The Joy of Debt
GLASSMAN, JAMES K.
The Joy of Debt The last thing we should want is a U.S. Treasury flush with cash. BY JAMES K. GLASSMAN Last Wednesday, investors, panicky over banking troubles in Japan, drove the Dow Jones...
...If no policy changes are made, then by 2006, the proportion of public debt to GDP will drop below 10 percent...
...President Clinton's OMB projected 3.1 percent...
...The graph depicts something that has never happened before, in America or anywhere else in the world...
...Even Greenspan seems to have been surprised that, at this rate, the Treasury won't have any retirable debt five years from now...
...It shows a government that has retired all the debts it can and begun accumulating vast "uncommitted funds"—a concept so new that the CBO had to invent the phrase...
...the consensus of private Blue Chip economists is 3.3 percent...
...The Treasury has discontinued regular auctions of 52-week bills and 3-year, 4-year, and 7-year notes...
...This is an unprecedented condition in government finance, and, while it sounds perfectly wonderful, it's not...
...they'll have to go elsewhere after 2006— but, of course, there is no elsewhere...
...Yes, and the ones who understand economics were being disingenuous...
...It also means a multi-billion-dollar windfall in "seigniorage," as foreigners give us interest-free loans of their currency in order to hold ours...
...The result, he fears, would be "sub-optimal performance by our capital markets, diminished economic efficiency, and lower overall standards of living...
...Greenspan, in his testimony before the House Budget Committee on March 2, said that investors who hold Treasuries do so because "they perceive them to be an extraordinarily valuable, risk-free, dollar-denominated . . . asset...
...As Alexander Hamilton, the first treasury secretary, said, "The national debt, if it is not excessive, can be a national blessing...
...But already, the surplus has inspired both Democrats and Republicans to start spending again—at growth rates not seen since the 1970s...
...Indeed, retiring the debt is more apt to harm future generations...
...In fact, federal borrowing is only a tiny proportion of total worldwide (or even U.S...
...Meanwhile, liberal Democrats have become green-eye-shade defenders of fiscal orthodoxy...
...So what...
...Clinton alumni have been peddling the story that by raising tax rates and reducing spending, their administration trimmed and then eliminated the deficit...
...hence, the scary chart...
...One big problem is that Treasury debt provides investors—and the world financial system—with stability and consistency, nice things to have in a time of volatile markets...
...He points out, for example, that during the Reagan years, while deficits rose, Gross Domestic Product grew a full percentage point faster than the post-1959 average...
...But some of that debt is in the form of non-marketable securities, like savings bonds...
...Paying off the debt has many negative consequences in addition to government ownership of corporate stocks...
...But imagine if there were no such securities to buy...
...Currently, the Treasury is absorbing one-sixth more in revenues than it needs to operate the government...
...And that's the scary part...
...A third difficulty is already starting to show up...
...Of course, debt can get out of hand—but we are far from that stage...
...Now, those same conservatives have been hoist on their own petard...
...What about the argument, heard from both parties, that if we don't retire bonds now, then we will irresponsibly be saddling our children and grandchildren with debt...
...Treasuries are used by small investors, charities, and other institutions that want a secure flow of income and by financial institutions fashioning derivatives and other instruments that spread risk and modulate it...
...If these unintended consequences don't look so terrible, then compare them to the benefits of paying down the debt...
...In other words, the greatest gift we can give future Americans is a booming economy—with abundant physical and intellectual capital on which to draw...
...Contrary to widespread claims, there is no theoretical or empirical support for the enduring notion that either lower budget deficits or surpluses that lead to government debt reduction are beneficial to the economy," writes my colleague at the American Enterprise Institute, the economist John Makin...
...That's a far more sensible—and far less risky —approach than shutting down the Treasury market...
...As the Treasury starts eliminating certain securities, the value of the remaining securities rises—which, in bond terms, means that their interest rates fall...
...No more...
...Was that so bad...
...These are estimates, of course, and they may well be wrong...
...But a law passed in 1993 sets a formula for student borrowers based on the 10-year Treasury note...
