Paul Krugman & Donald Trump Testing the limits of Debt

Two of the largest components of President elect Trump’s economic plan are to lower tax rates and to spend heavily on the Nation’s infrastructure. Most analysts believe that absent significant GDP growth or material reductions in entitlement these initiatives are likely to cause a significant increase in America’s debt structure.

Paul Krugman, a Nobel prize winning economist, appears to be in complete agreement with the President elect. Indeed, it might be said that Mr. Trump, the candidate, may have taken a page right out of Mr. Krugman’s playbook.

To begin with let’s take a look at how the U.S. compares to the rest of the world in terms of its GDP to debt ratio to as of October 2015. (data source:


America already has one of the highest debt ratios in the world. In fact, courtesy of data shown below we find that in 2016 we are ranked tied for 9th among the world’s largest debtor nations.

It may be instructive to look at some of the Nations with a larger debt structures to see how they are fairing. That is, did greater debt result in a faster growing economy?


Arguably, with the exception of Ireland, it has not. Japan as the largest debtor nation continues to experience economic difficulties, as the Wall Street Journal reports, even though they have had, “decades of blowout spending on airports, roads and bridges….”

We all know the story of Greece which is not one of success.Nor is Italy which the New York Times reports that, “Nearly one-fifth of all loans in the Italian banking system are classified as troubled …. That represents roughly 40 percent of all the bad loans within the countries sharing the euro.” I believe the point to be had here is that government spending can only go so far in creating economic health.

Ireland does stand out as having materially reduced their debt to GDP ratio but they did it through a combination of austerity and as CNBC reported in July, “data that can be totally bogus, and in this case they are. Ireland’s Central Statistics Office told the world this week that the country’s economy grew 26 percent in 2015,” which drove down the GDP ratio but, neither their production rates, income nor productivity grew at anywhere near those levels. The sole reason their ratio fell was as a result of tax inversions which artificially raised their GDP rate.

Thus, we really have no model of a nation carrying more debt to GDP than we are presently and managing to grow their economy in a healthy manner. The heretofore-traditional Republican Party position has been that we must control our deficit spending because it does not lead to economic prosperity.

But a friend of mine pointed out Krugman’s considerably different viewpoint on the subject. In August 2015 writing in the New York Times specifically about the matter of debt he said, “…There’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt…. a growing number of genuinely serious people — most recently Narayana Kocherlakota, the departing president of the Minneapolis Fed — are making the case that we need more, not less, government debt. So this is a very good time to be borrowing and investing in the future, and a very bad time for what has actually happened: an unprecedented decline in public construction spending adjusted for population growth and inflation.”

Certainly President elect Trump believes that. But, as with all issues, there always is the other side of the coin and a Forbes columnist writing at the time about Krugman’s article said, “Fiscal stimulus is a very useful thing to be able to do in the bad times, but we also want to do more than a bit of fiscal austerity in the good times….The net effect being that we should be in a roughly stable position over the business cycle with regards to the national debt.”

The bottom line being that while  government spending can be properly used to aid an ailing economy at some point it is the private sector that must drive the economy to enable a proper balancing of growth and debt.

Mr. Trump is betting that reduced corporate taxes and less regulation will free American businesses to reinvest and grow at home thereby creating a virtuous cycle of invention and jobs. All of us must truly hope that he is right because if it turns out otherwise our economic condition may be materially worsened.

To understand that is to focus on the plight of the Japanese. Italy, after all has not been a bastion of creativity and innovation since the Renaissance. Japan, however, was an industrial superpower. It wasn’t that long ago that their corporate success was seen as driving the world’s economy. What happened?

In the early 1990s Japan’s economic bubble burst. Krugman wrote about this in 2008 saying, “Japan’s banks lent more, with less regard for quality of the borrower, than anyone else’s. In doing so they helped inflate the bubble economy to grotesque proportions.” Importantly, just as Krugman was writing this, America’s own debt bubble was bursting with equally apocalyptic results.

