The writer, Morgan Stanley Investment Management’s chief global strategist, is author of ‘Ten Rules of Successful Nations’
New US president Joe Biden arrives at the White House on Wednesday with splashy plans for $1.9tn in new stimulus, buoyed by a solidifying consensus in the American elite that deficits don’t matter.
Warnings that rising deficits will reignite inflation and undermine the dollar have proved wrong for decades, so deficit hawks are increasingly easy to mock as crotchety old scolds. The new view, expressed by leading figures from the IMF, academia and media, is that with inflation long dead and interest rates at record lows, it would be unwise, even irresponsible, not to borrow to boost the economy. The amounts — billions, trillions — hardly matter, especially not for the US, which still has the world’s most coveted currency.
Mr Biden captured this elite view perfectly when he said, in announcing his spending plan: “With interest rates at historic lows, we cannot afford inaction.”
This view overlooks the corrosive effects that ever higher deficits and debt have already had on the global economy. These effects, unlike roaring inflation or the dollar’s demise, are not speculative warnings of a future crisis. There is increasing evidence, from the Bank for International Settlements, the OECD and Wall Street that four straight decades of growing government intervention in the economy have led to slowing productivity growth — shrinking the overall pie — and rising wealth inequality.
This research does not question the use of stimulus during a crisis; the problems flow from the cumulative impact of constant stimulus. That suggests strongly that the growing scale of each new infusion matters as well. Average voters are justifiably befuddled by the claim that governments can borrow without limit or any consequences.
We calculate that last year the US and other developed nations committed a median sum equal to 33 per cent of their gross domestic product to stimulus, shattering the mark of 10 per cent set back in 2008. Those figures do not include the Biden plan, which will bring total US fiscal stimulus to fight the pandemic to more than $5tn, more than the GDP of Germany or Japan. That’s a lot for an economy to absorb in less than a year, and Mr Biden plans a second, more ambitious spending proposal next month.
The incoming administration argues that low rates liberate governments to borrow and spend in unlimited amounts for the foreseeable future. But this claim gets the story backward. Instead of a path to freedom, low rates are a trap. They encourage more borrowing and rising debt, which drags productivity lower and slows growth. That makes the economy financially fragile, forcing central banks to keep rates low. Given today’s very high levels of debt, only a small increase in interest rates would make the debt burden unsustainable.
This “debt trap” is, despite elite dismissals, a real issue. Public debts in the US and other developed countries averages about 110 per cent of GDP, up from 20 per cent in 1970, according to IMF data. During the Bretton Woods system, from 1945 to the early 1970s, many developed countries ran consistent budget surpluses. Since then they have run consistent deficits, in good times and bad.
Increasingly, the money printed by central banks goes to finance government debts. Many elites see this as fine, since it has yet to revive consumer price inflation. Though governments can print all the money they want, they cannot dictate where it goes, and much of it has stoked a different kind of inflation — asset price inflation. Since the 1970s, the size of financial markets has exploded from about the same size as the global economy to four times the size. Most of those gains go to the wealthy, who are the main owners of financial assets.
As the era of constant stimulus gained momentum, average wealth in the past three decades has risen about 300 per cent for US families in the top 1 per cent, 200 per cent for the next 9 per cent, 100 per cent for the next 40 per cent, and zero per cent for the bottom 50 per cent. One out of 10 families in the bottom 50 per cent have negative wealth (they owe more than they own).
When those on the left, such as Senator Bernie Sanders, promise much more stimulus to come, they do not make this link between stimulus and rising wealth inequality. Yet Wall Street traders do. They drive up asset prices when Mr Sanders calls for more spending, or US Federal Reserve chair Jay Powell promises continued monetary support. They see these vows as more money in their pockets.
But recent studies show that easy government money has ended up supporting the least productive companies, including heavily indebted “zombies” that would otherwise fail. The support also favours monopolies that have expanded not because of their innovation but by lobbying governments for favours and sidelining smaller rivals. The OECD warned, in a 2017 study linking falling productivity to easy money, that these trends will make it harder for societies to deliver “on their promises to current and future generations”.
BCA Research recently demonstrated that nations with big spending governments tend to suffer slower per capita GDP growth. Similarly, Ned Davis Research found that, since 1947, US government spending above 22 per cent of GDP is correlated with periods of slower economic growth. It warned that this share has risen above 34 per cent during the pandemic. My team also found a statistically significant link between periods of rising government debt and slow GDP growth. These studies cannot show causation, but the consistent link between growing deficits and weakening growth is unlikely to be coincidence.
Even those arguing for unlimited new borrowing agree the money would be best invested in roads, green energy, and other projects that would boost productivity and future growth. Nonetheless, comforted by the faith that deficits don’t matter, Biden-backers are supporting a plan stuffed with cash transfers, including a $1,400 check for most Americans,
Like many in the no-worries camp, Mr Biden says more stimulus is urgently needed to limit the damage from job losses and bankruptcies. There was a case for that while the economy was in decline. But as vaccines roll out and normalcy returns, injecting more stimulus into a recovering patient is likely to do more harm than good.
The average person understands that there is no free lunch. The path to prosperity cannot be so easy as to just print and spend. If he relies on low rates to fund further massive government spending increases, Mr Biden will double down on policies that have magnified the problems he aims to fix: weak growth, financial instability and rising inequality. Decades of constant stimulus have left capitalism weaker, less dynamic and less fair, fuelling angry populism. Deficits matter for the damage they are already inflicting.