...They want to prevent a tax cut so that they can eventually use the $3 trillion in uncommitted funds either for new spending or for government investing in stocks...
...According to the latest estimates by budget experts, in five years, the market for Trea-suries—the safest, most liquid, most popular investment in the world—will disappear...
...If we end the overcharge through a tax cut, some of the income that doesn't go to Washington will be consumed, giving an immediate boost to an economy that has been sagging...
...At a time when the rest of the world is privatizing state-owned companies, it would be ironic—and danger-ous—for the United States to move in James K. Glassman is a resident fellow at the American Enterprise Institute and host of www.TechCen-tralStation.com...
...This is the specter that worried Alan Greenspan so much that, as a way to forestall it, the Fed chairman switched his position and forcefully backed President Bush's tax cut...
...As those notes become scarce (and, indeed, disappear), Treasury rates become irrelevant and the loan rate becomes detached from any market reality, threatening, says a Sallie Mae official, "to undermine the guaranteed student loan program . . . that serves 80 percent of America's schools and its students...
...And, finally, shutting down the Treasury market will make opening it again more difficult...
...the opposite direction, with government ownership of shares or bonds issued by U.S...
...As a result, the CBO estimates that excess cash will start rolling into the Treasury, with nowhere to go, in 2006...
...Many adjustable mortgages, for example, are linked to the one-year T-bill...
...In fact, in its latest report, the CBO estimates that "surpluses [will] exceed the amount of debt available for redemption in 2006...
...Actually, the opposite is true...
...Whatever the projections, already the market for U.S...
...One likely use of the money will be investments by the government (probably the Social Security trust fund) in private assets...
...There is so much cash flowing into the Treasury from tax revenues that every working day, on average, the federal government pays off another $1 billion in loans that it has made over the past three decades...
...BY JAMES K. GLASSMAN Last Wednesday, investors, panicky over banking troubles in Japan, drove the Dow Jones Industrial Average down 300 points in the first few minutes of trading...
...Too bad for them...
...The CBO projects 3.0 percent, on average, for the next decade...
...The real question is how to get there...
...Certainly, government investing in private assets is a dramatic policy shift which, at the very least, needs to be debated publicly...
...As more bonds are retired, the remaining bonds become more scarce and thus more valuable...
...Bloomberg Business News reported a worldwide "flight to quality"—from stocks into U.S...
...That supply rose sharply throughout the Clinton years—and, why not, since the economy grew, too...
...Even at current levels, debt owed to the public represents less than one-third of GDI, or about half the level of other developed countries...
...Another problem is that Treasuries are popular with foreign investors and governments...
...And the OMB, for its part, sees those "uncommitted funds" starting to appear in 2004...
...Instead, the answer is to stop the tidal wave of cash flowing into the Treasury by allowing Americans to keep more of what they earn...
...That's hardly excessive...
...It shows a flat horizontal line at zero from the years 2000 to 2006, then a sudden soaring trajectory, like a cruise missile, blasting off at a 45-degree angle, then arching ever more vertically...
...Squirreled away on page xvi of the latest report of the Congressional Budget Office there's a very tiny but very scary graph...
...That's not such a farfetched notion...
...government securities "is fast disappearing," says Francis X. Cavanaugh, who, as a federal official, managed the federal debt at the Treasury Department...
...During a decade of restraint, the unemployment rate dropped sharply, poverty and crime decreased, and the U.S...
...companies and (inevitably with such ownership) government control of those companies...
...In theory, these surplus tax dollars will just sit there and sit there...
...Sallie Mae, a private company, provides the cash for $50 billion worth of those loans...
...dollar is the world's reserve currency—a status that keeps the dollar strong and interest rates low...
...The loans are in the form of U.S...
...It is not hard to see why...
...But haven't conservatives been squawking for years about deficits and the national debt being out of control...
...Without Treasuries, the Fed will have a tough time conducting its "open-market" operations, the practice of buying and selling bonds that keeps interest rates where the central bank wants them...
...Conservatives need to convince the nation of the true story, which is that what counts is not so much how spending is financed (either through taxes or through debt) but rather how much spending is being done—and on what...
