Debt Is Good, so Use Surplus to Preserve It
The stock market’s recent volatility has probably made a lot of investors thankful for good ole U.S. government bonds. U.S. Treasury securities are perfect places to park savings while the market settles down. What many of them don’t realize, however, is that the U.S. Treasury market may not be around that much longer.
Treasury bonds, bills and notes are the means by which the federal government borrows. But the recent emergence of large annual budget surpluses has diminished the government’s need to tap the Treasury market for cash. Some of the surplus is being used to pay down the national debt. Estimates are that the bulk of the debt held by the public will be paid off over the next 10 years. The Treasury market, as we know it, will disappear.
It’s not just investors who will feel the pinch if the market disappears. The Federal Reserve buys and sells Treasury securities to influence the direction of interest rates and manage the money supply. Recent volatility in the Treasury market caused by fears of its potential disappearance has already made it more difficult for the Fed to affect interest rates along the yield curve. In testimony before Congress in January, Fed Chairman Alan Greenspan revealed that, “We have accelerated our efforts of the various alternate means that the Federal Reserve would employ to implement monetary policy, what assets would we use if [we] could no longer buy Treasury instruments.”
Competition to provide a replacement security to fill the Treasury void has already begun. Fannie Mae, for example, plans to continue providing debt instruments that mimic Treasury securities in scope and regularity of offering. And some corporations are planning Treasury-like offerings. But would we really be comfortable with the Fed trading debt securities from Fannie Mae or Ford? These debt substitutes come with the risk of default, and elevating a single stock, or even an index of stocks, to such a charmed status would confer special privileges on the companies issuing the debt. Not only would the increased demand for their debt lower the company’s overall borrowing costs, giving them an advantage over competitors. The government would also have an interest in ensuring the lasting success of the company, introducing moral-hazard problems into the equation while further blurring the line between government and markets.
Furthermore, it seems foolish to go through the tremendous turmoil of dismantling the Treasury market when we know, with virtual certainty, that it would not be gone for long. Annual budget surpluses are expected to persist for the near term, but, sooner or later, deficits will return, especially when the retirement and medical costs of the baby boomers kick in. Then the government will need to sell Treasury securities to help finance the burden.
There are a handful of options to preserve the Treasury market. We could pay off the national debt and preserve a liquid and stable Treasury market by continuing to auction off new Treasury securities and allowing the government to invest the proceeds in private assets such as corporate stocks and bonds. But there are huge conflicts inherent in such a policy, most notably, that it would be virtually impossible to insulate government investment decisions from political calculations.
Alternatively, the government could slow the pace of debt reduction by trimming the size of the annual surpluses beyond current budget proposals, either through larger tax cuts or new government spending. But that would sacrifice the positive economic benefits associated with debt reduction: greater national savings, which leads to lower interest rates, more capital for productive investment and higher levels of economic growth. Eliminating annual deficits and reducing the national debt is, in large part, responsible for the economic boom of the past decade. The same positive economic cycle is not generated from either tax cuts or new government spending, both of which lead to higher levels of consumption, not savings.
A good chunk of the $3.4-trillion debt should be paid off, to be sure, but not all of it. Instead, Congress should craft a plan that would produce a similar amount of savings as eliminating the debt while avoiding the potential pitfalls of zero government debt. For example, a percentage of the annual surplus could be rebated to taxpayers with the stipulation that it be saved as a part of Social Security or, more broadly, for such items as medical expenses, home ownership or education. With personal savings rates at an all-time low, there is a pressing need to encourage individuals to save. Since the more savings, the better, we could leverage the annual surpluses by using the rebates to match what individuals saved on their own. If done progressively--offering higher savings matches to those on the low-end of the income spectrum--many individuals who have never saved would have a strong incentive to start. As long as the dollars constituted new savings, they would generate the same economic benefits as paying off the debt.
What about using the surpluses to stimulate spending, to help pick up the lagging economy? Frankly, the fiscal stimulus package being bandied about in Washington would do little to gin up the economy. In all likelihood, it would take months for the stimulus to work its way into the economy, and the downturn is not expected to last that long. Monetary policy is far more effective in making capital available to businesses that need to grow. Encouraging consumers to spend more--when they already spend more than they earn--is not nearly as important as encouraging them to save.
A surplus rebate earmarked for savings would stimulate investment and productivity growth. Any other use of the surpluses would shortchange the economy of the benefits of debt reduction. Additionally, by making the rebate contingent on the size of the annual budgetary surplus, we could avoid spending ourselves back into debt. And the peace of mind of investors would be ensured because the Treasury market would be preserved.
