Rising Global Debt and the Deflation Threat

Years of deficit spending and near-zero interest rates have led to massive borrowing but little growth.

By George Melloan




Franklin D. Roosevelt’s March 1933 inaugural line “that the only thing we have to fear is fear itself” was inspiring, but wrong. There was plenty to fear, not least the deflation that then gripped the nation.

Today we’re in a new age of anxiety, with voters opting for anti-establishment outsiders like Donald Trump and Bernie Sanders. Americans are not experiencing deflation, but there are some early symptoms. More important, the potential cause is apparent.

Among symptoms, dollar prices of oil and many other commodities have slumped; the U.S. consumer-price index hardly budged in 2015. The European Central Bank and central banks in Japan, Switzerland, Denmark and Sweden are now charging commercial banks interest on their reserve deposits (negative interest rates) to try to stimulate lending.

The decline in energy prices is appropriately celebrated, but the big question is whether the Federal Reserve and other central banks can arrest a slide into a general deflationary malaise.

Here is a possible reason why they can’t: Years of government “stimulus” spending are working against them.

Irving Fisher, a prominent monetary economist in the 1920s and ’30s, explained how deflation could result from an abnormal buildup of debt. A debt bubble, he wrote ( Econometrica, 1933) ultimately would burst “through the alarm of either debtors or creditors or both.” Debt will be liquidated by the distress sales of assets, the contraction of bank deposits as bank loans are paid off, and the slowing down of monetary velocity (the turnover from account to account that modulates the effective supply of money).

With falling prices come plummeting profits that force employee layoffs. The resulting pessimism and loss of confidence leads to “hoarding and slowing down still more of velocity of [monetary] circulation.” The effective money supply contracts, hence deflation. In Fisher’s view, that’s why the American economy sank into Depression in the early 1930s. (Why it stayed depressed for a decade is another story.)

When global stock markets crashed in 2008, Fed Chairman Ben Bernanke was determined not to repeat a mistake made in 1929. After that crash the Fed failed to create enough money to compensate for the sudden loss of bank liquidity and a deflationary contraction of the money stock. And so Mr. Bernanke in December 2008 lowered the Fed’s interest-rate target to an upper bound of a quarter of a percentage point and a lower bound of zero. There it stayed until the quarter point increase in December 2015.

Unfortunately, Congress also passed, at President Obama’s urging, a massive and highly politicized $831 billion “stimulus” bill a few months later. The spending did not lead to much if any growth, but it was followed by a string of trillion-dollar-plus deficits. Federal debt, a bit over $10 trillion in 2009, has ballooned to more than $18 trillion.

In other words, while Mr. Bernanke and Ms. Yellen were trying to prevent deflation, the federal government was engineering its cause, excessive debt. And the Fed abetted the process by purchasing trillions of dollars of government paper, aka quantitative easing.

Near-zero interest rates also have encouraged consumers and business to releverage. Cars are now financed with low or no-interest five-year loans. With the 2008 housing debacle forgotten, easier mortgage terms have made a comeback. Corporations also couldn’t let cheap money go to waste, so they have piled up debts to buy back their own stock. Such “investment” produces no economic growth, but it has to be paid back nonetheless.

Amid the Great Recession, many worried that the entire economy of the U.S., or even the world, would be “deleveraged.” Instead, we have a new world-wide debt bubble. “The billions of taxpayer dollars that have been spent on bailing out the banks,” Aaran Fronda recently wrote in London’s World Finance magazine, “combined with huge amounts of quantitative easing and reducing interest rates to rock-bottom levels resulted in advanced economies holding the highest public debt-to-GDP ratios that had ever been seen.”

Global debt of all types grew by $57 trillion from 2007 to 2014 to a total of $199 trillion, the McKinsey Global Institute reported in February last year. That’s 286% of global GDP compared with 269% in 2007. The current ratio is above 300%. The big boost came from governments. The debt load, McKinsey noted, “poses new risks to financial stability and may undermine global economic growth.”

The Fed says it wants to “reflate” to the tune of 2% annual inflation—which would let the U.S. Treasury, among others, work off its debt with cheaper dollars. But the Fed isn’t getting the inflation it wants and the deflation risk persists. Its desperation can be deduced from Ms. Yellen’s suggestion that she would consider negative rates. “Helicopter money”—with the Fed bypassing the banks and somehow funneling money directly to consumer accounts—is even being discussed in the press.

Ironically, voters are turning toward a developer, Donald Trump, who never met a highly leveraged project he didn’t like. As for Bernie Sanders, his wishes are simple: more federal spending and borrowing on welfare programs. Should we be worried about any of this?


Mr. Melloan is a former deputy editor of the Journal editorial page. His book “When the New Deal Came to Town” will be published by Simon & Schuster in the fall.

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