by futurist Richard Worzel, C.F.A.
“Government ‘help’ to business is just as disastrous as government persecution… the only way a government can be of service to national prosperity is by keeping its hands off.”
– Ayn Rand
“Government isn’t the solution to your problems. Government is the problem”
– attributed to Ronald Reagan
“What stands between the current recession and a global depression is the survival of the business sector. Government efforts must therefore focus on supporting the business sector with policies that are direct, timely and effective. Tax holidays, rollover of loans, and suspension of payments of interest, rent and fees are a start.”
– “To Prevent Global Depression, Governments Must Act Soon” [1]
Forbes magazine, which calls itself “The Capitalist Tool”, 7 April 2020
For decades, conservatives have described government as an obstacle, a burden, a barrier to the efficient operating of the economy. It’s ironic, then, that when bad things like the Covid-19 pandemic, or the financial crisis of 2008 happen, it is corporate captains and conservatives that are loudest in demanding government help, bailouts, intervention, and support. It’s just a little hypocritical.
But the coronavirus Covid-19 has upended so many things that it’s not surprising that it has transformed critics into beggars.
So, what is the role of government in the time of pandemic? And what will be the downstream consequences that roll on from governments stepping up?
What IS Money, Anyway, and Where Does It Come From?
Money seems simple because we use it all the time. But actually, money is one of the most complex concepts in economics. Thick textbooks are written about it, and, like quantum mechanics, anyone who says they completely understand it is either fooling themselves, or lying.
That said, let me, as I did earlier in this series of blogs, grossly simplify this economic concept in order to illustrate what’s going on.
Money is life – your life. More particularly, the money you earn is a way to store the fruits of your work. That’s why theft is so upsetting: the thief is actually taking part of your life from you.
Which means that money comes from the time, effort, and skill of people.[2] And the currency of a country represents the effort of the people of that country. Attempts to dismiss a currency as “waste paper” or “fiat money”, and claims that money has to be backed by hard assets, such as gold, ignore this basic fact.
Hence, if a government prints more currency than the production of the people of that country, the currency becomes worth less than it was, which is called “inflation,” and prices go up accordingly.
So money comes from the productive effort of people.
Governments do things for people that they cannot do for themselves, like defend them from the attack of other countries, or negotiate trade relations with other countries. They also perform domestic policing, fighting fires, and the whole range of services we’ve become used to getting from governments.
But governments themselves don’t produce things of direct economic value. Let me illustrate with a story.
Once there was a municipal worker whose job included polishing the cannon by the war memorial on the front lawn of the town hall. He earned an OK living, but didn’t really feel he was getting ahead, so he decided to go into business for himself. Accordingly, he quit his job, took out his life savings, and bought his own cannon.[3]
Governments take actions that voters agree are important for a country, or, in global issues like trade or climate change, for all of humanity. But they fundamentally don’t produce anything.
They are also the buyer of last resort. When everyone else stops spending money in an economic crisis, it’s the role of government to step in a try to kick-start the economy by buying things, or giving consumers and businesses money to buy things.
In the current economic crisis, it’s not so much a matter of kick-starting the economy as it is filling a gaping hole as people stay home, and don’t go out and buy things.
So, let’s draw an analogy: governments today are using money to build a bridge over this gaping economic hole from past prosperity to hoped-for future prosperity. They are doing it to try to keep the economy from collapsing, and to keep individuals and companies from going bankrupt until we get to that hoped-for future. But there are limits on what governments can do.
A Trillion Here, a Trillion There
Former U.S. Senate Minority Leader Everett Dirkson once famously said, “A billion here, and billion there, pretty soon you’re talking real money!”
Now the U.S. government is throwing trillions of dollars at the economic damage wrought by the virus. Let’s remember that a trillion is a thousand billion. It’s a lot of money.
The size of America’s economy in terms of Gross Domestic Product (GDP) for 2019 was estimated to be just over $21 trillion. In the most expensive bill (no pun intended) ever passed by the U.S. Government, Congress voted to spend $2.2 trillion – an amount that is more than 10% of everything what America produced last year. That’s real money, especially when you consider it’s on top of everything else the U.S. government was already spending money on.
Other governments have voted to spend comparable amounts.
All of which raises two questions:
Is it enough? and,
Can we afford it?
Are Trillions Enough?
It’s important to figure out how to think about this crisis as it is unique. It’s almost as if the global economy was a speeding car that smashed into a wall. It just stopped, without warning, and in smashing into the wall, it sustained a lot of damage.
Some commentators have compared this to a natural disaster, but they disagree which one is comparable. Some say it is like a hurricane that hits, causes some damage, then moves on with the result that people emerge and go back about their lives pretty much unchanged except for an unlucky few. That’s not the right comparison.
