Trump: Debt Default Impossible Even With Higher Interest Rates, ‘You Print The Money’

Presumptive Republican presidential nominee Donald Trump has once again raised the eyebrows of observers with regard to his comments on the U.S. national debt. Citing his reputation as a the “king of debt,” the Trump debt plan involves continuing to borrow money or sell bonds at current low interests rates and then buying them back if the U.S. faced an economic collapse, as reported by Zero Hedge.

“I would borrow, knowing that if the economy crashed, you could make a deal.”

Last week, comments made by Donald Trump were interpreted as meaning that he intends to approach holders of U.S. debt and attempt to renegotiate better terms, which was perceived by some as the equivalent to default.

U.S. treasury bills are considered one of the safest investments in the world. Even as credit rating agencies downgraded U.S. debt from AAA to AA+ in 2011, investors continued to pile into T-bills, driving down the yield, as reported by the Wall Street Journal. This is a situation similar to terrified horses seeking safety in burning barns, almost as an instinctive reflex, despite the obvious danger.

The responsibility of the U.S. Federal Reserve is to ensure full employment, reasonable inflation, and a stable currency. Prior to 2008, the Fed only intervened in markets for short-term, overnight debt, raising interest rates to temper inflation and cutting interest rates to spur growth.

Then, in 2008, building on lessons learned from Japan in the wake of the subprime mortgage meltdown, the U.S. Federal Reserve began its first round of “quantitative easing.” Interest rates were already so low that the Fed had no further room to cut them any further. Then-Fed Chairman Ben Bernake and colleagues began the unprecedented step of intervening in markets for U.S. debt of longer maturities, not just overnight debt instruments, as well purchasing $500 billion in toxic mortgage-backed securities, as reported by the Board of Governors of the Federal Reserve System.

Other nations have followed the U.S. and Japan, to the point where further quantitative easing has become ineffective. Some central banks have followed a third path with negative interest rates. When accounting for inflation, negative real interest rates have been observed several times in the United States and other countries, as reported by Pimco, though the interest rate targets published the Fed have never dipped into negative territory like targets published by Denmark, Sweden, and other countries have, as reported by the World Bank.

With negative interest rates, buyers of government debt actually lose money, paying to save, rather than being paid to save.

As Matthew Yglesias from Vox has pointed out, perception is everything. He stated, “If risk-free federal bonds turn out to be risky, then every other financial asset becomes riskier.”

The only reasons investors flock to U.S. treasuries like horses into a burning barn is because of the perception that the U.S. dollar is the strongest in the world, and they believe in the fiscal strength of the U.S. government, although this belief may be eroding. The problems are severe enough that a leading presidential candidate, Donald Trump, has suggested that the best course of action may be to allow this carefully cultivated perception to fall by the wayside, allow markets to crash, and then buy back bonds at a discount.

If investors began to sell U.S. debt, particularly of longer maturities, interest rates could rise. The more investors sell, the higher rates might rise. Donald Trump’s plan involves hoping that something like this happens, rates skyrocketing to 20 percent for example, which would allow the U.S. government to buy bonds back for 80 cents on the dollar.

According to the U.S. Debt Clock, the current national debt stands at $19.2 trillion. Reducing this amount by 20 percent would be desirable. However, the money to fund this activity would either need to be borrowed, necessitating the issuance of more debt, or printed, which could cause inflation to skyrocket, neither of which is viewed as sustainable.

Trump’s plan to allow markets to fail and then buy back the debt at a discount, while mechanically feasible, could hurt the perception of investors about U.S. bonds for many years, and this important financial instrument could potentially never recover. The problem is the damage may already be done after being inflicted by citizens, Republicans, and Democrats alike long before any potential Trump presidency.

“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? So there’s never a default,” Trump was quoted as saying by CNBC with regard to his plan. A Zero Hedge reader pointed out that plans similar to Trump’s were instated in post-WWI Germany, and that “it didn’t end very well for them,” resulting in runaway inflation.

“If interest rates go up Donald Trump is right, we have no choice than to tell our creditors they are taking a big haircut,” Euro Pacific Capital CEO Peter Schiff was quoted by CNBC, voicing a view seemingly shared by more than one observer. There are respected voices among financial experts and economists who believe that the United States owes more than it can afford to repay, and the nation faces serious decisions on the road ahead.