The rhetorical winds, gathering force for a long time, reached hurricane Category 5 when the novel coronavirus made landfall. With the ensuing pandemic uprooting the normality of social, economic, and political life, the knee-jerk public rhetoric and reaction were proportionately chaotic.
Our focus is on the economic uprooting while acknowledging its interdependence with the political and social, as one might visualize through the three sets in a Venn diagram.
The political set (overlapping circle) rhetoric has been insupportably hyperbolic. During the NBC-sponsored Town Hall meeting on October 15, Pres. Trump unabashedly declared: “Our economy is going to be phenomenal next year … We are opening it up. We have a V-shape and it’s coming back. It’s coming back very fast.” This has been a constant refrain over many months. Trump’s divisive political rhetoric has also fomented social and economic uncertainty. The moderator challenged Trump on whether he would accept a peaceful transfer of power, noting that he had repeatedly stated: “The only way we lose this election is if it is rigged.” In a staccato series of rapid-fire exchanges over the next three minutes, Trump inconclusively obfuscated regarding the question.
The social set, the locus of which is coming to grips with the COVID-19 pandemic, has digressed to a bombastic tug-of-war pitting science against polarized politics. It seems increasingly irrelevant how adamantly epidemiologists advocate for virus mitigation through the wearing of masks. While the vast majority of the populace supports such measures, news coverage of the controversy and the intransigence of some is merely indicative of the rigid politicization that plagues our civic discourse today.
The economic set faces unprecedented challenges made nearly incomprehensible due to complexity and exacerbated further by a lack of data transparency. Disinclined as we are to accept with any measure of confidence the word of perhaps the least qualified among the cadre of White House incompetents—the president himself—we’ll look elsewhere for answers, to the confluence of theory and history.
The dynamics of the overlapping sets in our Venn diagram aside, the fiscal response has been impulsively Keynesian. The record-setting $2.2 trillion Coronavirus Aid, Relief, and Economic Security Act (CARES) became law on March 27, 2020, amounting to 10% of U.S. GDP to partially offset the reduction in economic activity. Individuals received $500 billion, including a $1,200 one-time payment to eligible adults. For the newly unemployed, it was $600 a week in supplemental unemployment insurance through July 26. As Figure 1 indicates, as of August 31, 2020, real personal income, including the above described transfer payments (blue), actually rose above its pre-pandemic trend line and is in stark contrast to what real personal income without the stimulus would have been (red).
Annualized real personal consumption expenditures had been trending at about $13.5 trillion through January, only to plummet to $11 trillion by the end of March. They bounced back to about $12.7 trillion by the end of May but have since plateaued. The difference between real personal income with transfer payments and personal-consumption expenditures is the personal savings rate. At the end of March, it soared to 33.6%, then by the end of August it had faded to 14.1%, still well above its 7% long-term average.
Fearing a “90% economy,” Congress has been at loggerheads trying to cobble together another stimulus package. Democrats are standing firm on $2.2 trillion, whereas the White House vacillates with its latest offer of a $1.8 trillion package. Mitch McConnell, meanwhile, is prepping a $500 billion stand-alone bill in support of the Paycheck Protection Program (PPP). With all eyes now on November 3, it likely won’t see daylight until after the election.
The Ship Has Sailed
Despite the posturing and pontificating on the course of the COVID-19 pandemic, the election outcome, and the post-election legislative response to the withering economy—in the soundbite age of television and social media—there are contemplative economists who reason that those hot topics are largely passé, that the ship of fate has already sailed. Real per-capita GDP, employment participation, population, and productivity have been in secular decline for years.
Lacy Hunt, chief economist at Hoisington Investment Management, argues that in the years if not decades before the latest crisis we were progressively painting ourselves more irrevocably into the “debt trap” corner. Echoing the seminal work of Carmen Reinhart and Kenneth Rogoff, This Time Is Different, when government debt as a percentage of GDP rises above 65%, economic growth is severely impacted. It becomes acute at 90%.
The causality linking high debt levels to slower economic growth is supported by the law of diminishing returns for one of the four primary factors of production (land, labor, capital, and entrepreneurship) when it is out of balance with the others. Analogously, for much of history the supply of labor and land was abundant was compared with scarce capital and entrepreneurship. In the largely agrarian economy, marginal revenue product (MRP) of labor—the additional revenue generated from using one more unit of labor input—declined, as did its cost, wages.
Think of modern-era debt in those terms, which, thanks to a supportive monetary policy, is by far the easiest of the four factors to manipulate, and success has led to excess. Only 32.6% in 1980, the ratio of government debt to GDP is now estimated to reach 127% by year-end. When you add private debt, which includes systemically fragile corporate debt, the ratio, which was 167.2% of GDP in 1980, will likely reach 405% by December 31. Stated another way, in 1980 each additional dollar of government debt generated a rise in GDP of $0.60. In 2019 it was $0.27. Correspondingly, the cost of that capital, interest rates, has declined as well.
