The yield on US government debt hovers near all time lows. This is because the US is viewed as a ‘safe haven” for investors in an increasingly dangerous global investment marketplace. Yet US finances are very precarious. That is why the ratings agencies have down-graded US debt. The recent failure of the Congressional ‘Super Committee’ to carry out its mandate to find spending reductions, required as part of the August 2011 budget deal, underscores the fear that the US political system is incapable of acting to control spending before the US government is hit by a funding crisis. It may be fairly said that US finances look like Greece on steroids.
It is paradoxical that the finances of the world’s ‘safe haven’ rest on a very unstable foundation. It’s debt is headed above 100% of annual GDP and, according to the CBO, federal government spending –around 20% of GDP for the past 40 years – is on a trajectory to reach nearly 45% of GDP; clearly not a sustainable path. There will be a crisis along the way if it does not undertake significant reform to reduce spending obligations.
It may be that the US has been spared a crisis solely because Europe arrived there first. Capital –always looking for a safe harbor in stormy waters – has come awash on US shores –for the moment.
An Opportunity
The US government is plagued by two financial problems: too much leverage and too much spending. It will take political will to rein in spending – and there is ample reason to doubt the US has that will at present. But there may be an opportunity to restructure debt and improve its sustainability.
The US could issue long term bonds – at low cost under current market conditions - that have a variable repayment structure that ties the level –but not the ultimate amount –of repayment to the rate of growth of GDP; the higher GDP growth, the higher the level of repayment (and the faster repayment of the entire obligation).
Such bonds have an equity –like property; the level of repayment is tied to the ‘profitability’ of the entity. In this case the US economy. The procyclical repayment attribute means the government will be under less stress to raise funds to pay on debt service during recessions. This will better enable the government to resist austerity measures when the economy can least afford it, and the procyclical payment structure should improve investor confidence that the debt obligations can be met.
The US government is plagued by two financial problems: too much leverage and too much spending. It will take political will to rein in spending – and there is ample reason to doubt the US has that will at present. But there may be an opportunity to restructure debt and improve its sustainability.
The US could issue long term bonds – at low cost under current market conditions - that have a variable repayment structure that ties the level –but not the ultimate amount –of repayment to the rate of growth of GDP; the higher GDP growth, the higher the level of repayment (and the faster repayment of the entire obligation).
Such bonds have an equity –like property; the level of repayment is tied to the ‘profitability’ of the entity. In this case the US economy. The procyclical repayment attribute means the government will be under less stress to raise funds to pay on debt service during recessions. This will better enable the government to resist austerity measures when the economy can least afford it, and the procyclical payment structure should improve investor confidence that the debt obligations can be met.
Here’s the rub. Bond investors crave the certainty of fixed repayment schedules and they normally exact a premium to finance investments with variable repayments. So, ordinarily, the shift to a variable rate structure will cause the cost of funding to increase.
Seize the Day
But we are in moment when investor fear is running so high it may well be possible for the US government to issue variable repayment bonds without any appreciable increase in its funding costs. Moreover, given the precariousness of the overall US financial position, investors may react positively to the improved sustainability of the variable repayment feature of the bonds.
In any event, the US should aggressively extend the maturity of its debt while it is able to do so at low yields. That will better protect it from a shift in global investor sentiment (and global capital flows) away from the US, by reducing its near term funding needs.
This opportunity, if it exists, may be fleeting, as the possibility of a reversal of sentiment and an investor flight from the US is an ever present threat under current conditions.
So the US Treasury should ‘Seize the Day’ and try It out.
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This is interesting, and there's no direct harm in offering variable-payment bonds. They could even be offered in the same auction as regular Treasury bills (with the option for investors to submit either-or bids) to ensure that the government raises whatever amount it would have raised otherwise.
ReplyDeleteHow should a switch to long-term debt interact with Operation Twist? An untwist (sales of long-term Treasuries by the Fed) would increase long-term debt on the consolidated books, but might undo Bernanke's plan to keep long-term rates low. Long-term debt that's mostly bought by the Fed presumably does not achieve what Aronoff intends. Should the Treasury or the Fed actively remove short-term Treasuries from the market?