By Stephen P. Pizzo
www.stephen.pizzo.com
As I write this the Senate is arguing over whether to increase cash aid to those hard hit by the pandemic from $600 to $2000. There's no doubt among those of us out here in the real world that even two grand is not going be enough for many. But, as serious as things are right now, this is a small matter when compared to the fiscal mess America faces going forward, as hard decisions collide with even harder facts.
While being a deficit hawk is considered a “Republican thing,” I am a lifelong progressive, and I worry a great deal about two things: 1) ever-expanding deficits, and 2) the Fed responding to every major economic crisis by flooding the markets with virtually free “fiat currency.” (https://www.investopedia.com/terms/f/fiatmoney.asp )
Businesses, banks, and Wall Streeters have become addicted to the Fed's flood of liquidity as if it were heroin. Evidence lays in their response any time the Fed tries to bump up rates or threatens to turn the money faucet off. When that happens, or even the hint it might happen, Wall Street firms panic, and the hue and cries from the corporate bond world is deafening. And for good reason, the Fed is buying a lot of their corporate debt.
“The Fed holds an expansive list of other companies indirectly, including names like Apple and Goldman Sachs, through exchange-traded funds it has purchased. In addition, it has purchased bonds in speculative-grade companies as well as ETFs, including the SPDR Bloomberg Barclays High Yield Bond, a fund in which the Fed holds a $412 billion position.”
https://www.cnbc.com/2020/06/29/the-fed-is-buying-some-of-the-biggest-companies-bonds-raising-questions-over-why.html
Meanwhile, even as the Fed floods markets with liquidity, the vast majority of working Americans haven't seen much of it and instead remains stuck with incomes that have not seen an inflation-adjusted jump in over four decades.
“Sluggish and uneven wage growth has been cited as a key factor behind widening income inequality in the United States. A recent Pew Research Center report, based on an analysis of household income data from the Census Bureau, found that in 2016 Americans in the top tenth of the income distribution earned 8.7 times as much as Americans in the bottom tenth ($109,578 versus $12,523). In 1970, when the analysis period began, the top tenth earned 6.9 times as much as the bottom tenth ($63,512 versus $9,212).”
https://www.pewresearch.org/fact-tank/2018/08/07/for-most-us-workers-real-wages-have-barely-budged-for-decades/
So, where is all this funny-money going? Look no further than the stock market. Even in the throws of the worst pandemic in a century, stocks reach new highs almost daily. Should the Fed turn the money machine off, stocks would drop by a terrifying amount...40%...maybe 50%. So it's like riding a tiger...you would love to get off, but dare not.
“The Fed's actions have essentially made mainstream alternatives to stocks impractical for most investors. Those who want to keep cash available can expect little or no interest at all, and with inflation still positive, that means savers are losing purchasing power every month on their cash savings... Low rates are also bolstering the case for other high-risk assets.” ( ie: stocks and corporate debt.)
https://www.fool.com/investing/2020/12/16/the-fed-just-gave-stock-market-green-light-2021/
But flooding the markets with liquidity isn't a solution, but a treatment, a treatment that has its natural limits...not unlike in physics...sooner or later you hit a point of diminishing returns. As we reach that tipping point, no amount of liquidity will bring this sick patient around. At that point, unless something different is done, you get depression...the real kind.
Also at that very moment, the growing federal deficit becomes a very real anchor around the country's neck. No matter how much money the Fed pumps out, it not only no longer boosts but actually starts hurting the economy. Dollars are like stock...the more of them in circulation, the less each is worth. So the dollar plummets in value, requiring more dollars to buy the same amount of anything. It's not hyper-inflation, yet, but either the Fed has to stop pumping funny-money into the system or hyperinflation is the only outcome.
Add to all this the continuing stream of annual federal budget deficits, which for 2020 came in at a breathtaking $3.1 trillion.
At this point the overall federal deficit is becoming a fiscal Chernobyl...a hard-to-control core meltdown, where $27.6 trillion or more obligations accrue hundreds of billions in interest payments to the deficit, meaning that, even if the Fed turned off the printing presses, the deficit would continue to balloon all on its own. https://www.usdebtclock.org
The federal deficit represents the money we owe to both foreign bond investors, (China holds over 5% of US debt,) (https://www.scmp.com/economy/china-economy/article/3112343/us-debt-china-how-big-it-and-why-it-important) and to ourselves (bonds sold to Americans.)
There is a “cheap” way to pay down we owe, but it would require the Fed sparking raging inflation, slashing the value of the dollar. And, since we must repay all those bonds in dollars, it effectively slashes the actual cost of repayment.
Of course, as the old saying warns, “every shortcut has its rent,” and the rent for that short cut would be unacceptably high. Bond investors would be very unhappy, and unlikely to consider US bonds a safe harbor in the future. The Fed could attract them back, but that too would be unacceptably high. The Fed could significantly raise interest rates. But that in turn would strangle any recovery by raising the cost of borrowing for already struggling businesses. It would also significantly raise the cost of government borrowing, which in turn would further increase the deficit.
Once more we learn, the hard way, that there really is no such thing as a free lunch.
With those moves off the table, the only other apparent option would be for the government to significantly slash spending. But at a moment when federal relief spending is the only thing that keeps millions of Americans' heads above water, that option would be cruel in the extreme.
So, as the nation battles a budget-busting, deficit exploding national emergency, what's the answer to this dilemma. There is one solution, unused and vilified by all conservatives and even some centrist Democrats...raise taxes.
You won't hear many in Congress pushing for tax hikes, even among Democrats. Instead, most of the talk is how much more to add to the deficit to pay for worthy stuff now while worrying about the deficit sometime down the road.
But higher taxes on those who can afford them, and who have garnered so much from previous tax cuts, it the only sane answer. Those tax cuts for the rich have also helped feed the federal deficit while enriching the already filthy rich:
“By the end of 2025, the tally of tax cuts will grow to $10.6 trillion. Nearly $2 trillion of this amount will have gone to the richest 1 percent. By then, the total impact on the deficit will be $13.6 trillion, including interest payments.”
https://itep.org/federal-tax-cuts-in-the-bush-obama-and-trump-years/
So the Biden administration needs to quickly and strongly propose revoking most of the tax cuts for the rich passed by Republicans from George W. Bush to Donald Trump. On top of that an emergency review of the US tax code is required to ferret out and close (really close) tax code loopholes.
That would start the process of refilling the federal coffers with enough money to begin paying down the federal deficit. That has only been tried once in my lifetime, and that was during the Bill Clinton administration. Clinton raised taxes on corporations and top earners and, for the first time since Eisenhower was president we had enough surplus to begin paying down the deficit.
Revoking many if not most of the tax cuts passed during the W. Bush and Trump terms really are the only sustainable solution. Will the Biden administration, and Democrats have the guts to grab this “third-rail” and take the necessary heat to get this done … for the good of the nation and future generations? We'll see.
If they don't, and instead keep “kicking the can down the road,” we'll be coming to a sorry dead-end.
