Gregory V. Milano
Philip G. Cohen
While it’s a fact that the national debt is growing as a percentage of gross domestic product, the effect of burgeoning deficits on the economy is a matter of heated debate. Before the presidential election, in an Oct. 21 New York Times op-ed, Peter G. Peterson and former Federal Reserve Chair Paul Volcker contended: “The projected rise in federal deficits would compete for funds in our capital markets and far outrun the private sector’s capacity to save, to finance industry and home purchases, and to invest abroad.”
The next day, in the same newspaper, Nobel Prize-winning economist Paul Krugman argued that the deficit is “less clearly a major issue than the scolds claim.” Now, with the election of Donald J. Trump, the question may be even more pressing: How will the new president pay for the huge, potentially debt-increasing tax cuts he proposed as a candidate? For our monthly Square-Off opinion forum, we asked contributors to zero in on the issue of the national debt, but from the point of view of how the national debt affects corporate finance.
Partly to contain the interest costs on the this ballooning federal debt, the Federal Reserve has been keeping interest rates low, notes Gregory V. Milano, a frequent CFO columnist. One negative effect of low interest rates, however, is that they make corporate assets costlier and harder to convert to cash. “Consider how low mortgage rates drive up housing prices, a phenomenon that affects many asset classes,” he explains.
Another downside for corporations of continuing low interest rates is that they diminish defined-benefit plan assets. “For companies that still offer these benefits, this ‘back door tax’ makes employees more expensive,” Milano writes.
With the national debt continuing to burgeon, “it may be unlikely the Fed will meaningfully raise interest rates without unprecedented federal cost cutting,” he says, noting that in that case the cost of corporate assets and back-door taxes on pension plans will continue to rise.
“The harm this does to corporate America is effectively a subsidy of the ballooning federal debt,” Milano concludes.
To be sure, history tells us that “the U.S. national debt has little impact on corporate finance on a day-to-day basis,” writes Alfred Sanders. a professor of corporate finance at the Jack Welch Management Institute. “But over the long term or in a financial crisis, the impact can be significant.”
As annual budget deficits continue to add to the national debt, corporate finance risk rises. If there’s another financial crisis or terrorist attack, “foreign investors, along with some U.S. investors, would flee to other currencies perceived as less risky, like the euro or even the Chinese renminbi,” which could lead to credit downgrades for the nation, Sanders says.
In such a situation, U.S. national debt could well become unmanageable. And if it did, “companies’ economic viability could be significantly compromised,” he adds.