I just took a peak at an interesting Business Week article from March 2006 called “How Japan fell into the Hole“.

The key message for me was this:

This shift to debt minimization, however, completely disrupts the normal workings of the economy. That’s because the corporate sector no longer borrows the funds saved by the household sector, even at ultra-low interest rates. With no one borrowing, those personal savings — plus the debt companies are repaying — pile up unused in the banks, effectively shrinking aggregate demand by the same amount. Left unattended, this deflationary gap will continue to shrink the economy until almost everyone becomes too poor to save any money.

In order for the disruption to become severe, we need reserves to be built up – money will need to be hid under pillows.  In this case, if the government can get hold these resources and put them to use (or say, if people are only willing to lend to government because of a substantially negative economic outlook) we avoid the paradox of thrift.

Fundamentally, for our demand deficiency to really get kicking, we need one of our prices (interest rates) to get “stuck” at a level which is “too high” leading to excess savings.  We are seeing a similar situation in the US, the question is – will we run into the same thing here in little old NZ?