A July 2016 Bloomberg article concisely describes the current Japanese econometric problems, “Japan has the world’s oldest population, as well as a low birth rate and little immigration, but its growth problems go far deeper. Japan started to suffer a shortage of workers. With the Japanese people unwilling to spend, companies are increasingly investing overseas rather than at home. A lack of deregulation further fuels the trend. Wages are stagnant and growth has stayed low, with frequent recessions.”

Fortunately, we are not in the same condition as Japan as the accompanying chart below shows. (Courtesy of Bloomberg)


Additionally, President elect Trump’s regulatory approach favors free market initiatives. Arguably econometrically the Trump administration appears to be moving in the right direction.

Unfortunately, whether or not his plan works is not truly within his control. For the plan to work American business and in particular large American multinationals, which have the greatest job potential, must either bring jobs home from overseas or they must innovate in such a manner that product can be developed and manufactured within the United States.

Otherwise, while the President may get a stock market lift he won’t get either the job or GDP growth necessary to meet the expectations of his voters and the balancing of our country’s growth and debt.

Barron’s reports that, “the various Republican tax reductions being considered … represent a meaningful increase to the corporate bottom line….” But, it is how those new found profits are used that really matters in the context of the President elect’s plan.

Elsewhere in Barrons another reporter notes that, “Net debt to Ebitda (Earnings before taxes, interest, depreciation and amortization) is pushing a high … so some of the cash might be quietly steered to pare debt. And companies are using just 75% of their capacity, still below the long term average of 80%.”

It is this latter point that is very important. Barrons notes that, “the optimism implied in the (stock market) rally suggests the market expects Corporate America to reinvest some of those tax dollars in equipment and labor to get the economy growing again, rather than spending only to buy back shares.”

But, if firms are only running at 75% of capacity one must ask whether or not they will actually do that? It’s one thing to keep Carrier from sending 2000 jobs to Mexico, but it is an entirely different and more complex issue to get firms to spend on greater capacity when they are already well within the limits of existing capacity.

Consider, as the Wall Street Journal reports that, “for two centuries, economic theory has held that trade increases the size of the global economic pie. The problem is that gains from that growth are spread unevenly. The winners include U.S. companies that were able to substantially lower costs and boost profit margins.”

While the President elect seeks to impose additional trade barriers it is important to understand, as the Journal writes that, “it is surprising how critical global trade is for most major U.S. companies …. Exports and imports now amount to 27% of GDP versus 17% thirty years ago. Trade restrictions would hurt profits in multiple ways. Tarrifs on imports would drive up costs for businesses and consumers. Exporters … could face retaliatory trade measures.”

But for President elect Trump’s plan to work, it is essential that American businesses heavily redeploy their tax gains into R&D and domestic production, manufacturing and equipment in order to create the jobs the new President has promised. Absent that order of events the economy will not reach the necessary GDP growth levels to properly manage our debt structure across the business cycle.

The big question then, for both the President and America, is whether corporate America will comply and bet on the come or whether they will be content to live within existing capacity and drive their share prices up through increased profits from lower taxes which would likely lead to higher executive bonuses.

My personal guess is that while the President-elect has a plan, our Nation’s corporate executives may be thinking about something entirely different. After all the election did not change human nature.

Thus, As General Eisenhower once said in his 1957 remarks to the the National Defense Executive Reserve Conference:

“Plans are worthless, but planning is everything. There is a very great distinction because when you are planning for an emergency you must start with this one thing: the very definition of “emergency” is that it is unexpected, therefore it is not going to happen the way you are planning. So, the first thing you do is to take all the plans off the top shelf and throw them out the window and start once more. But if you haven’t been planning you can’t start to work, intelligently at least. That is the reason it is so important to plan, to keep yourselves steeped in the character of the problem that you may one day be called upon to solve–or to help to solve.

It would behoove America and its leaders to think about that. It will be great if the President’s plan works but what if it doesn’t?






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