U.S. Economy Poised to Mirror the Post-WWII Glory
(Bloomberg Opinion) -- The U.S. government has spent $2.6 trillion to support the economy as the coronavirus pandemic spreads, and the Federal Reserve has about matched that amount in asset purchases. We’re not finished fighting Covid-19, so protecting the economy in 2020 may be the most expensive thing the U.S. has ever attempted. Consider that the U.S. spent about $4 trillion in today’s dollars fighting World War II. The good news is that the economic aftermath is likely to be similar.
I’m generally opposed to stimulus. Certainly spend to help the needy, but overgenerous compensation blunts economic signals that point to recovery. Money goes to cronies and failed businesses, hindering the innovation needed for growth. Unemployment benefits should provide a cushion, but not discourage people from seeking new skills or adapting to a changing workplace. That only extends the economic pain.
The virus is entirely different. We don’t want workers to retrain or move, we don’t want them hustling to start new businesses or finding what work is available. We want them to stay home, stay healthy, infect no one and be ready to resume their work when conditions improve. We don’t want businesses to liquidate because they can’t operate profitably under lockdown.
Still, we have to ask how all this extra cash that is being injected into the economy and financial system will be sopped up afterwards. Some of it will return to the government naturally. Loans will be repaid, guarantees will expire unused, bonds and other assets bought by the Fed can be sold back or allowed to mature. But that still leaves trillions of dollars of extra cash created.
If you’re an optimist, you hope that people and businesses will hold more cash voluntarily. While the overall economy will likely take time to recover to pre-virus production levels, many parts of it will see pent-up demand and restructuring investment. Cash will be needed to support that activity. Moreover, fear may cause everyone to want high cash balances. Cash might also be used to pay down private debt. We could end up with a vibrant, less-levered economy, lubricated with plenty of liquidity.
If you’re a pessimist, you fear that a weakened economy means less demand for cash and that expectation of government bail-outs will kill incentive to hold cash for emergencies. The additional government debt and bloated Fed balance sheet will undermine confidence in the dollar.
Optimists are likely to think about the stimulus and quantitative easing in response to the 2008 financial crisis. I was among those who warned about the risks of faster consumer price inflation, but it didn’t happen. Stimulus probably inflated asset prices, but there were no destructive bubble/crash events. Faith in U.S. government credit, the dollar and the banking system remained strong.
Pessimists will look farther back to the 1970s, when undisciplined spending and monetary policy caused a decade of economic misery. Stagflation—the unprecedented combination of high unemployment and high inflation—was the order of the day.
I don’t think either period is relevant to 2020. I look to the aftermath of WWII. Like soldiers drafted in a war, the lockdown has removed workers from the private economy, while continuing to pay them. In both eras, fewer civilian goods and services are produced, but business revenue is augmented by government spending. Lockdown rules act like wartime rationing to curb civilian consumption. The government takes on more debt, and central bank balance sheets expand.
When the war ends, civilians have cash, but there are shortages of goods and services. This could lead to recession and inflation if the economy cannot absorb the returning soldiers and convert wartime to peacetime production.
But the U.S. fared well after WWII. There was inflation as wage and price controls were removed, but it was not self-sustaining. Fear of inflation did not drive people to spend quickly before money loses its value and build inflation expectations into loans and other contracts. The economy grew strongly for eight years, other than a mild recession in 1949. Asset prices did not inflate.
Obviously, 2020 is not identical to 1945, but I believe economic resilience will be similar. I don’t think the economy has suffered permanent damage, and the effort to make up for lost production will not run into major capacity constraints that could cause either inflation or unemployment. I don’t expect a debt or dollar crisis as the virus recedes, nor will real assets soar in price.
That said, we’ll have all the long-term fiscal sustainability problems in 2021 that we had in 2019, plus a lot more government debt and a lot less dry powder for the Fed. The virus stimulus won’t be the trigger that forces a reckoning on the federal level (it probably will bring down some state and local governments), but it will make the necessary future adjustments bigger and more painful. With all of its pork, the 2020 stimulus will do more to help needy people than previous government bail-outs and giveaways. But it has a real cost.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is the author of "The Poker Face of Wall Street." He may have a stake in the areas he writes about.
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