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After the Boom, A Bill Awaits

A reversal of fortune is in the cards. After a year-long hibernation, the world salivates at the arrival of the vaccines. The summer season may be one for the record books as demand overwhelms supply in the leisure industries. These short-term forces shield from thought the prodigious debt expansion and monetary largesse that saved the economy. While the US was not alone with expansive economic policies, it was unique with the poorly targeted policies. Most assuredly, growing debt service will conspire with higher tax rates to crimp future demand. These lurking threats may impede the economy’s return to full employment as the polemic on debt washes over Washington.


A boom year will follow the devastating prior year with the leisure sector the primary driver.

As the year ended, the economy was slowing after its most volatile year on record. While the next year promises less volatility, it also offers continued uncertainty. The fiscal response and, vitally, the vaccine's distribution are essential to a return to normal. The former is necessary (and humane) to help avoid a permanent change in consumer behavior by workers in the leisure sector who are hardest hit by the Pandemic. This policy will create a bridge to herd immunity from the vaccine and the return to some form of normalcy during the summer season.


The disguising feature of the forecast is that the growth centers on the second and third quarters. The vaccine program's progression will enable a fuller return of the leisure sector and the workers waylaid by the Pandemic. After a hibernation of more than a year, the summer season may well set records in the leisure sectors as people break free of their internment. The summer pastime may see record crowds as sports return full throttle. All the forces that conspired to doom 2020 should reverse and cause a mini-boom in 2021. Alas, the party will not endure. As fiscal constraint will most certainly take hold and constrain future demand.


Exhibit 1. GDP Contribution by Component

Source: Federal Reserve Economic Database, CRM Calculations.


Borrowing from the future. The fiscal policy response to the Pandemic was the most significant US budgetary expansion since the mobilization during World War II. Indeed, the times required the action, despite poor targeting of some of the policy responses. In the presence of a demand collapse, waste is more acceptable than an insufficient policy response. The size of the program in absolute and relative terms was unmatched. While all Keynesian economists will regale in the response, trouble lies in the details.

The fiscal policy response is evident in the savings rates for the US. The government sector, principally the Federal level, ran a deficit exceeding four trillion dollars on an annualized rate, which the household sector's saving rate mirrored (exhibit 2). In the national accounts, money merely moved from one hand to another. The intent, of course, is to spur spending during a period of deficient demand. Unfortunately, good intentions do not necessarily lead to the desired outcome, as the policy design matters. In effect, it was borrowing consumption from the future. The debt will require higher future taxes, which will impair future consumption. Thus, the necessity for precision in the programs.


Exhibit 2. US Savings by Sector

Source: Federal Reserve Economic Database. CRM calculations.


The savings rate was the result of two parallel forces. First, consumer behavior changed in response to a likely recession, if not depression. Conspicuous consumption turned into frugality. This reaction came as no surprise. The second reaction did come as a surprise to the cognoscenti of the ivory tower and designers of the policy response, who argued that rebate checks to the masses would spur consumption during a time of depressed demand. They overlooked the obvious: consumer behavior had changed in response to the pending recession, and lockdowns impaired the ability to consume. While the policy response lacked coherence, it made up for it in size.

With rebate checks hitting the pockets of four out of five people who were still employed, it is not a surprise that the excess capital needed a home. The trouble was that business investment plummeted during the first half of the year. At the same time, government and households made little investment (exhibit 3). The dearth of demand for capital for investment led to excess money entering the stock market. On its face, this is a fair trade, as low-cost capital (e.g., Treasury bonds) finances the acquisition of the higher expected return on equities. The challenge is business does not need capital.


Exhibit 3. US Investment by Sector

Source: Federal Reserve Economic Database. CRM calculations.


During periods of slowing or declining demand, business pares back investing. This action is readily apparent when viewing net capital investment for the business sector (exhibit 4). During expansions, companies seek capital to finance their investments. In contrast, during retractions, they slow investment and hoard their cash lows as a defensive maneuver. These actions are coherent for a business when faced with uncertain demand in the future, even when the cost of capital is low. Thus, in the absence of new equity issuance, the money must find a home. Enter the equity market.