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ECONOMICS IS KNOWN as “the dismal science,” and perhaps for good reason. Oftentimes it can be abstract and overly academic. There are, however, certain economic concepts that can be helpful to individual investors. Below are two that I see as especially important.
When it comes to the government’s ability to control—or least influence—the economy, there are two main levers. The first is fiscal policy, which refers to Congress’s (as well as state and local governments’) ability to levy taxes and to spend money.
The most well known economist associated with fiscal policy was John Maynard Keynes. During economic downturns, Keynes argued, governments shouldn’t hesitate to spend more—and to run deficits, if need be—to help reduce unemployment and lift the economy back up. This is a generally accepted concept today, but in the 1930s, in the depths of the Great Depression, it was not obvious, and many believe that policymakers’ efforts to exercise fiscal discipline by balancing the budget during the Depression ended up prolonging the misery. It wasn’t until the mid-1930s, in fact, that President Roosevelt changed his view on this question. In their correspondence, Keynes convinced Roosevelt that loosening up on fiscal discipline, though counterintuitive, was the best way to bring the economy back to health.
This approach has been used in every recession since. Most recently, during the pandemic, the government issued several rounds of stimulus payments to help bolster consumer finances.
Monetary policy is the government’s second key lever. Unlike fiscal policy, monetary policy is the domain of the Federal Reserve. When you hear about the government “printing money,” it’s the Fed they’re referring to. Through a unique process, the Fed is able to create dollars out of thin air and then to use those dollars to help support the economy during downturns. During the pandemic, the Fed created trillions of new dollars through this mechanism. The Fed also lowered short-term interest rates, which it controls, in a further effort to nudge consumers to open their wallets.
Both fiscal and monetary policy are powerful. But as we’ve seen in recent years, each can also carry side effects.
In the case of fiscal policy, spending too much for too long can drive the deficit to unsustainable levels. This has become a persistent problem. Though it’s now been several years since the pandemic, the federal government is still running deficits of about $2 trillion per year. In round numbers, taxes bring in about $5 trillion, but spending exceeds $7 trillion. Of particular concern is the fact that more than $1 trillion of that $7 trillion must now be allocated to interest payments on all the accumulated debt. To put that in perspective, we’re now spending more on interest than on defense.
Is this situation sustainable? Here’s how I think about it: Imagine an individual with an annual income of $50,000 who spends $70,000 each year, including $10,000 in credit card payments. At some point, something will need to change, but neither political party seems interested in tackling it, for the obvious reason that any solution would require either raising taxes or cutting spending. Neither would be popular, so the deficits persist.
The consequence of overdoing it with monetary policy is also serious: inflation. That’s what we saw very significantly in 2021 and 2022, and that’s where monetary and fiscal policy can become intertwined.
For a brief period during the pandemic, a concept known as Modern Monetary Theory (MMT) gained popularity. The argument was that countries like the United States, with very large economies, were essentially immune to inflation risk and could print money almost without limit. It turned out, though, that MMT was a theory with no basis in reality, and that deficits do matter. Since ancient times, excessive use of monetary policy has always resulted in inflation, and that was exactly what we saw as a result of the Fed’s extraordinary monetary interventions in 2020.
After inflation rose to nearly 10% in 2022, the Fed was forced to reverse course and raise interest rates. That had the desired effect of slowing inflation, but it then caused another problem: Since the government has to issue new bonds practically every day, higher rates have the effect of driving up the government’s borrowing costs, which then worsens the deficit. Higher interest rates also hurt consumers, especially those looking to buy homes.
This, unfortunately, describes the situation we’re in today. In an effort to combat the pandemic, the government used both of the levers that it had, but now it’s effectively out of ammunition. Federal debt held by the public just recently climbed above 100% of gross domestic product for the first time since 1946. The Wall Street Journal referred to this as “a once-unthinkable threshold.”
But before we declare the situation hopeless, it’s important to look at a separate concept in economics.
In 1942, Harvard economist Joseph Schumpeter released a book titled Capitalism, Socialism, and Democracy. Among the concepts Schumpeter proposed was the notion of “creative destruction.” The idea—central to capitalist systems—was that entrepreneurs could always be counted on to move technology forward. At the same time, this meant that older technologies and companies would regularly find themselves pushed aside by new innovations. Importantly, though, Schumpeter argued that the net effect would be greatly positive.
