Debt Déjà Vu

NEW YORK – For two years, financial markets have repeated the same error – predicting that US interest rates will rise within about six months, only to see the horizon recede. This serial misjudgment is the result not of unforeseeable events, but of a failure to grasp the strength and global nature of the deflationary forces now shaping the economy.

We are caught in a trap where debt burdens do not fall, but simply shift among sectors and countries, and where monetary policies alone are inadequate to stimulate global demand, rather than merely redistribute it. The origin of this malaise lies in the creation of excessive debt to fund real-estate investment and construction.

During Japan’s 1980s boom, real-estate loans quadrupled in just four years, and land prices increased 2.5-fold. After the property bubble burst in 1990, over-leveraged companies were determined to pay down their debts, even when interest rates fell close to zero. While large fiscal deficits partly offset the demand-suppressing effects of private deleveraging, the inevitable consequence was rising public debt. Corporate debt slowly fell (from 140% of GDP in 1990 to about 100% today); but public debt rose relentlessly, and now exceeds 230% of GDP.

Since the financial crisis of 2008, that pattern has been repeated elsewhere. In the United States and several European countries, excessive debt creation before 2008 was followed by efforts at private deleveraging, initially offset by large government budget deficits. Advanced economies’ cumulative private debt-to-GDP ratio has fallen slightly – from 167% to 163%, according to a recent report; but public debt has grown, from 79% to 105% of GDP. Fiscal austerity has therefore seemed essential; but it has exacerbated the deflationary impact of private deleveraging.