With the COVID-19 pandemic came unprecedented levels of federal spending. As a result, the national debt has reached $26 trillion, and the Congressional Budget Office predicts that the federal deficit for 2020 will hit $3.7 trillion.
The government has been borrowing money from the taxpayers for various purposes related to the economic crisis precipitated by the national shutdown to combat the spread of COVID-19.
You probably have better things to do, so in case you haven't been keeping track, here are some highlights:
First, remember that we are already living in a time of historically low federal tax rates. So, while the government is spending more, it is taking in less tax revenue. Although lower taxes can spur economic growth, which grows corporate and individual incomes, it may not be enough to offset the federal deficit's impact.
Two interest rate cuts. The first lowered the Fed funds rate (the rates commercial banks charge each other overnight for excess funds), expressed as a range from 1.50%—1.75% to 0.00%—0.25%. The second reduced the Fed's discount rate (what the Fed charges member banks) down to 0.25%. The purpose was to make credit more available and at a lower cost to stimulate economic activity by helping banks, companies, and consumers to borrow more cheaply.
Lower bank loan rates make capital more affordable to businesses and consumers, which (hopefully) stimulates economic activity and growth. Low rates also have a net effect of adding money to the money supply—it injects more money into the system.
Loan and asset purchases. The Fed has reinitiated quantitative easing (QE), whereby it directly buys assets like U.S. Treasuries and mortgage-backed securities. To execute the purchases, it buys the securities from member banks and adds the same amounts back as credits to the banks' cash reserves. The effect is the same as printing the money and giving it to them to lend out to businesses and consumers, which should boost the economy.
Remember, the Fed is the banks' bank. Commercial banks keep deposits with the Fed to meet cash reserve requirements. They also borrow from the Fed when deposits fall below minimum thresholds. The Fed charges interest at the Fed funds rate, which is less than what banks charge each other and their customers. And it recently reduced the rate to near zero.
The Fed can shore-up bank cash reserves and liquidity by adding credit to the member banks' deposits. Despite what some people think, the Fed doesn't actually print money—"virtual" currency is credited to the banks, much like a direct deposit to your checking account. The U.S. Treasury does money printing. It prints the cash and coinage that goes into circulation, but not every time the Fed implements a QE measure.
Relief packages. In March and April 2020, the congress passed three major relief packages, and two supplemental ones, that totaled nearly $3 trillion. These packages funded many relief efforts directed at state and local governments, schools and universities, businesses, and individuals. The most well known being the Paycheck Protection Plan (PPP) and Economic Injury Disaster Loan Emergency Advance (EIDLE) programs, and one-time direct cash payments and extended unemployment benefits to all U.S. citizens who met specific criteria.
It's all borrowed money
Where did the money for all those relief programs come from? As noted above, the Treasury doesn't just print it. Instead, it borrows the money by selling U.S. government bonds to investors, including the Fed. The competition for treasuries can entice investors to sell corporate bonds and other investments to purchase them, making it more costly for companies and local governments to borrow. That is why the Fed reinitiated the QE measures I described above.
The net result of all this is an increase in the Federal debt.
To be fair, there has always been a federal debt, except for a short period in the 1830s. And, obviously, the government has managed to deal with it all along, but not without consequences.
The debt is currently the largest it has ever been, but the federal ledger was in bad shape before the coronavirus. Debt-to-GDP was already near 80%—a rate more than twice as high as the historical average.
Most government officials seem to believe that extreme borrowing during a time of global emergency is worth it. It seems so, given the financial carnage and personal hardship the shutdown has caused. There are arguments to be made on both sides.
But what, if anything, does Scripture have to say about it? And what do these unprecedented levels of debt mean for the average person?
A biblical perspective
There are no biblical references that specifically address government debt, at least not anything resembling our current context. But there is a verse in Deut. 28:12 that has some relevance:
The Lord will open to you his good treasury, the heavens, to give the rain to your land in its season and to bless all the work of your hands. And you shall lend to many nations, but you shall not borrow (ESV).