The evidence in favor of Schumpeter is all around us. Horse-and-buggy companies went out of business when the automobile was invented. Pony Express gave way to the telegram, then to the telephone. Typewriter manufacturers are mostly gone. And so on. And yet, despite all these changes, unemployment is under 5%, the economy is larger than it’s ever been, and income-per-capita is at an all-time high.
What’s the relationship between Schumpeter’s theory and the earlier discussion about the government’s debt situation? You may recall that in the late-1990s, the federal government surprised observers when it began to run budget surpluses after years of deficits. How did things suddenly improve? Most attribute it to the productivity boom and stock market rally set in motion by the popularization of the internet.
It’s too early to know whether artificial intelligence will deliver the same economic benefits in the coming years as the web did 30 years ago. But as investors, this history is important to keep in mind. It’s a reminder that, in making financial decisions, we should be careful about reacting to economic forecasts. To be sure, the government’s financial health doesn’t look great, but as history has shown, this could change.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
Milton Freemen made a video, I think it was back in the 80’s, He said, “Watch me stop inflation”, and then he turned off a printing press at “The Bureau of Engraving and Printing“.
Thanks, Adam, this was good to read.
Thanks for the interesting article Adam.
I believe your article thinking parallels the Bogle Center YouTube post titled Financial Historian Mark Higgins in Fireside Chat with Bill Bernstein from the 2025 Bogleheads conference. That chat and the Higgins book, Investing in U.S. Financial History, concluded that the best practice following the U. S. historical guidance, which started with Alexander Hamilton, was to pay off our national debt accumulated during war or emergency as soon as possible. In the interview Mr. Higgens noted the last time such a pay down of such national debt occurred was after WWI, long before any of us were alive.
Higgens and Bernstein’s conclusion for how should we as individuals invest given where we are today is that history argues for humility, diversification, low-cost indexing, and staying the course through crises in our own investment decisions.
I’m glad to see an article about this in HumbleDollar. I’ve been mentioning it in comments for at least two years. Deficit spending has gotten crazy out of control. It’s like meme stock valuations. At long as people believe in the dollar, we’re ok, but both the numbers and political chaos make it difficult to believe we’re having rational discussions about whether interest rates are good around 3.5% or 4.25%. I remember double-digit inflation and I find it incredible that it hasn’t come back given the amount of money the gov’t is throwing at all sorts of ad hoc programs while cutting much less, by orders of magnitude, programs which help people and pump capital back into markets, like SNAP.
Spot on Article about the Real World, thanks for your many contributions Adam. All your work is much appreciated, very interesting and meaningful. I keep learning at 80 years old and beyond. Thank you.
I greatly appreciate your carrying on the work Jonathan commenced. This article was great!
Economics is dismal not because it is arcane or academic, but, as my first economics prof taught, our wants are unlimited, but our resources are limited, at least in the short run. A lesson unlearned by the federal government, as Mr Grossman so skillfully explains
This article uncritically uses the word “pandemic” five times in explaining fiscal policy, but as a NEJM editorial from February 28, 2020 stated:
“This suggests that the overall clinical consequences of Covid-19 may ultimately be more akin to those of a severe seasonal influenza…”
One of the authors was Anthony Fauci.
So our government decided to run the economy on a credit card using covid as the flimsiest excuse possible. Trillions of dollars were spent on absolutely nothing.
We can’t blame politicians for doing what the majority of people wanted them to do. Same as every other issue – rich people get Medicare and Social Security, farmers get subsidized, and on and on, because that’s what people want.
To me, the “defense dividend” (aka reductions in military spending), Budget Enforcement Act, and rising income tax rates of the 1990s all factored large in reducing US government debt. I would be reluctant to attribute the budget surplus at the turn of the millennium solely to increased productivity and the stock market. The concept that a new economic paradigm had taken hold then turned out not to be the case. And now we have increased military spending, have little to no budget enforcement, and declining tax rates.
Honestly Washington D.C. and all of its debt scares me to death. Both parties are wrecking this country with all of the deficit spending at a time when we are NOT in a recession (not even close) and we are generally NOT at war. If we would’ve elected Ross Perot in 1992, we might now have a balanced budget amendment which I think would be an extremely good thing. Since I sat on a city council for 6 years, I have experience with the requirement of a balanced budget for a government.