Pandemic Policy Without a Plan
During a period requiring leaders, the US had politicians. Instead of addressing the problem in front of them, their eyes are fixed on the next election and placating their adoring masses. The long-term effect may be a lost generation. The short-term outcome may be needless hardship for those industries that are primarily hit. The immediate challenge is ensuring that consumer behavior doesn’t change permanently. The enduring challenge is to avoid crowding out programs and consumer spending from the required higher debt service and tax rates. A politician once said to never let a crisis go to waste. A leader would say never create waste during a crisis. The difference will determine the future.
Photo: Bermix Studio on Unsplash
As expected, the second quarter was the most significant decline since the 1930s. The critical concern is not what happened; instead, it is where we go from here. The US was virtually alone in keeping most of the economy open during the Pandemic. The growing toll of lives lost shows the cost. That is not the only price that the US will pay. An economic toll will occur that may exceed the initial cost.
Most other developed countries coordinated their national response, and the result is they are tentatively returning to normal. The US now sits as an economic laggard as its citizens remain persona non grata in other nations. At the same time, the US is terra incognito for foreign travel. Unparalleled monetary and fiscal policies helped with the latter totaling $2 trillion. Yet, the second quarter saw a decline in consumption of $1.8 trillion (exhibit 1). The problem is that a poor Pandemic policy trumps all. As fiscal policies expire, the economic toll will fall upon the economy's sectors experiencing the brunt of the Pandemic: retail, dining and hotels. American exceptionalism, indeed.
Exhibit 1. GDP Contribution by Component
Source: Federal Reserve Economic Database, CRM Calculations.
Policy response, particularly fiscal, is critical during times of deficient demand. When faced with a parallel economic tragedy that inspired Keynes's insight, the US decided an alternate path. The second-largest policy response was writing checks to increases demand, irrespective of need (exhibit 2). As a fire can’t ignite in a vacuum, spending can’t occur when stores are closed.
Exhibit 2. Major Fiscal Stimulus Programs
Source: Congressional Budget Office, https://www.cbo.gov/system/files/2020-04/hr748.pdf
The stimulus improperly targeted the recipients and industries in need, which resulted in the largest increase in savings on record. While the incentive for politicians to write checks in an election year is evident, partially focusing the program would better serve those in need. For example, the rebate program could cover the employment wages for the 27 million employees in the Leisure and Retail sectors over four months.
The paycheck program also failed with a lack of focus because it did not target the sectors in need. The damage to employment was severe; however, 80% of people remain employed. Thus, providing support to sectors that are in need does not address the problem. Merely taking half of the paycheck program and focusing it on those sectors in need (e.g., retail and leisure) enables extending their unemployment benefits for another three months.
The importance of focus in the programs is evident from the change in employment. Since the end of 2019, the leisure sector lost nearly five million jobs, despite the rebound in June (exhibit 3). Some sectors are experiencing a recession, while others are deeply in depression. By treating the economic response as one-size-fits-all, the outcome is an inefficient allocation of fiscal support that threatens sustained support for those sectors in need.
Exhibit 3. Employment Losses by Sector (Dec 2019 to Jun 2020)
Source: Federal Reserve Economic Database, Capital Risk Calculations.
An effective response is critical to recovery because of the enduring economic statement: one person’s spending is another’s income. The two next highest sectors facing high levels of job losses include the retail sector and the health sector. While not all workers have employee-linked health insurance, the leisure sector can potentially result in five million fewer consumers of healthcare. Some of the job losses are a result of lower demand for elective healthcare during the Pandemic. Indeed, other results from a material drop in demand as people lose their employment-based healthcare. Further, these jobs losses depress spending across other sectors. If the Leisure sector ran at 50% capacity for a year, it would result in an one percent decrease in potential growth.
A surprising outcome in the second quarter was the modest improvement in Net Exports. The US enjoys a privileged position in global trade with its exports dominated at the commodity level (i.e., food) and the value-added level (i.e., technology). Both are mostly demand-agnostic. Thus, with a severe retrenchment of imports caused by falling domestic demand, the expectation was for a higher gain. That exports fell at a similar rate to imports is worrisome for a quick recovery. The US should have enjoyed a greater terms of trade benefit: it did not. Global supply chains do not return quickly after implementing alternatives and places US global competitiveness at risk.
