When Donald Trump is inaugurated as President on January 20th, 2017, he faces a myriad of problems. Among the financial and economic dilemmas is the national debt.
The nation’s debt has grown at a pace that economists and policymakers feel is a disaster waiting to happen. However, Trump stated during the presidential campaign that he will improve the nation’s infrastructure, increase military spending, and upgrade veteran’s benefits, all while cutting taxes. How can this all be done while dealing with a burgeoning national debt?
How did we get here?
The National Debt is money the federal government owes consisting of the Treasury Department and other federal agencies debt instruments. These financial instruments were issued to pay for the federal government’s operation and deficits. When government spending exceeds tax revenues and other financial receipts, the federal government borrows using these instruments. However, the total gross amount the Treasury Department ultimately borrows is limited by the debt ceiling and only Congress may increase it.
In theory, this method can work. The premise is to pay back the borrowed money with interest, over time. The problem is that when the federal government borrows it is usually to cover deficits adding up to trillions of dollars. These debt instruments are purchased by commercial banks, mutual funds, pensions, and the Federal Reserve. Global investors believe in Treasury instruments’ safety and purchased trillions of dollars of U.S. debt. These instruments are considered conservative investments backed by the “full faith and credit” of the United States who will pay them back no matter what.
The United States traces its debt history back to 1790 when Alexander Hamilton, the first Treasury Secretary, started borrowing by issuing debt certificates. Hamilton also had the idea that the federal government assume state debts which came to almost $79 million. Since then, the National Debt has grown such as the surge in 1866 to $2.76 billion to pay for the Civil War.
America’s involvement in World War I saw the National Debt grow to $25 billion, $334 billion in today’s dollars, or 33 percent of GDP. Franklin Roosevelt used the National Debt to rebuild from the Great Depression by going $40.44 billion in debt, or 44 percent of GDP in 1934. World War II saw another increase in the National Debt as it grew to $241.86 billion in 1946 ($2.87 trillion in current dollars), 113 percent of GDP, still the record.
The 2000’s saw the National Debt go from $3.41 trillion in December 2000 to $5.80 trillion in December 2008 or 40.5 percent of GDP. This was used to fight Mideast wars, pay for tax cuts and a senior citizen prescription-drug benefit, while rescuing the American banking system in 2008. Under President Obama, the National Debt reached a new high of $19.5 trillion to revive the economy from the Great Recession. Many feel the American economy has improved and the National Debt must be reduced. But as he has stated during his campaign, Trump has other ideas.
Trump wants to “Make America Great Again”, but that takes a great deal of money. He wants Congress to pass an infrastructure bill costing $1 trillion for repairing America’s bridges, and roads, while modernizing airports. This plan faces two key problems. First, if borrowing occurs to pay for infrastructure spending, it helps if interest rates remained low. But the Federal Reserve’s Janet Yellen recently stated that interest rates will increase in 2017. Secondly, Congress’s spending hawks may not give Trump all he wants but rather 50 to 60 percent of his demands. The problem either way is that this will mean adding to the National Debt in a relatively short time.
Trump wants to increase military spending. Currently, military expenditures are over 50 percent of the federal budget’s discretionary spending which was $1.11 trillion in 2015. He also recently stated that the United States must expand its nuclear arsenal. Increasing military expenditures, as well as improving veteran’s benefits, means either cutting spending on transportation, education, and scientific research, or more government borrowing. Trump has not stated how this will occur.
Trump also campaigned on cutting taxes since he feels that the tax rate is too high on businesses and individuals. According to the think tank, Tax Policy Center, Trump is calling for $7 trillion in tax cuts over the next decade raising the debt-to-GDP ratio to 111 percent by 2026. But a tax cut will mean less revenue into federal coffers and if the U.S. economy does not expand, then borrowing will rise to pay for increased spending. Trump stated he does not want to touch Social Security or Medicare for current recipients. This will raise borrowing since expenditures for both programs are anticipated to increase as Baby Boomers retire in mass.
Trump stated during the campaign that his solution to the growing National Debt problem is have creditors accept less. In a May 2016 interview with CNBC, Trump stated he would use his business acumen to reduce the National Debt by forcing creditors to accept write-downs on Treasury holdings. He believes he can convince U.S. debt holders to reduce their investment in Treasury securities the same way he convinced bond holders in his companies. This unprecedented strategy would send financial markets into a highly-agitated state. Trump is not advocating debt default, but that the federal government repays its debt at less than the original amount borrowed. The federal government’s debt rating could drop below its AA+ level and substantially raise interest rates on Treasury instruments.
Many Questions, Few Answers
For investors, finance professionals, and economists, the next few years will be worrisome regarding the nation’s debt. The key question is not only whether the new administration will be able to carry out its financial and economic objectives, but at what cost to the national debt? There is also the concern that an unanticipated event may occur throwing the new administration’s plans askew, thereby driving up the national debt. But more importantly, how will Trump respond and how will the financial markets react?