In The Lonely Bull

The Bull is often asked, “what about all the debt the federal government is taking on to fight the economic fallout from fighting the coronavirus pandemic?”  So far, the incremental debt is around three trillion dollars and still counting. (The number actually looks like this: $3,000,000,000,000.) Is inflation to be expected? What mess are we leaving for the future? Will the government’s future budgets be overwhelmed by interest costs on a gigantic debt pile?

One thing needs to be pointed out, much of the new debt is being purchased by the Federal Reserve.  In essence, one federal branch is borrowing the money, and another is buying the new debt (bonds). To pay for the new treasury obligations, the Federal Reserve simply creates new money. It is the veritable printing press, but in this case, it is mostly credits created on the Treasury’s ledger. The Treasury pays interest on this debt and the Federal Reserve collects it. So, is it really new debt?

In theory, in the future both federal agencies can swap assets for liabilities and net much of this debt out. Interest payments are already being netted out with one branch paying it and another collecting it. If the Federal Reserve sells the Treasury Bonds to the public then it becomes real debt.  Then interest must be paid to the new owners.

The consequence of creating all the new money is that it enters the money supply. This could be inflationary if nothing else was happening.  It would be more money chasing the same supply of goods and services. However, in our case today, this new money is shoring up a shrinking money supply. Since the lockdown began, the velocity of money has largely collapsed.  Velocity is a measure of how many times a dollar changes hands and is part of the available supply. If new money was not supplied, then deflation would likely be the outcome; fewer dollars available to purchase the same goods and services with each dollar then worth more (correspondingly the goods and services worth less).

Deflation is a serious challenge to economic growth. In fact, it usually causes the economy to shrink, not what we want to happen. So, for the time being, the new debt is not a problem. It is stabilizing a damaged system with options as to how it can be dealt with in the future. There are many things to worry about today, this is just not one of them.

Stay steady and stay safe. The U.S. will prevail.

The Lonely Bull

Recommended Posts