The CBO now projects that the budget deficit will be 18% of GDP in 2020 and over 10% in 2021. This takes into account the estimated effects of all pandemic-related legislation enacted through April 24, but not the effect of any potential further stimulus. The year “2020” could come to stand for a 20% deficit and 20% unemployment. The country is consuming more than it is producing – our combined private plus public savings rate is negative. The private sector cannot finance this level of government spending without further crowding out private sector investments and driving up interest rates.
Historically, the U.S. has turned to its trade partners, particularly China, to finance its debts. However, China’s economy is already under pressure. Here in the U.S., there is widespread discussion of reducing our dependence on Chinese supply chains, and the chorus of voices blaming China for the pandemic is growing louder.
The lawsuits have already started, and it wouldn’t shock us if President Trump were to suggest using the debt we owe the Chinese to make restitution. All told, it is unlikely the Chinese will finance U.S. government deficits on this go-round. These large deficits can only be financed by the Fed through the creation of new money.
The inflation is unlikely to appear immediately. Opportunistic price-gouging on toilet paper, hand sanitizer, milk, rice and potatoes is not a signal of broad inflation.
However, a country that consumes much more than it produces, financed by ongoing money creation, will have more money chasing fewer goods and services. Once the initial shock wears off and the recovery begins, the inflation will begin to show up – and it probably won’t be limited to the share prices of money-losing “story” stocks. The deflationists point to Japan as the obvious counter-example. However, Japan never ran these kinds of annual deficits, never had a large negative public plus private national savings rate, and never grew its money supply this quickly. Now that the political fiscal dam has burst, the authorities have no incentive to slow the support. Stimulus packages 1, 2 and 3 will likely be followed by 4, 5, 6…
The Fed will create money (and attempt to suppress interest rates) to support the economy. And the U.S. is not alone – it’s a global pandemic and a global response. We expect inflation on a global basis. We expect policymakers to target and applaud mid-single digit inflation, which, combined with interest rate suppression, will be the only way to outgrow the mounting debts.
It might get tricky a few years from now if inflation accelerates further. The Fed has demonstrated it doesn’t have the stomach to slow the economy by reigning in policy. We believe the implied negative real interest rates are bullish for gold and for unlevered real assets with pricing power (home prices will rise, while leveraged commercial real estate will fall from lack of demand).
Freedom is driven by determination