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Stimulus, Inflation, Unsustainable Debt and America | Fidelity Investments and Peterson Foundation

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“America has been on an unsustainable fiscal path for many years, since long before this pandemic.” The Peter G. Peterson Foundation

  • The new $1.9 trillion stimulus spending package, on top of trillions already spent to revive the economy, is driving the national debt to unprecedented levels.
  • History shows that high government debt often leads to inflation, and an uptick in inflation is expected this year as the economy recovers.

The $1.9 trillion federal stimulus package will help many families, businesses, and state and local governments hard hit by the pandemic. But it is also fueling concerns about the ballooning federal debt, inflation, and how investors can protect themselves.

The Congressional Budget Office projected that the federal budget deficit will rise during the second half of the decade and climb steadily over the following 20 years.  By 2051, the federal debt is expected to double as a share of the economy.

The projections by the nonpartisan office forecast a more challenging long-term outlook, as interest costs on the national debt rise and federal spending on health programs swells along with an aging population.  “A growing debt burden could increase the risk of a fiscal crisis and higher inflation as well as undermine confidence in the U.S. dollar, making it more costly to finance public and private activity in international markets,” the CBO report said.

Our federal fiscal budget has structural problems, driven by well-known and predictable factors that include an aging population, rising healthcare costs and compounding interest—along with insufficient revenues to meet our commitments, according to The Peter G. Peterson Foundation.

Over the last 20 years, the federal government’s debt has grown faster than at any time since the end of World War II, running well ahead of economic growth. In addition to COVID-related spending, rising federal debt has been driven by longer-term trends including increasing Social Security and Medicare spending for an aging population. Today, according to the Congressional Budget Office, the federal debt is $22.5 trillion, more than 100% of gross domestic product (GDP).

Why debt matters

New Fidelity research suggests that higher debt can slow economic growth, and ultimately lead to higher inflation and more volatile financial markets. Warns Dirk Hofschire, senior vice president of asset allocation research at Fidelity Investments: “Debt in the world’s largest economies is fast becoming the most substantial risk in investing today.”

In the short term, Fidelity’s director of global macro Jurrien Timmer says a market consensus has emerged that inflation will rise in the second half of 2021: “An inflationary boom could result from the combination of COVID infections falling, vaccinations rising, ongoing massive fiscal stimulus, pent-up consumer demand, and low interest rates.”

FEDERAL DEBT IS ON AN UNSUSTAINABLE PATH

Longer term, Hofschire says, “The rise in debt is unsustainable. Historically, no country has perpetually increased its debt/GDP ratio. The highest levels of debt all topped out around 250% of GDP. Since 1900, 18 countries have hit a debt/GDP level of 100%, generally due to the need to pay for fighting world wars or extreme economic downturns such as the Great Depression. After hitting the 100% threshold, 10 countries reduced their debt, 7 increased it, and one kept its level of debt roughly the same.”

Only time will tell which way the US goes and when. But Hofschire thinks “government policies are likely to drift toward more inflationary options.” Among them:

  • Federal spending aimed at lower- and middle-income consumers
  • Increased public works spending not offset by higher taxes
  • Protectionist measures with a “made in America” rationale
  • Infrastructure upgrades targeting sectors such as renewable energy, 5G telecom, and health care
  • Higher inflation targeting by the Federal Reserve
  • Mandatory pay increases for workers benefiting from government assistance

In the longer term, if further free-spending fiscal policies are adopted while interest rates stay low and credit remains abundant, the likelihood of inflation could increase. But history suggests the magnitude and timing is uncertain. Many predicted an inflation surge the last time the federal government embarked on major fiscal and monetary stimulus after the global financial crisis, but inflation mostly failed to appear.

THE GROWING DEBT IS CAUSED BY A STRUCTURAL MISMATCH BETWEEN SPENDING AND REVENUES according to The Peterson Foundation

Why the national debt matters, according the The Peter G. Peterson Foundation:

  • High and rising federal debt matters because it reduces the county’s flexibility to plan for and respond to urgent crises.
  • Debt matters because growing interest costs make it harder to invest in our future — to build and sustain infrastructure, enhance education and support an economy that creates job growth and rising wages.
  • Debt matters because it threatens the safety net — critical programs like Social Security, Medicaid, Medicare, SNAP and Unemployment Compensation are essential lifelines for the most vulnerable populations.
  • Debt matters because America faces emerging and ongoing challenges that will require fiscal resources to keep the country safe, secure and strong — challenges like socioeconomic injustice, climate change, affordable health care, wealth and income inequality, international conflicts and an increasingly complex and competitive global economy.
  • Debt matters because the nation should care about its children and grandchildren. Borrowing more and more today reduces the opportunities and prosperity of the next generation.

