Barrons – ECONOMY AND POLICY
Robert Hormats – Aug. 3, 2020 4:05 pm ET
Virtually every government in the world has engaged in massive borrowing to address the medical costs of Covid-19 and the economic disruption it continues to inflict. The United States is no exception, as Congress considers spending well over a $1 trillion on top of the $2 trillion Cares Act. We now face record deficits. No doubt, more funds will be necessary and further revenue deterioration will occur. How the country deals with the debt it is now taking on will shape the nation’s politics for a generation. We need to start thinking now about the directions that collective argument could take us
The U.S. also has barely come to grips with the need to supply large-scale assistance to states and cities. States bear a substantial portion of Medicaid, so they are especially hard hit by the virus. And Medicare fundsare going to run out of money much sooner than expected as the result of the virus, unless it receives hundreds of billions of dollars in replenishments. The price of not addressing these and other enormous state- and local-government burdens will be sustained weakness in the overall U.S. economy—plus a sharp cut in social services. Such services are critical to many millions of people, a large percentage of whom are minorities and/or in the lowest income groups, and cutting back on them will exacerbate longstanding racial inequities. The social disruptions of this crisis have yet to be fully manifest.
Add to that huge increases in spending needed to get the economy moving, help workers and businesses get through this difficult period, create jobs, increase infrastructure investments, and overhaul the nation’s health-care system to address obvious inequities and prepare for the next pandemic. These and other initiatives will add vast sums to the nation’s already ballooning debt, but many are likely to be critical to sustained recovery, social stability, and long-term productivity, and thus vital to our country. Where needed, and it is and will be, the money should be spent.
How will the nation cope with these debts that have grown far beyond the levels that provoked debilitating political fights in past administrations? There is one school of thoughtthat argues we can sustain and even grow debt if the Federal Reserve and markets are willing to buy it for many years. A thoughtful study of how long that can last is clearly needed. Unless we conclude that it can go on for many years, we need to figure out what stops or disrupts that process and what are the consequences. However, if we do not accept the notion that debt levels can remain sky-high indefinitely, a plan will be required to gradually pay down our debt as a portion of GDP.
Aside from defense, the largest categories of spending are Social Security, Medicare, and Medicaid. Cutting these would place a heavy burden on those who are most in need of government support.
The problem could be postponed if interest rates remain at record lows, meaning that the cost of servicing this mammoth debt is effectively zero. That is a plausible scenario for a time, but it, too, has costs. Savers, particularly retirees, who put money into secure, fixed-income assets such as Treasury bonds will receive minuscule amounts of interest—well below the likely inflation rate. So, in real terms, they will fall behind in spending power year after year, enacting a heavy toll on the living standards of the elderly. Even substantial cuts to military funding would make only a small dent in the high debt levels the country will face.
The happiest answer to this dilemma would be a resurgence of growth for a sustained period. That would increase revenue and perhaps, if the growth is robust enough, produce a major surplus, enabling the government to buy back a large portion of its debt. But the federal government has not had a surplus since the Clinton administration, and few people predict a V-shaped recovery any more.
The outlook could change if a vaccine with durable benefits were developed, produced, and administered widely and quickly—likewise for a successful treatment of the disease. I am a big believer that great science and the great research centers and drug companies in this and other nations will come through in both categories, but that is likely to take time. Successful deployment of a vaccine or treatment would likely produce a sharp increase in growth due in part to a much higher degree of public confidence about travel, going to stores, enjoying entertainment in person, and other activities we shy away from now. But even this would not necessarily produce a recovery robust enough to significantly cut the nation’s debt. In the recent past, periods of well-above-average growth have actually seen deficits rise. We had sustained growth and very low unemployment in the years before Covid-19 and the deficit rose considerably. Plus, rapid growth could push interest rates up, adding new burdens to the companies and governments that have borrowed heavily in recent months.
Yet despite some silver linings in this now very dark cloud—the stock market has until recently done remarkably well—but with many jobs permanently lost and many sectors unlikely to recover rapidly, if at all, a sharp overall U.S. growth resurgence in the near or medium-term sufficient to generate a sizable fiscal surplus seems improbable.
Another alternative is to trigger a significant rise in inflation, which would boost earnings for many companies and push up prices, making it easier for the government to generate revenue sufficient to repay its debt. By raising wages and investment returns, inflation pushes households into higher tax brackets, increasing the portion of their income that goes to the government. Similarly, sales tax revenues go up because the price of goods goes up. But with numerous structural changes in our economy—including competition from online marketplaces, a more competitive global economy, major increases in productivity, and potentially a large number of unemployed people in the labor force looking for jobs even at very low wages—anticipating a high level of price and wage inflation would be a stretch.
So, we as a nation, and many of our communities, face two scenarios. One, we resign ourselves to the prospect of sustaining an enormous debt as far as the eye can see, which would be predicated on the willingness of the Fed to sustain near-zero interest rates equally far to avoid damaging the economy (the Fed is powerful, but not omnipotent.) We would be highly vulnerable if interest rates beyond the Fed’s control started to rise, squeezing government funds out of other programs to pay the higher interest and putting new burdens on highly leveraged corporate and individual borrowers.
Or two, we wage a bitter battle in this country over how either to raise taxes (on which groups, by how much) or cut spending (for which programs and by how much.) Both of these contests will trigger intense political struggles among affected constituencies and powerful social groups. An already divided and acrimonious political and social environment in this country could deteriorate even further.
At the local level, the debate will be particularly heated between those who question whether state and local governments should restructure their high debts and raise taxes, and those who argue for major cuts in various public services and benefits. The issue of what is equitable, and the social and racial implications of various programmatic decisions, will have profound consequences for social stability and even the prospects for violence. Urban areas will be particularly vulnerable, but so will other towns and cities.
I have no easy answers. But as we think about “normalization,” we also must think about the new “abnormal” that these kinds of scenarios would constitute. Sustained high debts? A sustained and potentially destabilizing series of social confrontations over national, state, and local fiscal policy? There are, of course, middle grounds and a multitude of scenarios, but moderation and compromise have not characterized American politics of late. And, much as I hope for that kind of approach, only a highly optimistic prognosticator is likely to bet much on it. The debate itself could fuel political extremism.
We should start at least by looking back to 1983 and the highly successful Greenspan Commission that stabilized a fast-deteriorating Social Security system. A new version could be headed by leaders from finance and business who have experience with the nation’s combined health, racial, and economic crises. Because legislation will be needed whatever the outcome, it should include one retired legislator appointed by each party and, because of state and local implications, a few highly regarded former mayors and governors. This should get started as soon as possible to demonstrate that, although there are no quick answers to these issues, top thinkers and leaders are aware of the looming problems and there is a serious process under way to figure out a sensible approach.
The time to begin strategic planning is now. Even if this group cannot find answers right away, it can frame the questions and trade-offs and launch a broader national dialogue, one that Americans can unite around and participate in—and that in itself is desperately needed.
Robert Hormatsis a managing director at Tiedemann Advisors. He was vice chairman of Goldman Sachs (International) and served in government under five U.S. presidential administrations, most recently as undersecretary of state from 2009 through 2013.