As the pandemic ravaged the economy, the Federal Reserve, White House and Congress built a facade economy around the ailing economy. In the long run, it is sustainable economic growth that supports asset prices, but in the short run, investors may continue to be mesmerized by the illusion of a booming economy. As a percentage of GDP, the current deficit is more significant than during the Civil War, WWI, Great Depression, and the Financial Crisis. Only the deficit funding WWII surpassed current levels. Before the pandemic, the level of government debt was already at record highs and climbing faster than economic growth.
The only way to keep such a scheme going is to continually lower interest rates to manage the federal interest expense. The Fed bought more than half of the Federal debt issued. This is not about whether the government should have supported the economy, and if so, to what degree. Despite recent reductions, the Fed is still buying bonds at a $105 billion monthly pace and pledging to keep interest rates at zero. The internal and external pressure on the Fed to fight inflation is increasing, but the Fed seems intent not even to discuss raising interest rates. Since the Fed can borrow at will with minimal impact on the bond markets or the government’s interest expense, the economic façade may last longer than we think.