Trump on federal debt “discounts”: an ex post

It appears few if any observers agree with my interpretation of Donald Trump’s idea for dealing with the federal debt, which was based on early reports. It seemed to me from a post on the New York Times’s Upshot that the policy idea would be to enter into novel debt contracts allowing the government to reduce the amount it owes on a given bond in certain situations. In fact, subsequent coverage appears to indicate that Trump might seek to make deals on existing debt with no special escape clauses for adverse financial situations. Some countries with unpayable amounts of debt in foreign currency do so, though they are likely to face a steep penalty in the form of reduced access to credit markets and higher costs of issuing new debt.  Moreover, international financial institutions handling such situations often impose harsh austerity measures, which include counterproductive policies that sometimes make both creditors and debtors worse off at the end of the day.

As I argued in the earlier post, the U.S. federal government does not face a problem in which it cannot pay full amounts when they are due. But Trump worries that interest rates will rise, perhaps as a result of  policy moves undertaken by an federal open market committee that is more hawkish on inflation than Janet Yellen.

The new article in the New York Times by Binyamin Appelbaum quotes a person from the Committee for a Responsible Federal Budget arguing that “It’s a policy problem, not a debt-management problem,” she said. “When it comes to fiscal responsibility, people are always looking for the easiest of answers. If there were low-hanging fruit here, the Treasury Department would already be on it.” In other words, according to the fiscal hawk being quoted, fiscal tightening is required, and debt management techniques such as changing the duration (length of time to maturity) of the debt or negotiating lower payments will not change matters.

It is apparent that the argument then becomes an argument about the feasibility and ethics of trying to get investors to accept smaller payments on existing federal debt securities, such as Treasury bonds and bills. As I pointed out earlier today, such a maneuver would probably be difficult for the U.S. federal government, because the team of the Treasury Department and the Federal Reserve System can print its own checks and create currency and bank reserves and hence always has the ability to meet all payment commitments. This situation would always obtain in countries where central governments are indebted in their own sovereign (national) currencies and have floating exchange rates. The Fed of course can raise interest rates if it so chooses. It seems likely that interest rates will need to be lower rather than higher than current Congressional Budget Office projections, so the hope for continued dovish monetary policy seems appropriate right now. Contra the quoted fiscal hawk, a more expansionary fiscal policy makes sense by much the same logic.

In essence, then, we cannot negotiate reductions in the amount of money owed by the federal government because we cannot reasonably claim to lack the ability to repay. So we do not have an option of reducing our principal (the amount of debt) even  if a future President Trump, in consultation with advisors, decides that doing so would benefit the economy. This situation of course differs from the one in places with true government debt crises, such as the U.S. territory of Puerto Rico, where investors will eventually have to accept “haircuts,” or reductions in amounts of money owed, or Argentina, where bondholders have accepted sharp writedowns of government debt that was effectively or actually denominated in the U.S. dollar, a foreign currency.

On the other hand, a form of debt security carrying credit insurance is certainly conceivable. It would involve agreements in advance (ex ante, rather than ex post) to pay less in various circumstances. Using such debt contracts might be desirable from a policy perspective, though one might even want to make larger payments to the non-federal sectors (the private sector, state and local governments, and the rest of the world) during recessions. As I mentioned in my earlier post, such payments increase the total net worth of those sectors, holding other variables constant—a desirable impact when private-sector spending is slack.

In general, debt management strategies that change interest rates or the composition of the debt do make a great deal of difference in the cost of debt to the federal government. For example, monetary policies that lower interest rates on government securities do constitute such a policy.  So my response to this Trump idea depends on his intended meaning–ex ante or ex post. It appears now that his idea amounts to an ex post (after the fact) reduction in debt that is in my view both unnecessary and extremely difficult to obtain.