EDITORIAL: Global deflation fears

Financial markets have signaled fears that both the United States and Europe may be sliding into Japanese-style deflation.

Amid such concerns, the yield on new issues of 10-year Japanese government bonds, the benchmark indicator of long-term interest rates in Japan, has fallen below 1.0 percent for the first time in seven years.

There is currently a massive global glut of money due to the extremely easy monetary policies adopted by major countries to stimulate economic growth.

A big chunk of the surplus money is staying away from stock markets and instead flowing into the markets for government bonds, which are regarded as much safer assets. This trend has driven down interest rates around the world. The drop in the benchmark Japanese government bond yield is part of the global decline of the cost of borrowing.

The trend was triggered by growing concerns about economic stagnation in the United States and Europe. There are now even fears that the entire developed world could get caught in the grip of deflation.

As a result, investors are, for now at least, pouring into the yen, which is seen as more stable than most other major currencies. They are also piling into Japanese government bonds, which are believed to carry relatively little risk of being dumped as they are mostly held by domestic investors.

Hence, we now have the puzzling situation in which investors are flooding into bonds issued by the heavily indebted Japanese government, causing bond yields here to slide.

If an overheated economy pushes up prices, raising concerns about inflation, people start spending money on goods and services. The upshot is higher interest rates.

On the other hand, expectations that prices will be lower amid deflationary pressure are likely to encourage consumers to squirrel away cash. The cash placed in bank deposits is then used by the banks to buy government bonds, thereby depressing interest rates.

A decline of long-term interest rates indicates mounting concerns about deflation among the public.

The current decline of interest rates is worrisome not because it indicates a possible pause in the recoveries of the U.S. and European economies from the recession precipitated by the failure of Lehman Brothers. It is disturbing rather because their economies are slowing down or deteriorating in a way reminiscent of the process in which chronic deflation took hold in Japan following the collapse of the asset-inflated bubble.

Increasing bad loans on bank's balance sheets set the stage for long-term weakening of demand by causing credit contraction, thereby crimping both consumer spending and business investment. This leads to a further increase in the government's budget deficit and bad loans on the banks' books.

There is no silver bullet to break this vicious cycle. It takes many years for an economy to extricate itself from such a deflationary downturn.

Even if the current situation is not threatening to push the world economy off the cliff, it is creating crippling fears among investors around the world that the global economy may keep limping for a long period.

Sagging interest rates, which lower the government's debt-servicing costs, may in a sense be welcome news given Japan's fiscal crunch, with government borrowing approaching 200 percent of gross domestic product. But investors are not buying Japanese government bonds because they are impressed by Japan's fiscal management.

Although the Japanese government bond market is riding high on notoriously fickle investment flows, the risk of a sudden crash of inflated bond prices is growing quietly.

It is important for Japan to achieve both economic growth and fiscal rehabilitation, which requires preventing any unnecessary turmoil in financial markets.

There is no good reason for Japan to be happy about an excessive fall in interest rates.

--The Asahi Shimbun, Aug. 5