Why Japan needs Abenomics and Bitcoin faces a lost century

What do Japan's "lost decade" and the intractable problem facing bitcoin have in common? Deflation.

Shinzo Abe. Photograph: Getty Images

The Japanese economy is in a mess. It has been for a while now. GDP broke $5trn in 1996, but then fell, and stayed low for a decade and a half. It only reached that high again in 2011, after well over a decade with growth fluctuating between mildly positive and mildly negative : the "lost decade" of economists' nightmares.

That's the background against which the new prime minister Shinzo Abe is struggling. Abe, a right-wing popular nationalist, was elected on a platform of giving the Bank of Japan a kick up the arse and using unconventional methods to restore the country to growth. His motivations have been questioned repeatedly: some fear that he's just trying to provide a short term boost to the economy before the upcoming election to in country's upper house; others, that he's only enacting bold new policy due to a stubborn belief that whatever conventional economists say must be wrong. Sure, a stopped-clock is right twice a day, but that doesn't mean you want to base your economy on what it says.

But the unconventional policies have been enacted, and now we are just waiting to see their effect. Abe has launched a ¥10.3trn stimulus package; his economic minister has explicitly targeted the stock market, in an attempt to push it up by 17 per cent in just two months; and he's got his choice of central bank governor, with the appointment of the maverick Haruhiko Kuroda.

But if we want to find out whether these plans are working, we don't look at GDP. That's too slow to change, it's too subject to external shocks, and, most importantly, it's a symptom, not a cause.

The real culprit is inflation. Or rather, deflation.

The Japanese economy has had inflation hovering around 0 per cent – and more frequently below it than above it – for almost as long as it has had stagnation. And while the country has seen a return, of sorts, to GDP growth, inflation remains as stubbornly negative as ever. Even after Abe's reforms, the headline rate fell – down to -0.9 per cent, the fastest rate of deflation in three years. That's against a background, not only of all those impressively major reforms, but also a far more direct one: raising the inflation target of the bank of Japan from 1 to 2 per cent.

But why is deflation a problem? In the west we're used to fearing inflation, after the scarring experiences of the 1970s, when prices grew by 20 per cent in a year. And we all learned in school about hyperinflation in Weimar Germany, where the price of bread would be higher in the afternoon than it had been in the morning, and how that led to the rise of Hitler. (Incidentally, that connection is largely mythical; although it was responsible for prompting the creation of many extremist groups, hyperinflation was largely beaten by 1924, long before the Nazi party became a force in German politics.)

But deflation – prices getting lower year-on-year – sounds like a good thing. Who doesn't like getting richer without having to do anything?

The easiest way to explain the issues is to look at another economy which could almost have been invented to illustrate the problems with deflation: the trade in bitcoins.

Bitcoin, you may recall, is an anonymous, cryptographic, peer-to-peer digital currency. It's been in the news because of its astonishing boom-and-bust dynamics, with the value of one bitcoin increasing by 2000% in two months, then losing almost all of that in a week, and now slowly returning to a second high. But what's interesting here is that it's a currency with deflation built in from the very start.

There will only ever be 21 million bitcoins. Half of them have been made – "mined", in the parlance – already, and the rest will be released in decreasing quantity at ten minute intervals until 2140. Add in the fact that, although they can't be created in any other way, they can be destroyed just by deleting the file that holds them, and you've got a currency which is designed to deflate.

That deflation was made far worse in the last couple of months by the hyperbolic increase in the value of a bitcoin measured in any normal currency. If you can buy a bitcoin for $10, and then a month later it costs you $200, then that is largely inseparable from inflation, particularly since you still need to use real currency to eat, pay your rent, and buy your travelcard to get to work. It got so bad that some started talking about "hyperdeflation".

What all that deflation does is ensure that, if you hold bitcoins, it makes sense to wait until you're absolutely sure you need to make a purchase before you part with them. After all, if you're the guy who bought a pizza for 10,000 bitcoins in 2010, you may have got a tasty meal; but if you had held off, you would be $1.3m richer now.

And it gets worse when you look at things like investment. If you used bitcoins to buy equity in a startup, your expected return would have to be through the roof to even stand still compared to where you would expect to be if you hoarded the money.

These are hypothetical questions for bitcoin – no stock market in the world lets you buy equity with the currency yet – but they're very real problems in Japan. The dearth of investment is so bad that the government has "nationalised" industrial stock, spending up to ¥1trn to buy plants in its biggest manufacturing industries.

There is optimism that Japan can pull itself out of this hole. Even as inflation continues to fall, predictions for future inflation are high; and there's a certain sense that with enough wild plans thrown at the wall, something is going to stick. Even if its just out of the frying pan and into the fire, a change of scenario would be nice.

The future's not so rosy for bitcoin. Even if its price stabilises, the long-term policy of deflation is not going to go away. The fact that Japan's "lost decade" lasted fifteen years may seem like a stretch, but bitcoin's could last a lifetime.