This verse does not appear to be referring to any kind of government debt as, in ancient biblical times, lending and borrowing were very "personal" and usually based on relationships of love, care, and promise-keeping.
God promised to bless Israel as a people with wealth so they could be a blessing to other nations (see also Deut. 15:6).
Government borrowing by most western nations is not "relational." Apart from marginal representation in legislative bodies, there is minimal influence on the borrower's (the government's) decisions and actions by the lenders (the citizens, companies, and other nations) who buy the debt.
Increasing government debt, with no ability to repay in a single generation, transfers the debt burden to future generations. It's like leaving a final estate of debt rather than positive net worth as a legacy.
As with individuals, governments would ideally operate as savers and investors rather than borrowers. But that is not possible when expenses and other obligations far exceed income.
The current public debt problem has been long-standing and can only be resolved by extreme spending cuts and higher taxation, default, hyperinflation, or some combination of those things.
Will inflation be the result?
A lot of economic theory supports the idea that when governments significantly increase their debt burden and central banks (like our Fed) buy most of the debt, thus pumping liquidity into the marketplace, inflation may result.
Inflation can help the government pay its debt. Inflation results in higher tax revenues as wages and prices increase, which eventually benefits the government by reducing the public debt-to-GDP ratio. Paying off debt with currency worth less than when the debt was initially issued is like defaulting on part of the debt without actually doing so.
Inflation may indirectly help the government, but it presents a genuine risk to the average person because it affects every dollar they earn or save.
We've all heard the phrase "a dollar doesn't buy what it used to." It sure doesn't. A dollar in 1915 was worth $26 in 2020. Nowadays, many people are concerned about the amount of money "being printed" and the effect it might have on our economy.
The dollar becomes devalued because there are more of them in the economy. And when the dollar loses value, it's generally bad for U.S. consumers and investors.
A devalued dollar drives up the cost of imported products (a good historical example is oil). It reduces our standard of living if incomes don't keep up. It also decreases the "real" value (purchasing power) of our savings.
Through the QE actions discussed above, the Fed has created "virtual" money to buy treasuries on the open market. That almost always leads to inflation. The reason is basic: if there is more money, but the same amount of goods, the ratio of money per good—the price—goes up.
Inflation has been relatively low for the last ten years or so, averaging around 2%. On the heels of the 2008-2009 recession, and now, in the aftermath of the March stock market crash and rapid slide into a COVID-induced recession, the Fed lowered interest rates to near zero to help stimulate spending, a key driver of economic growth.
The Fed believes that if prices go up only 2% a year on average (excluding food and energy), the economy will remain healthy.
The Fed seems to be betting that the stimulus, liquidity, and low interest rates they have put in place will enable economic growth while keeping inflation low.
But another school of thought says we are headed for "deflation." They believe that COVID-induced unemployment and a slow recovery makes inflation less likely because demand (and therefore consumer spending) will fall.
They argue that supply chain disruptions and social distancing may reduce the supply of goods, which would increase demand, possibly leading to inflation.
So, we have deficits in spending and employment, but surpluses of income and debt. This could cause a prolonged recession—it's too early to tell. And it's hard to say what all the lending and borrowing and will have and what the ultimate effects will be in terms of the value of the dollar, inflation versus deflation, taxes, etc.
What to do?
If I could sum all this up in a word, it would be "uncertainty." It seems that's always the case, doesn't it? Considering that, what should the "average" retirement steward do? It depends somewhat on which scenario you think is most likely.
During inflationary times
If you believe inflation (perhaps even "hyper-inflation") is on the horizon, you can focus on both your expenses and investments to ensure that your spending is manageable and your savings are invested in assets that at least keep up with inflation, or perhaps even benefit from it.
- Reduce living expenses. Inflation means higher prices, so reducing expenses can help you ensure that you can cover your essential needs with the dollars you have.
