Taps Coogan – July 29th, 2020

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“Americans will always do the right thing… after they’ve exhausted all the alternatives” – Abba Eban

Prior to Covid, during the ‘good times‘, reading and reflecting on the news was an exercise in seeing the structural problems in the economy and pointing out that we were headed for trouble.

Many of the problems were forecast to worsen, even with a continuation of the ‘good times’: the wealth gap, budget deficits, unfunded entitlements, corporate borrowing, social problems, etc…

Unfortunately, the ‘good times’ are now over and the ‘bad times’ are starting. The exercise of reading and reflecting on the news is no longer one of warning about potential problems. It’s a chronicle of disaster.

I, for one, am getting tired of reading and writing that chronicle. So instead of rehashing all of our insurmountable problems, let’s focus on the only way that we are going to get out of this awful mess.

Realistically Speaking

The US is going to run multi-trillion dollar budget deficits in 2020, 2021, and perhaps in 2022. It’s inevitable, both politically and economically, regardless of the outcome of the November election. The deficit is unlikely to get back to 2019’s $1.3 trillion level for many years.

The Federal Reserve has signaled that it wants to hold overnight interest rates at zero until at least 2022 and until inflation overshoots 2% for a sustained period of time.

If the Federal Reserve wants to keep rates near zero while the government runs multi-trillion dollar deficits for years on end, they will need to monetize large parts of those deficits. The Fed is going to be ‘printing’ at least a trillion dollars a year, likely closer to $2 trillion, for years to come. Not doing so will collapse financial markets, spike borrowing costs, and cause a depression. They will print the money.

Today’s monetary stimulus is not the same as the Global Financial Crisis era stimulus. New liquidity is not being contained within the banking system like it was after 2008. People are receiving thousand dollar stimulus checks and expanded unemployment benefits. Companies are getting PPP loans/grants and the Fed is buying corporate bonds. There will probably be a trillion dollar ‘infrastructure’ bill in the near future. Believe it or not, average personal income in the US has actually risen since January. Small retail stock trading has grown exponentially.

Gold, which declined in 2008, is at all time highs. The Dollar Index, which rose in 2008, is falling. The money supply is growing at the fastest pace on record, by more than double, and we’re in the middle of a recession.

Many people are worried about hyper-inflation. Hyper-inflation typically happens in countries dealing with foreign currency denominated debts, wars, and revolutions. Let’s not worry about that for now. Deeply negative real interest rates and mid-to-high single digit inflation is much more likely. The economy must get out of ‘lockdown mode’ first. That will take time.

Inflation will not be fun. Broadly speaking, it will hurt lenders, bond holders, retirees, importers, poor people, and the country. It will, however, make past debts shrink relative to current cash flows and nominal GDP. Eventually, inflation will become unbearable and the Fed will put the breaks on the money supply. That will almost certainly cause a deep recession, but afterwards debts may start shrinking relative to both nominal and real GDP.

If America is still a capitalist country by then, the economy may start to get progressively healthier.

The alternative is a long period of slow growth, deflation, and default. However, we all know that such a period will be met with more and more helicopter money and stimulus until we end up in the same inflationary place. It’s a question of time, not of destination.

The fundamental problem is that, for the US economy to get back to healthy growth, debts must be reduced relative to cash flows. Unless someone can think of a politically viable way to make America radically more productive, policy makers are going do whatever it takes to create inflation. Eventually, they will succeed.

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