U.S. economy is headed for a bleak day on Dec. 31

Dec. 31 is shaping up to be a bleak day for the U.S. economy. Millions of unemployed Americans will no longer qualify for government aid. Renters will lose their protections for evictions. Student loan debt-holders will lose their relief. And now it looks like the Federal Reserve will be forced to end a bunch of emergency lifeline programs for troubled businesses, cities and states.

The ending of all this aid is coming at a rough time. The economic recovery is stalling and starting to backslide. Layoffs are ticking up again, household spending is slowing and people aren’t venturing out much as coronavirus cases skyrocket in much of the country.

Business leaders, economists and even many Wall Street investors are urging government leaders to enact more aid to get the nation through the winter without more dramatic losses of jobs, businesses and even lives. Yet instead of looking for ways to get more relief out, the Trump Administration took steps this week to further reduce what aid will be available in January.

On Thursday, Treasury Secretary Steven Mnuchin stunned many by sending a letter to the Fed insisting the central bank return all unused emergency Cares Act funds to Treasury by the end of the year.

At first glance, it doesn’t seem like a huge blow to the economy. The programs Mnuchin is asking the Fed to end only made about $25 billion in loans. But that’s deceiving.

Ever since the Fed announced these special lending facilities that would provide additional aid, if needed, to small businesses, corporations and municipalities, the bond markets relaxed. It was basically the equivalent of a young child being able to see a parent at the edge of the playground. The child doesn’t necessarily need to hold the parent’s hand all the time, but just knowing that backup support is nearby provides enough of a sense of comfort. The cost of corporate borrowing fell after the Fed put these supports in place.

Mnuchin wants to take that support away just as the economy appears to be heading into a very rough winter - and a transition of power to the Biden administration.

“Mnuchin’s move will tighten financial conditions and removes a safety net for markets at the wrong moment,” wrote Krishna Guha at Evercore ISI.

The situation is so worrisome that Wall Street firm JPMorgan Chase just started warning clients that U.S. economic growth is likely to be negative in early 2021.

Even the Fed, which has gone out of its way to refrain from saying anything about the Trump administration, felt the need to issue a statement Thursday publicly disagreeing with Mnuchin’s request.

“The Federal Reserve would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy,” the Fed said.

The key word is “backstop.” The Trump administration wants to taking the training wheels off the child’s bike before most think the child is ready to ride fully on their own. It’s a gamble that could have devastating consequences this winter if the nation can’t get the coronavirus under control while layoffs and business closures escalate.

If the economy stumbles this winter, it will be far more costly in the long run than paying for a bit more aid now, many economists across the political spectrum argue.

That’s why numerous Wall Street analysts and the U.S. Chamber of Commerce issued statements condemning Mnuchin’s actions as “political machinations” and supporting the Fed’s stance that this is not the time to remove any supports. The $25 billion in lending the Fed has done is actually backed by about $100 billion in Treasury funds in case some of the loans are not repaid. In total, Treasury authorized $195 billion so far for these special Fed programs.

“For about three weeks in January the markets will be operating without the backstop they’ve had since the spring,” Michael Feroli, chief U.S. economist at JPMorgan, wrote.

Mnuchin fired back Friday in an appearance on CNBC, arguing that Congress only intended for these special Fed lifelines to be in place through the end of 2020. He said he wanted the money back so it could be reallocated to other critical areas of the economy that are more in need of help.

“Let’s go use this money for things and parts of the economy that need it,” Mnuchin said. “We don’t need this money to buy corporate bonds. We need this money to go help small businesses that are still closed and hurt for no fault of their own or people who are on unemployment and their unemployment [aid] is running out.”

Mnuchin presents a false choice that it is one or the other - either extend the Fed programs or help the unemployed. Treasury can’t just hand that money over to the unemployed and small businesses. Congress would need to approve that new use of funds. Also, there is nothing stopping Congress right now from spending as much as it wants on aid.

What the economy needs is both more stimulus to help small businesses and the unemployed as well as an extension of these Fed lifeline programs, many analysts say. Congress can do that now without waiting for the Fed money.

“The U.S. economy might be feeling better, but that doesn’t mean you stop taking your medication,” Edward Moya, a market analyst at OANDA, said.

Some Senate Republicans have indicated they don’t want to spend much more than $500 billion, while Democrats want to spend $2 trillion or more. There’s room to meet in the middle there - without having to sacrifice the Fed’s lifelines.