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Win or lose, Trump could cause a recession

Inconsistent comments could scare investors, lower employment, push up interest rates


By Simon Johnson

(Reuters) — The question of the moment is: If GOP front-runner Donald Trump were to be elected president, what would he do?

At least on the economic side, we recently had glimpses of what could lie ahead. And those fiscal hints have much broader implications, including for U.S. national security.

Trump contends he can run Washington far better by treating the federal government like one of his companies. He has a very particular style as a real-estate developer, and his general approach to business could indeed be applied to fiscal and monetary policy. Any way that you look at what Trump is inclined to do, however, the result could lead to unprecedented disaster on a global scale.

Trump has already demonstrated a great ability to make the kinds of inconsistent comments that — if coming from the mouth of a president — would scare investors, create a great deal of uncertainty, push up interest rates, lower employment, drive down stock market prices and cause the bottom to fall out of the value of other assets.

This kind of destabilization wouldn't just have negative effects on investor and consumer confidence in the United States. It would spread rapidly around the world and drive up interest rates, bankrupt private-sector companies and plunge countries into a downward default-recession spiral. U.S. exports would naturally crater in this scenario because U.S. allies and trading partners would be in deep crisis and could not afford to buy American products.

The Trump ripple effect would really be a devastating global tidal wave of rising interest rates.

Trump wants to be seen as a responsible business executive. Ironically, given his hostility toward Latinos and other immigrant groups, his messages most resemble those irresponsible populists who have repeatedly ruined Latin America. On three big macroeconomic issues — debt, inflation and financial regulation — Trump would put the United States firmly on the road to becoming Argentina, a once-prosperous country until Juan and Eva Perón took over.

On debt, Trump believes the more the better. His companies issue a great deal of debt because, in the downside scenario, developers like Trump can find ways to pay less than the face value of what is owed. He recently said this approach is an opportunity the U.S. Treasury is losing out on.

The U.S. government, however, is not a speculative real-estate company. Alexander Hamilton realized, at the very start of the nation that having the federal government pay its debts in full, as well as assuming the states' debts, was of fundamental importance. This was crucial not just for public finance but also for the ability of the private credit markets to operate in a reasonable fashion. And this is what Washington has done for more than 200 years.

"Risk-free debt" is how U.S. debt is described in the world of finance. Once you introduce default risk into those calculations, interest rates would spike for both the government and the private sector.

Trump's brand of real-estate development is about taking huge risks based on large amounts of debt, while making sure there is limited downside for himself. Bondholders get paid if things go well. If the project does not work out, however, those investors bear the brunt of the losses.

Trump's companies have gone bankrupt in this tactical fashion — using Chapter 11 reorganizations four times: the Trump Taj Mahal in Atlantic City in 1991, the Trump Plaza Hotel in New York in 1992, Trump Hotels and Casinos Resorts in 2004, and Trump Entertainment Resorts in 2009. In the 2004 experience, for example, total debt was $1.8 billion, and the Chapter 11 filing was designed to reduce this by about a quarter ($500 million).

Trump sees all these debt-restructuring experiences in a positive light. As he put it during a primary debate in September 2015, "I used the law four times and made a tremendous thing. I'm in business. I did a very good job."

Speaking on CNBC recently, Trump connected his past debt restructuring with prospective broad macroeconomic strategy for the United States. "I would borrow," he declared, "knowing that if the economy crashed, you could make a deal."

This must rank as one of the most irresponsible economic policy statements ever made by a major party candidate for the presidency.

Second, Trump also seems very weak on inflation. When pressed on his purported plan for buying back federal government debt at a discount, he responded by suggesting that we could always print enough money to pay off the debt: "First of all, you never have to default because you print the money, I hate to tell you, OK?"

No doubt this is a fantasy of every highly leveraged real-estate developer whenever the value of their properties falls below the value of their debts. When you have borrowed far too much, the economy is turning down and you can't make your interest and required principal payments, of course you would just like to print your own pieces of paper and hand those over to creditors.

As a statement of macroeconomic policy intentions from a potential president, this is another extremely scary idea. Combined with Trump's earlier assertion that he would replace Federal Reserve Chairwoman Janet Yellen, this amounts to politicizing the Federal Reserve - and pushing it toward a high inflation policy. What he is saying could lead to higher interest rates, disruptions in the flow of credit and a contraction of business that could translate into mass layoffs.

Third, on financial regulation, Trump has made clear that he wants to repeal Dodd-Frank financial regulations — a view that he shares with many other business people who live high on debt. This proposal would essentially bring the U.S. rules back to the status quo before the financial crisis of 2008.

But this is a recipe for — the financial collapse of 2008. That crisis crashed the economy, threw millions of people out of work, pushed up the U.S. national debt dramatically and undermined America's national security.

Any president obviously operates with constitutional constraints on his or her powers. But on all three issues — running up the debt, undermining the independence of the Federal Reserve and repealing or refusing to enforce financial regulations — candidate Trump is making it completely clear that a President Trump would have a major destabilizing impact.

Or perhaps Trump will walk his statements back — or forward — again. Just speaking in this unstable way about matters of profound importance is frightening for credit markets, with immediate negative implications for investment and for employment.

Any economic slowdown that we now experience will be in the private sector. Investors, businesses and millions of consumers could take the rational view that, if Trump became the next president, irresponsible economic policies — and the instability they would create — would head America's way.

Goodbye also to the idea that the United States plays a positive role in the world economy. Electing Trump, the self-proclaimed "king of debt," would undermine Washington's image, resources and ability to influence others around the globe. The best way to cause irreparable damage to our national security would be to make Trump president.

As it gets closer to November, if the probability of Trump being elected rises, expect long-term interest rates to increase, while business spending and household consumption will come under serious pressure. Because Trump could easily create a recession — even if he doesn't win the presidency.

(Simon Johnson is a professor at Massachusetts Institute of Technology Sloan School of Management and former chief economist at the International Monetary Fund.The opinions expressed here are his own.)


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