Opinion

KOLB: The Coming Economic Meltdown

Charles Kolb Deputy Assistant to George H.W. Bush
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Why is the American stock market still relatively strong (even after recent steep daily declines) when the Main Street American economy keeps chalking up more layoffs, more unemployment, and more bankruptcies?

Standard Keynesian economic policy calls for saving money during good times in order to address future economic downturns. Countries should run budget surpluses when times are good; in difficult periods, budget deficits are in order.

Then there are unavoidable emergencies like world wars and pandemics.

The global coronavirus pandemic has created a massive increase in public and private debt. Countries are incurring massive deficits to prevent full-scale, Great-Depression-style economic collapse. Companies are amassing debt as a result of rational responses to the Federal Reserve’s low interest rates and enormous federal-government stimulus programs that further increase annual deficits.

What’s the endgame? Are there no limits on how much debt can be amassed? Can interest rates remain near zero (or even negative, after considering inflation) forever? Will the American stock market just keep rising?

We’ve seen this movie before in the early 2000s when the tech bubble finally popped. What we discovered then (and have apparently now forgotten) is that wildly overpriced stocks will see their prices drop. Consider car company Tesla’s stock (before its recent split) that traded at 300 times projected earnings.  Such valuations are unsustainable.

The United States today is roughly where it was at the end of World War II: the country experienced massive debts exceeding 100 percent of Gross Domestic Product to prevent massive calamities. With World War II, the calamity averted was fascism’s triumph. With the coronavirus pandemic, the calamity averted was massive unemployment rivaling the Great Depression.

But here’s where several significant differences arise. At the end of World War II, the American economy was exceptionally strong; its manufacturing capacity drove global economic recovery; and the U.S. dollar replaced the British pound sterling as the principal international reserve currency.

As the Marshall Plan gradually rebuilt European economies and markets, war-ravaged countries were able to buy from American manufacturers and farmers. The United States promptly paid down its massive government debt based on its incredible productivity, higher tax rates, and a return to more sustainable fiscal policies.

What resulted between 1945 and 1975 was what the French call “30 Glorious Years” that saw sustained economic growth, rising productivity, and expanding global trade. But things were also changing. The dollar ultimately came under pressure, and inflation emerged given the massive Vietnam War spending and the expensive new LBJ-sponsored domestic entitlement programs.

In 1971, President Nixon removed the dollar from the gold standard, thereby establishing a regime of fiat currencies backed only by political good faith. Then came upheavals in the global energy markets with the Arab oil embargoes and the vagaries of OPEC pricing. The last 45 years have seen global economic expansion that has been financed primarily by fiscal and monetary irresponsibility that has culminated in today’s debt-driven economies.

By the end of 2020, our national debt will, once again, approximate 100 percent of GDP. If Vice President Biden is elected and implements his party’s progressive agenda of free college, Medicare for All, the Green New Deal, and a guaranteed minimum income, the national debt will grow by trillions more.

Raising taxes will offset some of these new expenditures, but higher tax rates alone can’t solve our massive structural deficit. We can expect to see a continued rise in the value of gold plus downward pressure on the dollar. Another way to reduce the deficit, of course, is to generate higher inflation, but that step will further erode global confidence in the U.S. dollar.

By keeping interest rates unreasonably low for over a decade, the Federal Reserve has aided and abetted today’s current economic quagmire: thanks to low interest rates, which have made real asset price discovery virtually impossible, there are bubbles in housing and equity markets; savers are penalized; and there’s the mistaken belief that debt-financed consumer and corporate consumption will somehow enable the American economy to reach a liftoff point of sustained economic growth and renewed productivity.

Throughout our history, savings and the productivity resulting from strategic public- and private-sector investments, have generated economic growth. While we need to do “whatever it takes” to keep the American economy from collapsing in the short-run, we also need a national discussion right now about how to escape the current trap of trying to boost consumption by relying on zero (or negative) interest rates, easy money, and more debt.

Charles Kolb served as Deputy Assistant to the President for Domestic Policy from 1990-1992 in the George H.W. Bush White House