Covid War

It was recently announced that the US government deficit for fiscal year 2020 was $3.1 trillion, or 16.1% of the nation’s output for that year. In the previous year, it was a more normal, but still large, 3.1% of GDP. It averaged about 4% of GDP over the past 10 years. That’s quite a hop to 16.1% in 2020. The government deficit is defined as government spending minus government revenues. The main reason the deficit went up so much in FY 2020 was the 47% increase in government spending. You heard that right. The Federal government decided to spend almost 50% more in 2020 than in 2019.

Each annual deficit must be funded – so this means we added $3.1 trillion to our national debt. Our national debt is now more than 100% of the size of the whole economy. The figure for FY 2020 is 102%. We have not had such a large debt in the last 75 years. Around 60% might be considered normal.

One could say that Covid 19 is as serious as a world war. If we could have large deficits and debts in the 1940s, then it should be okay to have large deficits and debts in 2020. While I have argued in this blog that we might have spent less to save us from Covid 19, I won’t belabor that point here. My point today is about what happens next. Our political parties are arguing now about whether or not to add either another trillion (or so) or another three trillion (or so) to the debt.

Once our government saves us from Covid and recession, what will happen next? I decided to go back 75 years and ask what it was like in the US when the world war was over and how we addressed our huge debt of that time period. Maybe we can learn from history?

Below is a table I put together using data from several US government sources (Congressional Budget Office and the Bureau of Economic Analysis). The data start in September 1940 and go through 1955. World War II went from September of 1939 through September 1945. The Korean War kicks up then and goes to around 1953, but that war is not the topic for today.

The data in the table going from left to right are: Federal government expenditures as a percent of GDP, Federal defense spending as a percent of GDP, Federal government revenues as a percent of GDP, Federal government deficits as a percent of GDP, National debt as a percent of GDP, and the annual percentage change in real GDP.

What do we see?

            Defense spending went up dramatically in two years – in 1941 it was 418% of GDP and in 1942 it was 256%. We definitely went to war!

            Total government expenditures also increased rapidly and were growing at 40% per year by 1943, 1944, and 1945.

            While tax revenues also went up in those years – they did not go up as much, so we see huge increases in government deficits from 1943 to 1945 and similar increases in national debt in those years. The debt as a percent of GDP rose from 52% in 1940 to 119% in 1946.

            The table shows that it took until 1955 for debt as a share of GDP to return to 67% of GDP. It took at least 10 years to go back to pre-war levels. Focusing on the deficits column you see there were mostly annual surpluses after 1956, some near-balances, and only two years of small deficits.

            Upshot: To get back to something like “normal” debt, it took a decade of surpluses or budget balances.

            We also see in the chart how real GDP reacts when governments increase debt – during the war we had high double-digit increases in national output. That economic strength did not last, however, as you see pretty much 5 years of negative or near negative growth starting in 1945.

That’s lots of information to process, but what I see is that it takes time to reverse extreme cases of government deficits and debts. I also see that reversing them causes recessions. I also see that it took a long period of austerity in budgets to bring us back to normalcy.

My question to you: Will the aftermath of the war on Covid 19 be like the aftermath of WWII? Will our politicians, after fighting the war fiscally, move to several years of annual government surpluses? Will they do the hard things necessary to restore the economy? If they don’t, what will our economic growth be after, say, 2022?

The Stock Market

The stock market is getting a bad rap these days. As I wrote last week, the recent relative success of the stock market is used as evidence of a growing rift between the fortunes of rich people and poor people. This rift gives people more confidence that they should do something with stocks to rectify the problem. Some politicians want to take stocks or the income from stocks away from the rich and distribute them to the poor. Or better said, they want to tax them to death and redistribute the proceeds through government.

Last week I pointed out that stocks are not owned just by rich people. Many of us less than rich persons own stocks and thus a lot of stockholders would be impacted by whatever is done to make stocks less valuable. I won’t repeat that information.

There is more to say about stocks. Stocks are created by companies. They are pieces of paper. They are pieces of paper that take on value because they promise the owner of that piece of paper a dividend. What does it take to get a dividend from a stock? Unlike an interest payment that is legally promised on a bond, a stock dividend is as gotcha. The promise is that if the company has a good year – it will pay dividends. If it does not have a good year, then it might pay a small dividend or maybe even nothing at all.  

