Record public debt and “tipping point” risk for businesses after the pandemic

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The United States is embarking on an unprecedented rapid-fire experiment, as government and businesses take on billions of dollars in debt to offset the economic damage from the coronavirus pandemic.



Waving the American flag with the US Capitol in the background


© Getty
Waving the American flag with the US Capitol in the background

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Federal government poised to spend nearly $ 4 trillion more on revenue this year, analysts say, budget deficit roughly twice the economy compared to any other what a year since 1945.

Corporate borrowing also sets records. Giant companies like ExxonMobil and Walgreens, which have gone into debt over the past decade, are now running out of credit and calling on bondholders for even more money.

To support these loans, the Federal Reserve lowered interest rates to zero and added more than $ 2 trillion in loans to its portfolio in the past six weeks – as much as in the four years after the Great Recession.

All of this borrowing is necessary to fill the gaping hole that the new coronavirus has made in the economy, while unemployment has reached levels never seen since the Great Depression. Few, if any, prominent economists or legislators have opposed the opening of government fiscal taps in the context of the current economic emergency. Last month, the Senate approved $ 2 trillion in crisis spending with a 96-0 vote.

However, high debt already weighs on many companies, which may be forced to choose between skipping loan payments and laying off workers. Millions of consumers are also facing large monthly bills for student loans and credit cards, a burden that could weigh on any economic rebound.

Dependence on such debt will also leave scars after the pandemic passes, economists say, making it difficult for policy makers to withdraw support and making the economy more vulnerable than before the start of the crisis.

“We should be very concerned,” said Atif Mian, a professor of economics at Princeton University who has written numerous articles on the subject. “We are talking about a level of debt that would certainly be unprecedented in modern history or in history, period. We are definitely at a turning point. “

On the eve of the pandemic, the US economy was buzzing, in part thanks to a jolt from the 2017 tax cut and the end of congressional spending limits. But Congress took these steps without any plan to pay for them.

Governments and businesses often turn to lenders in times of unexpected stress. This new wave is different because it follows an era of heavy borrowing.

For President Trump, debt is a familiar tool. The former real estate manager bragged once that he was “the king of the debt” and suggested negotiating with the holders of US treasury bills on the terms of repayment using hardball techniques that he had perfected in the business world.

Treasury Secretary Steven Mnuchin said last month that the government should spend freely to help workers and businesses affected by formal shutdown orders. “Interest rates are incredibly low, so there is very little cost to borrow this money,” he told reporters. “At different times, we will correct the deficit. Now is not the time to worry about it. “

Some argue that it takes even more spending to save the economy. Nobel laureate economist Joseph Stiglitz says the government should guarantee workers’ wages and ban evictions or foreclosures. Larry Fink, chief executive of BlackRock, a New York-based investment firm, told CNBC last week that an additional $ 1 billion may be needed for small businesses.

But once the coronavirus is tamed and the country recovers, American leaders will have to find a way out of the government’s extraordinary levels of borrowing.

It will be difficult to reach consensus on the combination of tax increases and spending cuts necessary to reduce the massive post-crisis debt. None of the political parties has emphasized spending limits in recent years. And the presumed Democratic presidential candidate, former Vice President Joe Biden, has proposed relatively modest tax increases compared to his former rivals. Republicans, on the other hand, reflexively oppose tax hikes.

Likewise, the Fed will find it difficult to lift the economy from today’s high levels of financial support. The Fed only partially succeeded in relaxing its efforts to support the economy after the 2008-2009 crisis before the pandemic plunged it back into an emergency position.

Economists generally fear that excessive debt will lead to a crisis triggered by investors who suddenly conclude that they will not receive the promised returns and start an incendiary sale of government securities, causing interest rates and prices to soar. inflation. This scenario has affected many small economies. But such a result seems less likely for the United States, given the dollar’s ​​primacy in the global economy and the country’s long history of relative economic stability.

Yet, for four decades, the US economy has become increasingly dependent on borrowed money. Total government, business and household debt now exceeds 250% of annual output, three-quarters more than in 1980, according to government statistics.

According to Mian, the author of “House of Debt”, which examined the role of household debt in the 2008-2009 financial crisis, the American debt burden will reshape the economy in subtle but powerful ways.

An era of still very low interest rates is distorting the economy by eliminating the traditional market discipline that distinguishes between worthy and unprofitable investments. If money is practically “free” for many years – as it has been since 2008 – even bad ideas can attract funding.

As the United States turns to debt again to save the economy, it locks in for a weaker growth future. The national credit card is widely used to stop today’s financial bleeding, rather than for investments – in the medical system, infrastructure and education – that would spur future growth.

Japan is stuck in an endless loop of disappointing growth, low interest rates and growing debt, and the United States could face a similar future.

The United States is trapped in a “debt trap,” said Mian.

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In the aftermath of the Great Recession, public debt exploded as the United States posted annual budget deficits of $ 1 trillion for four years until 2012. But even before growth returned, Washington set out spending cuts and tax increases that reduced the deficit from 2013..

This year, the deficit will reach a post-war peak of 18.7%, according to the Committee, which does not support a responsible federal budget. It was only when the United States fought against Nazi Germany that Washington was bathed in red ink.

