Paying off debt is a standard American value long revered as the pillar of financial discipline. However, debt reduction in an economy that can easily handle the debt is actually contractionary. In fact, eliminating debt in that circumstance leads to a lack of liquidity that can harm the economy and, most notably, the stock market.

While the zealous efforts of Elon Musk and the Presidential Department of Government Efficiency (DOGE) might result in the payoff of the annual deficit, it would also take annual GDP growth from its current +2.9 percent, according to the U.S. Bureau of Economic Analysis, to -1.1 percent. If that were to happen over the year, the deficit reduction would cause a recession, often resulting in a double-digit drop in the global equity market.

The logic is the following: The economy can be defined in a C + I + G model, as defined by Nobel Prize Winning Economist Paul Samuelson, where C = Consumption, I = Investment, and G = Government spending. Simple math says that if the Government is reduced, the economy contracts unless C and I increase to compensate for the loss. The idea is that government spending is less efficient, and when replaced by Consumption and Investment, the economy will be more productive, which is a strong conclusion. However, if the government reduction happens too quickly, Consumption and Investment will have a hard time keeping up in the short run. A contraction is inevitable, and the key is whether it is severe.

In his book "Essays on the Great Depression", Ben Bernanke blames the contractionary behavior of wealthy governments in the 1930s for extending and worsening the Depression. The world was on a gold standard at the time, and instead of continuing to lend money against the gold, wealthy countries, including the U.S., hoarded gold, thereby taking money out of the system. In effect, they paid down their debt by backing it with more gold, which destroyed the economy.

According to U.S. Treasury Department data, the current U.S. deficit is $711 billion. As a percentage of GDP, it is 2.5 percent, just slightly less than the annual GDP growth. Clearly, that number needs to be reduced. The question is by how much and how fast. If done gradually and over several years, the economy will easily withstand the reduction in government spending, and consumer and investment spending will flourish.

However, as Musk has promised, an immediate slash of $1 billion will cause havoc in the economy, and the stock market, as represented by the S&P 500, will likely not achieve the 16 percent annual return it had in Trump’s first term. Such drastic measures will likely result in a recession, which could mean a swift and punishing drop in the stock market that resembles those caused by the Pandemic in 2020 and the Fed rate rise of 2022—not the glory days of 2019.