...debt...
...They are one of the major reasons that the U.S...
...But it's important to remember that, in each of the past five years, congressional, presidential, and private prognosticators proved to be far too pessimistic about revenues...
...It would be better for our children, says Allan Meltzer, also of AEI, "if we reduced tax rates now, encouraged investment now, so that we would have a larger capital stock and higher incomes...
...Currently, the public holds about $3 trillion in loans to the federal government...
...Another use of the money might be in new government programs—or an expansion of old ones...
...Reducing its growth is not necessarily a bad thing but it has little effect on the total supply of debt...
...But the 10-year is slated for extinction next year...
...The truth is that Washington is rolling in dough...
...Treasury securities are benchmarks for other kinds of lending...
...We shouldn't blunder into it...
...Why should they...
...This year, federal taxes will reach 20.7 percent of GDP Only once, in 1944, has Washington taken a higher proportion of national income—and only twice (the other year was 1945) has it taken more than 20 percent...
...economy grew for the longest period in history...
...That leaves only the 13-week and 26-week bills and the 5-year and 10-year notes...
...The law was modified temporarily in 1998 but that fix will soon expire...
...They, too, would have a larger capital stock that would produce income that could be used to retire the debt that they inherit from us along with the capital stock...
...Treasury securities...
...The analogy is a family making $100,000 a year with total debt, including home mortgage, of $30,000...
...In fact, Makin calls paying down the debt a "preposterous idea...
...Greenspan told a congressional committee in January that "it would be exceptionally difficult to insulate the government's investment decisions from political pressures...
...As a result, distortions in rates along the Treasury yield curve have blossomed...
...In practice, however, they will be put to use...
...Clearly, the answer is not by repaying the debt, a process that is already causing serious disruptions in the capital markets and that confers no conceivable benefits on the United States...
...For example, interest rates have plummeted on the 30-year bond, which will soon become history...
...The Treasury has been offering financial enticements for investors to turn in those bonds, but the CBO—as well as the White House's Office of Management and Budget—estimates that very few of them will accept the deal...
...The rest will be invested, adding to the capital stock and increasing productivity and incomes for future generations...
...That's an overcharge that will mount with the years—reaching an incredible one-third by 2010...
...Or consider student loans...
...They used the deficit and the debt as a tactical weapon to stop liberals from spending...
...By 2011, the graph shows the line exceeding $3 trillion, which is the equivalent of about $30,000 for every family in America...
...And the money will keep flowing in...
...In other words, in five years, all the loans from the public that the government can repay will be repaid...
...there's nothing that comes close to the security of a Treasury security...
...They're right, and they aren't likely to part with such cherished objects...
...As time has passed, new generations have always had higher incomes, so they are better able to pay off the debt...
...Another $523 billion does not mature until after 2011...
...But, according to CBO, taxes will exceed 20 percent of GDP in every year through 2011...
...A tax cut could prevent both of those consequences, but a cut of the size offered by President Bush—a total of just $1.6 trillion, phased in slowly, during a period when the federal government will be collecting about $25 trillion in taxes—is unlikely to be large enough or quick enough to prevent the scary graph from becoming reality...
...Since government borrowing declined, general interest rates fell, and consumers and businesses benefited...
...Since CBO and most sober prognosticators believe the budget will go back into deficit in a few decades, a reopening looks inevitable...
...The key figure that determines future surpluses is the annual rate of growth of Gross Domestic Product (GDP), the sum of all the nation's output of goods and services...
...Treasury debt securities—bonds, notes, and bills...
...In the past, when those securities matured, the Treasury (since it didn't have the money) would simply roll them over—that is, pay off the old bondholders and issue new debt, typically in a higher amount...
...When the Clinton administration two years ago first proposed investing tax dollars in the stock market, the Senate unanimously passed a resolution opposing the idea...
...There really aren't any...
...It is expected to eliminate the 30-year bond as well," he says...
...One salutary effect of the deficit was to prevent big new spending ideas from being funded...
Vol. 6 • March 2001 • No. 27
