Tuesday, May 10, 2016

Bonddad Tuesday Linkfest; Trump's Really Stupid U.S. Debt Idea

Several days ago, Trump floated the idea that the U.S. should ask it's creditors to take a haircut on their respective U.S. debt holdings.  Below is a smattering of commentary on the idea.  I would add this point: a central idea in international finance is the idea that U.S. debt is riskless.  Analysts use U.S. interest rates as the risk-free rate of return.  Trump's idea would eliminate that assumption, which would throw a monkey wrench into international finance as we know it.

This is, quite literally, one of the dumbest ideas I've ever seen floated.  Period.

Truly, Donald Trump knows nothing. He is more ignorant about policy than you can possibly imagine...

Last week the presumptive Republican presidential nominee ... finally revealed his plan to make America great again. Basically, it involves running the country like a failing casino: he could, he asserted, “make a deal” with creditors that would reduce the debt burden if his outlandish promises of economic growth don’t work out.

The reaction from everyone who knows anything about finance or economics was a mix of amazed horror and horrified amazement. ...

So why is Mr. Trump even talking about this subject? Well, one possible answer is that lots of supposedly serious people have been hyping the alleged threat posed by federal debt for years. ...

His “very good brain” doesn’t seem to be firing on all cylinders here. Let’s unpack these comments because they’re both extremely wrong.  First, if interest rates rise by 2, 3, 4 points then what happens? Wait, no, I am being stupid now. Sorry. The right question is, WHY would interest rates rise by 2, 3 or 4%?  The only plausible case for rates rising that much is if the US economy is booming and the Fed is raising rates in an effort to slow the boom. So, Trump is constructing a totally false scenario in the first place. If rates are rising then America is great again and we certainly still have a country.

Perhaps he thinks we’re Greece where interest rates rose due to solvency fears. I don’t know if that’s what he’s inferring, but if he is then he doesn’t understand the solvency dynamics of the US government within the scope of the global financial system. I’ve explained that concept in excruciating detail many times over the years. See, Why the USA isn’t Going Bankrupt & Concerns About the National Debt.  And if he thinks today’s environment looks anything like the 1970’s then he’s still way off the mark as today’s environment resembles the 70’s in almost no way.  See, 3 Reasons Today’s Environment is not like the 1970’s.

But let’s go with this notion even though its causation is misleading. If interest rates rose by 4% what would the economic burden be?  Well, the average maturity on US government debt is roughly 5 years.¹ 5 year notes pay about 1.3% today, which is about what the US government pays on average for its debt. If rates rose by 4% then it’s likely that 5 year notes would offer a slight premium. Let’s just say 5% for fun. What happens to the budget deficit?  Interest payments would jump to about $950B per year which would bring the deficit to about 1.4T or 7.7% of GDP using today’s figures.²  That sounds unpleasant, but it’s not even close to the 10% deficit we experienced during the financial crisis and nowhere near the 30% figure we saw during WW2. We still have a country after these experiences if I have my history right.

This policy would be so disastrous that even its suggestion is dangerous. In the event of a recession, Trump would treat the full faith and credit of the United States to a capricious hair cut. As Josh Barro explained, this wouldn’t just represent a historic default, putting the U.S. in the position of a country like Greece or Argentina; it could also spark an international financial crisis, as “investors would cease to see Treasuries as a safe asset and demand higher interest rates in exchange for risk.”

US Treasury bonds have very low interest rates because investors are extremely confident they will be paid in full, even in poor economic conditions. Trump — by openly saying that he would keep partial payment on the table as an option — could spark a crisis in the Treasury markets if he became president. Investors would cease to see Treasurys as a safe asset, and they would demand higher interest rates in exchange for risk.

This, of course, is a terrible idea, and a good reason for Republicans to hesitate in coalescing around Trump. Do they really want manufactured economic crises to be part of the Republican brand?

Well, judging by their behavior during the 2013 debt-ceiling crisis, some of them do. This particular desperate measure floated by Trump is novel, but he is not the first Republican to advance the idea that usual concerns about prudence and risk can be thrown out the window because the country is already a smoldering garbage fire.

It has been common for years for some Republicans to talk about America's debts as unpayable. Starting from that incorrect premise, Trump is only adding the insight that if you're going to default anyway, you might as well borrow what you can while you still have access to the credit markets.http://www.businessinsider.com/donald-trump-treasury-haircut-idea-insane-2016-5