- Leverage rising interest rates. Inflation typically causes a rise in interest rates. Therefore, it's wise to keep your cash in money market funds or Treasury Inflation Protected Securities (TIPS). Both pay interest that will keep up with rising interest rates, and you also won't be risking the loss of principal that hits most fixed-income investments, such as bonds, during times of inflation. You can buy individual TIPs directly from the US. Treasury, or invest in a TIPS mutual fund or ETF.
- Invest in short-term fixed-income investments. Long-term fixed-income investments (such as bonds and bond funds) will lose money during rising interest rates. Instead of 10, 20, or 30-year bonds, invest in those with maturities of 10 years or less. I like SHV (short-term treasuries) and SLQD (short-term bonds); I hold both in my retirement portfolio.
- Invest in growth stocks. Many retirees and near-retirees shift their equity investments toward dividend-paying stocks or funds, or in balanced (growth and income) funds, which works great during low inflation. However, during inflationary times, they are affected much like long-term bonds. Growth stocks and funds tend to do well, especially those of industries like energy, food, healthcare, materials, and technology that rise in price with inflation. You can buy a sector fund (such as the Fidelity Select Health Care Portfolio—FSPHX) or a one with a growth company focus (such as the Vanguard Growth Index Fund—VIGRX).
- Consider investing in commodities. Some hard assets, like gold and silver, have traditionally benefited from inflation. Their fundamentals differ from those of stocks and bonds, so they can be an excellent way to diversify. But it's important to remember that gold and silver are highly speculative. Physical gold doesn't generate any income. You can only make money from gold if you sell it for more than you bought it. You can hold precious metals in a direct form, with coins or bullion bars, but you can also invest indirectly through ETFs (such as GLD or IAU) that hold actual gold. The price of gold has been rising for about a year now.
- Invest in real estate. Inflation usually benefits real estate, and if you own a home, you are already invested in it. Real estate typically appreciates the most during periods of high inflation. As rents rise, renters become more interested in owning as a way of offsetting the rising costs, and to receive the tax benefits. You can also invest in residential or commercial rental properties. Some do that directly, but most do so through real estate investment trusts (REITs). You can invest in sector-specific REITs, such as Tanger Factory Outlet Centers (SKT), or a diversified fund holding multiple REITs, such as Vanguard's Real Estate ETF (VNQ).
During deflationary times
Deflation is less common than inflation. It usually occurs during times of an over-supply of goods and services in the marketplace and lower levels of demand in the economy, leading to large drops in prices. Deflation is often precipitated by high unemployment and deep economic recessions or depressions.
Some are concerned about deflation if the economic recovery from the COVID pandemic is extended (I.e., unemployment remains high, and many businesses remain closed or operating at limited capacity), reducing the demand for certain goods and services.
In deflationary times, high-quality bonds may do better than stocks, especially government-issued debt (treasuries) and AAA-rated corporate bonds.
But on the equity side, companies that produce consumer staples that people have to buy regardless of which "ation" we are in, tend to do better than other companies. These are considered "defensive stocks." Dividend-paying stocks also sometimes do better than the rest of the stock market.
Unlike inflationary times, holding more cash looks better during deflation. If prices decrease, your dollars are worth more.
It's hard to tell
It's hard to tell whether we're headed for inflation, deflation, or "stagflation" (which is a real "killer"—high inflation along with high unemployment and stagnant demand). So, unless you're willing to time the economic cycles, it may be best to plan for any eventuality.
The best way to do that is with a diversified portfolio that includes assets that do well during inflationary times and some that do better during deflationary periods.
I am fond of blue-chip, dividend-paying stock funds that pay dividends. Their value may increase during inflationary times, and dividends can help weather deflation even when stock values whither.
Another diversification strategy is to invest internationally. Some markets, such as those in emerging countries, are typically exporters of high-demand commodities (which can protect against deflation). High quality bonds are another suitable option, and you can also invest in international bonds.
Finally, remember that your investing time horizon is important. If you are 20 or more years from retirement, you can probably weather any economic cycle.
But if you are retired and living off the income from your investments, you may want to make immediate adjustments when inflation or deflation appears on the scene.