It is clear that the economy is going to take a severe and
long-term hit from the CORVID-19 shutdown, despite the apparent recovery of the
stock market. A significant number of businesses are likely to fail, and of
those that remain, many will not be able to rehire as many workers, which means
a lot of people will be either unemployed, or at least earning a lot less than
they used to, which will depress spending and hence further depress the economy.
The Congressional Budget Office has a report out today (you can read it here) that
predicts that nominal GDP won’t recover until around 2030, and that real (inflation-adjusted)
GDP may never recover. That prediction assumes there is no additional effective
policy action by Congress to address this risk.
The core of the problem is that average household income
will be lower, so there will be less demand. One solution to that problem is
for the federal government to pump more money into the economy through grants/loans
to businesses and/or local governments, and/or various direct payments to
households like the $1200/person that Congress doled out last month. Of course the
federal government doesn’t have more money – it was already borrowing almost a trillion
dollars a year even before the pandemic. In essence the government would need
to “create” that money, either by borrowing even more, or perhaps just by “printing”
more money (the current euphemism for that is “quantitative easing”).
Two factors help us in the short term. First, dollar-denominated
assets at the moment look like a lot safer place to put wealth than anything else
in the world (however bad our economy, the economy of most other places looks
worse), so there has been a lot of capital flight worldwide to the dollar,
which is why so far the government has been able to borrow so much at such favorable
interest rates (current interest rates in new US debt runs about 2.5%). But the
federal government does something that your local bank won’t let you do – when a
bond comes due they simply “roll it over” by selling a new bond to pay off the
old one. That works as long as U.S. bonds are perceived to be safe investments.
If that perception ever changes, we
could have a lot of sudden flight out of Treasury Bonds, or at least we would
have to offer a far higher interest rate to sell our bonds, which would cause a
major problem for us.
And on top of this, the more extreme progressive wing of the
Democratic party is full of wildly expensive ideas that would push the demand
for federal funds and federal borrowing much, much higher, and that wing might force
Joe Biden to adopt some of their ideas in order to get support from that wing
of the party and win the election.
Second, for the moment at least the U.S. dollar is the world’s
reserve currency, which means we can get away with some things that other
nations can’t do so easily with their currency, like simply expand the money
supply by “printing” more (sorry, I mean “quantitative easing”). But there are
limits to how much of that we can get away with, and I don’t think anyone knows
what those limits are.
So the interesting question is this: what will be the
long-term effects of such increased borrowing and/or quantitative easing? In particular,
what risks does it entail, and are they as serious as the risks entailed in a depressed
economy? Not an easy question to answer,
but it seems to me the essential question to ask at this point.
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