The U.S. faces a range of complex, unprecedented health, economic and societal challenges, set against the backdrop of a poor fiscal outlook that was irresponsible and unsustainable before the crisis.

Building a brighter future for the next generation must become an essential priority for America, and the high cost of this health and economic crisis only makes that challenge more urgent. Once America has emerged from the pandemic, it will be more important than ever for its elected leaders to address the unsustainable fiscal outlook and manage the burgeoning national debt, to ensure that America is more prepared, better positioned for growth, and able to meet its moral obligation to future generations.

References:

  1. https://www.cbo.gov/publication/57038
  2. https://www.fidelity.com/learning-center/personal-finance/government-spending-2021?ccsource=email_weekly
  3. https://www.pgpf.org/what-does-the-national-debt-mean-for-americas-future

* The Peter G. Peterson Foundation is a non-profit, non-partisan organization that is dedicated to increasing public awareness of the nature and urgency of key fiscal challenges threatening America’s future, and to accelerating action on them. To address these challenges successfully, we work to bring Americans together to find and implement sensible, long-term solutions that transcend age, party lines and ideological divides in order to achieve real results.

Federal Debt has Surpassed the Size of the U.S. Economy | New York Times

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By Matt Phillips. Aug. 21, 2020 Updated 7:48 a.m. ET

The national debt of the United States now exceeds the size of the nation’s gross domestic product. That was once considered by economists a doomsday scenario that would wreck the U.S. economy. So far, that hasn’t happened.

“Economists and deficit hawks have warned for decades that the United States was borrowing too much money. The federal debt was ballooning so fast, they said, that economic ruin was inevitable: Interest rates would skyrocket, taxes would rise and inflation would probably run wild.”

“The death spiral could be triggered once the debt surpassed the size of the U.S. economy — a turning point that was probably still years in the future.”

“It actually happened much sooner: sometime before the end of June 2020.”

“”This is a 40-year pattern,” said Stephanie Kelton, a professor of economics and public policy at Stony Brook University and a proponent of what’s often called Modern Monetary Theory. That view holds that countries that control their own currencies have far more leeway to run large deficits than traditionally thought. “The whole premise that deficits drive up interest rates, it’s just wrong,” she said.”

“At the end of last year, the United States was about $17 trillion in debt — roughly 80 percent of the gross domestic product. In January, government analysts predicted that debt would approach 100 percent of the G.D.P. around 2030. But by the end of June, the debt stood at $20.63 trillion, or roughly 106 percent of G.D.P., which shrank amid widespread stay-at-home orders. (These numbers don’t count trillions more the government owes itself in bonds held by the Social Security and Medicare trust funds.)”

“Economists have long told a story in which debt levels this large inevitably ignited an economic doom loop. Towering levels of debt would freak out Treasury bond investors, who would demand higher interest rates to hand their cash to such a heavily indebted borrower. With its debt payments more expensive, the government would have to borrow even more to stay current on its obligations.”

“Neither tax increases nor spending cuts would be attractive, because both could slow the economy — and any slowdown would hurt tax revenues, meaning the government would have to keep borrowing more. These scenarios frequently included dire predictions of soaring interest rates for business and consumer borrowing and crushing inflation as the government printed more and more money to pay what it owed.”

“But instead of panicking, the financial markets are viewing this seemingly bottomless need for borrowing benignly. The interest rate on the 10-year Treasury note — also known as its yield — is roughly 0.7 percent, far below where it was a little over a year ago, when it was about 2 percent.”

“There’s a debate about whether a large amount of government debt hamstrings economic growth over the long term. Some influential studies have shown that high levels of debt — in particular debt-to-G.D.P. ratios approaching 100 percent — are associated with lower levels of economic growth. But other researchers have found that the relationship isn’t causal: Slowing economic growth might lead to higher levels of debt, rather than vice versa.”

“Others have found that they don’t see much of a relationship between high levels of debt and slow economic growth for rich developed countries.”

“The experience over the last decade has drastically shifted the way economists and investors think about how the United States funds itself.”

Read more: https://www.nytimes.com/2020/08/21/business/economy/national-debt-coronavirus-stimulus.html?referringSource=articleShare