In an interview with CNBC last week, Donald Trump sparked a furor on both the political Right and Left by suggesting the United States might have to default on our sovereign debt. Matt Yglesias wrote an article titled “Donald Trump just threatened to cause a global financial crisis.” Jim Swift at the Weekly Standard wrote an article titled “Donald Trump’s plan to destroy the U.S. economy.” Josh Barro at Business Insider called Trump’s idea “insane.”
Although Trumponomics is wrong on government spending, interest rates, and trade, Trump is actually being honest about the realities of our debt, and was largely taken out of context. Here’s Trump’s interview with CNBC’s “Squawk Box:”
Trump: I must be honest; I’m a low interest rate person. If we raised interest rates and if the dollar starts getting too strong we’re going to have some very major problems… Now if inflation starts coming in, and we don’t see any signs of that, but if inflation starts coming in that’s a different story, then you have to go up and slow things down…
CNBC’s Rebecca Quick: Mr. Trump, I agree with you and it’s a huge dilemma that we face that we talk about just about every day on the show, but the problem becomes if the Fed doesn’t raise interest rates, low interest rates, part of the real thing that we’ve seen is it has been such a huge contributor to inequality in society, if you want to look at why the middle class and the people who are less wealthy feel a lot worse off and the rich feel a lot better off it’s because of the low interest rate environment. How do you tackle that inequality in a low interest rate environment?
Trump: Well, before you get to inequality, we have another problem with raising rates. We have $19 trillion in debt, right? It’s going up to $21 trillion, I mean, we have numbers that are beyond belief. We’re paying a very low interest rate. What happens if that interest rate goes two, three, four points up? We don’t have a country…
But, what do we do with all the money we owe everybody, when rates go up and all of a sudden we have to borrow at 2 points more, at 1 point more even is devastating, but 2, 3, 4, 5 points more, it’s a real dilemma and we have to be very careful. And I am the king of debt, I do love debt, I love debt, I love playing with it, but you’re talking about something that’s very, very fragile, and it has to be handled very, very carefully.
I can’t find the relevant CNBC video for the next step of this conversation, but Trump’s “offending words” are in The New York Times. Ostensibly, Quick went on to ask Trump how we should pay down the debt, since Trump plans on increasing government spending on infrastructure and the military, not cutting entitlements, and reducing the government’s tax take through a big tax cut.
Trump: I’ve borrowed knowing that you can pay back with discounts… I would borrow, knowing that if the economy crashed, you could make a deal… And if the economy was good, it was good. So, therefore, you can’t lose.
This week, on CNN’s “New Day,” Trump tried to clarify his comments in a conversation with Chris Cuomo:
Trump: I said if we can buy back government debt at a discount, in other words if interest rates go up, and we can buy bonds back at a discount, if we are liquid enough as a country, we should do that. In other words, we can buy back debt at a discount. People said I wanted to go and buy debt and default on debt, these people are crazy. This is the United States government. First of all, you never have to default because you print the money, I hate to tell you, okay… It was reported in The New York Times incorrectly, that I want to default on debt… If there’s a chance to buy back debt at a discount, interest rates go up, and the bonds go down…
Where Trump Is Wrong
First, Trump is wrong about the government buying back its own Treasurys. If rates rise, bond prices do decline. But the U.S. government shouldn’t buy back debt at lower prices if rates rise. To do so, the Treasury would have to issue new debt at higher rates to get the money needed to buy back the old debt. The only reason this “old debt” would be cheaper would be because the old debt was paying a lower rate to the U.S. government’s creditors relative to any newly issued debt (if I have a ten-year Treasury that yields 2 percent, it is worth more than a 10-year Treasury that yields 1 percent).
On the other hand, Trump may be suggesting that the U.S. Federal Reserve print money to buy back the debt, which is in some respects already being done, although not directly. Directly “monetizing” deficit spending using the Treasury, where the Fed prints money to fund U.S. government spending, is an idea discussed within the economic and financial elite Trump’s supporters so often deride. Such a policy is popularly referred to as “helicopter money.”
Helicopter money would make the coming financial crisis even worse and handicap economic recovery. America needs less government spending and more household savings. Helicopter money means more inflation and overconsumption, which will erode consumers’ buying power by making their money worth less, continue to make American workers uncompetitive in the global economy, and reduce savings, which will reduce the business investment that leads to real wage growth.
Where Trump Is Right
But Trump wasn’t advocating that the United States default on its national debt willy-nilly. Trump was outlining a crisis scenario, where inflation forces the Fed to raise rates, which would send through the roof the cost of the interest the government pays on the national debt. Jim Grant recently wrote about this in Time magazine.
