The world economy is a stimulus addict. This year it’s going cold turkey.
In China, keeping growth on track for the past five years has required ever larger injections of credit. The ratio of private-sector debt to GDP pushed over 200 percent in the first quarter of 2014, up from about 125 percent at the end of 2008.
That presents China President Xi Jinping and Premier Li Keqiang with an unpalatable choice. China’s new leaders could cap loans and face a sharp slowdown in growth, or they could continue on the credit binge and risk a financial crisis. So far the choice has been option No. 1.
That’s the right decision, but the consequences are still painful. New lending is flatlining. Investment is fading. At 5.7 percent, annualized first quarter GDP growth was well short of Premier Li’s 7.5 percent target for the year. With a key gauge of factory activity pointing to contraction in April, the signs heading into the second quarter are little better.
In Japan, the bursting of the credit bubble in 1989 left corporations saddled with debt and unwilling to spend. To prevent a lost decade turning into a permanent coma, the government was forced to rack up enormous debts. In 2013, an Abenomics spending splurge to kick-start the economy added to the debt load.
With public debt at 237 percent of GDP, Japan’s Prime Minister Shinzo Abe faced a choice no more palatable than that facing China’s leaders. Raising taxes threatened to strangle the infant recovery in its cradle. Continuing to borrow risked a sovereign debt crisis that would make Greece’s recent problems look like the first act of a larger tragedy.
Abe’s solution for 2014 is a compromise. A hike in the consumption tax—the first since 1997—will be offset by higher public spending. Even that threatens to stop Japan’s recovery in its tracks. GDP in the world’s No. 3 economy is expected to contract at a 3.4 percent annualized rate in the second quarter.
Worse could be to come. If Tokyo wants to avoid a debt apocalypse, a budget deficit of more than 8 percent of GDP has to swing into surplus. That’s tough to do without taking a serious chunk out of growth.
In the U.S., meanwhile, exiting an extraordinary period of monetary stimulus is proving less easy than entering it did. The U.S. housing market—a key contributor to the recovery—is hooked on low rates. Even a modest percentage-point increase in mortgage costs in the past year has caused tremors. New home sales fell to an 8-month low in March.
The U.S. housing market is not the only one to suffer. With the cost of credit low, emerging markets from South America to East Asia became accustomed to capital inflows. In the years after the 2008 financial crisis, that buoyed stock prices and fueled a boom in real estate. As rates in the U.S. start to rise, emerging markets have been roiled by sudden reversals in capital flows twice in the past year.
Past stimulus in the world’s three largest economies had a purpose. Massive loan growth in China and close to zero rates in the U.S. eased the pain of the 2008 financial crisis. In Japan, the government had to keep borrowing to offset the impact of corporate saving. Still, even well-intentioned stimulus can’t go on forever. As policymakers in Beijing, Tokyo, and D.C. are discovering, breaking the stimulus habit is tough to do.