As Americans focus on survival under COVID-19, they remain largely oblivious to increasingly dire fiscal threats. A “debt monetization” virus (printing money without limit) has been unleashed on us, one that threatens inflation, economic stagnation, and unsustainable debt that will cripple future and present generations. And, if there is a resurgence of COVID-19, the combined wreckage will be irreversible: America will plunge into a new chaos.
There are certainly scenarios where this does not unfold, all of which are dependent on COVID-19 waning. The stakes are very high: economic weaknesses exposed during the 2007-2008 crisis (including high leverage and systemic risk) were not cured. Critics claimed the 2008 bailout itself created a lasting moral hazard for banks, and regulatory oversight created by 2010’s Dodd-Frank Act was pared back significantly in 2018. As one market commentator, Nouriel Roubini, observed in 2020:
After the 2007-2009 financial crisis, the imbalances and risks pervading the global economy were exacerbated by policy mistakes. So, rather than address the structural problems that the financial collapse and ensuing recession revealed, governments mostly kicked the can down the road, creating major downside risks that made another crisis inevitable…
Roubini forewarned that this weakness would be aggravated by protectionist policies enacted during COVID-19, and the United States government has done exactly as predicted: they’ve monetized the fiscal deficit to avoid total collapse. To justify this (and calm market anxieties), the Federal Reserve has broached “even more unconventional and far-reaching” monetary policies, to quote Roubini. These unprecedented policies include tacit promises by the Federal Reserve to the Treasury Department (and Biden administration) that, no matter how much money is printed, interest rates will remain low.
Since 2007-2008, ear-tickling arguments that the old rules can be cast away, and money printed freely have proliferated. John C. Williams, currently President of the Federal Reserve Bank of New York, is one such aficionado of “monetary policy under uncertainty.” While President of the Federal Reserve Bank of San Francisco, Williams hazarded that:
Milton Friedman famously said, ‘Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.’ We are currently engaged in a test of this proposition … In my view, recent developments make a compelling case that traditional textbook views of the connections between monetary policy, money, and inflation are outdated and need to be revised.
The Federal Reserve stated in mid-2020 that it will keep the federal funds rate near zero; this is itself a component of Fed aggressiveness called “forward guidance.” Traditionally, the Federal Reserve does not “guarantee rates for the future,” as this instills understandable market fear of unmonitored inflation. The federal funds rate (the rate banks charge for overnight loans, which is set by the Federal Reserve) strongly relates to interest rates on mortgages, credit cards, and other debt. But an important aspect of the Fed’s job is to monitor rates to prevent inflation—promising rates will remain low abandons that function, eliminating the Fed’s independent market monitoring function, and tying its (and the nation’s) fiscal hands in the event of rising inflation or other crises.
Promising low rates with unlimited spending power to the money-printers is a moral hazard: it encourages reckless debt monetization, unchallenged by a citizenry panicked by COVID and desperate for financial assistance. Morgan Stanley reported that early in the COVID-19 crisis, the Fed was buying securities at eight times the rate under 2007-2008 Quantitative Easing (QE), the process by which the Federal Reserve bought up trillions of dollars worth of mortgage and other securities to inject money into the economy and financial system. The Fed now holds more mortgages than ever, exceeding 34% of all mortgage debt.
The federal government has no choice. Mortgage (and rent) defaults skyrocketed when COVID-19 befell. Investors did not wish to own delinquent mortgages. Had the Fed not stepped in, the entire mortgage and banking system would have collapsed rapidly. The Fed’s actions kept interest rates artificially low, preventing (or merely postponing?) an uncontrollable rout.
