The Congress approved, and President Trump signed, four laws to address the COVID-19, novel coronavirus pandemic. The Congress and the President did what they had to do. The primary function of government is to provide, to the extent possible, a secure and safe environment for its people. In the face of the shocking damage to our society by the COVID-19 pandemic, the government is trying to do just that.

The four laws have been referred to as:

Phase 1,     $1.25 billion           ($1,250,000,000)

Phase 2,     $104 billion            ($104,000,000,000)

Phase 3,     $2.2 trillion             ($2,200,000,000,000) (the Cares Act”);

Phase 3.5,  $484 billion            ($484,000,000,000)

Four congressional appropriations enacted between March 27 and April 24, total about $2.8 trillion, substantially all of which adds to the national debt. This cost does not include the requirement on employers to protect employees with sick pay, emergency family leave and other matters. And yes, it takes four commas to put a trillion into numbers.

The Cares Act provides substantial funds for state and local governments, schools, and hospitals. There will be more in Phase 4, when Congress and the President come to agreement.  Funding for state and local governments will be with money borrowed by the federal government.   State and local governments have the power to levy taxes and borrow money on their own. For example, if Chicago is teetering on insolvency and borrows money, the Chicago taxpayers pay the debt.  But if the federal government gives money to Chicago, then the whole country pays the debt. Federal funding would be distributed to all 50 states, and the federal debt would be paid by the whole country.

FEDERAL RESERVE

The Federal Reserve (“Fed”) has provided up to $2.3 trillion in lending to support financial markets, state and local governments, households and employers. The Fed purchases long-term securities, Treasury obligations and mortgaged-backed securities. The Fed has issued “guidance” to reassure the capital markets that it will purchase Treasury and other securities “. . . in the amounts needed to support smooth market functioning…”  That translates to providing liquidity (that is, cash) to financial institutions to allow those institutions to extend credit and keep the economy moving. The Fed did this in the 2008-09 recession, calling it “quantitative easing” (a term not used now, but essentially the same) but at significantly lower amounts.

WHERE DOES THE MONEY COME FROM?

So we are talking about $5 trillion, none of which is in the 2020 Federal Budget.

Where does that money come from?

There are two basic sources. The first is borrowing and the second is creating.

Interest rates are at extremely low levels, so the Treasury can go into the capital markets and borrow money (much of it, ironically, from China, where the pandemic started). Those interest rates will not stay low forever and are bound to rise over a course of time.  Already about 15% of our national budget is spent on debt service (interest) on the national debt. That percentage is bound to increase substantially. Yes, successive generations will pay for the 2020 borrowing.

Some economists claim that the national debt is really not a debt because we owe it to ourselves. But sooner or later, somebody has to pay the piper. And today much of the national debt is held by foreign countries such as China and the European Union nations, all of which expect full payment. Our Social Security Trust Fund is funded with the national debt and those obligations have to be paid in cash.

The other way to get money is to create it. Only a sovereign government, and an agency with the powers of the Federal Reserve, can create money. The effects of creating money are debated among economists. Critics can point to some countries in South America that created money,  causing rampant inflation with dire economic consequences.

Creating money increases the money supply while not increasing the goods and the services which produce revenues. The result is a devaluation of the currency. That means that you will need more dollars to buy the same goods and services as you would have spent prior to the increase in money supply. In other words, you need more money to do the same business, with the result that less business gets done. So what was a $10 bag of groceries becomes a $20 bag for the same groceries.

Modest inflation is good. A healthy economy will easily digest 2% to 4% inflation a year, generated by the increased revenues and mutual benefits. When inflation goes to 10% and beyond, it then has a choking effect. This country suffered through double-digit inflation in the late 1970’s with corresponding double-digit interest rates (such as 14% for a house mortgage).

The U.S. national debt today is approximately $24.8 trillion. The Congressional Budget Office predicted that there will be a $3.7 trillion deficit this fiscal year and the Treasury just announced it is looking at an increase of $4.5 trillion in the national debt. That would push the national debt to almost $30 trillion.

One of the accepted measures of a healthy economy is whether the national debt exceeds the gross domestic product of that country. Today our national debt is greater than our gross debt domestic product, which is the total value of all goods and services in the entire country. And the national debt does not include the infusion from the Federal Reserve. When the national debt exceeds the gross domestic product, a country is on shaky financial ground. The U.S. government does not publish a balance sheet, as any bank requires of someone seeking to borrow money, but if it did it would show greater liabilities than assets. The difference is the power to tax.

What does all of this mean? We do know that the ratio of national debt to gross domestic product has not been this high since the end of World War II. At that time there was a pent-up demand for civilian goods and services following World War II, where the all-consuming war effort dominated the country. We don’t have that pent-up demand now. We have a consumer-driven economy. People have been purchasing goods and services, and borrowing much of the money to pay for those goods and services.

THE NEXT WAVE?

Some medical experts say that we can expect a second wave of COVID-19 in the fall. Those same experts do not expect a vaccine to prevent COVID-19 until 2021. Until there is a vaccine COVID-19 will be with us.

What do we do if there is a recurrence of the pandemic?

What do we do if later there are cataclysmic events that disrupt our lifestyle and/or threaten our very existence?

Can we afford to do then what we are doing now?

We don’t know if there is going to be a second wave pandemic. If there is one, we don’t know how severe (although some medical experts claim that it could be worse than the first). We shall have the opportunities to correct any mistakes we made in the first pandemic, we shall also have the opportunity to repeat any mistakes we made in the first pandemic. At some point we will reach the point where we can’t keep throwing money at the pandemic.

Is there a limit at how much money we can throw at these matters? If there is, what is it? If we overdo it, we could be setting back our economy for generations. How do we plan for long-term consequences in a short-term crisis? These are questions we have to keep in mind as we try to control the raging fire that is the COVID-19 pandemic. In the meantime, stay healthy!! We need as many taxpayers as we can get.

For more information or assistance, contact Lamb McErlane PC. 610-430-8000.

James E. “Jim” McErlane is a Senior Partner and one of the founding members of Lamb McErlane PC. His practice is concentrated in the areas of general business and governmental regulations. jmcerlane@lambmcerlane.com. 610-701-4404.

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