Over 190 countries have taken fiscal or monetary action to mitigate the effects of the coronavirus pandemic, according to the International Monetary Fund.
The US Congress has authorised an additional US$2.8 trillion in government spending, with further appropriations expected. The fresh US spending, all debt funded, comes on top of a $1,022 billion pre-existing budget deficit for 2019. The US$21,216 billion US economy had already been supporting outstanding federal government debt of $23,224 billion at the start of 2020.
Supplementing government initiatives, the US Federal Reserve has dramatically lowered interest rates and committed an unlimited budget for the purchase of financial assets to shore up their value. It already holds $5,886 billion in government and mortgage backed securities. Now, it is moving along the risk curve to buy publicly traded equities and low-grade corporate debt.
The government of the world’s second largest economy has committed an additional RMB3.6 trillion to support economic activity. The Chinese central bank has flagged a boost to its lending by RMB6.0 trillion as well as offering fresh loan support by way of guarantees and rate reductions.
The UK government is committed to spending another £48.7 billion with an undefined amount in loans to support business activity. The normally fiscally conservative Germans are spending another €427 billion and offering €820 billion in loan supports.
Some of the most historically dogged fiscal conservatives are voicing support for spending and loan commitments beyond the dreams of the most wild-eyed socialists.
Fiscal reactions to the pandemic threat have not been especially well planned. Their breathtaking speed has emphasised getting cash out the door. Nor has the longer-term impact on economic performance and future living standards been widely canvassed.
Out the window has gone the now old-fashioned warning that governments, like families, should live within their means.
Central banks, having acquired their independence since the 1980s, have morphed from behind the scenes lenders of last resort to licensed banks into frontline buyers of financial assets. Now, markets throw a tantrum if central banks are not signalling their support regularly and frequently. Central banks are seemingly obligated to assuage the slightest investor anxiety.
The ambivalence of economists towards debt funding has worked against financial discipline. Governments have sprinted to take advantage of their teaching that not all debt is bad. Don’t blame Covid-19. Central governments in advanced economies started 2020 with debt levels already exceeding the dangerously high 100 percent of GDP benchmark.
A simple example can illustrate the reasons for economists’ schizophrenic mindset about deficit spending.
Let’s assume that a country’s GDP of $100 is growing at 5%, comprising real output growth of 3% and inflation of 2%. You can scale that up with as many zeroes as you like. The results will be the same.
Then comes an exogenous shock of some sort, like a pandemic, which causes the government in this example to debt fund expenditure of $100. Let’s say that the interest payable on the debt, also debt funded, is 7%. If nothing else changes, after 25 years, the original debt and ongoing interest liability will have mounted to $543, more than a fivefold increase.
Debt will have risen to 168% of the higher GDP with dimming prospects of repayment unless residents cut back on their spending or find new sources of income. GDP would have more than tripled but 11% of the larger GDP would be committed to debt servicing.
The US government can issue bonds denominated in US dollars. Other countries’ governments, forced to borrow in US dollars, face currency risks. The debt of US dollar borrowers escalates even faster to the extent the value of their currencies declines as investors grow more fearful of a repayment default.
Governments in this predicament are usually forced into harsh spending cuts to keep a lid on the mounting debt burden. Think here about Greece, Italy and Argentina as conspicuous examples of the consequences among more advanced countries.
Let’s say, in our example, that the government spends its borrowings solely on productivity enhancing initiatives like new roads, ports to boost exports, public health services to improve life expectancy and education to raise the technical competence of the workforce. Let’s assume that these measures boost the GDP growth rate from 5% to 7%.
Also, interest rates have plummeted. Today, the US government can borrow for 10 years at around 0.8%. Almost incredibly, German rates are negative. So, let’s drop the assumed debt servicing charge in the example from 7% to 1%.
The economic outcome is radically different with these two changes. GDP is 57% higher. The debt rises to only $128 or 25% of GDP. Rather than 11% of GDP going in interest payments, only 0.3% is being absorbed in debt servicing. Spending on more productivity enhancing measures, social programs or lowered taxes becomes possible.
Done right, debt-funded government spending could greatly enhance future living standards. But here’s the rub. The coronavirus spending splurge is largely bereft of measures to improve long term growth potential. It is focussed, instead, on getting consumers to buy stuff now.
Without more investment, the bill for today’s spending will show up in lowered living standards in the future. Education, health and public welfare service delivery will seem to fall mysteriously short of what was expected as anonymous lenders take a growing chunk of income.
The intergenerational sharing of wealth, largely ignored in advanced economies, has received more attention in resource-rich developing countries which have had to plan for the exhaustion of their mineral or petroleum wealth.
Circumstances have forced governments in resource-rich countries to set aside a part of current revenue from the sale of natural resources to underwrite future provision of government services. Sovereign wealth funds are set up for such a purpose.
A sovereign wealth fund used to manage national savings does not of itself solve the problem. Generally accepted guideposts about what constitutes a fair intergenerational share of well-being are also needed.
Even if debt and savings rules were legislated, opting out of a self-imposed fiscal straight-jacket is tempting when an unanticipated emergency, like a pandemic or a financial crisis, hits.
History has not helped foster fiscal discipline. Warnings over the past 40 or 50 years of impending economic calamity as a result of governments having lived beyond their means have been ignored with little obvious consequence.
The emergence of China as an economic power has especially eased pressures for more conservative budgeting. China’s globally significant savings levels have removed an important fiscal constraint on the rest of the world.
Advanced economy budget deficits, funded by Chinese savings, have fuelled spending on Chinese goods. Propping up that nation’s employment and income base has, in turn, sustained the pool of savings on which Western countries have come to rely for their deficit funding.
Freely flowing capital and unhindered movement of goods have been at the heart of this benign circle of economic life.
Even before the new coronavirus hit, these mutually beneficial trade and financial arrangements were crumbling. Their restoration, at a minimum, would help ease the burden of the newly imposed debt.
If, on the other hand, capital mobility and trade freedom are scaled back, the enormity of recent policy actions will require governments to come up with new ways to mitigate their effects on future living standards. Governments owe that to those involuntarily footing the Covid-19 bill.