The global economy faces the effects of the worst acute pandemic in a century. HIV/AIDS killed more people over decades, but did not hammer economic activity, business profits and household income as COVID-19 has. For that, we must go back to the 1918-20 Spanish flu that killed my grandmother and some 50 million other people around the globe.
aWhen a nation produces a lower value of goods and services, national income as a whole drops, as must personal income. But this loss does not hurt everyone in the same proportion. Those with small businesses, hourly wage workers and self-employed people in the “gig economy” or who work as consultants are hit much harder than salaried people with jobs in safe locations or those who can work from home.
And people who live from financial assets, especially those in the top 5 or 10 percent of the income distribution do best of all. They may see the value of their stock portfolios drop but have enough income to not see even a blip in their consumption lifestyle.
There are two key economic questions we face: First, what can be done to spread the cost of a true “exogenous shock” or “act of God” more fairly across our nation’s people? Second, what can be done to try to keep the economy itself from falling into severe recession?
Call the first “relief.” The $1,200 payment intended for each citizen and the $600 addition to usual unemployment benefits fall into this category.
Call the second “stimulus.” The Federal Reserve lowering the target for short-term interest rates, promising support of liquidity for specific short-term credit instruments and announcing unprecedented new programs for loaning money to specific sectors are, in general, “stimulus.”
Then there are measures to help specific sectors, such as airlines or livestock production and processing, that are an uncertain mix of relief combined with general stimulus.
Where does the money come from for all of this, whether Treasury payments to individuals and businesses or Federal loans to businesses and purchases of sundry financial securities to keep markets liquid?
For an answer, go back to the military history of our nation. Some, including President Donald Trump, have termed the COVID-19 emergency a “war.” That is a bad analogy in some ways but fits in other. Already, more people have died in the United States from COVID-19 than from any war other than World Wars I and II. Moreover, in part due to our past imprudence, we face the sort of funding emergencies that we did when combating foreign enemies.
The pattern has been the same. In the Revolutionary War, the individual colonies raised taxes, mostly excises on specific products. They borrowed money from their citizens; money from taxing and borrowing went to pay salaries of the militias they raised and provide them with war materiel. They also increased issuance of their own paper currencies.
The Continental Congress, years before even the Articles of Confederation, could not impose a national tax. There really was no nation. But it did borrow money for the rebelling colonies as a whole, some domestically and much abroad, especially from Dutch bankers and the French government. It also created its own paper currency, the Continental dollar.
The paper currencies of both individual colonies and the Continental Congress were issued in such large amounts that inflation resulted. They dramatically lost value relative to gold and silver and relative to any physical commodity, including all those needed to fight the British. The depreciation of the currency was such that “not worth a Continental” came to denote worthlessness.
We gained our independence, but faced harsh political problems of who should pay off the war debts and what to use for currency. These problems eventually led to organizing our nation under our Constitution.
In the Civil War, the North borrowed large amounts by selling the first modern war bonds and increased the money supply by issuing paper money, the first “greenbacks.” Again, after the war, paying debt and setting the money supply were political problems that lasted 30 years.
In our wars of the 20th century, we followed similar combinations of borrowing and increasing the money supply. We had inflations from excess growth of money. But the economy grew fast enough that war debts shrank relative to the size of the economy even without paying much off.
Now, whether you like the war analogy or not, we will react to the COVID-19 economic challenges similarly with borrowing and increases in money and credit. You may not like that either. But political realities are such that this is what is will happen, with some skirmishing between the two political parties on the details.
Treasury borrowing and Federal Reserve money creation are not independent of each other. Unless a nation has an extremely domestic high savings rate, some of its government’s borrowing must come from abroad and/or from its central bank.
We long have a very low savings rate, and long have financed pre-epidemic budget deficits by borrowing abroad. And, whenever the Federal Reserve buys bonds in its ongoing “open-market operations, it is creating money that is lent to the Treasury. This happens even when ownership of the bonds passes temporarily through a third party.
Things would be easier if the long-term trend since 1981 already had not been to run deficits so large that our national debt relative to GDP has risen. There was a short break in this in the last four years of the 1990s, but we threw that progress away with tax cuts in 2001 and 2003.
Things would also be easier if we did not just “happen” to be in a 10-year period of extremely low interest rates. “Modern monetary theory” says we can continue to borrow and create more money. Not exactly, but we’ll examine that next week.
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