Peter Schiff
During a lengthy interview on CNBC the week before last, Donald
Trump, fresh from becoming the presumptive Republican nominee, came as
close as any major presidential contender ever has to saying that
America is not capable of repaying her debts in full, and that our path
to economic recovery might involve some pain for our creditors. This
moment of candor earned Trump almost as much condemnation as his earlier
suggestions to ban Muslims from entering the United States.
To many, the idea that U.S. debt obligations involved even the
slightest risks to investors was both the height of financial
naiveté and the epitome of political recklessness. The pressure was so
great in fact that The Donald, who has consistently refused to engage in
even the most sensible strategic retreats, appeared on
CNN last Monday to “clarify” his earlier remarks. However, he ignited
another firestorm when he inadvertently let slip another unspoken truth,
namely, that the United States can always print however much money she
needs to “repay” her debt. Apparently the only acceptable position to
hold on this issue is to completely deny reality.
Despite his public image as a premiere pitchman, marketeer, and
builder of glitzy gold towers, Donald Trump owes his business success to
his ability to walk into a roomful of people to whom he owes money and,
through the use of threats, bluster, and hardball negotiations,
convince them to accept less than what he owes. Time and again he has
used competitors' prior lending mistakes as a lever to get what he
wants. That's why he has said repeatedly that he is "the king of
debt." Evidently he thought that this private experience and common
sense could help in the counterintuitive arena of public debt.
Prior to Trump’s “clarification,” Jordan Weissmann of the online
news site Slate stated the case succinctly, “When a country prints its
own currency, markets don't typically worry about them running out of
money, and thus are willing to lend freely. ...The fact that the U.S.
controls its own currency does give us flexibility when it comes to
debt. If it weren't for our farcical, self-imposed debt ceiling, default
would rarely, if ever, be something people seriously
discussed.” (5/9/16)
It seems to me that Slate was arguing that Trump doesn’t really
understand that we print our own money at will. There may be a great
many things of which Trump is unaware, but he clearly knows where our
money comes from. The difference between Trump and his critics is that
he must believe there is a cost in printing too much money. Modern
economists do not appear to grasp this basic concept.
New York Times columnist Paul Krugman went even further. Despite
the fact that he has argued that the Federal Reserve should print an
unlimited supply of dollars to keep the economy afloat, he believes that
the greenbacks themselves will remain precious and coveted forever, as
long as reckless demagogues like Trump don’t spoil the party. In his
column on May 9, entitled “The Making of an Ignoramus” (which responded
specifically to Trump’s CNBC interview), Krugman said that Trump’s
default suggestion would, “among other things, deprive the world economy
of its most crucial safe asset, U.S. debt, at a time when safe assets
are already in short supply.”
That same day, during an interview with Jake Tapper on The Lead on
CNN, conservative economist Douglas Holtz-Eakin, former director of the
Congressional Budget Office (CBO), warned that if Trump, as president,
ordered the Federal Reserve to print money to buy debt, it would “break
the independence of the Fed” and undermine a Federal Reserve System that
“has been the foundation of our economic success.” I would ask Mr.
Holtz-Eakin what exactly he believed happened with Quantitative Easing
or operation twist, multi-trillion dollar programs in which the Fed
purchased trillions of U.S. government bonds? Is he okay with that
simply because there was no executive order compelling it? Does he
expect that during the next economic downturn an “independent” Fed may
refuse to buy government debt, thereby forcing the government to make
unpopular budget cuts, raise taxes, or default? What planet does he live
on? Perhaps it’s the earth in a parallel universe where the Fed was
actually the “foundation of our economic success” rather than merely a
perpetual bubble blower. Any success we have managed to achieve after
the founding of the Federal Reserve in 1913 has been despite the Fed,
not because of it.
At least some of the countless articles that have appeared on the
Trump debt ideas have begrudgingly admitted that there is a potential
downside to printing money as the only solution to debt management, in
that it could spark inflation that passes from the “good” range of 2-4%
to the “bad” range of 5% or more. In addition to the hardships that this
could create for consumers, especially at the lower end of the economic
spectrum, they also admit that higher inflation would constitute a
“haircut” for the bondholders themselves, as they will be repaid with
dollars of lesser value than those that they lent. In other words,
partial defaults are possible through above the table negotiations (such
as those Trump hinted at) or the backdoor channel of inflation. But
they almost universally agree that the covert losses through higher
inflation is the far, far better scenario than the global financial
meltdown that they believe would result from an overt restructuring of
U.S. debt. Or as Krugman argues in his “Ignoramus” article, “One does
not casually suggest throwing away America’s carefully cultivated
reputation as the world’s most scrupulous debtor...”. In Krugman’s
world, “scruples” must involve never admitting the truth.
