In July 2020, the Florida Squeeze published “Debt Lies and Economic Destruction,” which predicted the U.S. economy was steaming “toward catastrophe” as the spreading Covid-19 virus choked the growth out of the economy.
The U.S. avoided this catastrophe by a robust combination of $1.9 trillion in fiscal stimulus and monetary stimulus of more than $3 trillion. This debt combined with private debt now means that government, business and household borrowing has reached a historic peak.
As the Federal Reserve begins to withdraw the monetary stimulus, new fiscal spending will provide some adrenaline for the economy. President Biden and the Congress are looking to add between $1 and $4 trillion dollars in spending to build infrastructure and create a social safety net. There have been complaints that this will cause hyperinflation which will kill economic growth and employment.
As an issue of public policy, however, this is probably a step in the right direction. Monetary stimulus further inflames existing income and wealth inequalities. It massively shifts the nation’s wealth even further to the upper ten and one percent of wealth holders, corporate executives and fund managers.
It also subsidizes companies and governments that live beyond their means. U.S. companies borrow billions to buy back their stock which showers the largest shareholders and executives with lavish financial rewards. This money could otherwise be devoted to research and development, creating jobs, increasing wages and making the U.S. economy more competitive internationally.
The new fiscal spending will be financed by tax increases and new federal debt. As the spending increases cash flow into the private economy, tax increases of up to $2 trillion and debt creation will take it out. If these measures are passed as currently envisioned, the $4 trillion spending will add stimulus to the economy, which will be offset by increased taxes and new debt. A conservative view of the proposed changes would be $3 trillion in spending, with $1 trillion in taxation and $2 trillion in new debt.
As an issue of economics, an additional $2 trillion in spending within a total US economy of $22 trillion would be a significant boost; nearly 10%. But the spending will take time to flow into the real economy. Building new roads, bridges and power lines will take years in designs, environmental studies, purchasing rights of ways and citizen impact panels. New benefit programs will take months to set up, apply/qualify for and eventually receive. It will also take time collect taxes and sell new debt.
These fiscal changes are set against a backdrop of monetary contraction, as $3 trillion in is slowly removed from the economy. Viewed in this light, the total government changes could restrain the economy. The changes should have a zero to negative impact to inflation.
In the private sector, costs have increased as supply bottlenecks throttle down normal supply and demand relationships. Many of these blockages have been caused by the virus in terms of impacted workplaces and workers on unemployment. As announced corporate investment ramps up and Covid cases retreat, supply breakdowns should become breakthroughs.
If oil and natural gas production face resistance in the U.S. and Europe, the shortfall can be made up by Canada, Russia and Saudi Arabia. In other countries, restrictions on the use of fossil fuels will create inflation, some of which may be exported to the U.S.
In the last forty plus years inflation has often been rung out of the economy by technological advances and international trade. Technology continues at a Moore’s law pace while international trade and investment have slowed. While this could make inflation more persistent, nothing foreseeable would create hyperinflation.
Going forward, as the monetary stimulus is withdrawn, could equity prices be overvalued due to unsustainable leverage? Most U.S. equity indices have valuations higher than historical norms, but the Russell 2000 may be the most striking. It currently trades more than 350 times current earnings. At the present level, investors are paying more than $350 for each dollar in profit.
Prior to the 2020 and 2021 fiscal and monetary stimulus, Morgan Stanley chief global strategist, Ruchir Sharma, warned that sixteen percent of publicly traded U.S. companies, “earned too little to cover the interest payments on their debt and stay alive only by issuing new debt.” Morningstar’s credit rating agency and others issued similar warnings. Author, Michael Lewis wrote, “financial markets are a collection of arguments.” One argument could be that unless corporate profits increase substantially, some equities and corporate bonds may be overvalued.