We shouldn’t be worrying about the deficit now

Note: I wrote this for my Pandemic Blog, but I think the topic is important enough to include it in this blog as well.

The US economy clearly needs a lot of help – as today’s second quarter GDP number will undoubtedly show. A new aid package will be approved soon, but it seems a number of GOP Senators are digging in their heels because of a renewed concern about the deficit. While I realize there are political reasons for their saying this, I think it’s important to address their argument on its merits, because a lot of people will think it actually makes sense.

Of course, if we’re going to hand out $1-3 trillion dollars in new aid (on top of what’s already been approved), we’re not going to increase taxes to pay for it; it will result in an increased deficit. This means we’ll have to borrow the money for this new package. So our national debt will increase by that amount.

OK, our debt increases. What’s the problem with that? The interest rate we’ll pay will be very close to zero, so that’s not an issue. Of course, the problem is we’ll have to pay the money back when it’s due (say 10-30 years from now). Yet we don’t even have to pay it back then; we can always extend it, especially if the interest rate stays close to zero (and current interest rate futures markets don’t show any big jump coming anytime in the future. This doesn’t mean that a big jump couldn’t happen – just that it’s certainly not inevitable).

The big issue is that at some time in the future, the people who hold this debt may lose patience or trust in the US and they’ll demand – through the markets – that we either pay it back or extend it at a much higher interest rate. However, this ignores an important fact: It’s certain that these lenders we’re so worried about will be – either entirely or in the greater part – ourselves. This is because the Federal Reserve will buy all the debt that can’t be adequately financed at a very low rate. Chairman Powell has been urging Congress to spend big to prevent an outright Depression, which shows the Fed will do everything it can to allow this to happen.

This brings the question down to: Where will the Fed get the money to pay for all of this debt they’re going to buy? Do they have some sort of reserve – like the gold supply at Fort Knox – that they can tap into? No, any reserves the US has are owned by the Treasury. The Fed will create money to pay for this debt (which of course can be done simply by a credit to the Treasury’s account at the Fed. Wouldn’t it be nice to open your bank statement and see there’s an extra $3 trillion that wasn’t there yesterday? I’d be willing to settle for much less than that!).

So the real objection to further increasing the deficit at this point comes down to the question: What’s the downside of the money supply suddenly increasing by $3 trillion? Is it a totally “free lunch”? There are only two possible negative consequences: Interest rates will jump sharply, or inflation will jump sharply.

What do markets expect will happen? As far as interest rates go, long-term rates aren’t much higher than short-term rates; in fact, there was in recent months an “inverted yield curve”, meaning long-term rates were lower than short term. This is an implicit forecast for rates to go lower, not higher. And since the Democratic relief package was passed in May and had a $3 billion price tag, this has certainly already been included in the market’s expectations.

So how about inflation? Will the Fed’s actions to increase the money supply result in a big run-up in inflation down the road? Again, the markets don’t think so. The interest rate on inflation-adjusted bonds, which serves as the market’s “forecast” of inflation, is very close to the rate on “regular” bonds, meaning the market doesn’t believe inflation will increase significantly in the next ten years. Again, this forecast is based on the knowledge that a big relief package will be passed soon (which it will, although it doesn’t look likely this week).

Of course, the GOP Senators all know this. Yet they still believe that further running up the deficit will spell disaster for the US. I have an idea: They need to hear some words of comfort from someone that they all look up to: Milton Friedman. He’s no longer with us, but tomorrow I’ll share a point that he made over and over again during the two courses that I took with him at the University of Chicago in…hmm, I can’t seem to remember the year. In any case, it was a little while ago. But the words are as true today as they were then.

The numbers

Worldometers.info just restated their numbers for deaths and cases for recent days, and it seems things might not be as bad as I thought yesterday – i.e. the death projections may not be as grim as I thought. However, I want to wait at least a day before I do another projection, since they might restate their numbers again.

So I’ve simply filled in the actual numbers from yesterday. These show some marked improvements – with the 7-day rate of increase in total cases down to 10% from 12%, and the 7-day rate of increase in total deaths down to 4% from 5% (restated from the 6% based on yesterday’s numbers). I hope these are real!

I. Total deaths

Total US deaths as of yesterday: 153,840

Deaths reported yesterday: 1,485

Yesterday’s 7-day rate of increase in total deaths: 4% (This number is used to project deaths in the table above; it was 5% two days ago. There is a 7-day cycle in the reported deaths numbers, caused by lack of reporting over the weekends from closed state offices. So this is the only reliable indicator of a trend in deaths, not the three-day percent increase I used to focus on, and certainly not the one-day percent increase, which mainly reflects where we are in the 7-day cycle).

II. Total reported cases

Total US reported cases: 4,568,037

Increase in reported cases since previous day: 66,921

Percent increase in reported cases since 7 days previous: 10%  

III. Deaths as a percentage of closed cases so far in the US:

Total Recoveries in US as of yesterday: 2,189,592

Total Deaths as of yesterday: 152,358

Deaths so far as percentage of closed cases (=deaths + recoveries): 7%

For a discussion of what this number means – and why it’s so important – see this post. Short answer: If this percentage declines, that’s good. It’s been steadily declining since a high of 41% at the end of March. But a good number would be 2%, like South Korea’s. An OK number would be 4%, like China’s.

I would love to hear any comments or questions you have on this post. Drop me an email at tom@tomalrich.com