Coronavirus News Asia

Debt will define our next crisis

As events related to the coronavirus pandemic and the government’s response unfold, it is hard to separate financial from real economic effects. With a large part of the nation’s businesses shut down and St Louis Federal Reserve Bank President James Bullard warning that the unemployment rate may reach 30% in the second quarter, earnings forecasts are meaningless. Until there is clarity from Washington about the size, content, and timing of economic support, markets will shun risk assets.

Nonetheless, the American financial system has identifiable vulnerabilities which were brought to the fore by the coronavirus pandemic and which will condition the economic outcome over the next 12 to 24 months.

Two dangerous deficits

The cure for the last crisis is often the cause of the next. The public debt of the US government rose to $23 trillion today from $10 trillion just before the world financial crisis of 2008. That does not include unfunded liabilities of Social Security and Medicare, which have been estimated at up to $100 trillion.

The deficit is likely to rise by several trillion dollars more as the government rushes to provide support for consumers and businesses stricken by the impact of the coronavirus pandemic. The federal government probably will spend an additional $2 trillion during 2020 for emergency economic support and lose $1 trillion in revenue. The deficit ran at an annual rate of more than $1 trillion before the crisis, so the total deficit may come out at $4 trillion, or roughly 20% of GDP.

In addition, the Federal Reserve will expand its balance sheet by perhaps a trillion dollars to provide emergency liquidity to domestic and overseas markets, including purchases of municipal bonds for the first time.

The late economist Herb Stein famously said that what can’t go on forever, won’t. Two imbalances couldn’t go on forever, and now won’t. The first is America’s budget deficit. The second is America’s current account deficit caused by its low savings rate. Americans borrow, spend, and consume, while Asians and Europeans save and lend. Figure 1 below shows that the collapse of the personal savings rate to nearly zero at the height of the home price boom of the mid-2000s coincided with the largest US current account deficits in history.

Figure 1

A more comprehensive measure, gross national saving (including business and government as well as personal savings) shows that the United States saves about half as much as South Korea or Sweden relative to GDP (Figure 2).

Figure 2

Deficits don’t matter as long as it is easy to fund them. For decades the United States has been the preferred destination for the world’s savings. US Treasury securities offered positive real yields while European and Japanese yields went negative, as the European Central Bank and the Bank of Japan took extreme monetary measures to attempt to revive stagnant economies. 

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