Even the budget hawks who warned for years that Washington was courting the financial calamity with its rampant spending admit that the pandemic requires high levels of public borrowing. And indeed, there is almost universal support for the $ 2 trillion financial bailout package that President Trump signed last month to save the economy from depression.

But the costs of the pandemic are just beginning. House Democrats are negotiating with the Treasury Minister on $ 250 billion in additional loans for small businesses and an additional $ 150 billion for hospitals and state and local governments.

By the end of September, the public debt will exceed the economy by $ 21 trillion, according to calculations by the CRFB. The impact of the recession will push debt beyond the previous record of 106% of the economy, established in 1946.

The current low interest rates make the huge federal debt relatively affordable. The government pays less than 1% interest to raise funds by selling treasury securities to investors.

But Torsten Slok, chief economist at Deutsche Bank Securities, says interest rates are only kept low by massive purchases that the Fed started last month to settle markets disrupted by the pandemic.

In March, to smooth out dysfunctional trade, the Fed began buying $ 75 billion worth of government bonds every day.

The Fed has cut daily purchases by $ 30 billion, but it is still a staggering amount of central bank support. At the height of controversial efforts to fight the Fed crisis in 2010, it bought only $ 110 billion in government securities each month.

Today, he buys as much in less than four days.

The Fed wants to avoid compromising its traditional independence by funding unlimited public spending. Managing money printing at the request of politicians has always been a recipe for the financial crisis in several countries.

The central bank’s desire to quickly end its unusual role in the market may conflict with the need for the Treasury Department to sell an unprecedented amount of government bonds to raise funds for anti-government spending. pandemics.

“Who’s going to buy all these Treasurys?” Strangers? Private investors? Asked Slok. “All of this is contributing to supply growth at levels never seen before.”

Such concerns are exaggerated, according to Guy Lebas, chief fixed income strategist at Janney Montgomery Scott.

“The point at which the size of the US debt is too large for the market to take is decades away,” he said. “If anything, the lust crisis has increased global demand for US debt. “

Most economists expect inflation and interest rates to stay low for years. But they could be wrong. Rising public debt is “most important predictor” of future crises, including defaults, sudden increases in borrowing costs or runaway inflation, according to January study by four Fund economists international monetary.

“Governments should beware of high public debt even when borrowing costs seem low,” the study concludes.

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For many companies that have borrowed heavily in recent years, the pandemic is driving up borrowing costs, just as a fierce economic downturn is wiping out their income and jeopardizing their ability to repay debts.

Total corporate debt exceeded $ 16 trillion last year. As the Fed cut interest rates to zero in 2008 and held them there for several years, companies have taken on more and more debt, including buying back their own stocks and raising shareholder dividends.

In recent weeks, companies have withdrawn more than $ 200 billion from their permanent lines of credit. JPMorgan Chase alone provided $ 50 billion to borrowing companies through revolving lines of credit and, in March, extended $ 25 billion in new credit.

“This already dramatically exceeds what happened during the global financial crisis,” wrote Jamie Dimon, CEO of JPMorgan in his annual letter to shareholders.

In a survey of major bank business loan portfolio managers, 60% said they expected borrowing costs to continue to rise for many businesses over the next three months. And 90% said they expected more business borrowers to default, according to the International Association of Credit Portfolio Managers.

“People believe that credit risk is increasing,” said Som-Lok Leung, executive director of the industry group.

Similarly, with almost all Americans covered by mandatory government home support orders, the economy is in free fall. Profits of oil and gas companies could be cut in half, according to Capital Economics, a London-based investment analysis company.

The grim outlook has already caused layoffs at companies such as Halliburton and Apache.

Investors, meanwhile, are beginning to fear that large companies such as Ford and Delta Air Lines will find it difficult to repay their debts.

According to S&P Global Ratings, the number of companies at risk of falling credit ratings is at its highest level in 10 years. Chevron, Honda and Walt Disney Co. are among the most watched companies.

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For the time being, American consumers – whose loans played such a critical role in the 2008 crisis – have been mainly affected by job losses, vacations and lower wages, not debt.

While household debt hit a record $ 16.1 trillion last year, it remains much lower relative to the economy than in 2008.

But these statistics mask underlying vulnerabilities. Even though the majority of Americans have strengthened their financial situation, 40% – nearly 50 million households – have gone into debt again since the financial crisis, according to Moody’s Investors Service.

Asti Sheth, managing director of Moody’s credit strategy, said the most indebted households are also likely to lose their jobs in the unemployment wave that is sweeping the economy. The country’s four largest banks have set aside more than $ 18 billion so far this year to cover their anticipated losses on consumer and other loans, a level of reserves unprecedented since the 2009 financial crisis.

“The distribution of debt and income is uneven,” said Sheth. “And that’s something we’re watching. “

Congress granted mortgage relief, and Trump suspended student loan payments for most borrowers until September 30. But that will not be enough to avoid an economic spiral motivated by debt, according to Tomasz Piskorski, economist at Columbia Business School.

A severe recession that brought the unemployment rate down to 30% would bankrupt almost a third of mortgages and lead to 1½ times more foreclosures than when the housing bubble collapsed.

“In a few months, the recovery will not be there,” said Piskorski. “And these households will face very high debts, they will not have jobs and they will start to default.”

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