Thus, buying and holding a stock is a risky thing. We hope that the company will do well so that we get a nice juicy dividend. Another aspect of a stock is that it has a price. The price is set each day for stocks through the interaction of supply and demand. If word gets out that a firm is doing poorly, then the market price of its stock might fall.

Ugh. If the firm is doing poorly you might not get a dividend AND if you want to sell the stock, you might have to accept a lower market price and thus take a loss on it. Clearly, stocks are risky businesses. Why do so many people and retirement funds want to buy stocks if they are so risky? Answer – they are optimistic that firms will do well – stock prices and dividends will rise and the owners of the stocks will get richer. No matter your income from work, if the stock market rises, you get richer. It’s a gamble – because you don’t know if firms will do better or worse in the coming weeks and months.

But still, stocks are risky. Right, and that’s why a lot of people are very careful in how they use their saving. Aha – the world “saving” just snuck in. Most of us save.

Okay, not all of us save. I have some friends with high incomes and they manage to always spend more than they earn. They have negative saving – or what we refer to as borrowing and debt. And then there are a lot of people who cannot save because they don’t earn enough to even provide for a meager standard of living.

But national saving is a big number. Some of it just ends up in our checking accounts at the end of the month – or maybe our saving accounts. Or maybe we buy a certificate of deposit. Or maybe we buy a government bond … or a corporate bond. Or maybe we buy paintings. There are lots of ways to save. Stocks are just one of the ways.

It makes sense that people, rich or not, want to save and use some of that money for stocks. But why do firms want to sell them? Mostly because they need the money. The main idea is that a company might not generate enough revenue to pay more than wages, rent, intermediate goods, and so on. If they are going to be more successful in the future, they may want new equipment, a larger office building, better cars for the salesforce, etc. They can get that investment capital from a bank, they can borrow it by selling bonds, or they can ask you to be an owner of their stock. Whichever they do, the end result is that firms look ahead and try to be more productive.

So what? We want to save as a nation, and we want to buy stocks. Firms need money, so they sell stocks.

Simple. There is a reason for the stock market, and there is a reason we want it to be healthy with lots of transactions and with rising prices and values. People want good options for their savings and firms want to find lots of money to use for growth. 

The stock market is not the reason there are poor people. Killing the stock market will not stop or reduce poverty. Having a viable stock market means we funnel good savings into companies who can use it to grow, be stronger, and hire more people along the way. That might not end poverty but surely it won’t help if attacks on the stock market hinder firms attempts to grow and thrive. There are other and better ways to reduce poverty.  But those ways are neither quick nor easy -- maybe that's why some politicians would rather speak loudly and unkindly about the stock market. 

 

K

A topic of conversation these days is the impact of Covid 19 on distribution of income. Numerous articles point out that the stock market is healthy and benefiting rich people, while lower income people’s jobs and wages are bearing the economic brunt of Covid.

We now have a letter to illustrate these impacts, the K. It suggests that the upper part of the K has fortunes rising for rich people; the lower part shows incomes falling for everyone else.

As in many things that have to do with poverty and distribution of income, I cannot take exception with the facts. Surely those at the lower end of the income distribution are subject to disproportionately negative impacts when the economy tanks. Last-in-first-out is an inventory term but applies well to employment and jobs. Often those most recently hired in an expansion phase are the first to go when things turn down. Those hired near the ends of expansions are generally people who were not the first choices of companies.

Even though we agree largely on the facts, the issue is always what to do about them. Here is where it gets really messy. What do we do in this country to reduce the impact of economic downturns on our population? Surely people will be injured by recessions. How do we share those burdens better?

Answering that question is messy because it involves both politics and economics.

We have a progressive tax system that was supposed to be part of the answer. If you make more money this year, you might be bumped up to a higher tax bracket. The richer you get, the more money the country takes in to distribute.

That seems straightforward except for the fact that the tax code is wacky. As we have read lately, rich people in America sometimes seem to pay no taxes at all. If we like a progressive tax system, then why let them get off the hook? Write-offs like those that let you deduct charitable donations are designed to satisfy other goals. Let’s not list all those write-offs here. Argue about this one or that one – but let’s be clear that a lot of them exist and they often do a lot of good. A rich person who chooses to take advantage of these write-offs can reduce how much she owes in taxes. 

