2020 might be called the year of the COVID-19 pandemic. President Biden took office January 20, 2021. Professor Richard Clarida wrote this in a scholarly article [1] numbers correspond to References at the end.
“The Covid pandemic and the mitigation efforts put in place to contain it delivered the most severe blow to the U.S. and global economy since the Great Depression. In the U.S. more than 22 million jobs were lost in the two months of March and April 2020, and in the second quarter of that year GDP collapsed at a 33% annualized rate, an even steeper pace of decline than recorded in the early months of the Great Depression.”
Treasury, the Fed, Congress and the White House Had Jobs to Do
The Federal Reserve System, supported by the Treasury, ensure orderly markets and trading for short-term instruments like commercial paper and money market mutual funds. Next, additional support and facilities are made available for corporate and municipal bond trading.
The Regional Federal Reserve Bank Presidents were all senta script like the following, “we would rather err on the side of doing too much, than to have done too little” to get the economic system out of the crisis, including watching for inflation from the large injection of monetary support. The Fed’s most recent comparable experience was the Great Financial Crisis, also known as the Mortgage Crisis, of 2007-2009.
In 2020, Congress passed the Coronavirus Aid, Relief and Economic Security Act (CARES) with $2.5 trillion in appropriations. 2021 brought follow-on legislation in the form of the Consolidated Appropriations Act. According to the Clarida paper, the first three Covid fiscal relief packages totaled nearly $6 trillion.
Fast forward a bit to two of the Big Berthas in the armamentarium of Bidenomics, the cynically or comically named “Inflation Reduction Act” of 2022, referred to as IRA. I downloaded a PDF of the legislation, and it displayed on my printer at 2,468 pages! The IRA is a mind numbing, grab bag of cash handouts, grants, subsidies and credits to corporations, non-profits, and to state and local governments. A political centerpiece is the so called “decarbonization” of the economy, which will occur by coordinating the efforts of local, state and federal governments. Near-term “injection of funds into the economy” will be to develop a plan for decarbonization The IRA , could fund up to $3 trillion in projects over ten years, according to some commentators. It’s good that the federal government is making a plan for how to spend an amount which is over 10% of GDP!
To sum things up, using the FRED database at the Federal Reserve Bank of St. Louis, the total outstanding Federal Public Debt level at the end of Q2 2024 was $34.831 trillion. At its low point in Q1 2020, the outstanding debt level was $22.223 trillion, so the slope between these two dates has increased sharply from historical trends, even compared to the runup to WWII.
A Sharp Economic Recovery and An Inflation Disconnect
The recovery from the Covid pandemic was just as sharp as the decline from the policy responses. Richard Clarida, op.cit. , noted that “the strongest GDP growth in nearly 46 years” accompanied a gain of almost 7 million in payroll employment. This is not unusual in economic cycles. For example, a comparable snapback accompanied the short but draconian ’80-’82 Volcker Fed-induced recession, which wrung double digit inflation out of the system. The Fed noted that post-Covid inflation rates seemed broadly consistent with Fed’s long-term goal of a 2% annual inflation rate. In a sense, this was comparable to the tame behavior of the inflation rate after the recovery from the GFC/Mortgage crisis.
However, the sheer magnitude of the Biden response to the Covid pandemic dwarfed the historical fiscal response to the GFC. The sum of all the fiscal responses to the pandemic totaled $5.1 trillion (CARES, CARRA. ARA) of deficit spending, which totaled over 27% of real GDP. This was three times higher than the pandemic decline of real GDP which was 9%. By contrast, Obama’s response to the GFC, the American Recovery and Reinvestment Act ($831 billion) increased deficit spending by an amount just about equal to amount of decline in real GDP. Economist Mickey Levy [2] points out this scaling disparity between the two responses. Most economists would have expected to see meaningful upward inflation pressures in the case of the Biden team’s intervention. The Powell Federal believed that the inflation rate post the $3.1 trillion in the post-pandemic period would behave as it did during the GFC. Their theories and processes were complete failures, which the Levy paper documents.
