Fiscal conservatism is dead; long live fiscal conservatism

Fiscal conservatism is dead. Neither party is particularly interested in reining in spending, and pitching financial responsibility is about as sexy as steamed cauliflower. Between the political class and the Federal Reserve, most of us have been insulated from the consequences of ridiculous monetary and economic policies for more than a decade. Nobody really cares about government spending until it negatively affects their personal finances. Inflation has our attention, and the next lesson will be painful.

So how did we get here? From 2012-2021, the federal government deficit spent $11,603,703,000. By comparison, the United States’ annual GDP in 2003 was $11,456,450,000. In one decade, our leaders managed to spend an entire American economy without paying for it.

In a sane political environment, spending and taxation connect. Instead, Republicans have ensured taxes stay low, while neither party has meaningfully reduced spending. Rather than compromise, both parties blame each other and accomplish their preferred spending by borrowing money. Dumping trillions of dollars into an economy without enough goods and services to soak them up causes inflation.

Practically speaking, there’s no upper limit on the federal government’s ability to borrow and spend. The federal debt limit is a joke. Congress will always raise its borrowing ceiling to avoid financial pain. COVID-19 pushed federal spending to a fever pitch. In the past three fiscal years alone, Congress added $6.9 trillion to the national debt.

Over the 2012-2021 window, the U.S. money supply also doubled from $9.7 trillion to $19.4 trillion. Again, response to the COVID-19 pandemic led to an exponential increase. As Congress deficit spent, the Federal Reserve got in on the action by buying trillions in Treasury securities with “created” dollars to fund the bender. It’s not technically printing money, but it has the same effect.

Meanwhile, the Federal Reserve also kept interest rates, specifically the federal funds rate, artificially low. Those policy decisions encouraged individuals and businesses to take risks with borrowed money. Banks lending money don’t actually have all the money on hand to convey to borrowers. They’re typically only required to hold a specific amount of cash on reserve. Effective March 26, 2020, the Federal Reserve reduced reserve requirement ratios to 0%. The move incentivized banks to loan all their funds during the COVID-19 pandemic. As such, even more “created” money made its way into the economy.

As politicians, regulators and banks flooded the economy with dollars, supply chain woes from COVID-19 shutdowns prevented goods and services from reaching the marketplace. The perfect storm accelerated the acute pain of inflation.

To address inflation, we must remove dollars from the economy.

The obvious first step is for the political class to do no further harm. Stop spending what we don’t have. For example, President Joe Biden’s student loan forgiveness plan sounds like good politics to some, but it’s up to $1 trillion in revenue not coming to the federal government over the next 10 years. Without a spending offset, the measure will undoubtedly drive up deficit spending. Republicans don’t seem to get the message either. The House Republican midterm campaign calls for recruitment and retention bonuses for 200,000 police officers.

When we’re staring down more than $1 trillion in additional deficit spending, which politicians will volunteer to raise taxes or cut spending in an election year?

The Federal Reserve could also require banks to keep substantial cash reserves again to help slow monetary expansion. Banks understandably don’t want the expense of changing their policies, reducing lending and accumulating reserves, but the measure would undoubtedly dry up some of the excess money supply.

That basically leaves the Federal Reserve Board with interest rates and balance sheet manipulation to address inflation. The Federal Reserve is currently engaged in quantitative tightening by selling securities, and it’s also increasing interest rates. It’s a delicate dance with real world consequences.

The American economy is a jacked bodybuilder who needs to get off the juice before he has a heart attack. There’s no easy way to keep the ill-gained muscle mass and return to normal. Pulling money out of the economy too quickly will likely lead to a recession. Failing to pull it out quickly enough could lead to the combined increase in inflation and unemployment, also known as “stagflation.” Either way, the era of cheap money and consequence-free spending is coming to an end. Just when we thought rational fiscal policy had breathed its last, financial consequences came calling.

Now we’re looking for leaders who will pull our economy out of the ditch and deciding how much economic pain we’ll endure for them to do it.

Long live fiscal conservatism.