After a $1.9 trillion spending bill last month which included the third round of stimulus checks, the Biden administration has begun pushing for an additional $2 trillion of spending through an “infrastructure investment” plan.
You don’t need an economics degree to know these are big numbers. So, what are the implications of these massive spending sprees?
Let’s take a look at some possible scenarios that can play out over the rest of 2021 and beyond.
Is inflation coming?
Inflation is the rise in prices in the economy. When prices go up, this reduces the purchasing power of your dollar.
Indications are that inflation could be starting to tick up in 2021.
Why? The government has vastly increased the supply of money in the economy. Stimulus checks, loans to businesses, and additional spending disguised as Coronavirus relief are all examples of “printing money”.
An increase in the supply of money increases consumption and investment. This is the goal—boosting aggregate demand through the supply of money. Since inflation is a product of supply and demand, a bunch of people with flush bank accounts increases demand.
Besides the fact that the recent increase in money supply is historic, this is all happening in an economy that was already in relatively good shape. Sure, there are still some areas of weakness from the government’s response to COVID, but the economy is in expansion mode. Supplying too much money while the economy is already accelerating can result in inflation running too high.
Will taxes go up?
President Biden campaigned on no tax increases for anyone making under $400,000 per year.
The problem is, that makes 72% of the income tax base unavailable for tax increases. Because of the sheer magnitude of the administration’s spending plans, it is unknown how they will pay for them.
So, if tax hikes on middle-class families isn’t an option, what other avenues does the government have?
In addition to taxes, the government can pay for its programs through deficit spending. Think of deficit spending as spending money you don’t have (like using a credit card).
The government’s version of a credit card is Treasury Bonds. Bonds are loans that require the government to pay an interest rate to the bondholder. Higher deficits mean more issuance of Treasury Bonds. If a person gets into too much debt, this constrains his cash flow. More and more money is spent simply servicing his debt. Same thing with the government. Too much deficit spending means more debt which means more of the budget is spent simply paying the interest on that debt.
So, will taxes go up? It’s too early to tell, but don’t be surprised if new tax increases are proposed on middle-class Americans. This is where the money is!
What does this mean for stocks?
While there are always existential threats to the market (i.e., a pandemic), I can’t help but be optimistic about stocks for the rest of 2021.
The case for a strong stock market is pretty simple:
- People are sitting on a ton of money.
- The economy is reopening, and things are getting back to normal.
- Consumer spending should explode.
- Companies that survived the pandemic cut costs and are much leaner and more efficient.
One threat to growth would be if interest rates continued to shoot upwards too quickly. Because people are anticipating inflation and more deficit spending, investors have been selling bonds.
When bonds are sold, interest rates go up. This means higher borrowing costs for corporations, consumers, and the government. Naturally, this decreases spending and investment.
The Federal Reserve has said it will keep short-term rates low, but they could have a hard time keeping long-term rates in check if inflation and spending get out of hand.
What about the long-term implications?
Deficit spending can be positive if it stimulates long-term growth. This is part of the promise of the infrastructure spending plan—invest in these projects which will increase productivity growth.
However, much of what is in these bills do not invest in infrastructure or anything else with any type of return on investment. Think of it in personal terms. A 30-year mortgage to buy a house is good for your finances long-term. Racking up credit card debt to pay for your lifestyle is not.
Simply put, too much government spending through deficits hampers our ability to respond to future economic challenges.
Climbing the wall of worry
It’s said that stocks “climb a wall of worry.” Put another way—there are always challenges, a future that is foggy, and a million reasons not to invest. While we make educated responses to what’s going on, no one really knows what will unfold.
Good news—being a successful investor does not mean you need to predict the future! Can you remember a time when the future wasn’t uncertain?
My hope is that this gave you some insight into current policy discussions and possible implications as an investor.
