The government and the private sector are going deeper in the hole to survive the economic shutdown, which could be a drag on recovery if it spurs a period of thrift
The full impact of the coronavirus pandemic may take years to play out. But one outcome is already clear: Government, businesses and some households will be loaded with mountains of additional debt. The federal government budget deficit is on track to reach a record $3.6 trillion in the fiscal year ending Sept. 30, and $2.4 trillion the year after that, according to Goldman Sachs estimates. Businesses are drawing down bank credit lines and tapping bond markets. Preliminary signs are emerging that some households are turning to credit for funds, too.The debt surge is set to shape how governments and the private sector function long after the virus is tamed. Among other things, it could be a weight on the expansion that follows. Many economists believe low interest rates will help the nation manage the soaring debt load. At the same time, they say high levels of private sector debt could lead to a period of thrift, slowing the recovery if businesses and individuals try to rebuild their savings by holding back on investment and spending. “People and firms and government are facing a negative shock, and the classic textbook prescription for a temporary shock is to do some borrowing to smooth that out,” says Alan Taylor, an economist and historian at the University of California Davis, who has studied the economic effects of pandemics going back to the Black Death of the 14th century. Borrowing now amounts to a transfer of economic activity from the future to the present. The payback comes later. “You do have something to worry about in terms of the recovery path,” Mr. Taylor said. Leveraged Society Overall U.S. debt as a share of GDP has been rising since the 1980s. Since the 2007-09 crisis,stimulus plans pushed federal debt to post-World War II levels, while household debt shrank aspeople paid off commitments.Public and private debt as a share of GDPSources: Federal Reserve; Bureau of Economic Analysis The Federal Reserve, the nation’s central bank, will play the critical role of navigating the nation through the rising tides of debt. It sways the cost of debt service, whether inflation emerges and whether banks and other financial institutions can bear the burden of lending that the nation demands. So far the Fed is getting high marks from President Trump and many economists and investors for moving quickly to make credit widely available, though it faces challenges and uncertainties deciding how far to extend itself and when and how to pull back. On Thursday, it announced more programs to support $2.3 trillion in lending. The U.S. government currently has $17.9 trillion in debt held by private investors and other governments—the amount it has borrowed from others to fund its annual budget deficits. That works out to 89% of U.S. gross domestic product, the highest since 1947. Before the coronavirus crisis, debt and deficits were pushed higher by ramped up government spending on military and other programs and tax cuts enacted in 2017. Government borrowing will soar in the months ahead due to the $2 trillion economic rescue program, higher spending on programs like unemployment insurance and an expected fall in tax revenues amid lower incomes and corporate profits. Mr. Trump is pushing for an additional Washington stimulus program focused on infrastructure spending. House Speaker Nancy Pelosi said another round of stimulus could exceed $1 trillion. That could include an expansion of small business loans and grants by another $250 billion. “After the dust settles in the U.S. there will be arguments over who should pay for all of this spending and absorb the burdens of the debts, which will be political arguments,” said Ray Dalio, founder of Bridgewater Associates, the large hedge fund company. Many economists believe that for now the U.S. can manage the surge in government borrowing, in part because the Fed is likely to buy a lot of the debt itself. The U.S. Treasury funds government deficits by issuing Treasury bonds. In normal times the Fed isn’t a player in the Treasury market, but after the 2007-09 financial crisis it started buying government bonds itself. Its “quantitative easing” program was meant to hold down interest rates to help the recovery by reducing the supply of Treasury securities in public hands. In theory, large scale purchases of government bonds by the Fed should cause inflation, because it involves pumping money into the financial system in exchange for the securities. That money eventually finds its way to households whose purchases drive consumer prices higher. Such price spikes did occur after World War I and World War II, and the U.S. could head for such a repeat.
But inflation didn’t budge during or after the Fed’s purchases in the 2007-09 crisis. Despite warnings by critics that the moves would destroy the purchasing power of dollars, inflation has remained below the Fed’s 2% target for most of a decade. Interest rates also stayed low.
Japan, the world’s third-largest economy, offers additional evidence that inflation might not surge. Japanese government debt is even larger than U.S. government debt, at two-times GDP. The Bank of Japan has been buying Japanese government bonds for years, but inflation there has been subdued throughout.