We have just read an article entitled, Why printing money to avert a recession is not smart economics. It forms a tiny part of the debate raging at present about the huge sums governments are spending to cushion the impact on jobs, businesses and incomes of the coronavirus lockdown which, as we all know, has caused economic activity to fall very, very steeply. As if to illustrate that fact, as we write, shortly after the 75th anniversary of VE Day, it has been announced that US unemployment has reached 14.7%, the highest level of the whole post-war period.
The FT’s contribution to the debate last week was, Can governments afford the debts they are piling up to stabilise economies? The article involved two economists presenting the opposite sides of the argument: yes, the debts can be afforded, governments of countries with their own currencies, simply write a cheque to themselves. Or, no, governments can print money to cover their costs for only as long as the public retains confidence in a currency.
While the arguments rage, fortunately, for those whose livelihoods or businesses have evaporated almost overnight, governments and central banks have not waited for the debate to be settled. Quite the reverse. The pace at which the authorities have begun doling out loans, issuing grants and cutting interest rates is both impressive and, to those concerned about the consequences of such largesse, deeply worrying.
So, where do we stand? In the medium term will the authorities be viewed like the Lone Ranger – riding to the rescue and taking the necessary action to save the day, or are they serving us all the proverbial economist’s free lunch – which we will pay for many times over when the bill falls due?
The answer is by no means straight forward. It involves arguments about the efficacy and risks of central banks ‘printing’ money, the nature of sovereign debt, the mechanics of credit creation in a modern economy and, that age-old enemy of the people, inflation. We have some strong views which we will develop further over the coming weeks. For now, we set out why we believe governments and central banks the world over had little choice in the path taken, and why we shouldn’t fear an inflationary outcome.
Our starting point is that we should avoid the trap of believing that government finances can be thought of in a similar way to those of an individual business, household or person. They are quite different. Mr Micawber’s famous phrase about happiness resulting from living within one’s means may well hold true for the individual, but it has no relevance for a government or entire economy. As experience from the 1930s shows, if, faced with an economic downturn (and therefore reduced tax revenue) a government attempts to cut spending to ‘live within its means’ it will exacerbate the downturn. If it again attempts to balance its books at this new, lower, level of output, it would again make the economy worse, and so on. In fact, we now know that the opposite is the correct prescription. As Keynes pointed out in his celebrated illustration involving the burying of banknotes in disused coalmines by the public sector for the private sector to dig up – governments have to spend to try to create an upward, rather than downward, spiral. So, whereas to Mr Micawber, increasing spending when things are difficult might seem like a recipe for misery, this is precisely what a government should do, for the good of the whole economy.
Our second point involves the degree of choice that governments have in such circumstances and may help to explain why there was so little debate anywhere in the world about the direction of policy. Put simply, given the fully developed social safety nets in place in the UK as well as other advanced economies, it seems certain that governments would be destined to go deep into deficit even if they chose not to ramp up spending to cushion the economic impact of the coronavirus. One way or another, the public purse foots the bill. By greatly increasing spending now, governments hope that some of the costs, in unemployment and other benefits, as well as some of the shortfall, from tax revenue and VAT receipts no longer receivable, might be avoided. Considering our first point – that without intervention economies would spiral down to a new post-virus equilibrium – it is likely that without intervention, these costs would arise over an extended period, perhaps up to a decade or more, and that the total cost would be higher in the long term. More importantly the human cost in terms of unemployment and lower standards of living would be much higher. So, when considering whether governments should be ramping up spending, we should acknowledge that in reality, there is little choice.
Finally, considering the longer term, we would highlight to those worried about the cost of higher government spending in terms of future inflation or the debt burden on future generations, what the real long-lasting damage of the lockdown has so far been. No factories have been destroyed by enemy aircraft, no productive capacity lost for ever (except, sadly that of those people carried off by the virus). No restaurants that previously were making a perfectly respectable living for those operating them have been judged permanently surplus to requirements going forward. But such businesses may struggle to withstand the short-term impact of their incomes stopping, suddenly and for an extended period. It therefore follows that to consider the government’s pandemic spending as new, additional money, and therefore in some way profligate is to misunderstand macroeconomics. This money is an attempt to put back some of that which has disappeared through lost incomes, lost profits and lost credit creation. Only if it hugely exceeds that lost, will it be inflationary. The risks of that, in our view, are minimal.
Of course, as well as the quantum of additional spending, the method by which it is financed is a subject of hot debate – with the emotive term ‘resorting to the printing press’ conjuring up nightmares of wheelbarrows full of banknotes as hyperinflation destroys buying-power and savings. While a full discussion is beyond the scope of this note, we would point out that deflation is, in most circumstances, a far more destructive phenomena than inflation and it is the former that central banks have been struggling to fend off in the years since the financial crisis. To worry about inflation at this juncture is understandable, but premature.
If, having laboured thus far through the note, you are wondering what this all has to do with investment markets, portfolios and retirement pots, our answer, in a word is, everything. The success of the economy, future growth, corporate profits, dividends and the direction of share prices very much depends on the actions taken now to address the impact of the virus. Similarly, the return on savings, the yield on bonds – and the credit worthiness of such securities will depend on the path of economies and the impact of inflation or deflation on the buying power of those savings. Considering the very short term, we believe that the prompt and aggressive steps taken by governments and central banks explain why share prices have rallied after the initial sharp falls.
A follow up to this note will delve further into this debate and its implications for investment markets and portfolio returns. In the meantime, if you have any comments, questions or feedback we would be delighted to hear from you.
