March 31, 2020
Do you remember back in the good old days when government announced deficit spending to aid the economy? The country would increase the deficit by $20 billion or $30 billion and employ thousands directly to build roads, or bridges or build schools? Those deficits would create economic activity in hard hit regions where industries were dying or invest in modernization or productivity gains. Do you remember those days?
During the financial crisis of 2008-2009, it became clear that the financial framework that current policies had supported would collapse if money was not provided to shore up the financial system. In 2007, the US government had about $9 trillion of debt and the Canadian government had about C$692 billion. US debt loads doubled in eight years, Canada’s debt load will double by this year (2020).
The annual deficits are now so common place and the arguments for them so acceptable, that this seems to be perfectly fine.
- “Interest rates are near zero, so the economy can support the debt payments . . .”;
- “The economy needs to grow or the debt will be impossible to manage . . .”;
- “If we don’t support employers, then your job will disappear . . .
The arguments are tinged with the fear of loss. Even economists who understand the alternate path are well aware that the ‘other’ path is dire and not an approach that would be undertaken by the typical voter.
In a cruel twist, the COVID-19 outbreak has rapidly transformed from a nasty flu, to a pandemic and will almost certainly make it to the status of plague. (not, the Plague which is a specific disease). If it continues on its current path, it will bring about all of the downsides these stimulus bills are seeking to prevent.
During the 1987 market decline, equity prices slumped rapidly and the central bank stepped in to provide liquidity to avoid a liquidity crisis. There were many structural differences in the financial world of the time, among them, commercial banks were NOT allowed to operate investment banks. In effect, two separate management teams were at odds over risk taking, one working to actively preserve capital, the other risking capital to improve returns. While this dynamic reduced opportunity, it also likely reduced risk taking. The support required by the government and central banks around the world was modest relative to the size of the economy and things returned to normal within a year. Growth in the US, barely even slowed down.
Within a decade, trade with China and India were opening up. Jobs were being sent off shore to reduce costs and improve profitability. At the same time, the internet was becoming an important technical innovation. This all occurred while the barriers between commercial banking and investment banking were being removed. After a spending binge to prepare for the “Year 2000” transition, prices again collapsed, particularly with technology stocks. The declines in the market were substantial, but the economy still grew. All of this turmoil did not require massive increases in government debt.
Then things changed. During the Bush Presidency, in the aftermath of the attack on the World Trade Center, America spent $3 trillion fighting a war. At the same time, policies to support home ownership for Americans, lax lending rules and a wide array of products that made financial engineering possible, caused a near collapse of the banking system in 2007/2008. At the end of 2007 the US national debt was about $9 trillion.
The subprime mortgage crisis threatened the US banking system, but also financial intermediaries around the world, and central banks banded together to support the economy. First the US central bank under Ben Bernanke told the world they would provide massive liquidity (and they did). Between 2008 and 2012, the US flooded the country with $6 trillion to support the economy.
Initially much of that money went to support financial institutions and to prevent their collapse. It went to large corporations who were saved from bankruptcy despite massively over leveraged balance sheets. It went to emerging industries to support research, innovation and a variety of other buzz word worthy projects. The problem is that much of that capital failed to meet the objective of any capital investment. It failed to provide a return on capital.
To be sure, individual companies such as banks, insurance companies, car manufacturers, airplane makers and thousands of smaller enterprises did recover nicely. But this rebound was met with another set of policy decisions which were clearly erroneous. After society at large literally bailed out companies for poorly managing their financial well being, they were then offered massive reductions in taxes. The companies were saved, but the general public was never repaid. What’s worse, it has now become clear that they didn’t learn anything about managing their financial well being.
At the beginning of this year, the largest economies in the world were touting how great their economies were doing, while ignoring that the (arguably, limited) progress made for the average individual was being fueled by massive deficit spending. During the ‘good times’ over the past 13 years, while almost every asset class saw valuations rise substantially, there was a strikingly similar rise in public debt [See table below covering the period from 2007 to 2018.]
As the world undergoes another crisis, governments are rising to the occasion by promising to spend massive amounts of money to support an economy that appeared mis-aligned during the LAST crisis.
The Federal Reserve in the United States has made about $2 trillion available to ensure liquidity in financial markets. Congress will spend about $2 trillion to support selected companies, individuals, borrowers and others. Many of these individuals and companies would be unable to function in a financial world without the assistance. It’s hard to take the other side of that argument and say stop!
In Canada, the Federal Government and the Bank of Canada will spend about 100 billion and up to $500 billion respectively to support the economy. A similar story is unfolding in all economies around the world; unfortunately some will not have the financial flexibility to borrow the large sums required to maintain their current economies.
While it would be harsh and perhaps callous to question how appropriate this economic support is DURING a crisis, the evidence suggests that the long term benefits of these activities are questionable at best. In a system that is supposed to celebrate the successful and offer a chance at redemption for those who fail, the system has instead moved moral risk onto government without clear benefits for the people that they serve.
The alternative is very harsh. Capitalism doesn’t take prisoners but if capitalism is going to survive, it needs to serve the people, not corporations. Hopefully all of this debt capital being placed on the backs of the citizens will provide more than a lifeline of a few months of working capital.