Exhibit 4. US Treasury Marketable Debt Outstanding
Source: Federal Reserve Economic Database, Capital Risk Calculations.
These outcomes are a challenge for the US economy in the context of the national debt. With domestic and external demand expected to return slowly, the US still needs to service an expanding debt load. The current expansion of debt by $3.5 trillion is understandable, given the economic peril the US faces (exhibit 4). What is incomprehensible is the nearly $4 trillion added between December 2016 and February 2020 that resulted in a GDP growth rate that did not exceed the prior six years. When we spend borrowed money, we should be thoughtful of how we spend it.
This egregious spending shows up is in the equity markets as it exceeds prior highs during the worse contraction in a hundred years. This outcome is significant because of the debt service that is required. Every dollar spent on paying interest is a dollar less spent on value-enhancing activities such as infrastructure, education, and healthcare. These activities enable people to work.
Exhibit 5. US Interest Payments on Treasury Securities
Source: Federal Reserve Economic Database, Capital Risk calculations.
The US can’t have constrained demand, both domestic and external, while concurrently servicing a growing debt. The debt service maintained its level for the last two decades as lower interest rates met increasing debt (exhibit 5). The trouble is that debt service expanded by nearly 50% during the previous four years. It does not include the current debt expansion. Higher interest rates account for half of the increase, while the other half is simply a result of $4 trillion more of debt. The current debt expansion of another $4 trillion should add about $40 billion to the debt service, pushing the level over $400 billion.
This level of debt service is roughly equivalent to 75% of non-defense federal spending. Two options exist to mitigate the impact: cut programs or raise taxes. Regardless of the choice, reduced future demand occurs. This outcome is the peril that the US faces: slower demand, higher taxes, and less spending. These growth inhibitors may wipe out the benefits of the Millennial generation entering their prime productivity and spending years. The net result is a decline in US competitiveness versus the rest of the world.
These outcomes will delay the recovery of the US. A quick rebound is not probable, given the history of recessions in the US. While the expectation is not for a depression, the prolonged effect of a change in consumer behavior is possible. Consumption growth may slow as savings increases to insure against future calamity. This result would further dampen demand and exacerbate the situation.
The US must avoid these outcomes to ward off a lost generation. The vital importance of this outcome is evident in the workforce size. Poor policy decisions magnified a declining workforce that began for Japan in 1996. Europe’s workforce decline began in 2011, China in 2016, and 2020 is the year for the US. Without this beneficial wind pushing growth, the US could experience an one percent decline in the growth rate.
Growth focused policy is the only way out. Encumbering the US is tax-cut induced debt that adds nothing to growth. Adding to it is the generational challenge of overcoming a debt-surge from the global pandemic. The demographic dividend that lifted the US after World War II is absent. The GI Bill brought post-secondary education to the masses. The interstate highway system delivered the infrastructure for inter-state trade, and women entered the workforce en masse. While the latter is a one-off event, the underutilized people at the bottom of the income spectrum and disadvantaged minorities are a parallel that shows promise. An initiative that begins with aligning education and infrastructure to maximize today's workforce can avoid a lost generation and reboot the US economy. Policy must trump politics.
Exhibit 6. Forecast for US GDP Growth
Source: Capital Risk estimates. Amounts are annualized rates.
The forecast for 2020 remains at a 3.9% decline (exhibit 6). A return to peak output occurs in the first quarter of 2021. This decline is the largest since the 1930s and highlights the economic peril facing the US. There is a material risk to the forecast. An anti-viral/vaccine/testing program is assumed to arrive in the fourth quarter. This outcome permits the dynamism of the US to jump the economy back to normal. Inadequate fiscal policy, poor pandemic management, or political upheaval would place this outcome at risk.
This an extract from Capital Risk's US Economic Outlook for the second quarter.