Before we can focus on avenues for creating new growth for an economy devastated by the effects of COVID-19, we need to understand what our constraints are and why they need to be in place. Overextension on stimulus could have devastating effects on future growth and creates very real risks of destabilizing inflation. Conversely, responsible and carefully planned stimulus can quickly pay for itself with new growth and the creation of lasting assets, both tangible and intangible. We can exit this crisis stronger than we entered it if we use the right blueprint of the future.
The above chart shows the growth of the total amount of cash (and equivalents) in the economy. This spike prevented a collapse in bonds and business credit, but it also has driven stocks and bonds to all-time highs in the midst of one of the most rapid and severe economic contractions in American history. Asset price inflation has come because there isn’t anywhere else to put enormous warehouses of new cash. It also means that investors have gobbled up any sovereign debt at rock-bottom interest rates without thinking twice while debt to GDP ratios have reached all-time highs globally. It makes it easier to borrow, sure, and our 401(k)s look ok, but inflated asset prices constrict social mobility. The trend is not new, but it has accelerated. Here, we can see housing prices over time (there are other factors at play, too, but excess liquidity is a major one). It is making it exceptionally difficult for low- and middle-income young people to participate in the single easiest way to build wealth.
We have also seen the highest levels of personal savings in history following the stimulus checks that were sent out earlier this year. Uncertainty in future income pushes people to save, but when we re-emerge from the pandemic, spending will return to normal. That money, when deployed, will help jumpstart the economy and it will help jumpstart inflation. Some of that is healthy – we have had stubbornly low inflation since the financial crisis more than 10 years ago. Small amounts of inflation encourages consumption while higher inflation can be destabilizing for low-income individuals in particular. Wages are sticky while assets generally change in price accordingly, creating a buffer for the wealthy. Inequality is thus exacerbated.
Higher levels of debt, meanwhile, drag down growth. Our debt to GDP ratio is already higher than at any point in history. It just surpassed the levels we reached in World War II this year. A big part of that is that it constricts the government’s ability to spend on things like infrastructure, research, and education. Debt service costs rise as a portion of the budget, scaring investors away from buying bonds as they roll over*, which forces the government to pay higher rates of interest and thus creates an even bigger crunch. The only way out for an economy as large as the United States would then be austerity and we only have to look at southern Europe to know what that looks like (stagnation).
There are some things that tend to perform well as government investments. Infrastructure, when there is any underinvestment, can even appreciate in value. Intellectual property investments in technology and basic science (as in fundamental science that may not yet have commercial applications) can have startling returns as it grows human capital and gives a base from which new ideas can grow. GPS and the internet are both examples of things that came about because of government investment. The key is that these are investments. When we make one-time expenditures, we have to be much more certain of their efficacy in accomplishing specific goals. Growing the economy with stimulus can be incredibly effective if the economy grows more than the Federal debt. You grow both the pie and its container. It is when we stop grounding our spending in its real impact that debt grows out of hand and then the problem becomes a snowball rolling down a hill covered in fresh powder.
*Rolling debt is the practice of issuing new bonds to pay off old ones. When finances are healthy, this is not a problem. When debt levels get too high, markets tend to punish the issuer by requiring a discount to buy their debt.