Well, borrowing usually corresponds to a productive asset, to an increase in value. If a bakery borrows to buy an oven, the bakery will make more bread, and use the additional profits on the extra bread to pay off the loan. If it doesn’t work out, the oven is a real asset, collateral that the bank can sell to get some of its money back. A city borrowing to build a highway gets more tax revenue from greater activity, which helps to pay off the loan.
But there is no economic value to these loans. These are consumption loans, stay-afloat loans, preserve-the-business loans. They are loans against future profits, but not additional future profits. They are a transfer of the franchise value of the business to the lender—the Fed, in this case.
Clearly, at some point the business is better off shutting down than promising its entire profit stream to a lender just for the right to reopen someday. Furthermore, the government, already inclined to forgive, say, student debt, has every reason to forgive these “loans” as well. The business loans explicitly promise forgiveness if the business keeps workers on board. When we are in a sluggish recovery, and businesses are saying, “Well, I would hire more people, but we have all this extra debt because we took Fed loans to keep our employees fed while we were shut down,” let’s see just how tough the government is going to be on repayment.
So, in a matter of months, these loans turn into gifts. The $4 trillion Fed lending package winds up as $4 trillion permanently added to Treasury debt.
The threat of inflation
You would think that if the Fed and Treasury are going to print up something like $1 trillion a month to pay everyone’s bills and prop up markets for the duration, we would soon be heading for inflation.
But we won’t, or at least not immediately, because reserves pay interest. Reserves are just another form of Treasury debt. (Reserves that pay interest are one of the best innovations of recent decades, and kudos to former Fed chair Ben Bernanke and everyone else involved.)
With abundant, interest-paying reserves, reserves and Treasury debt are almost exactly the same thing. In roughly functional markets, what matters is their total supply, not reserves alone. Inflation is a danger, but from the total quantity of government debt, not its split between reserves and bills. Inflation comes, basically, if the US hits a debt crisis where people don’t want to hold or roll over US debt.
(That is, so long as the Fed pays market interest on reserves, and lets the market basically have as much or as few reserves as it wants. If the Fed, and the Treasury, start worrying about interest costs of the debt, and do not pay interest on reserves and do not allow people to convert to Treasurys, inflation will come sooner. )
Why does it matter that reserves pay interest? Couldn’t the Treasury just print up T-bills, sell them for reserves, hand out the reserves, collect loans in due time, and retire the Treasurys? In the short run, it matters for a rather disturbing reason: apparently the Treasury had a hard time finding willing buyers, so printing up the reserves directly and handing them out made a difference.
Instead, the Fed ends up with a loan asset on its balance sheet against reserves, rather than the Treasury having that loan as an asset on its balance sheet against T-bills. Conveniently, also, reserves—though equivalent to Treasury debt—are not counted in the debt limit along with many other contingent liabilities.
In the long run, though, it does not matter. The Fed and Treasury print up reserves, they lend to Joe’s Laundry, Joe pays his mortgage, and the mortgage company pays its investors. If those investors are happy sitting on reserves (bank accounts backed 1:1 with reserves on the margin), the reserves sit there. If they are not happy to sit on reserves, which would be the beginning of the inflationary process, the Fed can just raise the interest rate on reserves until they are happy to hold them, thereby really, really transforming reserves into Treasury debt. Or the Fed can give people some of its stock of Treasurys and so soak up unwanted reserves. That is, so long as people want Treasurys. If people don’t want Treasurys or reserves, if the US has to promise so much interest to get people to hold them that the budget is consumed by interest payments, we get inflation.
We’re looking, for sure, at raising US debt from $22 trillion to $27 trillion, likely hitting 150 percent of GDP if this is a short and swift recession. It could be much larger if the recession goes on a year or more. Is there a demand for that much more Treasury debt in the long run? Is there a flow of that much new saving that people are willing to park with Uncle Sam? How much more can markets take?
So the chance of a global sovereign-debt crisis and accompanying inflation is not zero—but not centrally because of the fact that recession relief efforts are currently financed by printing money.
How long can this go on?
As you can see, the viability of this whole plan depends on a short recession. As I noted earlier, the Fed is printing up something like $1 trillion per month. If the recession ends up being L-shaped, those numbers will ramp up as reservoirs of private cash dry up. A few large companies need bailouts, a few more “dysfunctional” markets turn to the Fed to buy everything, and so on. The International Monetary Fund wants $1.2 trillion to bail out emerging-market economies. State and local governments, already facing pension crises, will be toast when sales- and income-tax receipts collapse.
Where is the limit? Perhaps the peasants with pitchforks, remarkably absent so far, will revolt. Perhaps the willingness to hold interest-bearing reserves or US Treasury debt will find its limit after $10 trillion. Or $20 trillion. There is no magic. The sad lessons of a thousand years of government borrowing and its limits can be forgotten, but not erased.
John H. Cochrane is a senior fellow at the Hoover Institution at Stanford University and distinguished senior fellow at Chicago Booth. This essay is adapted from a post on his blog, The Grumpy Economist.