Pandemics are deflationary. A demand shock happens before a supply shock. It takes times for supply chain disruptions to be felt, but people stop buying immediately. A good portion of what we buy is discretionary. Entertainment, travel-these are dollars that do not have to be spent. Food must be purchased, but most everything else does not have to be, and reduction in demand should lead to price drops. Price drops allow purchasing power to increase. Technological innovation also causes deflation that we might not see until a sudden shock forces it to concentrate its powers on goods that can’t be substituted for. Food, health, housing. However, two staples of our financial system force federal intervention at a much deeper level than we should accept. Pension obligations, and debt.

Pensions have unrealistic return targets, trillions in liabilities, and are eventually going to cause a massive financial crisis post-CoVID. In the short term the pensions’ need for an immediate return to fulfill existing obligations puts massive political pressure on the Fed to reduce interest rates beyond equilibrium. Especially if pension funds don’t understand how to hedge tail risk. This creates larger long term liabilities in the market by leading to inefficient allocation of capital in both public and private markets. Simultaneously, pension targets, even adjusted for changes in the CPI, are too slow to adjust, and too inflexible-promised returns should not exist! They’re also absurdly high.

Now, let’s look at debt and interest rates. Interest rates can only be dropped so low. It does not make sense to pay a borrower to borrow money. It just doesn’t-I could go into a huge dissertation on why now, but it comes down to: It doesn’t make sense. When interest rates make money free, there’s nowhere left to hide when something that’s even slightly unexpected happens. Progressively lowering interest rates has a concave effect-it multiplies poor capital allocation. Corporations and individuals lever up even more than they already were because capital is cheap, enabling them to cover existing debt and take on more debt, when they should be taking on less. We already know risk models don’t properly price risk, because they use backwards-looking estimates of variance and tail risk, and there’s no guarantee that things won’t be worse than they have in the past. Thing inevitably get worse than we expected, because humans are optimistic creatures. And when there are layers of debt, all dependent on receiving a debt payment from someone else who is receiving a debt payment from someone else, when the system misses (as it inevitably will), a single event can cause a massive debt cascade. It’s turtles all the way down. Think of forest fires in the Western United States that burn after years of fire prevention. Without localized fires, we get conflagrations that threaten eco-systems.

Avoid debt at all costs. Avoid guaranteed returns because they inevitably aren’t guaranteed. Americans must accept both of these statements going forward, or we’re going to see crashes at some point in the not so distant future that make 2008 and CoVID-19 look small. Successively larger shocks will have implications far beyond 401ks ticking down for a few years. We falsely believe that future floods won’t be larger than previous floods, we falsely believe that future financial drawdowns won’t be larger than previous financial drawdowns, and we falsely believe our political and social systems will maintain equilibrium when faced with new and unexpected shocks.