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THE NATION

Debt Is Good, so Use Surplus to Preserve It

April 22, 2001|MAYA MacGUINEAS | Maya MacGuineas is a fellow at the New America Foundation

WASHINGTON — 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.

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