Damn the Deficits, Full Speed Ahead

“Old soldiers never die, they just fade away,” General Douglas MacArthur told a joint session of congress seventy years go. Not true of old politicians, as Joe Biden has proved. Old soldiers often try to fight new wars with outdated methods developed in their long-ago battles. The risk for the American economy is that Biden might do the same – attempt to fight the economic damage inflicted by the pandemic using obsolete weapons forged during the Great Recession.

Barack Obama decided to fight the Great Recession with a traditional Keynesian/Democratic policy weapon – stimulus spending to the tune of $831 billion, the expenditures to be supervised by his vice president, Joe Biden, or “Sheriff Joe” as Obama dubbed him. Biden did his job: only 0.5% of the money doled out to contractors was attributed to waste or fraud. An unfortunate side effect of the Sheriff’s imposition of law and order was that money was dribbled rather than poured out.

2021 is not 2007

Fast forward to today. In retrospect, Biden and those of that Obama team who now serve him believe that the 18-month length of the recession and the slow recovery were due to too little, too late. Now, they say, we must go big and fast. Hence a $1.9 trillion package on top of the $3.1 trillion already spent. Unfortunately, today’s economy is not revealing the same symptoms as it did during its last relapse, when Biden was Vice President and Sheriff.

In the Great Recession, house prices fell by 30% and share prices by 57%. In the pandemic-ridden economy the approximately comparable figures are +13% and +16%, with existing home sales in 2020 at their highest level since 2006 and January 2021 sales 23.7% above those in pre-pandemic January 2020. During the Great Recession, Bear Stearns and Lehman Brothers collapsed, losses on mortgage defaults soared, interbank lending froze and consumer credit dried up. During the pandemic “Banks absorbed large losses related to the pandemic but remained well capitalized throughout; moreover, capital ratios have since [by November 2020] generally recovered to pre-pandemic levels,” according the Fed’s Board of Governors. During the Great Recession the yield on 10-year Treasury bonds never fell to 2%; during the pandemic they fell to about 0.05% and didn’t pierce 1% until early this year. When Obama was borrowing to pay for his stimulus, the national debt was a mere $12 trillion. Biden will be tapping lenders to pay for his relief bill with the debt more than twice as high, and rising. It might be unfashionable to say so, but then-Vice President Dick Cheney in 2002 was, and the Modern Monetary Theory crowd today is wrong: deficits do matter, some day.

America is awash in cheap credit and last month manufacturing activity returned almost to pre-pandemic levels while retail sales jumped a shocking 5.3% (economists expected 1.2%) over last month and 7.4% over last year. Lower- and middle-income consumers led the way in spending the $600 relief checks that were part of the earlier $900 billion December relief package signed by Trump. Others topped up their mountains of savings, to be spent as vaccines spread, infection rates decline, and the economy reopens. Oh yes, producer prices recorded the largest increase (1.3%) since December 2009 and have now risen 1.7% in the twelve months through January. “In our judgment, this is just the beginning,” warns former Fed governor Larry Lindsey.

Beware inflation

A rising chorus of economists is warning that the borrowing binge will trigger a major inflation:

  • Democrat Larry Summers believes the Biden package “will set off inflationary pressures of a kind we have not seen in a generation.”
  • Republican Doug Holtz-Eakin says the package “is far too large”, and notes in an article in Barron’s that “the U.S. entered the Covid-19 pandemic with a federal budget that was on an unsustainable trajectory…”.
  • Oliver Blanchard, former chief economist of the International Monetary Fund says, “The $1.9 trillion program could overheat the economy so badly as to be counterproductive. Protection can be achieved with less.”
  • Even the Biden cheerleaders on the Washington Post editorial board write, “There’s room to scale this back.”

Don’t let inflation fears shrink relief package

Alarmist talk say the policymakers in charge of the economy. They point to the recent Survey of [39] Professional Forecasters by the Philly Fed: inflation to run a tad above 2% for the next ten years, a rate in line with the 2.25% the IMF is predicting for 2022, which it says “is nothing to be concerned about and, indeed, would help underpin the achievement of the goals outlined in the Fed’s policy statement.” Fed chairman Jay Powell believes recent price increases are overstated because they spring from an abnormally low base, are “transitory”, and that the labor market needs serious help to reach full employment and reduce widening income disparities. Alan Blinder, former Fed vice chairman and now economics professor at Princeton, writes in The Wall Street Journal that the harm caused by an under-sized program far exceeds the harm that might be caused by one that is larger than is needed, while Treasury Secretary Janet Yellen regards the risk of inflation as something we have the tools to manage.

Adding to this view that fears of inflation should not result in a paring down of the $1.9 trillion package, is an irrefutable statement by Austin Goolsbee, former chairman of Obama’s Council of Economic Advisers, “The onus should be on anybody who says the economy is about to overheat. There have been many prominent voices saying that – that there was about to be inflation – for more than ten years.” In the end, the argument is settled, as it should be, by the President, who says, “Others think that things are getting better…. That’s not what I see. I see enormous pain.”

Where the $1.9 trillion is headed

A very rough calculation from raw data provided by the nonpartisan and fastidious Committee for a Responsible Federal Budget (CRFB) suggests that about 25 % of the $1.9 trillion relief package will go to help the unemployed and small businesses, and push the vaccination programs forward; 23 % to top up the $600 payments already received for each adult and child with new $1,400 checks, many headed for families that have not lost a day’s pay; and a bit more than half to schools, states and cities and to some programs that I recall seeing on progressive wish-lists long before Covid visited. Biden’s left may despise centrist Rahm Emanuel – they threatened mayhem if Obama’s former chief of staff were given a cabinet post – but they are true believers in his game plan, “You never want a serious crisis to go to waste. I mean, it’s an opportunity to do things that you think you could not do before.” Surely, Covid qualifies as a serious crisis.

Other analysts, including some experts at the CRFB, will classify individual spending items somewhat differently, but few economists disagree that the total spend includes items unrelated to Covid, and far exceeds the Congressional Budget Office estimate of the gap between the economy’s likely level of activity and its full potential, an arrow in the quiver of the inflation-fearful.

On to the green infrastructure

Next in line is “Building Back Better”, the President’s infrastructure/greening program, which he has been discussing with interested parties, most especially his life-long friends in the trade unions. Presumably, he has worked out three problems:

  • how to cope with his former boss’ discovery, “There’s no such thing as shovel-ready projects”;
  • how to persuade his green brigade not to file environmental law suits to stall construction of the “canals, to highways to airports” he intends to have built; and
  • how to get stuff built while channeling the jobs to union members, a mere 7.1% of the private sector work force, called in his home state “the folks that brung me to the dance,” says Biden

The program will be financed with higher taxes on the better-off and corporations, rather than by borrowings. It would be ironic if some of those whose taxes jump pay with the proceeds of their $1,400 checks.