The economy is currently held together by a roughly neutral monetary policy that ignores inflation and monetizes an irresponsibly loose fiscal policy.

The markets and the mainstream media are supporting the idea that we shall somehow muddle through the next elections in early November.

After that – we shall see. Some might even say, like Louis XV, the King of France: "Après moi, le déluge" (After me, the flood).

Those of you ready to blame the country’s budget deficit of 7.8% of GDP, and a runaway public debt of $34.5 trillion, or 123.5% of GDP, on the U.S. Congress are only partly right.

The U.S. economy was in excellent health until the country’s central bank – the U.S. Federal Reserve (the Fed) – lost control of the monetary policy and created a huge financial crisis, starting in the middle of 2008, and leading to the Great Recession and massive publicly funded bailouts.

Deep and open wounds of Great Recession

That was a sad coda to a decade (1997-2007) when the U.S. budget deficit and public debt averaged 3.2% of GDP and 60.5% of GDP respectively.

Indeed, in the immediate aftermath of the financial crisis, budget deficits increased fourfold, and the public debt nearly doubled as a share of GDP.

What we got there was a huge and lasting deterioration of America’s public finances -- caused by a monumental case of monetary mismanagement.

Consider this: Before the financial crisis broke out, the Fed’s monetary base in May 2008 stood at $827.2 billion. That was a “normal” level of the Fed’s main monetary aggregate called M0. By the end of that year, the U.S. financial system needed a rescue, forcing the Fed to double its money supply to $1.7 trillion. And the latest news is that on March 6, 2024, the Fed’s M0 was a whopping $7.5 trillion.

Now, the Fed’s M0 is the liability side of its balance sheet. That is the money the Fed creates against its assets, mainly consisting of U.S. Treasury debt (bonds and notes).

And there you have the linkage between the monetary and fiscal policies. When the Fed buys Treasury paper it increases the money supply and short-term interest rates go down. Conversely, when the Fed sells Treasury paper it withdraws money from the financial system and short-term interest rates rise.

Since the middle of last year, the Fed has held short-term interest rates fluctuating in a narrow range around 5.35%. That was a good idea: a pause to assess the impact on economic growth and employment of a sharp increase in credit costs from zero interest rates.

An equally important test was an empirically validated concept of monetary neutrality defined by real policy interest rates of around 2% (e.g., nominal policy rate of 5.35% minus a core consumer price inflation of 4%).

Optimum optimorum: peaceful coexistence and free trade

Both tests seem to have been confirmed. Business surveys show a slowing expansion of service sector (90% of the economy) and a declining manufacturing activity, with the unemployment rate moving up slightly and inflation remaining around 4%, far above the official medium-term target of 2%.

Asset markets are trading up on lower interest rates in the months ahead. That could happen in an election year, although, on current evidence, such a move does not seem necessary.

That’s all fine and encouraging. But the truth is that the U.S. economy cannot continue to grow with (a) an inflation rate suppressed to 4% by pushing up energy supplies, (b) budget deficits of 7.8% of GDP, (c) a soaring public debt of $34.5 trillion, (d) a current account deficit of 3% of GDP, and (e) a net foreign debt growing at a quarterly rate of $15.5 billion.

Washington must focus on stabilizing the economy and doubling noninflationary growth potential from its dismal current rate of 1.7% by increasing the stock and quality of human and (physical) capital through education and science.

Foreign trade needs attention. Excessive trade deficits are a drag on U.S. growth and a large source of our foreign debt. We need to import foreign capital accounting for 3% of our GDP to make ends meet.

Our friends and allies – Europe, Japan and South Korea – represent one-third of our trade deficit. Adding China, we have nearly two-thirds of our trade gap. That must be quickly and sharply narrowed through free, fair and reciprocal trade policies.

Underlying all that must be a thorough review and update of U.S. national interests and security requirements in a world ruled by the MAD (Mutual Assured Destruction) doctrine. The optimal postmodern security concept is still peaceful coexistence based on free trade – rather than geoeconomic fragmentations along the lines of elusive blocs and ad hoc “alliances.”