But now, the debt-printing holding pattern must be maintained: interest rates are approaching zero, and the Federal Reserve is basically backing the entire mortgage market. The Fed dare not pull its monetary finger from this massive fiscal floodwall. President Biden’s tax plans will add another revenue-sapping straw to businesses’ backs—the Tax Foundation estimates some 46% of increased tax revenues will come from business, even as expansions of Child Care credits and other provisions reallocate wealth. Increases in corporate, capital gains, and individual income tax rates will undermine rather than bolster economic growth, especially when twinned with growing debt. As the Tax Foundation cautions, “Biden’s tax plan would reduce the economy’s size by 1.62% in the long run. The plan would shrink the capital stock by about 3.75% and reduce the overall wage rate by a little over 1%, leading to about 542,000 fewer full-time equivalent jobs.”
Meanwhile, not all COVID-19 spending is COVID-related—that pork is tying rocks to the feet of businesses trying to swim in fetid fiscal waters. Huge sums are being routed to arts organizations, and the President has launched a massive “infrastructure rebuilding program” for roads and bridges that he touts will “win the future.” Raising taxes while raising debt to fund expanded spending inflicts a chokehold on economic growth while creating strong inflationary pressures. Using COVID as an excuse to launch brave new economic experiments will have consequences: the risks of both inflation, and recession, are amplified by a reckless (desperate?) Federal Reserve policy that promises unconditionally to keep interest rates low long-term.
Note the constant pressure on the government and Federal Reserve to support Main Street and poor Americans, concurrently with banking Juggernauts that are “too big to fail.” This, too, is an almost impossible balancing act, as money funneled to Wall Street is more likely to cause asset inflation. One insightful investment analyst explains it this way: “When QE is used to buy mortgage-backed securities, corporate bonds, stocks, or other things, it mainly goes to financial markets rather than Main Street. When QE is used to buy Treasuries in a normal sense, it makes it to Main Street.” A large proportion of COVID relief funds have been applied in that first category, which artificially inflates asset values (as opposed to income). As Forbes magazine recently noted:
By now pretty much everyone knows that the massive amount of financial stimulus from the central banks and the government has bid up all asset prices. But the Fed and the rest of the central bank community … are now all leaning on Modern Monetary Theory (MMT) which says that as long as there is no inflation, a sovereign government can, and should, print unlimited amounts of money to solve economic, financial and social problems.
Contrary to popular belief, 62% of the 2019 federal budget supports social programs like Social Security, Medicare, and Medicaid, versus merely 21% in 1960. This (inefficiently) fuels the economy, while gradually supplanting it: social program investments support consumer spending (demand), but provide zero investment capital, or business support. An economy doesn’t grow by service sector (healthcare, for instance) alone, so overlarge social programs tap economic vitality and undermine the economy more than they might stimulate it. Perhaps the President will soon announce his first Five-Year Plan.
This Scylla and Charibdis will narrow: for Biden, the Fed, and all Americans. As the COVID relief (and tax “stimulus”) spending works its way through the economy, both pressures on interest rates, and demands for yet more cash infusion, will increase, squeezing the nation between those competing pressures. Ironically, many people are earning more money on government relief than pre-COVID, and dependencies are increasing. It is unsurprising that narcotics overdose deaths spike each time COVID-19 “relief” checks are issued. But it is not sustainable, and at some point, substance abusers are just going to have to “earn” their fix (and food) again.
The Federal Reserve’s purchases forestall mortgage rate spikes (temporarily), but they threaten artificial asset inflation (by pumping up demand, which causes prices to rise) that then tempts the Federal Treasury to shift its tax base from income (Main Street) to asset appreciation (Wall Street) in order to preserve revenue flows. This too is a moral hazard: taxing “gain” that is attributable to inflation is behind the current Dem push to tax wealthy New Yorkers for holding on to assets in an inflationary cycle.
