Breaking bad habits

Consistent with this new mindset, the PBOC's unwillingness to put a quick end to the June liquidity crunch in short-term markets for bank financing sends a strong signal that the days of open-ended credit expansion are over. That is a welcome development. China's private-sector debt rose from around 140 percent of GDP in 2009 to more than 200 percent in early 2013, according to estimates from Bernstein Research - a surge that may well have exacerbated the imbalances of an already unbalanced Chinese economy.

There is good reason to believe that China's new leaders are now determined to wean the economy off ever-mounting (and destabilizing) debt - especially in its rapidly expanding "shadow banking" system. This stance appears to be closely aligned with Xi's rather cryptic recent comments about a "mass line" education campaign aimed at addressing problems arising from the "four winds" of formalism, bureaucracy, hedonism and extravagance.

Financial markets are having a hard time coming to grips with the new policy mindset in the world's two largest economies. At the same time, investors have raised serious and legitimate questions about Japan's economic-policy regime under Prime Minister Shinzo Abe, which unfortunately relies far more on financial engineering - quantitative easing and yen depreciation - than on a new structural-reform agenda.

Such doubts are understandable. After all, if four years of unconventional monetary easing by the Fed could not end America's balance-sheet recession, why should anyone believe that the Bank of Japan's aggressive asset purchases will quickly end that country's two lost decades of stagnation and deflation?

As financial markets come to terms with the normalization of monetary policy in the US and China, while facing up to the shortcomings of the BOJ's copycat efforts, the real side of the global economy is less at risk than are asset prices. In large part, that is because unconventional monetary policies were never the miracle drug that they were supposed to be. They added froth to financial markets but did next to nothing to foster vigorous recovery and redress deep-rooted problems in the real economy.

Breaking bad habits is hardly a painless experience for liquidity addicted investors. But better now than later, when excesses in asset and credit markets would spawn new and dangerous distortions on the real side of the global economy. That is exactly what pushed the world to the brink in 2008-09, and there is no reason why it could not happen again.

The author is a faculty member at Yale University and former chairman of Morgan Stanley Asia. Project Syndicate