Missing the Prime Suspect in the Global Slowdown

“You want quantitative easing? I’ll show you quantitative easing!” That’s the message Japan’s central banker Haruhiko Kuroda sent to global securities markets Friday, spurring the Dow to a record high. He announced that he will boost asset purchases by up to one-third, snapping up even more debt paper than the Japanese treasury is issuing.

Mr. Kuroda believes he is fighting deflation, an idea that seems to be contagious. The European Central Bank (ECB) also has been buying bonds to stir the continent out of its torpor. And President James Bullard of the St. Louis Federal Reserve Bank urged the Fed to extend its QE purchases of government securities beyond the planned October shutdown last week, advice the Federal Open Market Committee chose not to take. Mr. Bullard told an interviewer that he feared “inflation expectations” were too low, a concern cut from the same cloth as Mr. Kuroda’s fear of deflation.

Many people think low inflation and inflation expectations are a good thing. U.S. consumer prices barely budged in September and the consumer-price index (CPI) was up only 1.7% from a year earlier. Motorists are enjoying the lower cost of filling gas tanks.

But the Fed wants higher inflation, targeting a rate of 2%. That would have certain beauties for the government if not for consumers. Inflation devalues debt, and of particular moment is federal government debt, which has soared well over $4 trillion in the past four years to $17.9 trillion. Inflation expectations are believed to stimulate spending as consumers try to get ahead of price increases, a presumed effect that appeals to the Fed’s Keynesians.

Central-bank worries about deflation may be misplaced. Couldn’t it be that it is the mounting global debt that is dragging down economic growth, not a lack of fiscal or monetary stimulus? Yet central banks seem wedded to the so-called monetary stimulus course set by the Fed after the stock-market crash of 2008.

The rising debt burden was detailed on Sept. 16 in the annual Geneva Report, vetted by an international assemblage of 70 central-bank officials and other monetary specialists under the aegis of the International Centre for Monetary and Banking Studies (ICMB). The report concluded that central banks “should be slow to raise interest rates” because of the continued and disturbing expansion of global debt. There would seem to be an element of illogic in that advice. An outsider might think that raising interest rates would be the correct way to curb debt excesses, but then outsiders also think that inflation is bad, not good.

The Geneva report is titled “Deleveraging, What Deleveraging?” It says that after the debt explosion of the 2000s contributed to the 2008 crash, there was a widespread expectation that governments, households and businesses would shed debt, or “deleverage.” But that hasn’t happened. While American households have de-leveraged, world-wide debt has continued to grow rapidly, thanks in large part to governmental deficits. According to the report, global debt (excluding that of the financial sector) as a percentage of GDP has risen 36 percentage points since 2008, to a record 212%.

At the same time, “world growth and inflation are also lower than previously expected,” creating a “poisonous combination” of rising debt and slow growth. The growth slowdown makes deleveraging harder while at the same time high indebtedness exacerbates the economic slowdown, a phenomenon the report describes as a “vicious loop.”

Governments are big contributors to the debt boom. The U.S. ratio of public debt to GDP has climbed 40 percentage points to 105% since 2008. The report cites studies showing that high debt levels increase vulnerability to financial crises and give rise to “moral hazard” issues deriving from borrower expectations of government bailouts.

The Geneva report reflects the anxiety that afflicts central bankers around the world at a time when the most important central bank, the U.S. Fed, seems to be at sixes and sevens about where to go next with the highly unorthodox monetary policy it has practiced since 2008 with so little positive effect.

As the global economy slows from an already low rate of growth, despite recent signs of life in the U.S., it should be clear that artificially suppressed interest rates have done little to stimulate growth. They have discouraged saving, hence retarding capital formation, and have encouraged borrowing, adding to the economic burden of debt service. If, as some economists argue, the Fed is keeping inflation in check despite zero-bound interest rates by exercising its Dodd-Frank powers over bank lending, the equivalence of that to central planning can hardly be considered healthy.

The Fed well remembers what happened in 2006 when belatedly raising rates to a normal level caused pumped-up housing prices to fall. But it perhaps forgets that the most important factor in the 2008 crash was that falling house prices exposed the frailties of the many billions of dollars of toxic securities in circulation, held by the likes of Lehman Brothers, that were based on subprime mortgages engendered by government affordable-housing policies. Had it not been for those faulty debt instruments, the debt bubble could probably have been deflated with relatively little damage.

As the Geneva report suggests, central bankers are now motivated by fear, no doubt hoping that the day of reckoning for the continuing global rise of debt will occur on someone else’s watch. But what if it doesn’t? Might it not be better to take more sensible measures now, like allowing interest rates to rise to a level that would bring saving and borrowing into better balance?

George Melloan, a former columnist and deputy editor of the Wall Street Journal editorial page, is the author of The Great Money Binge: Spending Our Way to Socialism (Simon & Schuster, 2009).