With stocks marching back toward levels seen at the beginning of the year, investment statements are looking much less unsettling than they were a few weeks ago. While investors I talk to are reassured by the recovery in stocks, they are also at the same time uneasy about some of the remarkable actions taken by the Federal Government and Federal Reserve during the COVID-19 crisis to attempt to stabilize the economy and financial markets.
The biggest concern I am hearing on a regular basis is basically boils down to “how are we ever going to pay for all this government spending?”.
Year to date, the federal government has appropriated $3 trillion in coronavirus relief legislation and Democrats in the House are attempting to engineer another $3 trillion in spending in a COVID-19 package passed this week. $6 trillion is a staggering amount of money, and putting this spending in perspective, according to usaspending.gov, the government spent “only” $4.45 trillion during 2019 for all government programs including Social Security and Medicare.
Most of the expenses comprising the spending from last year will also be spent in 2020, so it's reasonable to conclude the federal government will spend $7.5 to $10.5 trillion in 2020, a year which is likely to experience a material reduction in tax revenue due to the COVID-19 recession.
The concern I am hearing from investors is valid, but the answer is also convoluted and possibly not as scary as it may seem.
First, let’s just get it out there, the federal government is extremely unlikely to ever pay off or even materially pay down the national debt. So, with no actual intention to pay off the debt, the real question becomes about servicing the debt. The term servicing here is used to describe paying interest and refinancing bonds that mature.
In the area of servicing the primary cost consideration is of course interest rates, and as we all know interest rates have never been lower than they are right now. This means from a servicing perspective, the actual cost to the federal government related to this debt is extremely low, and as bonds mature all the time, costs are only going lower in this interest rate environment as higher interest bonds mature and are refinanced with lower interest bonds. Because of these low rates, In a very real way, the cost of the national debt is at the lowest level in years despite all the new spending. Yes, I know it's strange, but it gets even more bizarre.
To push money out the door in payroll loans, unemployment benefits, pork projects and COVID-19 expenses, the government actually needs real money to do so. Now this real money isn’t of course cash or currency, but it still must be a credit in some government account so it can be keystroke credited to where it is going.
To get this real money, the government issues bonds to attract it. Who buys these bonds? Well, banks, pensions, insurance companies, mutual funds and one other very important buyer, the Federal Reserve Bank (Fed).
The Fed is important because it not only has the money to buy the government’s bonds, but it also actually creates (yes, out of thin air) the money to buy the bonds in processes called open market operations and quantitative easing.
Here’s the bizarre part, the Fed isn’t really part of the government, but it also isn’t really not part of the government. While the Fed is an independent body which strives to fulfill its function free of political influence, its goals have been mandated by the government and it is ultimately supervised by the government as well.
Two more questions. If I am borrowing money with my right hand, and creating the borrowed money to loan to myself in my left hand, what is the true net effect of the process? Well, the answer is beyond the scope of this column but one thing looks pretty certain, if I am able to create the very thing that I owe to myself does it sound like I won’t be able to pay myself interest? Bizarre, but not quite as scary as owing $25,314,000,000,000 and not knowing where to get the money.
Opinions are solely the writer's and are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing involves risk, including loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at firstname.lastname@example.org. Securities offered through LPL Financial, member FINRA/SIPC.