The Word No One is Talking About

Six weeks into lockdown mode, the U.S. economy is a mess. States are just now starting to open back up, but the damage has been done — some of it permanently. The current unemployment rate in the United States is 14.7% and by some calculations (likely the bureau of labor statistic’s U6 measurement), as high as 23.6%, not far from the peak of the Great Depression.

Bankruptcies are beginning to pile up too. In the month of May alone, Neiman Marcus, Gold’s Gym, and J. Crew have filed for bankruptcy and J.C. Penny is considering it (AMC Theaters possibly too). Wall Street believes the vast majority of the 20 plus million Americans jobs lost will only be temporary — but maybe not so with bankruptcies piling on. Even companies that avoided bankruptcy are slashing jobs at a historic rate: Boeing cut 16,000 jobs in April and, according to a coronavirus layoffs calculator site, 375 startup companies have laid off more than 42,000 employees.

Ok, the point is made. Unemployment is breaking out as a bad as the virus. People are losing their sources of income. Jobs are vanishing — temporary or not.

But there’s something else going on that’s headed straight for the unemployment quagmire.

In the six weeks of shutdown due to COVID-19, the Federal Government has spent over $6 trillion. Trillion with a ‘T’. That’s $6,000,000,000,000 — or one trillion dollars per week. $2.4 trillion of that amount comprises four coronavirus relief bills; this includes the CARES Act, SBA Payroll Protection Programs. The remaining money has come directly from the Federal Reserve, who has acted aggressively to stave off economic collapse through numerous programs, including purchasing securities directly. On top of all this, the Fed also reduced bank reserve requirements to zero. This means if you deposit $100 in a bank, they can lend out all $100 of it, keeping none in reserve. This has massive implications — too much to explain here, but watch this to see the impact of reserve requirements in bank lending.

Furthermore, the Fed has also lowered the federal funds rate (the rate banks use to borrow from one another) down near 0%. This rate is used as a benchmark for various other loan rates, reducing the cost of borrowing for mortgages, auto loans, etc. This is the equivalent of turning on the spigot and the handle coming off.

Make no mistake — this is a massive amount of liquidity suddenly appearing out of thin air. The national debt just crossed $25 trillion, and the juice is running. And at the time of this writing, this whole thing is not over. Congress is discussing more stimulus packages. Just today Congress unveiled another coronavirus relief bill (the fifth so far), costing another $3 trillion. No problem — the Fed’s Neel Kashkari says the Fed is going to do “whatever we need to do to make sure the financial system continues to run.”

Sure, what’s another $3 trillion on top of the 6 just minted?

In short, there’s more money coming but not necessarily jobs. So what’s the word no one is talking about?

Stagflation.

An odd little portmanteau of “stagnation” and “inflation.” It is a period of high inflation coupled with economic depression. It’s odd too that no one in the media or government is mentioning it, because it looks exactly where we’re heading: $6 trillion and counting in six weeks coupled with job losses and bankruptcies.

Stagnation is a nasty beast because it’s difficult to resolve. In an inflationary environment, rates can be raised to cut off the spigot of currency expansion and reel in spending — a by product is reductions in borrowing and ‘tightening of the belt’ so to speak. Value returns to the currency. In a stagnation — or deflation — prices are falling and money is hard to come by. Loosening the belt allows money to flow a little easier, lending to be encouraged, which leads to businesses expanding via credit (and hiring).

So what do you do when you have falling employment and rising inflation?

If you ‘tighten the belt’ to choke inflation, it worsens the unemployment and makes it even more difficult for businesses to access credit. The currency may level off, but higher interest rates deepen the deflationary hole. If you ‘loosen the belt’ to make credit easier to obtain (e.g., federal funds rate) to save jobs, inflation gets worse prices go up and you risk a total collapse of the currency a la hyperinflation.

The choice is no win, but the effect felt by the average American is even worse. Job loss or cutbacks result in less income. People are left rubbing nickels together and deciding to pay bills or put food on the table. But in a stagflation, prices are rising due to inflation of the currency and suddenly you can’t afford bills OR to put food on the table. You can’t afford anything and there’s no way to bring in more money with the drag on employment.

The last time stagflation hit the United States was in the 1970s. Core inflation (CPI) was over 5% annually during the back half of the 70s, with unemployment high and an official recession running from November 1973 to March 1975. (As a point of reference, the Fed’s federal funds rate during the 70s was mostly between 5% and 10% — it currently is 0.25% to 0%) To choke off the inflation, Federal Reserve Chairman Paul Volcker raised federal funds rate to near 20%, throwing the U.S. into another recession but alleviating the increasing inflation.

I believe Volcker was a rare breed and no one today would pull the trigger on such a hefty interest rate increase. But there was no COVID-19 lockdown in 1979. With unemployment so high, companies going bankrupt or drawing heavily on available credit, jacking interest rates up would shatter all remaining functional pieces of the economy. To wit, another word has surfaced that people are talking about — NIRP.

NIRP stands for Negative Interest Rate Policy. NIRP is the theoretical physics of economics. A negative interest rate works in theory, but suddenly everything goes to plaid. It goes something like this: If an interest rate is 10%, that is the amount it ‘costs’ to borrow money. A loan of $10,000 would cost you a total of $11,000: the original $10,000 principal plus $1,000 (10%) interest. An interest rate of -10% would (in theory) pay you to borrow money. You would borrow $10,000 and get $1,000 for doing so. An $11,000 loan costs you $10,000.

Up is down. Black is white.

This would greatly increase the velocity of money, as banks essentially got paid to take out loans. The problem is, this cuts both ways. Cash deposited at a bank that previously paid interest now costs money. Your $20,000 life savings earning 1% annually now costs you 1% to leave in the bank. Last year your $20,000 became $20,200. This year under negative interest rates it goes from $20,000 to $19,800. You lost $200 by having it in savings.

The concept behind NIRP becomes searingly obvious — borrow and spend. Who in their right mind would save money with negative interest rates? Who wouldn’t borrow when you get paid to do so. In theory, since mortgage rates are tied to the 10-year Treasury yield, but in theory you would pay back less than you borrowed to take out the mortgage.

NIRP would cause everyone to borrow and spend away savings (why keep it in cash losing money when you can invest it or buy something with it?) But how would this impact things like bank profitability when you’re paying people to take out loans? In a NIRP world, home-owners would refinance to try and take advantage of negative rates which would disrupt interest and mortgage-backed bonds. The whole thing is bizarre.

But in any case, the result would certainly be increased borrowing and spending. Would the Fed actually consider doing NIRP? It’s already being floated in financial circles…

So if the Fed doesn’t crank up interest rates in positive territory, then the only end game here is inflation and prices going up while people struggle to hold or regain jobs. The government can hand out cash in relief packages all it wants to offset jobless and loss of income, but this just further fuels the fire. If this keeps going, a $1,200 stimulus check from the government won’t buy much or things just won’t be affordable at all.

But cutting stimulus checks gives the pretense of ‘doing something’ for the people on the street. Granted, they’re walking a fine line with the COVID lockdown, but spending into infinity is going to be a losing proposition for all. Giving someone a check is simpler than explaining how velocity of money or banking interest rates work.

Especially in an election year.