In the second half of 2019, fears that the U.S. economy was steaming towards an imminent recession began to swell. On any given day, media headlines were absorbed by the repo market seizing, the yield curve inverting, the trade war raging, the national debt rocketing, and, most certainly, the president tweeting. It’s all deafening and mad, but what’s most troubling of all is the lack of discourse around what will be done when the tides eventually turn.
To be clear, we are not trying to postulate whether or not we are at the precipice of another recession, nor are we trying to guide you on how to position your investments for the next recession. We are simply exploring what actions the U.S. can feasibly perform to mitigate the next recession. Perhaps the best place to begin this exploration is a quick review and inventory of the standard recession fighting toolbox.
Starting with the fiscal policies that Congress and the president can pursue to curb a U.S. economic downturn: taxes can be cut, and government spending can be increased. Both of which are performed to stabilize the economy by spurring consumer spending and business investment. Ultimately, the effectiveness of such policies can be determined if increases in Real GDP and decreases in unemployment are realized.
Next are monetary policies that the Federal Reserve’s Board of Governors (BOG) and the Federal Open Market Committee (FOMC) can pursue. These policies include purchasing securities (normally treasury bills, notes, and bonds) through open market operations and quantitative easing, reducing reserve requirements (the amount of cash determined by the BOG banks are required to hold), lowering interest rates on reserves (refers to the Fed funds rate determined by the FOMC that banks charge each other for borrowing funds), and decreasing discount rates (the rates determined by the BOG that the Fed charges banks for borrowing funds). Similarly, these intend to stimulate business investment and the availability of credit.
Having reviewed the toolbox, let’s take inventory of our current tools.
Taxes Have Been Cut: In December 2017, the president signed the Tax Cuts and Jobs Act (TCJA). At its essence, the TCJA is intended to lower taxes for individuals (in most cases and through 2025), lower taxes for corporations (permanently), and lower taxes for pass-through businesses (some). The impact is that the TCJA is projected to save businesses and households $1.5T in taxes over the next decade. As for where this leaves taxes as a tool, another cut could be attempted but would unlikely succeed given the political maneuvering required and the current budget deficit.
Government Spending is Alarmingly High: The federal government, in 2019, collected about $3.5T and spent about $4.5T. Moreover, this spending can be roughly broken down as follows: Social Security ($1T), national defense ($700B), medicare and health ($1.2T), income security ($515B), interest on debt ($375B), veterans benefits ($200B), education ($135B), and several more categories ($375B). The impact is that the U.S. has been regularly overspending, has created a trillion-dollar deficit for 2019 alone, and will likely struggle to reallocate spending in the future. As for where this leaves spending as a tool, an attempt could be made to allocate additional funds to unemployment benefits, education, healthcare, federal contracts, grants, and loans as performed under 2009’s American Recovery and Reinvestment Act (ARRA), but it would be unlikely to succeed given the increasingly partisan political environment, and it would further exacerbate the federal deficit.
The Fed Has Been Purchasing Securities: Between 2007 and 2015, the Fed’s balance sheet increased from approximately $870B to $4.5T. The impact is that the Fed’s current $4T balance sheet is still overloaded with a mix of treasury securities and mortgage-backed securities initially purchased to increase the money supply and restore confidence during the Great Financial Crisis (GFC). As for where this leaves future purchases of securities as a tool, it’s uncertain as to where and to what extent the Fed will intervene during another recession, given the roughly $4T it will likely still have on its balance sheet when the next one arrives.
The Fed Has Been Reducing Rates and Reserve Requirements: Effective October 2019, the FOMC decreased the Fed funds target rate from 1.75%–2.00% to 1.5%–1.75%. Also effective October 2019, the BOG adjusted discount rates - decreasing the primary credit rate from 2.50% to 2.25% and the secondary credit rate from 3.00% to 2.75%. Meanwhile, effective January 2019, the BOG requires all banks with more than $124.2M ($127.5M effective January 2020) on deposit maintain a reserve of 10% of deposits. The impact is that rates and reserves have already been reduced to encourage lending and bolster growth during a period of record expansion. As for where this leaves future rate and reserve reductions as a tool, there is still some room for future reductions, but there’s far less flexibility now than there was going into the GFC, when the Fed funds rate was hovering over 5.00% and discount rates were hovering around 6.25%.
What Happens Now? That appears to be an increasingly grim question. Today’s toolbox is depleted compared to where it was going into the GFC. When tides turn, the U.S. government’s best bet will be reducing rates and reserve requirements, purchasing what securities it possibly can, and hoping the next crisis is not nearly as bad.
*This article was originally published in the Winter 2019 Issue of the Family Office Magazine.*
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