Calling out Federal Reserve Chairman Jerome Powell for essentially giving Congress a green light to print money without fear of rate hikes, Wall Street Journal writer Joseph Sternberg cautions:
Treasury will benefit from Mr. Powell’s success in stoking stock and other asset markets to record highs over the past year even as the pandemic and attendant lockdowns throttled the Main Street economy. The growing disconnect between Wall Street prices and Main Street profits holds open the prospect that capital-gains taxation will grow ever more reliable as a revenue source … The government traditionally relied for revenue on the economy’s underlying productivity … To make the government proportionately more dependent on Fed-inflated capital gains, as Democrats are wont to do, would weaken an important tie between Congress’s fiscal role and the real economy. This is especially dangerous…
The government is becoming “more dependent on Fed-inflated capital gains,” Sternberg cautions, which is “especially dangerous given mounting evidence in the economics literature that monetary and financial excess saps Main Street productivity rather than bolstering it.”
Properly understood, the Federal Reserve is not competently managing this crisis—it is feigning control while it is compelled into an unsustainable holding pattern of printing money. If it stops purchasing mortgages, rates will spike sharply, and panic will ensue. If it stops printing money for Main Street, upheaval and business decline are assured.
U]nder realistic parameter constellations, a debt ratio of 130% of GDP constitutes a critical threshold, where the line between sustainability and unsustainability is very thin. With a debt ratio above this ‘reference value’, a government might struggle to cope with the cost of debt … With very low interest rates, it is tempting for governments to spend more. However, while risk-free rates hover around zero in the euro area, high-debt countries face considerable risk premia that can lead to a feedback loop in which high-risk premia lead to higher debt, which in turn leads to ever higher risk premia.
Debt service (the amount of revenue diverted to meet growing interest payments) begins to swallow real growth, even as interest rates spike (in part due to that debt), creating a vicious cycle (that “feedback loop” referred to above) from which not even the mighty Greenback is immune. America is now well beyond that threshold, praying it is not a cliff. Stratospheric lending levels led to widespread suffering in some European nations, who, because of their penchant for borrowing and spending, became known as the PIIGS nations (Portugal, Ireland, Italy, Greece, and Spain). Has America become a PIIGS country?:
During the early 2000’s, fueled largely by an extremely accommodative monetary policy, these countries had access to capital at very low interest rates. Inevitably, this led to some of the weaker economies, especially the PIIGS, to borrow aggressively, often at levels that they could not reasonably expect to pay back should there be a negative shock to their financial systems. The 2008 global financial crisis was this negative shock.
The Federal Reserve promises rates will stay low, and it will buy all mortgages—and market securities—required to uphold the markets. In essence, the Federal Reserve has become the economy, itself a terrifying prospect. But in all its promises and forecasts, the Fed is assuming a rosy national GDP growth of approximately 6.5% for 2021.
The March 10th, 2021 Economic Conference Board Forecast for the U.S. Economy considers a “pessimistic” scenario unaddressed by the Federal Reserve, in which an “additional wave” of COVID-19 mutations cause “the U.S. economy [to grow] by just 2.8 percent (year-over-year) in 2021.” Of course, a COVID-19 resurgence is just one of many economic shocks that could instead push national GDP into negative territory. But at 2.8% growth the Economic Conference Board forecasts
In this scenario, U.S. monthly economic output does not recover to pre-pandemic levels until sometime in 2022.
Economics may be the science of yawns, but Americans should bolt awake to the knife’s edge along which President Biden and the Federal Reserve are so dangerously crawling. There is no margin for error: even if COVID disappeared tomorrow, a 140% deficit coupled with a declining economy and more taxes on businesses means that future generations carry the largest fiscal burden in U.S. history, bar none. Meanwhile, spendthrift state and federal governments are using COVID funds to expand rapidly, increasing long-term drains on real growth.
In the race through this treacherous channel, America must care for its poor and avoid revolt, while nurturing its banking and securities systems without sparking crushing inflation. The Federal Reserve pretends it has its hand on the monetary rudder, when in fact, the COVID-19 current has flung it wildly into uncharted seas. President Biden, too will howl at the wind, as we see whether we crash onto the rocks of strangling runaway inflation, or plunge into the whirlpool of economic and political anarchy.