The Fiscal Theory of the Price Level
The Federal Reserve Bank of Kansas City holds an annual meeting at Jackson Hole for the glitterati of economics, corporate titans, investors and financiers. In 2022, they received a paper by Francesco Bianchi and Leonardo Melosi, “Inflation as a Fiscal Limit” [3] One of the pioneers of this theory is the Stanford and Chicago Booth economist John Cochrane, who has written an academic book [4] on this subject. I picked their paper because it is widely available, and unless participants were not paying attention, it had a striking message for the participants about the current and likely future environment could hold for U.S. government debt.
The Federal Reserve policy aims at a low and stable interest rate target, currently around 2%. It has a secondary mandate to keep unemployment rates low. (Humphrey -Hawkins). When fiscal policy is lax, there will be an incompatibility between between monetary and fiscal policies. In this situation, inflation functions as a sort of fiscal brake or limit.
Fiscal stimulus and higher deficits will continue through the rest of Biden’s lame duck presidency and it can only get worse under a President Harris, who will be a prisoner of her own economic vacuity and her debts to the extreme left wingers of the Democratic party and to the elitist billionaires who underwrite her election. This genteel mob will come calling to get their spending handouts for bottomless pit issues like decarbonization.
The fiscal theory of the price level posits that if buyers of Treasury paper were to conclude that the fiscal authority had no intention of paying down the approximately $28 trillion of debt in the hands of the pubic, a fiscal theory adjustment , over time, would have price level increases so the the real value of the outstanding debt would decline. At the same time, rising inflation would disarm the Fed’s primary monetary policy tool, namely actively raising rates rates in order to stabilize inflation around a 2% target.
According to some forward looking Treasury market indicators, it currently appears that a 2% rate is currently embedded in investor expectations.
When faced with the mismatched scale of team Biden’s response to the Covid pandemic economic decline, which we discussed above, the Powell Fed with its DSGE model and its consensus SEP forecasting methods, never really believed that sustained, meaningful inflation would follow an unprecedented injection of liquidity 3x the decline in GDP. Instead the Powell Fed through all its committees and processes, chose to categorize any subsequent spikes in inflation as “transitory.” Fast forward to 2024, and the Fed’s dithering about the onset of rate cuts has put it in a dilemma ahead of the Presidential election. Mickey Levy’s writing about this is worth reading, for those interested in gaining insights to the Fed’s policy making.
As Bianchi and Melosi write, “When fiscal imbalances are large, and fiscal credibility wanes, it may be increasingly hard for the monetary authority( to stabilize inflation around its desired target” At the end of this policy contradiction, recession is one possibility, and a stagflation is another.
Either one of these outcomes would be unpleasant, especially with a regime change in the middle.
What Happens in Fiscal Year 2025 and Beyond?
The Federal Reserve Board, with the blessing of the Treasury, took an additional series of steps to support the flow of credit to households, businesses and to state and local governments under Section 13(3) of the Federal Reserve Act. The assistance under these programs are mainly in the forms of credits and guarantees [5] by the Federal government. Miraculously, $200 billion in unexpended funds under the CARES Ac to kick off the Fed program.
These guarantees and credits will, however, have real cash impacts in FY 2025 and beyond. This is not identified in many respected sources which I have read on the internet, and the reason is arcane and opaque accounting by the Federal government.
New accounting methods make it difficult for even their own experienced analysts and watchdogs to keep abreast of the current status of finances and short-term risks. We came across a valuable report from the Congressional Budget Office [6] which points out some issues in 2025 (fiscal year ending September 30th, 2025).
For 2025, Federal Credit Programs will take on credit obligations and commitments estimated at $1.869 trillion. The CBO examined 129 programs through which the federal government provides credit assistance. 82% of this total is accounted for by housing and real estate loans, and 13% by commercial loans, with the remaining 5% being student loans. Administration of these loans are delegated to federal agencies, which have no transparency, accountability, and little competence; nothing is subject to an audit akin to what a comparable commercial lending program would require .
