I don’t know whether Gideon Gono, former governor of the Reserve Bank of Zimbabwe, is still dreaming big dreams. But if he is, news reports from America must, if only briefly, have offered him hope that his talents would once again be in demand.
In the course of an interview earlier this month on CNBC, Donald Trump appeared (to some) to suggest that he would be able to reduce the U.S. government’s debt (which at roughly $19 trillion needs some reducing) by subjecting creditors to what financial folk call a “haircut.” That’s a euphemism for being paid back less than 100 cents on the dollar.
What Trump said was this: “I would borrow, knowing that if the economy crashed, you could make a deal.”
Quite how such a haircut would be arranged is anyone’s guess, but the consequences are not: They would be catastrophic, a bloodletting of which ten thousand Sweeney Todds would be proud. Faith in Uncle Sam’s credit underpins the global financial system. For the GOP’s presumptive nominee for president even to hint that such faith may be overdone would, under normal circumstances, be to play with fire. But Donald Trump is not normal circumstances. The markets shrugged. Investors don’t think he has a chance.
It’s worth adding that the world’s trust in the star-spangled spendthrift (Sam not Donald) is a windfall for Americans, enabling them to buy more—and borrow more—for far less than would otherwise be the case. Oh yes, most of the U.S. debt is held, not by wicked foreigners, but by the Social Security Trust Fund, federal agencies, our banks, our pensions, our money market funds, and even our neighbors. We have met our creditor and, more often than not, he
is us.
Trump’s comments caused something of a storm. He later explained that he had been misinterpreted in the “failing New York Times and other places.” Default was “crazy” talk. United States bonds were “absolutely sacred.” What he had meant was, well, before we get to that, there was this: “First of all, you never have to default because you print the money.”
Did those words send another expectant thrill through Mr. Gono, father of the 100 trillion Zimbabwean dollar banknote? Treasury secretary? The Fed?
To be fair, Trump was not wrong. If a country’s debt is denominated in its own currency, that country can print more of it to pay that debt off. Technically at least, it will avoid default. And technically counts in this field. The risk of default was one reason the eurozone crisis was so dangerous for that currency union’s weaker members. Having given up their own money, they had lost the ability to print their debts away. This lack of a last resort triggered market nervousness about default, a nervousness that could all too easily have become self-fulfilling.
But there’s no printing a free lunch. Print too much money, and sooner or later (as one day we will again find out) its value will start to depreciate as inflation gathers pace. Print too much and lenders will demand higher interest rates to compensate for the risk that they will be paid back in a currency worth considerably less at the time of repayment. Back in the day, relatively frugal, printing-press-phobic Germany was able to borrow far more cheaply in deutschmarks than Italy could in lire.
Print too much and international lenders will eventually only make loans repayable in a more respectable currency. Those loans will begin by being expensive and may end up in catastrophe: Russia, Argentina, there are plenty of ugly precedents to pick from.
The United States, mercifully, is not Russia and nor is it (yet) Argentina. It will remain large enough and powerful enough and enough of a safe haven to be able to borrow in its own currency both at home and abroad, and to do so more cheaply than its economic fundamentals might warrant. But it cannot print itself a free lunch either. The Donald’s press would print inflation, and to the extent that inflation increased the cost of government programs (in many cases it would do so automatically, and Trump, of course, has said he “won’t touch” entitlements), it could drive the deficit up further still. Interest rates would rise (a nasty thought with that $19 trillion outstanding); the only question would be by how much.
As I mentioned earlier, the self-proclaimed King of Debt says he was misinterpreted. He wasn’t, he argues (more or less plausibly), talking about haircuts, but about taking advantage of a crash in the debt market. He’d do this by repurchasing government debt (which would then be trading at a discount to face value) in the marketplace. That would lead to a reduction in the nominal value of government debt outstanding. But as usual with quick fixes, there are some catches. The most likely reason for a sufficiently dramatic sell-off would be a suitably dramatic increase in interest rates. The net cost of any repurchase operations (which would be financed with new debt paying those higher interest rates) would depend on the depth of the discount, but it’s very possible that the result would be far from an artful deal. And given the amount of U.S. government debt outstanding, it’s doubtful that anything a President Trump could do would be of a size large enough to make any real difference.
Maneuvers of this type can make good sense in trading the securities of distressed companies (a field in which the King of Debt has some expertise), but beyond that, well . . .
Even if we accept Trump’s explanation, markets are hardly going to be reassured by the thought of a country led by someone who “love[s] playing” with debt and for whom the printing presses may hold less fear than they should. There’s also the fact that Trump wants to see a weaker dollar, not a point of view shared by those wicked foreigners. They may not hold most of our debt, but they do hold a lot of it.
Investors for now do not believe that Trump will win. What happens if that changes?
Andrew Stuttaford works in the international financial markets and writes frequently about cultural and political issues.
