It’s been ten years since I published my book, “Boomergeddon,” in which I advanced the argument that the fiscal/monetary system of the United States would collapse into chaos by the late 2020s or so. The nation has continued down the path to perdition, but not at the rate I had expected. I did not anticipate private-sector innovations like fracking, which put an end to fears of “peak oil,” nor did I foresee policy innovations such as Quantitative Easing, which repressed interest rates and bilked lenders and investors (retirees, pension funds) but eased the burden of paying interest on the national debt. And I never imagined that the nation could last a decade without a recession.
Our national leaders did a brilliant job of fighting the last financially-led recession through regulations that strengthened the finances of our biggest banks. But a true “black swan” — a rare and unanticipated event, the COVID-19 epidemic — and the governmental response of shutting down large swaths of the economy are plunging us into a severe downturn that no one saw coming. The Congressional Budget Office estimates that Gross Domestic Product for the 2nd Quarter of 2020 will “decline by at least 7 percent or at least 28 percent at the annualized rate.” Unemployment is spiking, and will likely linger. The CBO expects joblessness to linger around 9 percent through the end of 2021.
Needless to say, a recession of this severity will have devastating impact on federal, state, and local finances. The federal government was already running a $1 trillion-a-year deficit. To that, we can add another $1 trillion or so (the CBO offers no official forecasts) from lost tax revenue, and another $2.3 trillion from the congressional rescue package, and that doesn’t include a second-round package. This year alone, the U.S. will likely add $4 trillion or more to the national debt, which is already approaching $24 trillion. That compares to a $21.4 trillion GDP. By the end of this year, the debt as a ratio of GDP could well stand at 140% — totally uncharted waters.
Congress, President Trump, and the Federal Reserve Bank are going to do whatever they’re going to do, and there is precious little that we, as citizens of Virginia, have to say about it. But we can have some influence over policy decisions in our home state. And the time to begin thinking about the implications of the COVID-19 recession on the fiscal sustainability of state and local governments is now.
There are short-term, intermediate-term, and long-term considerations.
Short-term considerations include:
- How severe will the recession be in Virginia, and how sharply will it cut into state and local government revenues in the final four months of the 2020 fiscal year? What mid-term corrections must we make in order to balance budgets?
- What will be the lingering effects of the recession into the next fiscal year (for localities) and on the next biennial budget (for the state)?
- To what extent will the helicoptering of federal money and massive monetary stimulus counteract the recessionary impact of shutting down much of the economy?
The situation is dynamic, meaning it changes from day to day. Uncertainty reigns. There is no preparing for a disaster of this nature (although Secretary of Finance Aubrey Layne did model a stress test a year-and-a-half ago and concluded that a repeat of a 2008-style recession would result in multi-billion-dollar declines in state revenue for three years running). We must err on the side of caution.
Yesterday, Governor Northam prudently announced that the state would suspend all new spending in the upcoming two-year budget and divert planned deposits into the states’ reserves to pay for essential services in the public-health/economic crisis.
According to the Richmond Times-Dispatch, “the budget strategy will give Northam and the General Assembly time to reassess the economic damage and outlook for future state revenues, as determine how much money the federal government will send to Virginia in emergency stimulus funding, and how the state can spend the money.” The Governor’s Chief of Staff Clark Mercer likened the action to “a great timeout until we get a better idea of what the economy looks like.”
Only time will tell if the response is aggressive enough.
Intermediate-term issues. Once Virginia has dealt with the short-term issues, many will be tempted to stick to the same tax-and-spend course charted by the General Assembly in the 2020 session. But we cannot lose sight of the intermediate-term issues:
- Virginia Retirement System. First and foremost is the impact on the VRS. Administrators of the system count on generating a 7% annual rate of return over the long run (acknowledging that year-to-year results will fluctuate widely). With the stock market down 25%, and bond prices repressed by Federal Reserve action, and returns on other investment categories jeopardized, it’s safe to say that VRS investments (like those of other government pension funds) will be drastically sub-par this year. Will prudence dictate that state and local governments increase their yearly contributions, and, if so, by how much?
- Quasi-Government authorities. The Washington Metropolitan Area Transit Authority (WMATA) has suffered a massive loss of ridership and revenue from the stay-at-home orders. The authority is asking for a $50 million bail-out. What are the repercussions on Virginia’s other mass transit agencies? How about the airports authorities and port authority? Housing authorities? Economic development agencies? Will they be asking for bail-outs?
- State hospitals and higher-ed institutions. Hospitals are hemorrhaging revenues as they turn away elective procedures in order to dedicate themselves to COVID-19 patients. Colleges and universities are refunding students some or all of their tuition. How many of these critical institutions will need bail-outs?
Longer-term issues. I have posted repeatedly on this blog — much to readers’ boredom, as I gather from the low readership metrics — that Virginia needs to insulate itself from the fiscal and monetary irresponsibility of the federal government. Maybe now that we are collectively experiencing the unthinkable — or what seemed unthinkable two months ago — we may be receptive to the idea that even more unthinkable things could occur in the future.
The thesis of “Boomergeddon” is that the U.S. is headed for a fiscal meltdown due to a structural mismatch between spending and tax revenues. Republicans love cutting taxes and spending money on defense. Democrats dream up a never-ending list of new “needs” that can be addressed only through increased domestic spending. In a nation with divided government and no governing consensus, the pragmatic way for everyone to get what they want is to jack up domestic spending, crank up defense spending, and cut (or refuse to raise) taxes. That political dynamic has not changed one iota in the past ten years. Fiscal responsibility gets lip service, but we’re not at the fiscal precipice yet, so no one is taking the fiscal imbalance seriously.
Back in 2010, I suggested that the U.S. had the wherewithal to survive one more recession like the previous one. The COVID-19 recession is it. We’ll survive this. We’ll muddle through. But we’ll have exhausted our fiscal and monetary ammunition. The U.S. national debt will be so humongous that at some point lenders will stop seeing it as a safe haven, interest rates will rise, and borrowing will become punishingly expensive… Unless the Fed continues to suppress interest rates with unforeseen but massive consequences. One possibility is that the political class, in its desperation, will turn to inflation as a way of whittling down the massive debt… a recipe for stagflation like we experienced in the 1970s. Whatever path is chosen, in the next recession, whether it comes four, five, or ten years from now, the U.S. will have no effective counter-measures. We could very well enter a deleterious spiral that ends in a crash giving new meaning to the phrase “Great Depression.”
When the federal government fails, Virginians will turn to their state government to hold it all together. The question then will be: What condition will our state government be in? Will we be a fiscal basket case like Illinois or Puerto Rico? Or will we have demonstrated the foresight to shore up our fiscal strength and engineer more resilient K-12, higher-ed, healthcare, and transportation institutions?