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Could a Peter Schiff and Donald Trump Economic Plan Work?

Written By Geoffrey Pike

Posted May 9, 2016

trumpschiffDonald Trump was recently on CNBC, later followed with an appearance by Peter Schiff. There were some interesting discussions regarding economic issues, but particularly on the U.S. national debt.

We know the story with Donald Trump. He is a nationalist and somewhat of a populist. Some people love him and some people hate him. For once in politics, I guess you could call me a moderate on this one.

Although Trump speaks with confidence, he does not have much in the way of core principles. This is good in comparison to many politicians whose core principles are almost always bad. Trump will judge each individual issue on its own merits.

When he was talking about the national debt on CNBC, Trump talked about his history of handling debt in the private sector by restructuring it and convincing creditors to accept a reduced payment. The interesting thing is that Trump was talking about this as a comparison to how he might handle the national debt.

Peter Schiff quickly picked up on this point in this appearance. Although Trump seemed to backtrack a little in his comments by saying that he would try to refinance the debt, Schiff pointed out that there isn’t much refinancing to do. Rates are already near historic lows.

If the Chinese central bank (or anyone else) bought a 10-year bond at 2%, there isn’t really much negotiating to do, unless the U.S. government simply doesn’t fulfill its original promise. It could pay 1% instead of 2%, but this would still be a default from it original contract.

The U.S. government could choose not to pay back the principal amount, or pay a reduced amount, but this would be a default. It would put the entire bond market into an upheaval.

There is debt that is maturing all of the time, and the debt is then rolled over. New debt is also issued. The new debt is what increases the national debt. If the government just rolled over existing debt and did nothing else, then the national debt would just stay the same.

But the U.S. government is already getting a bargain with ultra-low interest rates. There is no refinancing to do. Investors are already turning over their money for 10 years for an annual rate of less than 2%.

The Safe Haven

A U.S. government Treasury security or bond is considered about the safest investment on earth right now. I’m not saying it should be, but that is the perception. This is reflected in the extremely low interest rates.

There may be a tiny inflation premium on longer-term interest rates. There is virtually no risk premium. Investors are basically 100% certain that there will be no default.

Even with Trump’s words, there is still almost no chance of default in the near future, or even the longer term. With Trump now being the presumptive Republican nominee, interest rates have not changed. If investors feared any kind of a partial default on the U.S. debt, there would have already been a reaction.

Schiff basically reiterated Trump’s initial indication that there should be some kind of restructuring, but I find it hard to believe that any U.S. president would risk the great credit rating of the U.S. government.

There is no question that the debt cannot be paid off. Right now, Congress cannot even come close to a balanced budget, let alone actually getting a surplus. Entitlement spending is only going to go up as baby boomers retire, and Trump has said he will not cut there. About the only thing of any significance that Trump has suggested in cutting is military spending, especially spending on behalf of U.S. allies. But even here, it is not all that clear.

The federal budget is virtually set right now, regardless of who the next president may be. Most of the budget is filled up with military spending and entitlement spending. Even if the Departments of Education, Agriculture, and Transportation were all shut down, it still wouldn’t come close to balancing the budget. And the candidates certainly aren’t even suggesting that.

Right now, despite a growing debt, it seems manageable because interest rates are so low. But what will happen if interest rates rise, even just to normal historical rates? The interest payments would balloon quickly. We could all of a sudden be facing trillion dollar interest payments. The Congress can’t even balance the budget with low rates when interest on the debt is “only” about $220 billion per year.

While there is no fear of default and little fear of inflation right now, things can spiral out of control quickly. Just think back to the 1970s when interest rates quickly spiked into double digits.

I doubt that a Trump presidency would actually default on the debt. It is at least a positive step that someone is talking about the problem.

The more likely scenario is that there will be a backdoor default with the help of the Fed. In order to attempt to solve the problem, the Fed will create money out of thin air as its debt reduction plan. Creditors will be paid back in depreciating currency. Of course, this happens now, but just to a much lesser extent than what we will see in the future.

U.S. debt will remain a safe haven for getting back your principal investment. The problem is that it just won’t buy you as much as when you first handed over your money.