If you wanted to draw a natural disaster comparison, it would be to hurricane Katrina when it hit New Orleans. That city still hasn’t fully recovered, and Katrina killed unknown thousands of people.
So, to decide if spending trillions is enough, we have to ask: Is it enough for what? What do we need to accomplish?
Any business person, faced with bankruptcy, could answer that question: Is it enough to my business from going bankrupt, and to keep the economy from collapsing and producing another Great Depression?
Well, the first problem is that it takes time for any organization, including governments, to undertake a major re-organization and start up a massive new operation in order to hand out money, especially to hand it out to millions of individuals and small & medium-sized businesses. And that time may mean that either help gets stuck in organizational snafus, the hurried design isn’t actually very helpful, or it doesn’t come in time to be of use.
It won’t help a business that goes bankrupt in May to be approved for a government-backed loan that arrives in September, for instance.
As for the size of the aid / bailout, let’s remember that $2.2 trillion is about 10% of what America made / produced in 2019. So, how deep might this recession be?
We don’t know, but economists are at least trying to estimate the depth of what’s to come. Here’s one forecast from the economics group at the Bank of America, publicized on April 2nd, 2020:
“We now believe that there will be three consecutive quarters of GDP contraction with the US economy shrinking 7% in 1Q, 30% in 2Q and 1% in 3Q. We expect this to be followed by a pop in growth in 4Q. We forecast the cumulative decline in GDP to be 10.4% and this will be the deepest recession on record, nearly five times more severe than the post-war average.” [4]
So, if the Bank of America economists are correct, then the amount of spending roughly matches the size of the hole in the economy. But this also assumes that all of the money allocated is spent, spent quickly enough, and that all of it reaches the people that need help the most. That seems highly unlikely.
It’s probably not going to come fast enough to make up for the instant recession we are experiencing. Moreover, with governments throwing money around, you can guarantee that chunks of it will end up in the pockets of cronies and favorites rather than those for whom it will do the most good.
And yet, despite this, it will make an enormous, positive difference.
In the Great Depression of the 1930s, government policies went in precisely the wrong direction. Governments of the day were convinced that the best thing they could do to turn the economy around was to balance government budgets. Since taxes were declining in the face of a bad economy, governments actually cut spending! This made everything worse by further reducing demand for goods and services.
At least this time, governments are going in the right direction.
So, let’s turn to the second question: Can we afford it?
Where Does This Money Come From?
This is money we’re taking from our own future. It’s not based on what we have produced already, but rather based on what we expect to produce later on. That’s what borrowing money means: getting money today from a lender with the promise to pay it back from your future earnings.
It’s our money that is being spent. Or perhaps our children’s or grandchildren’s.
Is this sustainable? How long could it go on?
Well, let’s consider what would happen if all businesses closed, all consumers stopped all spending, and governments were the only part of the economy still functioning. What would happen? Could governments spend us out of a hole like that indefinitely?
Asked this way, the answer is a clear “no” because governments don’t produce anything.
Borrowing Until We Can’t
Governments recycle money, they don’t create it.[5] Seen in that light, it’s clear that governments cannot spend us out of this problem. The most they can do is to provide a temporary bridge across from the period of prosperity behind us to a hoped-for period of recovery. They do that primarily by borrowing money from our future, hoping that that future will be more affluent than today’s crisis.
And that means it will depend on how deep and how wide this chasm is – and therefore, how long a bridge governments have to build.
But who do they borrow this money from?
They borrow it from pockets of people who have more money than they need right now, such as pension funds or individual investors.
Traditionally, a company sets up a pension fund for its workers, and both workers and employer contribute money to it. This money is invested, and the combination of contributions plus the return on investments produces enough money to pay for pensions when workers retire. (That’s the theory. I’m going to ignore the much messier reality.)
Or governments borrow from individual investors. If I’ve saved up for my retirement, and have money I will want in the future, I can lend it to a government in exchange for a government bond. The government promises to pay me back at the end of a period, say 20 years, plus pay interest on the loan semi-annually during that period. I can sell that bond to someone else, or hold it until it gets paid back.
So, governments borrow money from people who will have a temporary surplus, but who will want it back at some point in the future.
And it’s the “wanting it back” that can cause problems because governments can generally borrow as much money as they want – until suddenly they can’t, when people stop believing they will be able to pay it back.
In 1984, the government of New Zealand found this out the hard way. Throughout the 1970s, the government had run persistent, (comparatively) large deficits to subsidize industries and farmers, finance a large social safety net, and fund a top-heavy civil service. It financed this spending by borrowing on the international bond markets.
But one day, bond buyers who had routinely put New Zealand bonds in their portfolios decided that they didn’t like the way New Zealand finances were being managed, and weren’t sure they would be paid back on time. As a result, they stopped buying New Zealand’s bonds. With no warning, the government of New Zealand was faced with the ultimate crisis: it had less than a week to find money to pay its creditors, or default on its debts.
