EN Canada Institutional
Macroeconomic & Geopolitical

The Best Way to Get a Car Out of a Ditch

22 January 2021 - 3 min read

And how investors should judge the next round of government spending.

Your car is stuck at the side of the road, so you gun the engine. 

Metaphors are often as misleading as they are helpful, but imagining President Joe Biden—or any world leader—at the wheel may help visualize this moment in economic policymaking. He’s got to get moving again and he knows there’s no tow truck big enough to help. He also knows that stepping on the gas risks either an uncontrollable lurch that collides with speeding traffic or spinning wheels that sink the car deeper into mud. 

As the new administration seeks to add another $1.9 trillion to America’s debt, with more spending to follow later this year, investors raise some natural questions. Will this blast of money ultimately jolt the economy into an inflationary catastrophe? Or does it produce a generation of corporate zombies and years of sagging productivity?

The best answers coming into view are “no” on both counts. If inflation begins to rise someday, it will likely return just as slowly as it has melted away over the last several decades. Meanwhile, the new debts will take care of themselves as long as the spending keeps growth higher than interest rates.

The debt debate usually triggers a lot of muddy thinking. While America’s debt stock has risen above 100% of GDP through the latest crisis and looks to be headed higher, service costs have actually fallen with interest rates. Meanwhile, default risk is virtually zero since a country that issues debt in its own currency can always print more.
 

FEDERAL DEBT AS A PERCENT OF GDP

Source: Bloomberg. As of January 21, 2021.
 

CPI 
(Y/Y PERCENT NSA)

Source: Bloomberg. As of January 22, 2021.
 

The harder question to answer involves inflation, which has been falling even as America’s deficits and debts soar. Some economists argue globalization and China’s disruption of the world’s labor markets helped keep wages in check; others point to an ageing population that has boosted savings, keeping rates low. Poor infrastructure and inequality may contribute as well. 

Nothing is permanent. Someday, inflation may actually return as the older population’s spending starts to outpace the savings of relatively fewer younger workers, which Charles Goodhart and Manoj Pradhan argued in a provocative book last year. Indeed, new tariffs and trade wars may further throttle the benefits of globalization. But if these were the forces most responsible for driving costs down over decades, it’s hard to imagine a sudden or unexpected reversal, especially as relentless technological innovation continues to drive down production costs.

“Most important about the ramp up in government spending will be ensuring a focus on projects that boost the economy’s long-term growth potential, especially in infrastructure and education.”

If an inflationary lurch looks unlikely, what about the spinning wheels and the mud? Sending out overly generous checks may discourage some from going back to work, but the rising legions of the long-term unemployed signal a greater concern. The longer someone is jobless, the harder it is to find a new job. More difficult to answer is the impact of cheap money on business productivity and the firms that remain afloat solely because their interest payments are so low. But these theoretical concerns do not seem to match the data so far as bankruptcies in the age of cheap money have not fallen and productivity is actually starting to edge up.
 

U.S. NEW BANKRUPTCY CASES

Source: Bloomberg. As of January 21, 2021.
 

U.S. LABOR PRODUCTIVITY (Q/Q SA)

Source: Bloomberg. As of January 21, 2021.
 

Most important about the ramp up in government spending will be ensuring a focus on projects that boost the economy’s long-term growth potential, especially in infrastructure and education. Of course, the spending needs to be accompanied by difficult policy choices that streamline the project approval process and tackle the complex social issues that shape teaching and learning. Climate policy will need to strike a balance between the costs and the economic opportunities. Immigration reform is about as controversial a topic in America today, but sustainable growth requires an expanding labor force.
 

PUBLIC SPENDING ON INFRASTRUCTURE AS A SHARE OF GDP (PERCENT) 

Source: Congressional Budget Office, using data from the Office of Management and Budget, the Census Bureau, and the Bureau of Economic Analysis. As of December 31, 2017.
 

Ensuring the money is spent well and debts remain sustainable is at the heart of a fresh paper by former Treasury Secretary Robert Rubin, former Budget Director Peter Orszag and Nobel Laureate Joseph Stiglitz. Instead of relying on arbitrary debt or deficit targets, this unlikely trio suggests extending debt maturities to reduce vulnerability to an eventual rise in rates. They also argue for more robust “automatic stabilizers” to boost spending, for example, on infrastructure in a downturn when it’s needed most, and adjust through the recovery.

There are no easy or automatic solutions to the problems facing the Biden administration as it charts the next four years of recovery, and the economic debates on what makes good policy are shifting almost as fast as the realignment in political debates. What is clear, however, is that the car can’t stay in the ditch and there’s no tow on the way. 

Any forecasts in this material are based upon Barings opinion of the market at the date of preparation and are subject to change without notice, dependent upon many factors. Any prediction, projection or forecast is not necessarily indicative of the future or likely performance. Investment involves risk. The value of any investments and any income generated may go down as well as up and is not guaranteed by Barings or any other person. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Read More Less

Any investment results, portfolio compositions and or examples set forth in this material are provided for illustrative purposes only and are not indicative of any future investment results, future portfolio composition or investments. The composition, size of, and risks associated with an investment may differ substantially from any examples set forth in this material No representation is made that an investment will be profitable or will not incur losses. Where appropriate, changes in the currency exchange rates may affect the value of investments. Prospective investors should read the offering documents, if applicable, for the details and specific risk factors of any Fund/Strategy discussed in this material.

Barings is the brand name for the worldwide asset management and associated businesses of Barings LLC and its global affiliates. Barings Securities LLC, Barings (U.K.) Limited, Barings Global Advisers Limited, Barings Australia Pty Ltd, Barings Japan Limited, Baring Asset Management Limited, Baring International Investment Limited, Baring Fund Managers Limited, Baring International Fund Managers (Ireland) Limited, Baring Asset Management (Asia) Limited, Baring SICE (Taiwan) Limited, Baring Asset Management Switzerland Sarl, and Baring Asset Management Korea Limited each are affiliated financial service companies owned by Barings LLC (each, individually, an “Affiliate”).

NO OFFER: The material is for informational purposes only and is not an offer or solicitation for the purchase or sale of any financial instrument or service in any jurisdiction. The material herein was prepared without any consideration of the investment objectives, financial situation or particular needs of anyone who may receive it. This material is not, and must not be treated as, investment advice, an investment recommendation, investment research, or a recommendation about the suitability or appropriateness of any security, commodity, investment, or particular investment strategy, and must not be construed as a projection or prediction.

Unless otherwise mentioned, the views contained in this material are those of Barings. These views are made in good faith in relation to the facts known at the time of preparation and are subject to change without notice. Individual portfolio management teams may hold different views than the views expressed herein and may make different investment decisions for different clients. Parts of this material may be based on information received from sources we believe to be reliable. Although every effort is taken to ensure that the information contained in this material is accurate, Barings makes no representation or warranty, express or implied, regarding the accuracy, completeness or adequacy of the information.

Any service, security, investment or product outlined in this material may not be suitable for a prospective investor or available in their jurisdiction. Copyright in this material is owned by Barings. Information in this material may be used for your own personal use, but may not be altered, reproduced or distributed without Barings’ consent.

21-1492033

X

We use cookies on our website to provide you with the best experience. By proceeding to our site you agree to our Cookies Notice and our site Terms and Conditions.