. The overlay retains Japan's inflation to illustrate a point discussed later in this post.
Follow up:The left sides of the two bubbles are remarkably similar. More conspicuous, however, are the dissimilar contours of the post-bubble declines. A key difference is the fact that Japan experienced nearly simultaneous bubbles in equities and real estate; the former peaked in December 1989, the latter in early 1991. The equity and real estate peaks in the US were separated by approximately five years, and the 2005 peak wasn't generally recognized for another year or two because of the highly regional nature of the real estate market.
Inflation or Deflation?
Many economists and market experts predict high US inflation as a result of the massive government intervention in the recent financial crisis. However, in the wake of the Financial Crisis, the US economy slipped into an eight-month period of deflation unparalleled in nearly 60 years.
The decade following the Japanese twin bubbles was accompanied by mild inflation averaging around 1.4% with occasional brief periods of deflation. Thereafter, the Japanese economy has tended more toward deflation (see the circled area in the chart above).
The daily peak for the S&P 500 came in March 2000. However, in both real and nominal terms, the S&P 500 monthly close peaked in August 2000, which is the reference point of overly for the two charts. Following the 2000 high, the annualized rate of inflation averaged 2.8% until March 2009, when the economy moved into an eight-month period of deflation.
To some extent the widespread predictions of high inflation in the US have a political bias. Opponents of government intervention often point to excessive inflation as the inevitable outcome of bailouts, incentives and monetary easing. The Japanese government also played a strong interventionist role following that county's twin bubbles. As the chart shows, accelerating inflation has not been the result.
Of course the two countries differ in many respects. Both experienced stagflation during the 1970s, but the inflation charts during that period do not mirror one another. Likewise Japan's long-term post-bubble struggle with deflation does not preordain a similar fate for the US. The charts and commentary here merely constitute an observation that severe inflation is not the inevitable outcome of government efforts to manage the US economy. Deflation may be a greater threat than is commonly thought. It's worth noting that deflation didn't become a significant issue for Japan until near the end of the decade following the 1989 peak. Our 2009 bout with headline deflation occurred nine years after the top of the Tech Bubble.
The complexity of economic issues and political biases will no doubt fuel the inflation/deflation debate for some time.
A Closer Look at Japan's Deflationary Struggles
In closing, here's a close-up look at Japan's annualized monthly headline CPI going back four decades. I've included an overlay of the Discount Rate to help us see one aspect of Government's efforts to manage the economy.
Since 1998, deflation has been the dominant trend, with an average annualized rate of -0.20% over this time frame. Over the past ten months, however, the rate has averaged 0.18%. This is a modest rise, to bue sure — but one we'll want to watch. I'll update this commentary periodically in the months ahead.
For a more detailed view of the Nikkei performance, see this analysis of post-bubble rallies and declines.
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