David Lange, who was prime minister of New Zealand at the time, has since reflected on what caused the crisis: “It was a whole series of pork barrel politics using overseas debt to build up domestic expectations, far ahead of any common sense view of what economic development ought to be.” [6]
So, governments can keep borrowing money until the bond markets get spooked and decide they don’t want to lend any more. And there’s often no warning except for very general signs that debt levels are getting too high. We can’t tell what causes investors to decide a government can no longer be trusted to pay back its debts.
Or, to put it another way, investors stop lending money to a government when they decide that the government is borrowing more than it will be able to repay.
America’s Different
For a developed country, America has run up some enormous deficits, which means enormous debts. The George W. Bush presidency ran up big deficits, and therefore debts, then left a financial crisis that forced the Obama administration that followed it to borrow even more. But that pales in comparison to what followed.
The Trump administration has largely ignored conservative orthodoxy and borrowed for tax cuts for its cronies and corporate supporters, and spent money like a drunken sailor, all at the peak of an economic cycle when the economy did not need stimulation. This used up a lot of ammunition (borrowing capacity) that would have been useful now.
As a result, according to the Federal Reserve Bank of St. Louis, America’s total public debt as a percentage of GDP stood at 106.8% as of March, 2020, [7] before the current stimulus package was passed. As a rough rule of thumb, government debt as a percentage of GDP starts to get dicey once it exceeds 100% of GDP, which opens America’s financial standing to question.
Even so, America is considered the safest haven for international money. Part of the reason is that the U.S. dollar is the currency that the world uses for business. And America can print as many dollars as it wants.
Of course, in the long run, there’s a cost for printing too much money, which is inflation. But in the short run, inflation is the last thing worrying policy-makers right now. In consequence, America can spend almost whatever it likes to build a bridge over this crisis.
Canada Is Different for Different Reasons
Canada’s story is different from America’s in that, much as it might surprise American conservatives, Canada has been far more fiscally prudent than America:
“Canada does have fiscal elbow room, as the [Parliamentary Budget Office] confirmed … that capacity has been built up over 25 years as successive governments, both Liberal and Conservative, acted to rein in first deficits and then debt, starting in the mid-1990s, when Jean Chrétien was prime minister. Mr. [Justin] Trudeau’s Liberals, despite four years of deficit spending, have kept net debt at relatively low levels, and the net-debt-to-GDP ratio close to the government’s ‘fiscal anchor’ of 30 per cent.” [8]
According to the IMF, Canada’s net public debt as a ratio of GDP stood at 27.8% in 2017, or about one-third of America’s, which stood at 82.3% for the same period.[9]
So, although Canada does not print the world’s reserve currency, it has room to run up deficits and debts.
A critical question for all countries will become: is the money spent wisely and is the spending effective? We won’t know that for years.
Of course, in all cases, younger generations may question whether it was worth it as they will be the ones left paying back the debts we run up today.
But regardless, governments truly had no choice but to try to build a bridge to a more prosperous future. We must just pray it’s not too long – or too expensive – a span.
© Copyright, IF Research, April 2020
Blogs in this Series:
Part 1: What Are Stocks Worth?
Part 2: What Will Happen to Businesses?
Part 3: Bankruptcies, Panics, and Opportunities
Part 4: ’Til Debt Do Us Part…What Will Happen to Governments?
Part 5: Reset of Reboot? The Virus & Society
[1] https://www.forbes.com/sites/yuwahedrickwong/2020/04/07/to-prevent-global-depression-governments-must-act-soon/#2abb922a6c36
[2] I’m deliberately ignoring things like winning the lottery. That, too, is the product of time, effort, and skill – but on the part of the people running the lottery. The winners are merely a by-product, a cost of production, to the people running it, as most of the money, often the large majority of it, goes to the people running it, not the people who win it.
[3] I borrowed this story from Robert Heinlein’s book, The Moon Is a Harsh Mistress, although I doubt it was original there.
[4] https://finance.yahoo.com/news/us-economy-entering-deepest-recession-on-record-172304066.html
[5] I am aware that governments do, actually, create money by printing it, but that is really just another way of borrowing from our own future. That’s another discussion for another – very technical – day.
[6] As said to reporter Eric Malling, Canadian network CTV’s W5 television program, February 28, 1993.
[7] https://fred.stlouisfed.org/series/GFDEGDQ188S
[8] https://www.theglobeandmail.com/business/article-canadas-ready-and-able-to-spend-in-this-crisis-so-long-as-it/
[9] https://en.wikipedia.org/wiki/List_of_countries_by_public_debt
The difference between total debt and net debt is complex. Generally speaking, net debt subtracts out debts issued by one part of government but held by another. The point I’m making here is the relative debt loads of the two countries.
