What to make of the surge in US government debt

What to make of the surge in US government debt

What’s happening in economics regarding governments and companies? Deloitte’s team of economists examines news and trends from around the world.

Deloitte article by Ira Kalish

I’m often asked by clients how it is possible that the US government can perpetually run large budget deficits. They note that if their companies did this, they would quickly go out of business. The answer is that governments are not companies. Governments have monopoly power to create money and monopoly power to tax people and business. As such, they can issue safe debt to a degree that companies cannot. Moreover, governments cannot go out of business. The only dangers from debt issuance that a government can face are higher borrowing costs and/or higher inflation. Interestingly, in the current crisis, borrowing costs and inflation have both declined in advanced economies. If you believe that markets know best, then you likely believe that the rise in debt is sustainable. Why?

There are a few reasons. First, the surge in borrowing is expected to be temporary. That is, it will last while the crisis lasts, but not longer. Second, the government is not competing with the private sector for scarce funds. Thus, bond yields are not being driven up. Third, much of the extra debt is being purchased by the Federal Reserve, thereby boosting the money supply. Yet this has not led to an increase in expectations of inflation. That is because much of the extra money is being hoarded by businesses and consumers. Moreover, it is expected that, should that money be spent thereby creating inflationary pressures, the Fed will likely reverse what it has done. Finally, it is likely that the pre-crisis large deficits will continue in the post ̶ COVID-19 world. However, if borrowing costs remain low, the debt service payments-to-GDP ratio should be stable and the debt-to-GDP ratio will stabilize. Indeed, even though latter ratio has increased, the debt servicing-to-GDP ratio has not.

Does this mean that Modern Monetary Theory, with its notion that there is no limit to debt-funded government spending, is correct? Not at all. Rather, it means that the United States and other governments can sustainably borrow a great deal. But a great deal is much less than infinity. There is a theoretical limit beyond which the United States would face severely higher borrowing costs, higher inflation, a much lower dollar, and much slower economic growth. The good news is that we’re not there yet. The implication is that the United States can avoid ruinous austerity when the crisis is over. The implication also is that the best way to avoid disaster is to get the virus under control, thereby setting the stage for fiscal policy to revert to normal.

Global manufacturing bounces back

The global economy now faces considerable downside risk owing to the surge in infections in both Europe and the United States. This has the potential to significantly curtail activity in consumer-facing industries. However, the manufacturing sector appears to be doing very well despite the outbreak. The latest Purchasing Managers’ Indices (PMIs) from IHS Markit signal faster growth of activity in manufacturing, driven by rising demand for consumer durable goods and, in some countries, stronger external trade. The PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing sector. They are based on sub-indices such as output, new orders, export orders, employment, input and output prices, inventories, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa. Early in the crisis, PMIs declined catastrophically as supply chains were disrupted and demand softened dramatically. Yet now, even as infections in Europe and the United States soar to levels above what happened early in the year, the manufacturing sector appears to be coping, with demand remaining firm and supply chains not severely disrupted.

Here are the details. Markit’s global manufacturing PMI hit 53.0 in October, a 29-month high and an indication of moderate growth in activity. With the exception of Japan, every major industrial nation had a PMI above 50, indicating growing activity. Even in the case of Japan, the PMI improved from September to October. For the global PMI, the strongest sub-indices were output, new orders, and future expectations. The weakest ones were export orders, employment, and output prices. Thus, the industry has benefitted from strong current and anticipated domestic demand in each country as well as investor expectations for the future. The industry faces a challenge stemming from weak global trade, although there were improvements in some countries, such as Germany and Japan. Moreover, hiring is limited by fears that additional workers will not necessarily be needed. Plus, businesses are likely engaged in more automation.

What to expect from President-elect Joe Biden

The US election is over. Joe Biden will be the next president. The result is now largely accepted by the press, business leaders, foreign leaders, and others. What will the election outcome mean for government policy going forward? The answer is that it depends on the outcome of Senate elections which will determine which party controls the Senate. Currently, we know that the Democrats control 48 seats and Republicans will control 50 seats in the 100-seat Senate. Two seats are yet to be determined. The general consensus is that Republicans have a better chance of holding all four, but there is some uncertainty. The Democrats need two of those seats to gain control while the Republicans need three. The most likely scenario is a Democratic president and a Republican Senate. This means little likelihood of passing many of the ambitious domestic plans offered by candidate Biden. It means a more scaled-back fiscal stimulus.

On the other hand, it is reported that Biden intends to issue some initial executive orders that will shift the direction and tone of the Federal government. These include rescinding the restrictive immigration and refugee policies of the current administration, rejoining the Paris Accords on climate, rejoining the World Health Organization, allowing transgender people to serve in the military, and allowing government workers to join unions. Other potential actions might include reducing tariffs, changing rules regarding cross-border investment, and changing environmental rules that affect the automotive and energy industries. On the other hand, there are many legislative actions that the Biden campaign had proposed that are not likely to happen if there is a divided government. These include raising the federal minimum wage, expanding the Affordable Care Act, spending more money and imposing new regulations related to climate, reforming law enforcement in order to address systemic racism, raising taxes on upper-income households, and increasing the corporate tax rate. Another proposal is to spend heavily on infrastructure investment. This might have a chance given that there are some Republicans who favor this kind of expenditure.