I believe the opposite. Given the proven failure of debt-fueled
policies to spark real growth and the monetary quagmire that will
swallow us just as surely as it has swallowed Japan, a partial debt
default would allow the United States to honestly deal with the mistakes
of the past, break the cycle of never-ending debt, and set the stage
for an actual economic recovery. Just as companies can be resurrected
through the bankruptcy process, so too can a nation. Of course, this
would involve a great deal of pain in the short term, both for creditors
and citizens. But breaking an addiction is never easy. We are addicted
to borrowing, and our creditors are addicted to pretending we can repay
in full. We would all be better off if we dispel that illusion.
However, Trump clearly went off the rails, even in my book, when he
suggested that the United States could repurchase our outstanding debt
at a discount if interest rates were to rise. On this point he drifted
into pure fantasy.
In his corporate career, Trump is well familiar with the technique
of buying out creditors at a discount. If, for instance, a lender buys a
10-year corporate bond at a 3% rate from a company when interest rates
are relatively low. If interest rates were to rise generally, the
bondholder may not be happy with such a position if he knew
that he could buy a 6% 10-year bond from a similar company. At that
point the bondholder may be happy to resell his 3% bond back to the
issuer at a discount, just so he could free up cash to get those higher
rates. Similarly, the corporation may benefit from simplifying its
balance sheet and retiring outstanding debt.
But this scenario requires fresh cash to make the purchases.
Corporations can cut into profits to find the cash, or take an infusion
from new investors. But the United States has essentially no reserves
from which to draw upon; we already have debt of nearly $20
trillion and, as of now, we will run massive deficits every year for the
foreseeable future. The only way we could get the money to retire old
debt is to issue new debt. But since such a scenario would, by
definition, occur in a higher interest rate environment, there would be
no benefit.
Of course, Trump also overlooks the fact that a large portion of
Treasury debt held by the public is short-term. There would be no need
for holders of short-term debt to sell at a steep discount when they can
just hold to maturity and in theory be repaid in full. Thanks to QE and
Operation Twist, the lion’s share of the Fed’s assets are longer-dated
securities. But even if Trump could raise taxes or cut spending to
generate the funds necessary to buy back Treasuries held by the Fed at a
discount, the Fed’s losses would be invoiced to the Treasury for
reimbursement. So what we gain with our right hand would be surrendered
by our left.
But Trump’s biggest oversight is that when interest rates do rise,
which would be the only environment where Treasuries would trade at a
discount, the U.S. budget deficit would already be soaring. That is
because not only could such an increase in rates help push the economy
into a recession, if we were not already in one, but all of that
low-yielding short-term debt would be maturing into a higher rate
environment. So with the cost of rolling over our existing debts
soaring, requiring tax hikes, spending cuts, or additional borrowing at
higher rates, where would we possibly come up with the extra money to
pay off principal, even if we could do so at a discount?
But even with these inconsistent musings, Trump acknowledged a hint
of realism that other politicians can't. He said that the U.S. economy
remains extremely dependent on ultra-low interest rates, and that even a
1% increase in rates could make our budget position untenable. But
Trump’s policy ideas on expanding the military and shoring up social
security, taking better care of our vets, building walls, rounding up
and deporting illegals, and replacing Obamacare with some as yet
undefined program, will require even more borrowing. To square that
budgetary circle, Trump acknowledged that we have to push down the value
of the dollar.
In the CNBC interview, he said that a strong dollar sounds good "on
paper" but that a weak currency offers much greater benefits. In fact,
he credits weak currencies as the primary weapon used by China to
engineer its own success. He wants to do the same for America. Of course
the Achilles heel of such a plan is that a significantly weaker dollar
is bound to usher in a wave of inflation that could rival, or even
surpass, the 1970s. If Trump is willing to let the dollar fall steeply,
the poor especially could suffer as purchasing power evaporates and
poverty rates increase.
But based on the opinions of economists, that is exactly the policy
path for which we should prepare. Inflation and a weak dollar are the
only solutions they can envision to “solve” our problems, and that is
exactly what we will get. So nice try Donald, but from now on you may as
well just keep talking about the Wall.
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