The federal government now owes $1.07 for every dollar of U.S. economic output
The thing about tipping points is that you never quite know where they are until you, well, tip.
Since the current debt super-cycle began in the early 1980s, economists and investors alike have fretted — intermittently, at least — over the size of the federal budget deficit, which this fiscal year is set to reach $3.7 trillion, or 18% of gross domestic product, the highest relative to the economy since 1943 and eight percentage points more than during the Great Recession.
Those accumulated deficits have pushed total government debt to over 100% of GDP, up from 30% when the borrowing binge began in 1981. In effect, the federal government now owes $1.07 for every dollar of U.S. economic output.
Deficit spending — and the accumulating debt that results — has always been a contentious subject, and one without clear guardrails.
Alexander Hamilton, the nation’s first Secretary of the Treasury, argued in 1791 that “a national debt, if not excessive, will be to us a national blessing.” In 1983, President Ronald Reagan’s tax cuts and increased defense spending swelled annual shortfalls to a then-worrisome 5.7% of GDP, despite a robust economic recovery.
Besides stimulating domestic growth, however, Reagan-era fiscal policies may have served a geopolitical purpose by enticing the Soviet Union to join in an expensive arms race, a ploy which, intended or not, might have played a role in the Evil Empire’s demise.
In any case, Reagan seemed unfazed by the deficit issue. “I am not worried about the deficit,” he quipped. “It is big enough to take care of itself.”
Hefty, too, is the Federal Reserve’s balance sheet, which in May reached $7 trillion, up from $800 billion in 2007. The latest installment of almost $3 trillion tossed a badly needed liquidity lifeline to thousands of companies battling to stave off insolvency.
A free lunch?
To be clear: Monetary and fiscal policymakers had little choice but to respond aggressively to the current downturn, as well as to that of the Great Recession 12 years earlier.
Without government support, the path to anything approaching full recovery from the global financial crisis — though tepid by historical standards — would have been longer. And the government’s response to the COVID-19 recession could prove to be even more effective due to its size, access to proven monetary tools and absence of a villain, such as Wall Street banks.
Yet the question remains: Is there a point at which virtually unlimited government borrowing and spending tips the U.S. into an economic crisis? If so, here is a small sampling of potential trouble spots:
Financial bubbles. Fiscal and monetary stimulus run the risk of unduly inflating asset values. Zoom Video Communications — an apparent favorite of homebound retail investors trading commission-free — enjoys a market capitalization of $75 billion on earnings of $27 million.
More broadly, the Russell 2000 Index of small U.S. stocks trades at almost 80 times next year’s earnings when money-losing companies are included, based on calculations by Vincent Deluard supplied to Mark Hulbert and published in MarketWatch. Writing in the Business Insider in May, Linette Lopez called the combination of 780,000 newbie investors speculating in a time of massive uncertainty “a perfect storm of stupid.”
Dependent markets. The magnitude of recent government interventions in the economy — necessary as they were — nonetheless calls into question whether U.S. financial markets are now truly free, and what the need for such ongoing support indicates about the nation’s economic health. It should be noted that each time the Fed has attempted to drain the monetary punch bowl in recent years, markets have at best stalled and at worst, rioted.
Central bank losses. If bond yields eventually rise as private borrowers compete with the government for funding, the value of the Fed’s main asset — Treasury debt — will decline. Unless there is a commensurate fall in central bank liabilities, the result will be … nobody knows.
So is the latest round of government largess something of a free lunch, or will there be a heavy price to be paid down the road?
Robert Louis Stevenson once cautioned that ”sooner or later, we all wake up to a breakfast of consequences.” Nice line, but is it true for an economy built on staggering sums of fiat money? Time will tell.