The COVID 19 outbreak has exposed fundamental weaknesses in the structure of the global economy that serve to amplify the damage caused by the pandemic.
The U.S.'s pre-existing sea of public debt…
To peer into the abyss, just take a look at the fiscal and monetary situations in the United States.
Prior to the onset of the coronavirus crisis, the U.S. federal government was already expected to run a trillion-dollar deficit in the current fiscal year.
Right now, that same government is planning to layer on top of that pre-existing deficit fiscal stimulus of around $2 trillion, with even more debt to be added behind that.
This means the U.S. budget deficit is likely to hit $3 trillion this year.
… is going to get greatly worsened by the Coronavirus crisis
But that number doesn't even take into account the loss of tax revenues that are due to the decline in business activity and employment.
In the 2008 recession, federal tax revenues declined by over $400 billion. That number is likely to be greater this time around.
Nor does it take into account higher levels of spending on social welfare programs that are part of existing programs and do not require special "stimulus" funding to be appropriated. They go up automatically.
Longing for the good old days of 2008
It is therefore safe to assume that the federal budget deficit in the current fiscal year will zoom past the $4 trillion mark – and approach $5 trillion before it's all over. This makes the $1 trillion deficit of 2009 look quaint by comparison.
The U.S. GDP in fiscal 2019 had been expected to come in at $21.4 trillion. Assuming there is a 15% decline in fiscal 2020 due to the pandemic, GDP looks like it will come in at around $18 trillion.
That would put the projected U.S. budget deficit at around 28% of GDP!
Unsustainable, yes, but…
Many economists would consider that number unsustainable on its face. But the situation is even worse than what economic theory might suggest. The fact is that there are precious few options for funding the government deficit.
With interest rates about to go negative, for example, how is the federal government going to induce U.S. investors to pour money into financing a $5 trillion deficit?
A breakdown in global economic symbiosis
To make matters worse, the biggest foreign investors in U.S. treasuries are hitting economic walls of their very own.
Specifically, the Chinese economy is suffering because of a lack of foreign demand and the Gulf States are hurting because of the collapse in oil prices.
China and Saudi Arabia are indispensable links in the recycling of global capital and a breakdown in that flow of funds augurs a fundamental repositioning of the U.S. dollar on the world market.
The "Japanification" of the U.S.
The only remaining alternative to dealing with U.S. budget deficits will be to continue Fed policy prescriptions enacted following the financial crisis of 2008 and intensified during the current crisis.
That would translate into a potentially massive expansion of the Fed balance sheet as it stands up as "purchaser of last resort" for Treasuries, a process which has already begun.
Just don't forget about massive U.S. corporate debt
Funding U.S. fiscal deficits is a problem of one sort. Some of the more secular problems embedded in the global economy are of a different sort.
For example, there have been indications of a looming corporate debt crisis in the United States for some time. Corporate debt today stands at over $10 trillion – an historically high number that is equal to more than 50% of the U.S. economy.
To make matters even worse, much of this debt has been issued by non-investment grade rated companies and are considered junk.
From cashflow pressures to corporate defaults
As these issuers come under cash flow pressure due to the pandemic, defaults are likely. And the blowback from this will hit the U.S. banking industry squarely in the face. It bears the additional burden of holding syndicated loans to these self-same borrowers.
And to make matters worse, a large percentage of these corporate bonds are directly or indirectly related to the energy sector, which has problems of its own. Industry observers estimate excess capacity is around 20% of global production.
Enter China into the equation
And then, there is China. It has been overleveraged for some time. The Chinese government has been sweeping its structural economic problems under the rug of obfuscation. But hiding the problems doesn't make them go away.
And what about the EU? The EU has embraced leverage through the ECB, even though its member states, especially Germany, remain wary of leveraging their currency and economies in the first place.
ECB President Christine Lagarde recently announced an 850 billion euro facility to purchase EU government and corporate bonds. This underscores the scope of structural problems within the EU.
Depression becomes a reality
Against this backdrop, lawmakers in Washington seem determined to stave off recession. This in itself may be a mistake, because it doesn't seem possible to hold back the economic tide, no matter what level of stimulus is applied.
The first rule here should be to stabilize the patient before working on recovery. With so much of the United States (and Europe) in lockdown already and more to come in the weeks ahead, there is little scope to reverse a massive decline in GDP.
Instead of trying to stop the decline, the important consideration should be to make the decline in GDP temporary.
Shoveling money at the problem now may seem like a good idea. But when the pandemic is deemed under control, there will be precious little in the way of resources available to jump start a robust recovery.
The U.S. fiscally and monetarily bankrupt?
If the crisis ends with the United States of America fiscally and monetarily bankrupt, the idea of a full-blown depression becomes all too real.
Given the way policymakers are behaving, the U.S. seems set on a course to be fiscally and monetarily bankrupt when the crisis ends.
The wiser solution now might be to judiciously provide limited financial support to the needy and encourage forbearance in both the public and private sectors for the next 60 days.
In other words, put the economy on hold for 60 days and provide for the needy, while the medical issues are addressed and resolved.
Forget about the stock market
But tragically, many in Washington consider the crashing stock market to be the real problem.
The stock market, which is President Trump's favorite performance metric, has taken a beating and will continue to take in on the chin – in spite of the short-lived upticks it may realize through the application of stimulus.
And that's the problem, short-lived upticks will do more to undermine economic confidence than to restore it. And sustaining confidence may be the single most important factor on the road to long-term economic health.
Finally: The Trump factor
There is already a broad-based lack of confidence in the current Trump Administration's ability to handle these unprecedented challenges.
This lack of confidence not only applies to the experts, i.e., economic policymakers and professional investors inside and outside the United States. Confidence is truly nonexistent among the more than 50% of Americans think the President is not fit for office.
So far, the President's handling of the crisis has failed to build confidence in anyone other than his most ardent Fox News watching fans. Trump continues on a daily basis to gild the lily, misstate the facts and ad lib serious policy all along the way.
Conclusion
Instead of panicking and succumbing to the whims of a President fixated on the stock market, policymakers need to take a sobering look at the state of the U.S. economy and then proceed cautiously in a sober-minded fashion.
They need to keep in mind that this is not reality television!
This article is republished from The Globalist: On a daily basis, we rethink globalization and how the world really hangs together. Thought-provoking cross-country comparisons and insights from contributors from all continents. Exploring what unites and what divides us in politics and culture. Follow us on Facebook and Twitter. And sign up for our highlights email here.
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