Donald Trump made some controversial comments the other day regarding the national debt. First, he said:
“We’re paying a very low interest rate — what happens if that interest rate goes up 2, 3, 4 points?” he said. “We don’t have a country. We have tremendous debt, tremendous.”
Second, he said:
“I’ve borrowed knowing that you can pay back with discounts….Now we’re in a different situation with the country, but I would borrow knowing that if the economy crashed, you could make a deal.”
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.
Second, Trump’s comment about making a deal on the national debt is, to be kind, very stupid. Trump makes deals on his debt at times because his creditworthiness is challenged at times because his entities can’t pay back loans. This is why several of Trump’s businesses have undergone bankruptcy. When creditors are offered the option of a default or a haircut they go for the haircut because they’re dealing with an entity that they know cannot pay in full. This is absolutely not the case with the US government.
US government bonds are the absolute safest instruments in the financial asset world. We know this because every time a little hiccup occurs in the financial markets US government bond prices RISE. They don’t get discounted like many privately issued bonds do. This is due to the fact that the US government generates the highest quality revenue stream of any entity in the world since it can tax 22% of US output.³ So, Trump again has this exactly backwards. In a crisis Trump wouldn’t be able to negotiate a discount. In fact, US borrowers would demand a premium just as history has shown. If Trump tried to “make a deal” creditors would literally laugh in his face.
Trump claims to have a “very good brain”, but I am not so sure that brain is filled with “very good” understandings of the national debt.
¹ – 69.6 months as of 6/30/2015 according to ODM.
² – I am being a little lazy with the math here, but forgive me because this scenario is so implausible that it’s not worthy of accurate math.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.