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n most countries, investors are free to decide whether they believe deflation or inflation is the bigger threat. That depends on whether they fret more about excess money supply or excess capacity. In Japan, however, such choices are a luxury. The country was the first to bring miniaturised gadgets to the world. It was also the first to bring a sustained miniaturisation of prices.

For all the Bank of Japan’s worrying about incipient bubbles, inflation has barely appeared over the past decade. After stripping out food and energy, average annual prices have continued to fall since 1999 – except for last year, when they remained broadly flat. Now the drop is accelerating. Japan’s consumer price index, excluding fresh food, fell 1.1 per cent in May compared with last year.

Worse, prices in Tokyo, a lead indicator for the rest of the country, are dropping at a 1.3 per cent rate. Electronics shops are filled with ever bigger television screens carrying ever smaller price tags. And breakeven rates, which measure the yield difference between index-linked and government bonds, suggest prices could continue falling by 2 per cent annually for years.

That signal may be wonky, given Japan’s dysfunctional index-linked market. Still, the BoJ believes deflation could last another two years.

One worry is that this could be a harbinger of trends elsewhere. Many of the building blocks are familiar: Japan has an output gap that deflation tracks with a lag. It is suffering a big drop in demand as workers and companies are too nervous to spend and can defer purchases continually as prices will be lower tomorrow.

As governments everywhere also increase spending, other countries will empathise at the way deflation raises the real cost of all debts – although, as the most indebted rich country, Japan suffers most.

Miniaturised prices, like miniaturised gadgets, are not all they are cracked up to be.

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