The economy at present is finally emerging from our pandemic constraints. During March, employment was remarkably strong as unemployment continued to fall. The lowest interest rates in a century together with massive pent-up demand backed up by stimulus liquidity is creating a perfect storm for rapid short-term recovery and growth. There is little uncertainty that the pandemic will retreat. Our scientific knowledge base of mRNA techniques will grow and our producers will quickly refine and distribute vaccines for emerging covid variants as necessary. We may be looking at upcoming annual booster vaccine shots for these variants along with the seasonal flu.
Many people have expressed concern that the huge deficits will cause inflation and a subsequent collapse of the dollar. However, these massive deficit spending policies have successfully been deployed in our past but under very different circumstances, so let’s briefly review them.
Massive deficits (or money printing) in the past were of necessity liberally deployed in the service of wars. During the civil war, after New York Banks demanded exorbitant interest rates for war loans, President Lincoln turned his back and ordered the Treasury to print “greenbacks” to fund the war effort. These greenbacks circulated for another fifty years and later with the help gold freely dug out of the ground, funded the massive costs of westward expansion and settlement. Massive deficits funded by the newly created Federal Reserve provided funding for WWI, dropped unemployment to 1.9% and funded the subsequent “roaring twenties” boom with negligible inflation. The boom was brought to a halt by the collapse of hyper-leveraged speculation loans causing a series of domino-like bank failures vaporizing private savings.
An economic recovery had begun in 1936 as unemployment fell from 21% to 14% while GDP had been recovering at a rate of 12% growth. However, Treasury Secretary Henry Morgenthau had become uncomfortable with the idea of continuing ongoing large deficits and successfully persuaded President Roosevelt to begin balancing the budget. The government effectively ran a balanced budget in 1937 with a deficit of only $100 million or 0.5% of GDP. Spending dropped another 10% in 1938 and predictably, in hindsight, in 1938 the unemployment rate spiked back to 19% while GDP contracted over 6%. We experienced a double-dip Depression.
It was only a scant 3 years later as WWII exploded across the globe that our government embarked on “never before seen” massive deficit spending to produce military arms, to pay soldiers and to keep them supplied on two fronts overseas. These massive deficits immediately brought the economy to full employment while expanding the workforce (Rosie the Riveter). The resultant debt was never paid off, the dollar became entrenched as the dominant currency of global trade and the hyperinflation that the inflationistas all knew was just around the corner, never materialized. The war money that was spent into circulation fueled for several more decades one of the greatest industrial expansions and the strongest middle class that the world had ever seen.
Most recently, the pandemic forced us to greatly curtail economic activity and growth in order to contain the spread of the deadly Coronavirus. The old “balanced budget dogma” was quickly thrown overboard by both parties as Congress and the Fed began again to relearn these important lessons of the past and to exercise their Constitutional duty to “coin money” and spend it into circulation.
Some years after the 2008 financial meltdown I wrote, “… until someone finds and proposes a way to inject money directly into circulation to fuel a vibrant economic expansion, we will continue to have low employment growth, low wage growth, low tax revenues and will continue to run the risk of further economic stagnation.” Thanks to the pandemic, we re-discovered both the way, and the will, by means of pandemic relief cash payments directly to consumers.
Staying on course, the current administration seems determined to energize the economy into the future with infrastructure refurbishment and replacement policies. The $1.9 Trillion dollar package currently being structured will continue to inject liquidity and spending in coming years. These funds won’t immediately be placed in circulation, but will be spread over time in the form of time consuming planning, engineering, contracting and construction that could easily last a decade or more. Hopefully this will be followed by an expanded multi-year permanent plan of infrastructure needs, prioritization, implementation, maintenance, and funding.
The fringe benefit of this spending is that we will be spending it on ourselves and on our national wealth instead of on wars where conversely things tend to get, literally, blown up. The recent stimulus cash together with pent-up demand is quickly reviving the economy, and the up-coming infrastructure spending will likely keep it growing for years to come as we try to transition from a low-paying service economy to higher paying green industrial growth.
It need not require a war to put American labor and industrial might back to work. The plausible constraint to this optimistic outlook seems to be, and necessarily always seems to be, whether the political party out-of-power succeeds in demonizing and fearmongering the policies of the party-in-power in order to claim in the next election that they failed to govern. Is inflation a risk? Yes and no, but we’ll address that in a future letter.
The markets seem to have digested the short-term good news, but may be somewhat turbulent for some time until the longer-term outlook becomes more clear. As always, we remain cautious and vigilant. Please remember that these quarterly thumbnail sketches are very brief, so do not hesitate to call me if you wish to discuss your account or our outlook in greater detail.
Very Best Regards,
Joseph L. Toronto, CFA