As Tim Worstall has aptly written for Forbes, “If you read Trump’s statement as ‘I’ll default on the debt’ then of course that’s a terrible, truly lousy, economic idea and bad public policy to boot. If you read what he actually said, which is that if the economy crashes and we can’t repay the debt then we won’t, then it’s just a statement of reality.”
When Trump is talking about printing more money with CNN’s Cuomo, he’s also probably referring to this crisis scenario. What Trump misses is that printing more money, which reduces the “value” of debt in real terms, is just about the same thing as a default. If anything, a quick and painful haircut on what the Treasury will pay bondholders is probably preferable to debt monetization (inflating the debt away), as long as government spending is also reduced.
As Peter Klein has noted, the real insanity is to treat U.S. Treasurys as “risk-free” when the U.S. government’s promised expenditures minus future tax revenue totals more than $100 trillion, a conservative estimate. If anything, Trump is being somewhat honest with the U.S. government’s creditors, something a politician isn’t supposed to do.
Where Everybody Has Been Wrong
Dylan Matthews at Vox pointed out that Trump’s economic policy seems to have adopted the “Left-wing” economic school of thought called Modern Monetary Theory (MMT). MMT is a crackpot theory that says government debt doesn’t matter, government spending is almost always great, money printing will hardly ever lead to inflation, and if inflation does occur all one needs is tax increases and the inflation will go away.
First, all the MMT-ers should go live in hyperinflationary Venezuela, raise taxes, and see how that works out. Second, tongue out of cheek, the rest of us should realize that the only thing separating us from becoming Venezuela is the fact that foreign central banks hoard the dollars we send abroad, which keeps the value of the dollar artificially high. For example, Argentina can print pesos, but they have defaulted more times than Trump has been divorced. The only difference between us and Argentina is that foreign central banks hoard dollars and shun Argentine pesos. What happens when foreign central banks stop hoarding dollars?
There’s a financial short-termism gripping the country, but it resides in the halls of power in Washington DC less than it does in Wall Street, New York. The United States is broke. We have made promises we can’t keep. We can only currently sustain our bloated government through easy money policies from the Fed. The only reason the United States hasn’t experienced substantial inflation during the easy money policies of the last 30 years is because the dollar is the world’s reserve currency. China, Trump’s punching bag, sells us goods and takes our paper dollars in return. If anything, China is getting ripped off, not us.
As the debt grows due to too much government spending and too little economic growth, the prospect of the dollar weakening substantially in the foreign exchange market increases. Eventually, foreigners will get sick of holding paper dollars that increasingly decline in value. When this happens, the dollar will sell off, and U.S. consumers will get hit with vastly reduced purchasing power.
When does this happen? The dollar’s reserve-currency status could end 50 years from now, or it could end five years from now. The important point is that unless the United States cuts spending and enacts sound-money monetary reform, our economic malaise will get much worse. Until a crisis happens however, the likelihood of this happening is near zero.
We’re All Debt Crackpots Now
Trump isn’t a MMT crackpot, at least no more than the rest of DC. Trump might push us over the edge faster with a big infrastructure stimulus and a massive tax cut, but those deriding Trump, such as Yglesias, love the government overconsumption and low rates that led us down this road in the first place.
Even many of Trump’s loudest critics on the mainstream Right, especially neoconservatives, have been far too relaxed about easy money, the debt, and deficits. Marco Rubio, for example, promised increased government spending. Some have been ardent supporters of quantitative easing, despite this recovery being the most lackluster on record since World War II. Neoconservatives need to realize that nothing brings pax Americana to a close faster than a dollar crisis. Business conservatives need to realize that the biggest government intervention in the free economy, by far, has been with interest rates.
The whole country, Democrat and Republican, needs to lose the idea of the free lunch. The debt isn’t manageable as long as we can make interest payments; we can only make interest payments because the Fed is putting price controls on interest rates, causing rates to be artificially low. Low rates aren’t great until inflation hits; they’re bad right now, as they suppress wages and future growth. Tax cuts are great, but only if accompanied by spending cuts. Military spending is great, but only if it gets paid for with taxes, instead of the incredibly regressive tax of money-printing.
The idea of a free lunch only ends when voters decide to stop placing the here-and-now above their children, and their children’s children. If even half of GOP voters got this right, we could save the country. GOP candidates have gone astray, too. The two biggest issues facing our country aren’t ISIS and illegal immigration, they are family breakdown and the government’s price controls on interest rates, both of which have to do with the size of government. But at GOP debates, candidates chest-thumped about “making the sand glow,” promised to grow government in the “right areas,” and regurgitated focus-group-tested statements about President Obama being a weakling. That’s why Trump is the nominee.
In the meantime, we will have to deal with the situation at hand. I suggest each conservative vote his or her conscience, and consider how terrible Hillary Clinton would be. But for those now promising to never support Trump, know that Trump is much more a creature of the Republican establishment than the establishment, or his supporters, would like to admit.