Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: how a weak dollar could unravel U.S. economic policy, Facebook bans Trump, the case against Big Tech antitrust, and Reagan’s Imperial Circle. To sign up for the Capital Note, follow this link.
Biden’s Imperial Circle
With full control of all three chambers of government, Democratic lawmakers are poised to deploy unprecedented amounts of fiscal firepower. Following $3.5 trillion in stimulus spending last year, the federal government will likely add another $900 billion in the form of continued enhanced unemployment insurance and state and local assistance.
Old concerns about deficit spending have largely receded, with interest rates and inflation holding low despite a massive buildup in the federal debt. Only after spending nearly 20 percent of GDP — coupled with Federal Reserve asset purchases and a commitment to keep rates near zero for at least three years — did inflation expectations implied by financial markets reach the Fed’s 2 percent target.
Most economists expect this fiscal largesse to boost GDP growth. After the most recent round of stimulus, incomes are projected to increase by 13 percent year-over-year. The Congressional Budget Office estimates that stimulus programs will contribute 3.1 percent to GDP in 2021. Low interest rates mean those benefits come with a relatively low price tag.
Opponents of Keynesian stimulus typically cite the potential for inflation: You can boost consumer spending all you want, but if the production of goods and services does not also rise, that spending will simply increase prices — more money chasing the same number of goods.
Recent history has belied that theory. For one, while interest rates are low in the U.S., they are even lower in the rest of the developed world. The European Central Bank moved rates into negative territory in 2014 and has pushed them lower since. Those in the market for sovereign debt could do worse than to purchase U.S. Treasury securities — not to mention that Treasuries remain the world’s benchmark risk-free asset. For countries such as China with large current account surpluses, as well as large financial institutions, U.S. debt will always be part of the portfolio so long as there is no viable alternative.
This state of affairs reflects the second reason inflation hasn’t materialized: The “neutral” rate of interest — the price of money set by supply and demand — has been on a downward march for decades. While the neutral rate isn’t directly observable, economists peg it at less than 1 percent. Theories abound as to why: Some blame a slowdown in technological progress, while others point to a savings glut caused by mercantilist economies in Asia and the Middle East. In any event, zero interest rates are less accommodative than they appear.
That’s part of why Fed chair Jay Powell has repeatedly encouraged fiscal authorities to do more. When easier credit conditions cannot increase demand, federal spending can. And last year’s spending packages appear to have contributed economic growth — even if a good deal of federal spending went to savings or debt servicing.
In many ways, the unprecedented COVID-19 recession looks like an accelerated version of prior recessions. Some event (e.g., a stock-market sell-off or a downturn in the housing market) sets off a chain reaction that reduces household spending and business investment, the Fed and Congress step in to alleviate the downturn, and the economy recovers. Last year, economic policy-makers responded much more quickly than in the past, so the recovery was relatively swift. Not to mention that the catalyzing event (the pandemic) was external to the economy, and that the recovery would therefore not have the overhang.
The looming question: Is economic policy really this easy? Can we simply spend our way out of recessions?
Maybe. But an underappreciated pillar of economic policy since Reagan is a strong dollar. Since the start of the pandemic, the dollar has declined roughly 8 percent, and analysts expect it to keep depreciating against other major currencies over the next year.
While a weak dollar is not necessarily an economic headwind, if it continues its downward trajectory, it could break what George Soros called the Imperial Circle of American economic policy. Soros initially used it to describe the Reagan administration’s combination of high budget deficits and high trade deficits. In his book The Alchemy of Finance, Soros described how a strong dollar propped up the Imperial Circle because it compelled foreigner investors to move capital into the U.S., thereby financing budget deficits and stimulating the economy.
The Imperial Circle waned late in the Reagan White House, but picked up again as deficits ballooned during the Bush years. They’ve continued since, particularly following the 2008 crisis. All along, a strong dollar has kept capital moving into the U.S. But if the dollar falls enough, it could remove a key pillar of U.S. economic policy in recent decades.
Around the Web
Markets shrug off Capitol riots: “US stocks rallied for the second consecutive day as investors looked past the violent clashes in Washington and focused instead on the prospect of government spending being ramped up.”
“We believe the risks of allowing the President to continue to use our service during this period are simply too great,” Facebook CEO Mark Zuckerberg wrote in a statement. “Therefore, we are extending the block we have placed on his Facebook and Instagram accounts indefinitely and for at least the next two weeks until the peaceful transition of power is complete.”
Shameless plug: I wrote a long feature on Big Tech for the latest issue of NR:
The Big Tech debate often overlooks just how innovative this market structure is. Before the consumer-Internet era, you might mention your name, age, and hometown when introducing yourself to someone at a bar. Now, these nuggets of personal information buy you intricately detailed maps, a plethora of tools for communicating with anyone on earth, a library containing much of the world’s accumulated knowledge, and more high-resolution video than you could hope to watch in a million lifetimes.
In the pre-Internet world, the 2.5 quintillion bytes of data created by human beings every day lay out of reach, like heavy oil too deep to drill. Dispersed among millions of people with no means of storing and selling it, personal information was a massive untapped reservoir. Now, it’s a means of exchange for billions of consumers. Google makes roughly $250 for every American using its products, while Facebook pockets $110 per user. Amazon and Apple make $15 and $30 per user, respectively, in their “platform” segments (advertising and add-on services, as opposed to retail sales).
Since I touched on Reagan’s Imperial Circle today, let’s look back at a column Soros wrote in 1984 explaining the phenomenon:
The budget deficit keeps interest rates higher than they would be otherwise. High interest rates coupled with financial deregulations suck in funds from all over the world, political considerations also play part: a strong defense posture in a world fraught with conflicts tends to attract foreign capital.
The budget deficit stimulates the economy. Without it, the recovery could not have been as fast and vigorous as it turned out to be. The recovery, combined with high interest rates and the influx of foreign capital, tends to keep the dollar strong. The recovery, combined with a high exchange rate, tends to suck in imports and create a trade deficit. The trade deficit combined with a high exchange rate tends to moderate inflation, as a consequence, the U.S. enjoys the best of all possible worlds: strong economic growth combined with low inflation and budget deficit financed by the influx of foreign goods and foreign capital. I shall call this benign circle the “Imperial Circle.”
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