Money: Recession or Recession?

Last week I wrote about a mountain of money and showed concern that if it is not removed it will eventually cause a problem for the US economy.

Many of you are not convinced. You believe that the Fed should be stimulating the economy after a quarter when the real GDP crashed by 33%. Many of you do not see any signs that all that money is causing problems.

But I am going to be stubborn. The case for keeping that huge chunk of money is not very good, and the fact that no problems have popped up yet doesn’t mean we can ignore some very real risks.

The recession and the rise in unemployment were not the result of people wanting to spend less. Rather, the lack of spending is mostly because COVID-19 regulations shut down many of our purchasing options. Yes, we are opening the economy but so far that is an experiment. As COVID-19 comes back, along with us getting out and spending more, we will have more limits on our spending behavior.

Point? Fed monetary policy is not doing very much. What matters is the course of COVID-19 and the shutdowns that go with that. We don’t need to pile up all that money. What we need to do is tame COVID-19.

The bigger issue is the risks arising from a successful attack on COVID-19. That medical breakthrough is what will get us spending again. With banks flush with money and with us ready to spend our brains out, now we have some problems. Why? Wouldn’t that be good for output, profits, and employment? It sure would. But look back at history. When demand comes roaring back, but supply cannot possibly keep up the pace, it leads to shortages -- and those shortages have consequences.

Think basic economics? When demand rises and supply doesn’t match it, it causes inflation. Real and marked progress against COVID-19 will bring rapidly rising prices, wages, cost of materials, rents, and more. Many companies have gone out of business with little chance of snapping back. Supply chains are in total disarray. Workers may have found alternative uses for their skills and time. Firms will not find it easy to find, hire, and train people. Banks have all that money sitting around and they will want to induce us to borrow it and spend it. And we will want to – demand is not the problem. The risk is that demand soars and supply inches up. The difference results in inflation.

What can the Fed do in such a case? One approach is to ignore the inflation. Think of inflation as a negative but natural side-effect. The good thing is that the Fed would be letting supply restore itself and economic growth would be appreciated. The bad thing is that inflation will rise. It might be worth the risk, but history suggests that once the Fed mounts that pony, it is not easy to get off. We learned that rising inflation often turns into runaway inflation and that causes recessions.

There is ample risk from too much money, but the Fed won’t try to suck it out of the system for fear that interest rates will rise and cap off the national recovery. It sounds like a terrible choice – leave the money in and get inflation and recession, or take the money out and get recession.

My vote is to take the money out. Take it out gradually. After all, it's just sitting around in vaults. We are not using all that money. I doubt that a discernible move in that direction will create much harm at all. If and when the economy recovers there will be plenty of money around to facilitate a supply response. 

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