While an immediate political and social necessity, the $2.2 trillion debt-financed CARES Act in March and what could be a similar amount enacted after November 3, depending on the post-election political landscape, will provide a short-lived adrenaline rush, but eventually will lead to even slower growth to follow.
Monetary Policy to the Rescue?
But surely monetary policy can save the day? Isn’t the Fed monetizing all this government debt? The short answer is yes. The long answer is more involved and requires addressing the temporal aspects of the policy.
In April 2013 the St. Louis Fed considered the question, distinguishing among multiple paths going forward. It opined that if monetization were permanent, then the supply of new money would remain in the economy as cash in circulation or bank reserves. Under that scenario, money creation becomes a permanent source of financing for government spending. If temporary, which was the intended outcome following QE, the balance sheet would eventually shrink.
That intention had been set forth in a November 2010 speech by James Bullard, St. Louis Fed president.
The Federal Open Market Committee (FOMC) has often stated its intention to return the Fed balance sheet to normal, pre-crisis levels over time. Once that occurs, the Treasury will be left with just as much debt held by the public as before the Fed took any of these actions.
If that happens, it will be clear that the Fed hasn’t been using money creation as a permanent source for financing government spending. Implicit in the speeches of Bullard and others is the notion that perpetually monetizing debt has unwanted consequences. The quantity theory of money posits that prices rise as a result of an expanding money supply, assuming velocity is constant. The Fed acknowledged it was increasing the money supply through QE. The consequence the market feared was that the new money would lead to inflation.
The manifest result has been minimal inflation for a decade. This was surely to the Fed’s consternation. Former Fed Chairman Ben Bernanke’s greatest fear was always deflation and a repeat of the Great Depression. Thus, he was willing to risk public fears of rising prices and resistance to the policy. Inflation concerns in the investment community proved hollow as stagnant prices continued for years. Whether a wet blanket of debt smothering the economy or the gap between output and capacity resulting from a decline in consumer purchasing power, inflation was an empty threat, at least in the medium term. Eventually, the central bank determined to target a 2% annual inflation rate in 2012. It has regularly failed to clear even that low bar, calling into question the effectiveness of the tools with which it claims to regulate the economy.
In the end, the statement of Bullard and Bernanke present a muddled picture from the Fed on its own expectations regarding the impact of QE on inflation. What is clear, however, is that the U.S. economy could not withstand the shrinking of its balance sheet. The Fed tried from 2015 through mid-2019 to reduce its liabilities. Then along came funding irregularities in September 2019. Clearly something was amiss in financial markets.  A few months later came the coronavirus, dealing a devastating blow to the economy that continues to the present.
Facing crashing global markets, the Fed put the same tools to work, likely more out of habit and in an effort to spur confidence than from a strong conviction about the economic utility and impact of its actions. Monetary policy has not proven itself capable of managing the economy, and it won’t be able to eliminate the very real problems associated with the debt load on the shoulders of the U.S. government, households, and corporations.
While Washington fiddles, tail risks smolder like embers in California’s forests. A huge new debt-financed fiscal package will result in a short-lived boost to GDP at the possible cost of an uptick in interest rates. Meanwhile, the Treasury is actually flush with cash, money allocated by the CARES Act that the government has been unable to distribute. The dangers of fiscal policy have been outlined above, but its greatest risk may lie merely in its failure.
If monetary and fiscal policy both fail to right the economic ship, there may be outcries for a major change in the Fed’s modus operandi. The economic whirlwind may fan the flames of desperation to have the Fed’s liabilities become legal tender or a medium of exchange. This legislative change would mean the central bank could dispense with bond purchases in the market (though it would likely continue them in order to pin interest rates lower) and fund the government, its citizens, or select industries directly.
Inflation would rise, and Gresham’s law (“Bad money drives out good”) would induce individuals to hold commodities to be consumed or traded for consumable items. Massive declines in productivity, real growth, and the standard of living would likely follow as inflation finally escalates. The capital markets? Some outcomes are self-evident.
The institutions of government have sown the wind. The nation, writ large, can expect to reap the whirlwind.
 Lacy Hunt, Hoisington Investment Management, Quarterly Review and Outlook (Q3 2020).
 Carmen Reinhart and Kenneth Rogoff, This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2011).
 The spike in repo rates in September 2019 indicated stresses in international dollar markets that possibly represented an inherent limit to the balance-sheet roll-off in which the Fed was engaged.