The American economic response to the COVID-19 crisis has been lauded by many on the world stage, but what exactly are the implications of their ambitious stimulus package? America has spent or plans to spend roughly 7% of their GDP in stimulus to revive their economy, similar to many packages being discussed here in India and across the world. The multi trillion dollar government aid has been facilitated through central bank quantitative easing, which simply means that the Federal Reserve introduced or is introducing trillions of dollars into the American economy, out of thin air. This monetary and fiscal stimulus is not funded by vast dollar reserves or excess tax revenues, but with a few strokes on a computer. Governments can simply print as much money as they want, and get away with it.
COVID-19 was a wakeup call. Previous economic downturns, recessions and depressions are far out of memory. The Great Depression took place in the ’30s, the dot-com bubble burst in the mid ’90s and the most recent Sub-Prime Mortgage Crisis of 2008 although only a decade ago, was nothing close to the potential economic collapse we are now directly encountering. Large swathes of the economy have crumbled throwing 26 million people out of work with the GDP contracting by 4.9%. White House economic advisor Kevin Hasset in fact went on to say that ,“The coronavirus is the biggest shock since the Great Depression. It’s a very grave shock and it’s something we need to take seriously.”
Add on top of this nation wide political unrest and racial tensions, and America is hanging by a thread with Donald Trump’s Presidency called into question, and his prospect of a second term turning into a pipe dream.
However, the stimulus package was the one potential factor that could save American jobs and lives, preventing anarchy and utter breakdown of civil society.
If you’ve ever paid attention to Economics 101 while you were in school or are generally familiar with how the economy works, you may have heard of an economic concept called inflation. When as children we think of just printing more money to satiate everyone’s needs and wants, as we grow up we realise that it’s because of inflation that this doesn’t work. Printing money for everyone is not a real representation of wealth, because after all, paper money is just paper unless there is real productivity behind it. Yet, America made it work. Like magic, the Federal Reserve virtually printed money out of nothing, injecting it into commercial banking systems.
The proposed amount to be printed in 2020 according to the Federal Reserve Board of Governors was $146.4 billion, however, the projected purchase was $3.5 trillion in government securities, and this isn’t the first time America has printed away it’s problems. In fact in 2008 to pull themselves out of recession under the Bush administration, America unveiled the controversial asset purchasing program TARP (troubled asset relief program). Asset purchasing is commonly known as quantitative easing and is controversial because it requires mass amounts of wealth to be created out of nothing in order to purchase toxic assets.
Economists argue that doing so would result in hyperinflation, much like the condition in Venezuela, however, economists never predicted one thing. The world economy is so dependent on the dollar’s value that they would simply not allow it to drop.
If the value of the dollar doesn’t drop then the prices of commodities and services will not inflate. In-fact the inflation rate from May – June, much after the stimulus was introduced and put into effect, was 0.12%. What is even more surprising is that America’s ability to print more money pushed them towards deflation, and although it didn’t, it just didn’t make sense. In the age of $25 trillion of debt, America doesn’t seem to have much of an issue, we would envision that there would be total economic turmoil with so much debt. However, we need to understand something, a new model of economics is forming, and such sound money concepts are just relics of a bygone era in which the value of the dollar was ascribed to a fixed amount of gold.
The Federal Government now has the ability to simply pay of its debt by printing more money, much like paying your credit card bills with just a copy paste. While it’s a little more complicated than that, the Federal Government doesn’t exactly “print money” (since that is the job of the Treasury), rather they purchase assets injecting money into the economy as aforementioned. As a result, the markets that crashed are now back up in business, banks have a larger reserve allowing them to loan more money to the masses.
America is able to do all of this because of one simple reason, as stated previously, the world economy is dependent on the Dollar. Decades of economic growth and trade agreements have made America’s economy so strong that other nations work towards protecting the American economy. It’s simple, if the value of the dollar were to drop then there are 2 primary reasons that it would be detrimental to the global economy.
The first reason is that the world has informally made the American dollar as their default reserve currency. As countries earn an export surplus, they purchase dollars to keep it as reserves solely because of the strength of the dollar. A majority of the reserves in nations is parked in dollars with the rest being euros, gold, etc. India has a record high of forex reserves of $455 billion dollars as reserve. Therefore, if the value of the dollar were to deflate then it would be detrimental to nations as the value of their reserves would come down too.
The second and most important reason is that America is one of the biggest import markets in the world, having imported $3.5 trillion of goods and services from foreign countries in 2019. Countries earn export surpluses out of exporting their goods to America; however, here’s the problem. If the value of the dollar were to fall then it would ultimately mean that the value of the currency of the country importing to America would subsequently increase; after all currencies are inversely proportionate. This would have a bad effect and I will take the example of a pencil to demonstrate why. India exports pencils that cost 60 rupees, this price would be valued against the dollar and approximate to $0.82. An American would buy the imported product at $0.82 because of the current exchange rate (assuming there are no customs tax). However, if the value of the dollar falls, then that same product might cost $2 dollars now. This isn’t because India has upped their export prices, on their end everything is the same, production cost, selling cost, revenue. With an increase in price that American would no longer purchase that product and instead look for an alternative, causing India to lose out.
Magnify that example to some of the more common imports of America, if the value of the dollar drops then products that China, Saudi Arabia, India, Japan, South Africa exports would all inadvertently become more expensive. Due to this America has gained the economic upper hand on nations, allowing them to print as much money as they like. Simply because nations would inch back their currency and its valuation so as to ensure that the dollar value doesn’t drop and create losses for them.
Although there are several other factors at play, it really boils down to the fact that a once controversial program of quantitative easing is no longer controversial. The once fairy-tale like story that a country can just print and give everyone money is certainly a reality now. Such an interesting economic phenomenon makes us aware of how dependent nations are on America. America has managed to incorporate the MAD doctrine into global economy, and this simply puts perspective of their global standing into play. This time, American banks might just be too big to fail.
The Candid Contrarian 