Lately, politicians aren’t the only ones fighting over whether the Biden administration’s proposed go-big $1.9 trillion COVID fiscal response plan is too big. Economists are increasingly weighing in and, this week, inflation fear seems to be dominating the zeitgeist—hinging on the notion the plan will “overstimulate” America’s economy, especially after the $900 billion bill that passed Congress in December. In our view, while it makes sense to monitor inflation now, the argument currently circulating seems a little hollow. Positively, though, the more it makes the rounds, the less of a threat inflation seems to be to stocks.
At its root, the overstimulation case rests on estimates of potential GDP. Potential GDP, for the uninitiated, is an estimate of where growth should be, were it not for shocks like the COVID lockdowns. Many also see it as a ceiling of sorts—the level at which GDP can grow without sparking hot inflation.
The overstimulation argument holds that growth is nowhere near $1.9 trillion below potential GDP. Most prominently, former Clinton administration Treasury Secretary and Obama advisor Lawrence Summers argued in a recent Washington Post op-ed that the gap is actually only about a third of that, or a bit over $600 billion—a figure likely to shrink as 2021 progresses, with or without Biden’s plan passing.[i] His view isn’t the only one. Many now say pumping $1.9 trillion into America’s economy would overshoot potential GDP and stoke hot inflation—particularly given the degree of money supply growth the Fed has engineered over the last year.
Perhaps that all seems straightforward enough. But potential GDP is a theoretical construct, at best a guesstimate. It accounts for contractions and shifts in the growth trajectory only after the fact. It is a fine enough thing to facilitate debate about where growth ought to be, given some set of inputs and assumptions. But it is the furthest thing from precise. Said differently, economics is not science or a math equation. No one can know how much output is below “shoulda-been” GDP now, and there is limited evidence such a theoretical figure has any real-world meaning.
Moreover, even if the Biden plan passes with the $1.9 trillion price tag, it isn’t “stimulus” in the traditional sense of the term. The plan is highly unlikely to boost demand by anything approaching the headline number. For one, a not-insignificant portion of this plan are checks to American households. As economists John F. Cogan and John B. Taylor noted in a January Wall Street Journal op-ed, history doesn’t suggest direct payments to households boost growth materially.[ii] One reason why: There is no assurance they will spend the money. Households could use it to pay down debt or rebuild savings. The huge increase in America’s savings rate from 7.2% in December 2019 to 13.7% at 2020’s close suggests many are doing just that.[iii] Maybe that money will be spent after re-opening! But maybe it won’t be, and consumers took away the lesson from the crisis that they needed a bigger cushion. That was one lesson Corporate America took from 2008’s short-term credit and money market freeze. In the years thereafter, they increased cash holdings massively.
Biden’s plan also allocates $350 billion for state and local government assistance. This money isn’t assured to be spent—it is designed to fill holes in their budgets. Other provisions, like increased federal unemployment benefits, rent and utility subsidies and food stamps aren’t an increase to demand—they replace what lockdown-driven joblessness wrought. This isn’t to say they are unhelpful. Just that they aren’t the stuff of white-hot economic growth.
In short, Biden’s plan is light on direct spending. Now, even direct spending very often suffers from misallocated investment and/or delays in getting going. The “shovel-ready projects” so many touted in 2009 were always much more rhetoric than reality. But whatever you think of said stimulus plans, they at least theoretically have a multiplier effect as money changes hands and gets spent time and again. Absent direct spending, this effect looks likely to be very weak, if it is present at all.
We aren’t saying inflation generally isn’t a risk. It is one. The massive money supply increase the Fed somehow concluded was justified, even though no amount of monetary action could “fix” economic lockdowns, is potentially inflationary. But we say “potentially” because money supply alone isn’t likely to do it. Inflation erupts from too much money chasing too few goods and services. Chasing is key—money must change hands via lending and spending. Yet a key metric of that, M2 money velocity, is hovering near all-time lows.[iv] That is worth watching for a rise, but there are few material signs of it now. In our view, because it isn’t a big boost to demand, there is little reason to think Biden’s stimulus plan—even at its full price tag—will light the fuse.
In our view, perhaps the biggest takeaway from the whole debate is this: People are increasingly watching for inflation and worried about it. For investors, that is good news! As we often say, surprises move stocks most of all. More and more pundits watching and warning of inflation means it is less likely to sneak up on stocks, in our view.
[i] “The Biden Stimulus Is Admirably Ambitious. But It Brings Some Big Risks, Too,” Lawrence J. Summers, The Washington Post, 2/4/2021.
[ii] “Those $2,000 Checks Won’t Boost the Economy,” John F. Cogan and John B. Taylor, The Wall Street Journal, 1/14/2021.
[iii] Source: Federal Reserve Bank of St. Louis, as of 2/10/2021. Personal savings rate, December 2019 – December 2020.
[iv] Source: Federal Reserve Bank of St. Louis, as of 2/10/2021. M2 money velocity, January 1959 – October 2021.
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