U.S. Fiscal Crisis Coming Closer

For half a century, the U.S. government has run budget deficits and built up an entirely unsustainable pile of debt. The incoming Biden administration has not even put its feet inside the White House yet, and they are already in the unfortunate position of having to mount a salvage operation to avoid a runaway fiscal crisis in the American economy.

It is unlikely, though, that they will. On the contrary, Biden appears to be as oblivious of the threat the national debt represents as his three most recent predecessors, Bush Jr., Obama and Trump. (Clinton, on the other hand, was well aware of the importance of balancing the federal budget.) But it is not just the president-elect who seems to lack insight into this problem; in a moment we will hear from one of his top economic advisors whose attitude to the deficit is downright worrisome.

First, let us listen to the Wall Street Journal (Jan. 15, pp. A1, A6, print ed.):

President-elect Joe Biden called for a $1.9 trillion Covid-19 relief plan to help the nation weather the economic shock of the pandemic and pump more money into testing and vaccine distribution. Mr. Biden in a speech Thursday evening described his priorities related to the pandemic for the early days of his administration. His plan calls for Congress to approve a round of $1,400-per-person direct payments to most households, a $400-per-week unemployment insurance supplement through September, expanded paid leave and increases in the child tax credit.

The new round of direct-payment public welfare checks would be sent out to people who were previously not eligible, such as college students.

In total, approximately one half of the $1.9 trillion would be paid out as entitlement checks and tax credits to households. The plan appears to be to pump out this money before the end of September, which also marks the end of the 2021 fiscal year.

Now over to the economic expertise that Biden will be listening to. Heather Boushey, who was tapped by Hillary Clinton as chief economic advisor back in 2016, explained in an interview with PBS that we have nothing to worry about when it comes to the budget deficit. There is definitely room to grow it even bigger, she explained:

Well, that is certainly a very important question, but for right now, we can afford to … spend this package through deficit financing. But you’re right, moving forward, we’re gonna have to think about the fiscal situation. You know, during the campaign, the President-Elect outlined a whole series of tax increases focused primarily at those at the very top. He committed to not raising taxes for those making less than $400,000, during the campaign, and making sure that we fix the tax system and make it more fair, while at the same time encouraging domestic production, encouraging businesses to produce goods and services here at home, and to make sure that those workers are fairly paid. So there’s a lot of options there, but those are not tonight’s problem, but it’s certainly something we’re gonna be talking about in the weeks and months to come.

Boushey exhibits the same arrogant ignorance toward the enormous risks with monetized inflation. Despite the extreme monetary expansion we saw all the way through the fourth quarter of 2020, interest rates on U.S. Treasurys have ticked up in the new year. The increases are slow thus far, but it is worth noting that the rate is now above one percent for all bills and bonds with a maturity date of 10 years or more. From March through December and early January this year, the 10-year bill came with a rate below one percent.

It is too early to draw major conclusions from this, but it is likely that this is a signal from the sovereign-debt market that investors are beginning to worry about inflation in the U.S. economy. If investors link the risk for inflation to the monetary expansion, the incoming Biden administration is digging a deep hole for itself. The probability is rising that they will be the first administration of the U.S. government to have to deal with an open, unmitigated fiscal crisis.

To avoid that situation, they have three options, two of which are equally bad:

  1. Press on with monetization of the deficit. This would allow them to fund their $1.9-trillion new spending package, but it would also reinforce inflationary worries among investors. As a result, more investors will abandon U.S. government debt and force the Treasury to borrow even more from the Federal Reserve. This in turn increases further the very money supply that scares off investors. A vicious downward-bound spiral gets going where inflation and interest rates rise together.
  2. A partial debt default. This could take the form of a default on debt owned by the Federal Reserve. The attractive part of this is that it would reduce the debt and appear to reassure sovereign-debt investors that the U.S. government will always afford to honor its debt obligations. At the same time, any debt default, even a partial one, is sure to make a big dent in a government’s credit worthiness.

A debt default could also follow the Greek architecture, where the government in Athens simply told investors that it would not honor any obligations for one quarter of its debt. To guarantee that investors would still want to keep Greek treasurys in their portfolios, the European Central Bank created a program where it promised to buy every single note, bill or bond issued by the Greek government (and other troubled welfare states in the euro zone) at a guaranteed price.

Any type of debt default in the United States would have the same effect. Again, nobody is suggesting a debt default – not in the incoming Biden administration or elsewhere – but with emerging signs of concern in the sovereign-debt market and with plans for continued combined fiscal and monetary expansion, the new administration is facing a narrowing window when it comes to measures to avoid a runaway fiscal crisis.

The third option, of course, is to cancel the new Covid-19 stimulus package and to chart a course toward a balanced budget. Republicans could certainly be of help here, but they need to abandon the Laffer-Supply Side doctrine that tax cuts can fix everything from ingrown toe nails to the budget deficit. If they can do that, and if the Biden administration can cancel its intended entitlement monstrosity package, there is a fair chance that our country can avoid a deep, unprecedented macroeconomic crisis later this year.

This week’s Economic Newsletter (available to subscribers for a low $2.99/month) which will be published on Friday, presents an in-depth analysis of how the fiscal and monetary expansion of 2020 and 2021 will create a fiscal crisis of the same kind that many European countries – and more recently Puerto Rico and Costa Rica – have experienced. Don’t miss it! Sign up today and join a growing readership with exclusive access to macroeconomic analysis you will not get anywhere else!

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