Fannie Mae and Freddie Mac, both GSEs now in conservatorship, handle $0.937 trillion of housing and real estate loans, while Housing and Urban Development (HUD) handles $0.331 trillion, and the Department of Veterans Affairs handles the remaining amounts of $0.190 trillion. It’s not stated how individuals qualify for, or are approved for these loans.
Under the FCRA method for calculating the budget impacts of these programs, which method dates back to 1990, $1.9 trillion in loans, guarantees and credits would have a lifetime budgetary impact of a paltry $2.4 billion. (This is not a typo!) The CBO study, under a fair market value of the total program of loans, subsidies and guarantees,, the 2025 budgetary impact is estimated at $62.5 billion.
The growing size and complexity of the Biden regime’s spending initiatives like the IRA (Inflation Reduction Act) make it difficult for even experienced groups like the Government Accounting Office (GAO) and the Congressional Budget Office (CBO) to accurately estimate even near-term amounts. A recent lookback by the CBO of their past budget revenue and expense estimates versus actuals showed that government revenues were overestimated by 2x, while spending was underestimated by 3x.
WHAT ABOUT THE DEBT TO GDP RATIO?
The U.S. Government Accountability Office [7] writes,
“Our simulation shows that under current revenue and spending policies, debt held by the public will reach its historical high 106 percent of GDP by 2028 and grows more than twice as fast as the economy over a 30-year period, reaching 200 percent of GDP by 2050.”
The current debt to GDP ratio is already the previous high of 106% after WWII in 1946. The slope of the ratio growth is higher than all the historical periods,the even runup to WWII.
A Lame Duck President and a Successor Who Can’t Describe Her Plan
The upcoming Presidential election is unprecedented in our history in some important ways. A President who had amassed enough votes from the Democratic Party’s caucus delegates to earn its nomination for re-election to the Presidency, is pushed aside by a cabal including his own current Vice President, now turned candidate Kamala Harris and mega-donors of both political stripes.
The growth of persistent deficits can be addressed by either raising revenues or reducing expenditures, or both. On the revenue side, a minimum corporate tax rate of 15% will increase corporate paperwork but it will mean minimal additional revenues.
According to the Tax Foundation, in 2022 153.6 million individual returns were filed, down 3.9 million returns from 2021. In total, individuals reported AGI of $14.7 trillion, on which $2.2 trillion of income taxes were paid. The top 50% of taxpayers paid 97.7% of all income taxes paid; the bottom 50% of all filers paid 2.3% of all individual income taxes.
However, since the Office of Management and Budget classified refundable credits (for earned income. child credits and so on) as ‘tax expenditures’, the effective percent of taxes paid by the bottom 50% is overstated at 2.3%.
The individual income tax system is a revenue raising mechanism for the federal government, but since it has now incorporated a large redistributional element, for a Harris regime to create substantially more revenue without generating more economic growth would have to hurt middle class taxpayers.
With two Obama terms, a 1.x Biden term, and a successor Harris regime, no spending on social programs will be cut. Social welfare programs never achieve their aims and never sunset, so the mass of means tested social welfare programs dating back to Lyndon Johnson’s War on Poverty are all additive in perpetuity.
A recent Tax Foundation study looks into the incidence and economic impacts of the tax provisions of IRA. [8] It is a valiant attempt to use their general equilibrium model to work out some of the impacts of IRA’s tax provisions. Superfund taxes on crude oil and imported petroleum will rise to 16.4 cents per barrel and are indexed to inflation. Other taxes and fees on the petroleum sector will increase. Gasoline taxes will be passed through directly to consumers, while electric cars and other subsidies will increase. The $80 billion ins spending for the IRS has already begun, and this needs to be revised in the estimates. Overall, their estimate of $150 billion in additional spending through 2031 is too low, and will be revised. Their bulletins are worth monitoring for readers of this Substack. Even financial advisers will struggle to keep up the nuances of this fuzzy legislative language.
