The Commerce Department last week reported the steepest-ever decline in the U.S. gross domestic product. The value of goods and services fell at an annual 32.9% in the second quarter, wiping out nearly five years of growth.

The collapse was unprecedented in its speed and its severity. The decline is attributable to the lockdowns imposed on millions of Americans in response to the coronavirus pandemic. For many of us, we were faced with a Hobson’s choice. We could quarantine ourselves or stay in the workforce and expose ourselves to the coronavirus.

Continued consumer unease and renewed shutdowns will dampen a meaningful economic rebound until 2022. Until we defeat the virus, we will be fighting on the defensive.

Diane Swonk, chief economist for Grant Thornton, wrote, “We are in a desperate situation. Everyone wants to keep putting on rose-colored glasses, but it is blinding us to the reality of the situation.”

The Labor Department reported the 19th straight week that America’s unemployment claims exceeded one million.

Understandably, Americans are tightening their belts. Across the board, consumer and business spending has declined in large part because of lockdowns, social distancing and other initiatives aimed at containing the virus.

The magazine Economist in an article “Free money” summarized the global response to the pandemic:

  1. Government borrowing has increased at unprecedented levels. The IMF predicts that developed countries will borrow 17% of their Gross Domestic Product.
  2. The monetary stimulus is unprecedented. In America, Britain, the eurozone and Japan, central banks have created new reserves of money worth some $3.7 trillion in 2020.
  3. The government has become more engaged in allocating capital to private enterprise. The Federal Reserve and the Treasury have now guaranteed 11% of America’s entire business debt.
  4. Low inflation means that monetary policy will remain accommodative. In essence, it looks like “we have free money.” Federal Reserve Chairman Jerome Powell reportedly said he “was not thinking about raising rates.” In response, I might be a voice in the wilderness. Powell’s assurances remind me of Neville Chamberlain’s hollow promises to the British people after the Munich sellout. He claimed that he had achieved “Peace for our Time.” Inflation, like the flu, remains an ever-present threat.

Why might this economic downturn break the back of America’s ability to regenerate?

The Economist predicted that the role of the state would not magically return to normal once the pandemic passes. Although governments and central banks may reduce their spending and bailouts, the long-term trend of more government involvement in the economy reflects long-term trends.

In each era, economists face new challenges. After the 1930s, economists focused on preventing depressions. Keynesian economics embraced government spending to supplement the traditional reliance on private business investment. In the 1970s and 1980s, we suffered from stagflation. Stagflation reflected persistent high inflation with high unemployment. Paul Volcker raised overnight rates to above 20% to stifle inflation. Today’s economists have a new challenge. Policymakers will need to encourage private enterprise to function without government takeovers and yet impose more government oversight.

Since I was a little boy, I was taught that money does not grow on trees. Near zero interest rates creates the illusion of free money. While I appreciate the necessity of massive injections of cash to prevent millions of Americans from starving and losing their homes, I also recognize that there are limits to even the federal government’s indebtedness.

The greatest long-term risk is inflation if it jumps unexpectedly. To fight inflation, central banks must increase interest rates. If interest rates rise, the carrying costs of our humongous government debt will crowd out other government mandates such as expenditures on health care, retirement benefits, national defense, education, transportation, etc. A sharp reduction in government spending on the foregoing will create social havoc.