Meanwhile, a divided government will likely lead Mr. Biden to be more focused on tasks a president can undertake without Congressional support. These include carrying out foreign policy, ordering the use of military force or changes in military deployment, and implementing changes in policy related to trade and cross-border investment. These are areas that Biden is well-prepared to do having spent decades on the Senate Foreign Relations Committee (some of which were as chairman) and having played a significant role in the foreign policy of the Obama administration.

Biden is likely to face resistance to his policies on two fronts. First, some Republicans could follow a scorched earth policy meant to disrupt the success of the new administration. This would be especially true if Donald Trump continues to have an influential role in the party. Second, Biden will likely face trouble from the left flank of his own party. Already, there have been grumblings that Biden might be too much of a centrist, that he might choose technocratic centrists rather than those with ideological purity, and that he might even appoint Republicans to his administration. Biden has counseled compromise and respect for opponents. This attitude does not resonate with many people in both parties.

Biden’s supporters had hoped for a clear mandate in the form of a landslide election. This did not happen. Still, the presidential election was not nearly as close as it has been portrayed. Biden won the election, carrying more than 78 million votes and obtaining the largest share of the vote of any challenger to an incumbent since 1932. He got the third-highest share of the overall vote of a Democrat since 1944 and the highest share of the population of any candidate ever. Thus, although the result was closer than anticipated by pollsters, it was not actually close in terms of the number of votes cast. As for the more important electoral college, all major news organizations now predict that he will obtain 306 electoral votes compared to the 270 needed to win. This is the same number that Donald Trump received in 2016. On the other hand, Democrats made no gains in Congress, having lost seats in the House and at this time gaining only one in the Senate. Thus, the status quo nearly held. Yet it held as Americans voted in larger numbers as a share of the electorate than any time in the last century. Biden got the most votes ever achieved by a presidential candidate while Trump got the second most. Citizens were clearly engaged.

Vaccine economics

PFIZER and BioNTech announced a test of a potential vaccine for COVID-19 that has been 90% successful. Pfizer said it can produce 10 to 15 million doses by yearend. This sent share prices soaring, especially for Pfizer but also for airline, hotel, and aerospace companies. Shares in food delivery services and home improvement retailers fell. Bond yields increased on expectations that economic growth and inflation could soon accelerate. Meanwhile, even if this vaccine and others turn out to be successful, it will take time to produce on a mass scale, distribute, and deliver. There will be issues regarding who obtains the virus first, both by age, risk factor, income, ethnicity, and geography. There is still plenty of work to be done before we can breathe easily.

What economic impact can we expect from a successful vaccine? The reaction of equity markets suggests an answer. The surge in shares of airlines means that investors expect people to once again engage in social interaction, especially people in business. If that happens, we could see a surge in demand for consumer-facing services such as restaurants, live entertainment, travel, and retail stores. This could be followed by a renewal of hiring in these industries that are currently operating well below capacity. The result could be a temporary acceleration in economic growth as major economies return to precrisis levels of activity. It could also be a temporary surge in inflation. However, central banks have adequate tools to reverse their largesse and avoid ruinous inflation.

In the United States, President-elect Biden has indicated that virus suppression will be his first order of business, especially at a time when the virus appears to be spiraling out of control. The number of new daily infections in the United States is now about twice the last peak reached during the summer. The number of daily deaths is now at the highest level since August. Public health officials are warning that we have not yet seen the worst. Biden announced the appointment of an advisory committee on COVID-19 and offered a seven-point program for fighting the virus. His plan envisions free testing for all citizens, enhanced guidance to state and local governments for virus suppression, more spending on medical equipment for medical workers, use of Federal government powers to mandate more production of medical equipment, and a nationwide mask mandate. He hopes to implement this plan upon taking office in late January. Meanwhile, he said that “the single most important thing we can do” to suppress the virus is to wear a mask. He noted that “a mask is not a political statement.”

Biden intends to shift the focus of how COVID-19–related federal funds are allocated. Specifically, the Biden team wants to divert some funds from vaccine research toward improving testing. They noted that about 40% of all infections in the United States happen to asymptomatic people, most of them young. Unless such people are tested, it is nearly impossible to decide who should be isolated and therefore difficult to stifle the spread of the virus. Currently, testing in the United States is not easily available unless someone is symptomatic. Moreover, test results often take several days to get back. The Biden team wants testing to be more widely available and the results to be available almost immediately. The team believes that this could go a long way toward suppressing the spread of the virus.


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