My longtime friend, Thomas P. Vartanian, formerly a bank regulator at two different federal agencies and then a private practitioner for four decades, is the executive director and professor of law at George Mason University’s Antonin Scalia Law School’s Program on Financial Regulation & Technology. He is the author of “200 Years of American Financial Panics,” which will be published in May 2021.
As Congress begins to reconcile the different versions of financial stimulus passed by the House and Senate to relieve the devastation of the COVID-19 pandemic, we can only hope that someone brings a rigorous sense of financial reality to the table. There is a lot at stake beyond the immediacy of the devastating effects of the pandemic. Congress may once again be paving the path to the next financial crisis.
Financial collapses typically follow the creation of economic bubbles, so it is useful to understand when bubbles are forming. Most bubbles are characterized by too much credit chasing overvalued assets. Many financial bubbles often masquerade for some time as strong economic growth, shedding their disguises only when it is too late to stop them from bursting. Just like the contestants in the popular 1960’s TV game show “To Tell the Truth,” which climaxed when the real baseball player or plumber was asked to stand up and surprise the audience, many bubbles are quite accomplished at fooling even the most sophisticated viewers.
While there are undoubtedly Americans in distress from the pandemic, a short-term fix should be made with full knowledge of the longer-term economic issues that the country faces. As the effects of the pandemic appear to be retreating, the firehose approach to economic assistance should be jettisoned and replaced with targeted assistance. The more pork and unnecessary subsidies that Congress includes, the closer we get to our next financial panic given the context we find ourselves in.
What is that context? Take the bubble that no one seems to ever worry about — the national debt. It sits today at $28 trillion and is growing by the minute. Over the last quarter century, it has continuously been nurtured by Congresses and White Houses that seem to believe that there are no restraints on the country’s borrowing and spending power. That has necessitated an endless series of governmental actions that have distorted markets, which then of course requires further attention and adjustment as markets evolve, leading to even further market distortions.
Since interest rates hit 21 percent in the early 1980s, the Federal Reserve has taken increasing control of the economy, managing it through ups and downs. During the panic of 2008, the Fed rescued a reeling economy by purchasing, among other things, Treasury notes and mortgage-backed securities, ballooning its balance sheet from a meager $870 billion in 2007 to an eye-popping $4.5 trillion in 2014.
Even before the Fed could shed itself of that portfolio and return markets to “normality,” the pandemic of 2020 and the relief efforts enacted by Congress compelled it to increase its portfolio to a whopping $7.6 trillion. It is not clear how long it will take the Fed to unwind its current holdings, if it happens at all. This combination of relentless spending and borrowing has maneuvered the economy into a position that requires constant realignment by the government to avoid new catastrophic economic events.
Exhibit A is how desperately the country needs low interest rates. It is not that it is stimulative to have low interest rates. The country needs rates to be low to avoid even greater financial distress. According to Jimmy Chang, the insightful chief investment officer at Rockefeller Capital Management, a 1 percent uptick in the general level of interest rates would increase America’s annual interest payments on its outstanding debt by about $280 billion, which is 54 percent higher than its interest outlays in 2020, more than 5 percent of the federal government’s total spending in a typical year (pre-pandemic levels) and 40 percent more than the Pentagon’s annual budget for the Navy. Consider what would happen to the U.S. economy if rates climbed to a 6-8 percent level, which traditionally would not have been considered abnormal.
But this is only the tip of the economic iceberg. The United States continues to borrow and print money at a furious rate. The money supply represented by checking deposits, cash and other financial figures is up an unprecedented 26 percent on a year-over-year basis. That means that about a quarter of all money in the U.S has been created in the last year.
This is not a sustainable course of action. The longer-term effects, which may include inflation, deflation, increases in interest rates, increased unemployment and devaluation of the dollar, will all trigger further governmental intervention and adjustments, which will lead to the need for yet further action. While I am not suggesting that the government should not be acting to avoid financial calamities, there is a limit to what it should do. It has acted to bail out markets in every financial crisis since the 1980s, conditioning them to expect soft landings. But not everyone has received a soft landing.
Notwithstanding these and other troubling trends, our leaders seem to be tone deaf to financial realities. Ten financial panics in the last two centuries are proof of that. There will be clear consequences, and perhaps none more likely than the U.S. economy and dollar being surpassed by China as its economy continues to grow and as it surpasses the rest of the world in investments in technology and rare earth metals.
Consider the recent canary in this cave. Some U.S. corporations seem to be hedging their bets against future collapses of the U.S. economy or dollar. Why else would companies such as Tesla and MicroStrategy move billions in Treasury funds into cryptocurrencies that have no intrinsic value? Is it the hype described by Chang as the “Tinker Bell Effect,” or is it that Bitcoin is becoming more trusted than the dollar?
As Congress decides how much to provide in additional relief to Americans, an estimated $1 trillion of the $4 trillion already appropriated has not been spent. But it is difficult to stop the music and actually identify what has been spoken for and what has not been spent.
Those who have been devastated by the impact of COVID-19 should be helped. But using a firehose to distribute that relief will result in more financial pain down the road.