Coronavirus Crisis: Mountains of Debt

The full impact of the coronavirus pandemic may take years to play out. But one outcome is already clear: Government, businesses and some households will be loaded with mountains of additional debt.

The federal government budget deficit is on track to reach a record $3.6 trillion in the fiscal year ending Sept. 30, and $2.4 trillion the year after that, according to Goldman Sachs estimates. Businesses are drawing down bank credit lines and tapping bond markets. Preliminary signs are emerging that some households are turning to credit for funds, too.

The debt surge is set to shape how governments and the private sector function long after the virus is tamed. Among other things, it could be a weight on the expansion that follows.

Many economists believe low interest rates will help the nation manage the soaring debt load. At the same time, they say high levels of private sector debt could lead to a period of thrift, slowing the recovery if businesses and individuals try to rebuild their savings by holding back on investment and spending.

“People and firms and government are facing a negative shock, and the classic textbook prescription for a temporary shock is to do some borrowing to smooth that out,” says Alan Taylor, an economist and historian at the University of California, Davis.

Borrowing now amounts to a transfer of economic activity from the future to the present. The payback comes later. “You do have something to worry about in terms of the recovery path,” Mr. Taylor said.

Past crises and buildups in U.S. government debt led to changes in the tax code and sharp fluctuations in inflation. In the private sector, debt loads could become a dividing line between firms that fail and those that emerge more dominant in their industries.

Because states generally run balanced budgets to avoid large debt, they are likely to dip into rainy day funds in the weeks ahead.  This could quickly turn to cost cutting to keep their budgets in line in a downturn, squeezing the economy.  Moody’s Analytics sees $90 billion to $125 billion of such cuts or tax increases coming and says the hits will be unevenly spread around the country.

The Federal Reserve, the nation’s central bank, will play the critical role of navigating the nation through the rising tides of debt. It sways the cost of debt service, whether inflation emerges and whether banks and other financial institutions can bear the burden of lending that the nation demands.

In the initial stages of the coronavirus crisis, the Fed has stretched its holdings from $3.8 trillion last September to $5.8 trillion as of April 1, and is on track to increase them by trillions more in the months ahead.

“Had the Fed not come in these past few weeks, we would have had a combination of the Great Depression and the 2008 financial crisis,” said Mohamed El-Erian, chief economic adviser at Allianz.

Source: Wall Street Journal