Republican presidential front-runner Donald Trump has some interesting plans for U.S. debt. They could lead to nothing short of a global financial disaster.
In an interview Thursday, the billionaire businessman suggested that in order to lighten the American debt load, he would refuse to pay creditors back. Those holding U.S. Treasury bonds would have to negotiate repayment with the United States in an attempt to get a “haircut” — a term for creditors being paid back less than what they initially loaned.
Trump began, “I am the king of debt. I love debt. I love playing with it.”
He then suggested he would “do discounting” in the $14 trillion government bond market.
“I would borrow, knowing that if the economy crashed, you could make a deal,” Trump said. “And if the economy was good, it was good. So therefore, you can’t lose.”
In other words, Trump would refuse to pay U.S. Treasury bonds — considered one of the safest investments in the world — in an effort to force creditors around the world to accept less than what they’ve lent the federal government. Trump is betting he can make the U.S. economy strong enough to survive the ensuing chaos.
This would make every asset in the world much, much riskier, because investors could no longer retreat to the safe haven of U.S. bonds. The price of borrowing would go up across the board. Credit would disappear, as people and banks would hoard their cash. It would make the 2008 crash — caused by the quick implosion of mortgages, also thought to be the safest of investments — look like a walk in the park.
One might think Trump is borrowing a trick from Puerto Rico’s playbook. The island is refusing to pay back what it owes in hopes of getting its creditors to take a haircut.
But there’s also a comparison to be made between Trump and a fiery populist in Greece: Alexis Tsipras, the far-left Greek prime minister who brought his country to the brink of bankruptcy last summer in a debt standoff with Europe.
For years, Tsipras has insisted — and continues to insist — the only way Greece will be able to pay back Europe hundreds of billions of dollars Athens has borrowed to stay solvent is for Brussels to forgive some debt. The International Monetary Fund agrees, while Germany insist this won’t occur.
Tsipras can play this game because everyone knows Greek debt is risky, and so far, Europeans have refused to call his bluff and withhold bailout cash. Check out the chart below. It shows bond yield — the amount of return an investor will realize on a bond — for both 10-year U.S. bonds and Greek Treasury bonds, dating back to the start of 2015.
As shown above, Greek bonds are considered much riskier investment than U.S. bonds. By comparison, investors consider an investment in Athens as risky as one in Pakistan.
On the other hand, U.S. debt is so reliable that it pays just a small return. Investors have confidence Washington will make good on its promise to pay its debt, with just a small amount of interest. It’s why grandmothers give savings bonds as opposed to stock in Goldman Sachs: she can be 100 percent confident the bond will pay out a bit more than what she bought it for. Stocks provide no such safe haven.
If Trump follows through on his threat to transform one of the safest investments in the world into one of the riskiest, it would shake the underpinnings of the global economy. Either he knows something the rest of the world does not, or he has no idea what he’s talking about when it comes to sovereign debt. Given his call for Puerto Rico to declare bankruptcy — something that is forbidden under U.S. law — our bet is on the latter.
Photo credit: ALEX WONG/Getty Images