To have more money for lower income families, perhaps we should get rid of these write-offs. That becomes a very economic and political decision. What if preventing a write-off lowers how much money people contribute to not-for-profit institutions? Who gets hurt? That’s economics. But there is also the political dimension. How do we pass legislation to get rid of write-offs? Which ones do we end?

Write-offs are one of many challenges. What about the stock market? Those writing about inequalities point out that rich people have done well lately as evidenced by the stock market. Surely the stock market has bounced back, but like many other economic dimensions of the economy since last January, it has also taken a hit.

But what about the stock market? Is it really owned by Richie Rich and no one else? I don’t think so. One economic reality is that you are not going to own stocks if (1) you don’t save and (2) you don’t work for an institution that puts money into stocks for you. More than half of the population in the USA own stocks. Many of them are very rich. But many have great pensions earned by working for the government and private companies. Still it's only about 50% of the population.

It is not surprising that poor people – who don’t work for companies with good pensions and who often earn so little that they have very little to save – don’t own many stocks or other financial and real assets.

That is a main source of inequality – the stock market’s performance favors those who own stocks. What do you do about it? To answer that question, we are back to economics and politics again. How do we help those at the lower end of the income distribution have permanently higher incomes? How do we help them to earn more and save more without throwing the baby out with the bathwater? Or in political terms, how do we get government to agree on effective ways to accomplish this?

To those who point a boney finger of blame at one party or at rich people, I challenge you to do less pointing and more hard thinking about how we effectively help those with lower incomes earn and save more. Wouldn't it be nice if our programs attacked the real causes of poverty and moved people permanently to higher levels of income and wealth? Or is it sufficient to transfer money to them so that they can continue to live on the edge of poverty. While some people may never be able to live through their own efforts, I am guessing that the situation of most poor people can be improved by helping them overcome obstacles. That sounds better to me than helping them stay poor forever. 

Bizzaro World

Bizzaro World was a fictitious planet found in comic books which featured situations that were unexpected or opposite to what would be expected. It seems to me as I try to write this blog that I am having an increasingly difficult time fitting into our current Bizzaro World.

Maybe this is what always happens. People live and they get old. They find that the world around them has changed. They no longer understand how the world works. They are ready to spend the rest of their lives grazing on the lower 40.

I’ve never had trouble finding a good topic to write about. I have written over 500 posts for this blog in the last 10 years. But I have to say that I am wondering how I fit into this bizarre world we now live in.

Last week I wrote about the Fed. How bizarre is that? After a century of trying to keep inflation low, the Fed now says they want to make inflation high. Zero interest rates for three or more years? What does that even mean?

I often write about economic growth. But no one seems to care much about that topic. Economic growth depends on the growth of productive inputs like the growth of the labor force and its productivity. Have either candidate for president said a word about those topics?

And then there are the usual ups and downs of the business cycle. Macro looks at the key components of spending to discuss these cycles and how to end recessions and start expansions. But apparently, the sizes of the recent changes in spending from one quarter to the next are so huge that they almost lose meaning. What does it mean when consumer spending falls by 30% one quarter and then rises by 50% in the next one? Bizarre.

And isn’t it crazy that we don’t seem to care how large the money supply and the national debt are? We even have a new theory called MMT which says debt is irrelevant. Seriously? When is the last time your friendly banker told you not to worry about your debt?

And what about letting markets work? Isn’t it interesting that in what appears to be one of the biggest recessions in decades, firms raise prices in the face of declining markets?

And what about supply and demand? Supply left through the back door. Better said, everything now seems to depend on the resurrection of demand for goods and services. And we need a little Viagra to get demand up and going again. The government wants to give people more money so they can spend more. Presumably, that will cause firms to hire more workers and produce more goods and services. But how can we spend more when stores aren’t really fully open or they can accommodate only a small group of buyers. Many of those stores will never open again.

Our government says our challenge is raising demand and they are spending trillions to get us to buy more. But the real constraint is Covid and that restricts output. The government is pissing away our money, putting a cast on your right arm when your left arm is broken. Bizarre.

I’m sure that a lot of this has to do with special problems associated with Covid but I am guessing that there is more to it. Maybe it’s getting to be time for me to head out to pasture. I could start writing about duck cloacas but then my editors might wonder about that choice. Of course our government does function a bit like a cloaca so you better get your dictionary out.