COVID-19 proves capitalism is financially sustainable---no structural collapse.

Why the U.S. Is Unlikely to be Headed Towards a Structural Regime Break

Though the path from the crisis we’re in now to either depression or debt crisis is not impossible, it’s not easy or natural, if we examine each of the four paths in regards to the current situation:

Policy Error — The policy challenge of coronavirus is enormous, but what is on display is the opposite of the inaction of the Great Depression. On the monetary side, the first signs of stress in the banking system — in the repo and commercial paper markets — were met with timely and sizable monetary policy action. On the fiscal side, it didn’t take long — certainly by Washington standards — to pass the $2 trillion CARES Act to provide funds to counteract the wave of liquidity and capital problems for the real economy (households and firms). Beyond any specific policy action, we are seeing a mindset in which policy makers will keep throwing policy innovations at the problem until something sticks — quite the opposite of the 1930s.

Political Willingness — It certainly is possible that political calculus gets in the way of averting a structural breakdown, but not very plausible because the political costs are high. To be sure there are two risks involved: 1) The unwillingness to craft a piece of legislation, perhaps because of differences in analysis, beliefs, or dogma; and 2) the failure to pass legislation because one side sees greater political gain in obstruction. While the TARP fiasco reminds us that both risks are real and shouldn’t be dismissed, crises tend to lubricate deal making, and the costs of political obstruction are particularly high, even in a hyper-partisan election year.

Policy Dependence — This path is not applicable in the U.S. because of monetary sovereignty. The Federal Reserve will always facilitate fiscal policy in a time of low and stable inflation and a healthy currency.

Policy Rejection — A debt crisis seems improbable for the U.S.: Inflation expectations are very well anchored (and, if anything, too low). The rate-risk correlation is very solid, where in risk-off periods (moment when investors are less tolerant of risk and prices of risk assets like stocks fall) bond prices rally (yields fall). The USD reserve currency status is deeply entrenched as the rest of the world needs to hold U.S. safe assets (and don’t wish to see their currencies appreciate). And nominal interest rates are generally lower than nominal growth (r – g < 0). All of these factors make for favorable financing conditions. Can coronavirus damage all that and deliver a crisis where markets refuse to purchase U.S. debt? It’s possible, but very implausible, and it would be a long and painful process. A break in the inflation regime plays out over several years.