An article by economist (Ph.D. University of Georgia) and long time Senator, Phil Gramm [9] notes that means tested social welfare programs—such as Medicaid, refundable tax credits, federal housing subsidies, food stamps, Temporary Assistance for Needy Families and some 100 other programs—had 2023 expenditures $1.6 trillion which they calculate as being 73% of all federal unobligated general revenue (a measure excluding interest rate on the debt, Medicare and Social Security on a net basis).
The article raises other points worthy of a serious discussion by our legislators. Our point here is that the notion of a Harris regime making a dent in Federal budget deficits via significant federal expenditure reduction is ludicrous.
Joe Biden is an angry man by nature, behind the phony public persona of the genial, doddering uncle. Biden’s party and sycophantic media protected him by keeping his plainly evident neurological deficits hidden from his electorate. But now, he must be angry about the way his own party and donors rejected the traditional Democratic party caucus mechanisms and their elected delegates which came to Biden. However, the shadow leadership of bosses Pelosi, Schumer and mega-donors have found the formerly MIA Kamala Harris to be the best the Democrats can offer the nation.
Perhaps Markets Will Help to Bring Order to the Fiscal Wild West?
Dr. Clarida is now global advisor to PIMCO [10] one of the largest managers of fixed income investments in the world. As such, he has to be more circumspect since no clients should be upset or alienated by any of his long-term outlooks. If they were upset or angered by a scenario, then the Head of Capital Markets would come raining down like a banshee Clarida makes quite a lot of the dollar’s still being the single globally acceptable reserve currency, and loss of that status may come someday, but no one would make a bet now.
However, it doesn’t mean that every Treasury auction will go smoothly or instantly be oversubscribed.
Clarida says, “Worse, unlike other developed markets, there appears to be little appetite to tighten the (U.S.) fiscal stance. Many U.S. policies on immigration, trade and regulation will hinge on the November election. But regardless of the party composition of Congress the White House, the deficit will remain broadly unchanged in coming years---and even increase a bit if the Trump tax cuts are extended at the end of 2025.”
Think for Yourself. Don’t Trust Anything Served Up By Search. Rejoice in Hope.
REFERENCES
Clarida, Richard H. (2023 draft), “U.S. Monetary Policy and The Return to Price Stability,” Columbia University and the National Bureau of Economic Research.
Levy, Mickey (2023), “The Fed: Bad Forecasts and Bad Monetary Policy,” The Hoover Institute at Stanford University, Economics Working Paper 2103.
Bianchi, F. and Melosi, L. (2022). “Inflation as a Fiscal Limit,” paper presented at the Federal Reserve Bank of Kansas City, Jackson Hole Meeting. Authors from The Johns Hopkins University and Federal Reserve Bank of Chicago, respectively.
Cochrane, John C. (2023) “The Fiscal Theory of the Price Level,” (New Jersey: Princeton University Press)
Clarida, R., Duygan-Bump,B., Scotti, C.(2021) “The COVID-19 Crisis and the Federal Reserve’s Policy Response.” Federal Reserve Board, Finance and Economics Discussion Series, ISSN 2767-3898 (online)
Congressional Budget Office (8/1/2024), “Estimates of the the Cost of Federal Credit Programs in 2025.
U.S. Government Accountability Office (February 2024), “The Nation’s Fiscal Health: A Road Map Needed to Address Projected Unsustainable Debt Levels.”
Durante, A., et al, (8/10/2022) “Details & Analysis of the Inflation Reduction Act Tax Provisions,” (Preliminary Revenue and Economic Estimates) The Tax Foundation.
Gramm, P. and Arrington, J. (2024). “Welfare Is What’s Eating the Budget.”Wall Street Journal Online Edition, https://www.wsj.com/opinion/welfare-is-whats-eating-the-budget-10c9d093 (retrieved 9/11/2024 at 5:02 PM ET
Beck-Friis, P., and Clarida, R. (7/18/24). “Developed Market Public Debt: Risks and Realities.