Friday, April 3, 2020

Could Coronavirus Lead To A Debt Crisis?

We aren’t done fighting the Coronavirus and repairing the economy, but the next crisis may already be shaping up. Part of the prescription for getting the country through the pandemic was a $2 trillion relief bill. Unfortunately, most of the cost of that bill is going to be added to our national debt.

The problem is that the national debt is a lot bigger than the $2 trillion price tag of the rescue package. At the end of 2019, the national debt was $23.2 trillion and today, before the relief money is added to the total, it stands at 23.6 trillion per the Debt Clock.

We don’t know how much of the total will be financed by debt at this point, but it is reasonable to assume that the relief spending added about two years’ worth of debt (the 2019 deficit was $984 billion) to our national credit card. With a rapidly shrinking economy, the red ink will probably be even worse. While the relief spending won’t break the bank immediately, it does move us closer to the possibility of a debt crisis.  

For decades now, we have been spending far more than the government takes in, but the problem has gotten worse since the turn of the century. The US has been running deficits and carrying debt for much of its history, but the past three presidents have done the most damage. Presidents Bush and Obama both watched as the debt almost doubled on their watch. Under Obama, the debt exceeded 100 percent of GDP for the first time. President Trump was on track to add almost five trillion dollars to the debt even before the Coronavirus emergency.

For many, the answer to the impending debt bomb has been that we should grow our way out. If the economy was growing at a faster rate than the debt then we could eventually solve the problem. It would be like using a larger salary to pay off debts incurred when you weren’t making as much. The problem is that our borrowing has increased at a faster rate than our revenues.

If we are honest, tax reform was part of the problem. Although the economy grew after the tax overhaul in 2017, tax revenues were flat. The fruits of the boom did not fill government coffers. The problem was made worse by the fact that spending continued to increase.  

And now our economy is not growing at all. It’s contracting and probably doing so at a record clip. The result is going to be a YUGE increase in our debt as a percentage of GDP.

In times past, deficit spending was used by governments in times of emergencies to see the nation through the crisis. Debt would be paid down when times were good to keep the economy healthy. These days, government spending is debt-financed in both good times and bad, leaving little room for emergency funds when things truly hit the fan.

I’m not saying that we shouldn’t have passed the relief bill. It was and is an emergency and we were between a rock and a hard place. With or without social distancing measures and the economic pause, the country was going to face a downturn because of the pandemic. The only question was whether we would try to minimize the death toll or let the virus run rampant. Trying to save millions of lives was the right choice.

But let’s be realistic: The $2 trillion is probably not going to be enough. When Congress passed the bill, we were thinking about a two-week economic hiatus. Now the president has extended the social distancing guidelines through the end of April. Some states are planning on longer breaks. Individuals and businesses are both going to need more bailout money than the initial package provides.

And even when we restart the economy, things won’t immediately go back to normal. The virus will still be around and we still won’t have a vaccine. We’ll have to be careful about a second wave of outbreaks. High-risk people – and many others – won’t feel comfortable being in large groups or traveling for a long time. Some parts of the economy may never return to the pre-Corona status quo.

But that choice does come at a price and prices must be paid. And the fact that we are running about three years’ worth of debt in one year is going to make tackling America’s debt problem an even bigger priority. It should anyway but what are the odds?

Unlike the Coronavirus crisis, the looming debt crisis is not coming out of the blue. It’s like watching a train approaching on a long, straight track. You have plenty of time to step out of the way, but if, you don’t move, you’ll eventually get run over.

In the case of a debt crisis, getting hit by a train might take several forms. One possibility is that our debt might become harder to finance. Right now, with the world in chaos and interest rates at zero that may sound ridiculous but this situation won’t last forever. At some point, interest rates are going to return to normal, however. Interest on the federal debt is already more than six percent of federal spending and that number has nowhere to go but up.

A worst-case scenario is a Greek-style crisis in which the government loses the ability to borrow more money or a federal default. Can you imagine a world in which federal spending was limited to actual revenues minus payments on debt and interest? The economy would almost certainly collapse under the weight of lost entitlements and subsidies. The effects could cascade around the world given the amount of spending that the US government does in other countries.

One thing that has saved the US in the past is the dollar’s status as a world currency and Treasury debt as a safe haven. However, there has been a movement afoot for years, driven by China and Russia, to create a global competitor to the dollar. A debt crisis in the US could spur those efforts and deepen an American debt spiral.

Unfortunately, neither party seems interested in the debt problem. In fact, days after putting the $2 trillion relief bill on the national credit card, President Trump announced his intention to spend another $2 trillion on an infrastructure bill, touting the fact that interest rates are currently at zero.

There are two problems with that plan. The first is that interest rates will not always be zero. The second is that we owe more than we can pay back even without paying interest.

It is difficult to fight two wars at once and Coronavirus is the most dangerous short-term threat. We have to beat back the pandemic before we can do anything else. Doing that is probably to require more deficit spending. However, the increased deficit spending in this emergency is going to mean that the ballooning national debt is dangerous in the long term. That should be our next focus.

Originally published on The Resurgent

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