Amer­ica’s loom­ing debt de­ci­sion

Financial Mirror (Cyprus) - - FRONT PAGE -

Un­til now, the US Trea­sury and the Federal Re­serve Board, act­ing in com­bi­na­tion, have worked to keep down long-term gov­ern­ment debt, in or­der to re­duce in­ter­est rates for the pri­vate sec­tor. In­deed, at this point, the av­er­age du­ra­tion of US debt (in­te­grat­ing the Fed’s bal­ance sheet) is now un­der three years, well be­low that of most Euro­pean coun­tries, even tak­ing into ac­count their own cen­tral banks’ mas­sive quan­ti­ta­tive-eas­ing (QE) pro­grammes.

The tilt to­ward short-term bor­row­ing as a way to try to stim­u­late the econ­omy has made sense un­til now. Given that the in­ter­est rate on 30-year US debt is roughly 200 ba­sis points higher than on one-year debt, short-term bor­row­ing has saved the gov­ern­ment money as well.

But the gov­ern­ment should not op­er­ate like a bank or a hedge fund, load­ing up on short-term debt to fund long-term projects. It is too risky. With net US gov­ern­ment debt al­ready run­ning at 82% of na­tional in­come, the po­ten­tial fis­cal costs of a fast up­ward shift in in­ter­est rates could be mas­sive.

No one is say­ing that such a shift is likely or im­mi­nent, but the odds aren’t as triv­ial as some might like to be­lieve. For starters, in­ter­est rates could spike in the event of a war or some other cat­a­strophic event. Less dra­matic but more likely is that the Fed will some­day find a way to push up in­fla­tion ex­pec­ta­tions, which, as in most ad­vanced economies, have been drift­ing in­ex­orably down­ward. If in­fla­tion ex­pec­ta­tions do start ris­ing, this will push up rates.

A rise in bor­row­ing rates could also come from self­in­flicted dam­age. Sup­pose, for ex­am­ple, that US vot­ers elect as their pres­i­dent an un­pre­dictable and in­com­pe­tent busi­ness­man, who views bank­ruptcy as just busi­ness as usual. Al­ter­na­tively, it is not dif­fi­cult to imag­ine a se­quence of highly pop­ulist lead­ers who em­brace the quack idea that the level of gov­ern­ment debt is ba­si­cally ir­rel­e­vant and should never be an ob­sta­cle to max­imis­ing public spend­ing.

Un­for­tu­nately, if the US ever did face an abrupt nor­mal­i­sa­tion of in­ter­est rates, it could re­quire sig­nif­i­cant tax and spend­ing ad­just­ments. And the over­all bur­den, in­clud­ing un­em­ploy­ment, would al­most surely fall dis­pro­por­tion­ately on the poor, a fact that pop­ulists who be­lieve that debt is a free lunch con­ve­niently ig­nore.

Mind you, length­en­ing bor­row­ing ma­tu­ri­ties does not have to im­ply bor­row­ing less. Most econ­o­mists agree that larger deficits make sense if used to pay for nec­es­sary in­fra­struc­ture and ed­u­ca­tion im­prove­ments, not to men­tion en­hanc­ing do­mes­tic phys­i­cal and cy­ber se­cu­rity. There is a sig­nif­i­cant back­log of wor­thy projects, and real (in­fla­tion­ad­justed) in­ter­est rates are low (though, prop­erly mea­sured, real rates may be sig­nif­i­cantly higher than of­fi­cial mea­sures sug­gest, mainly be­cause the gov­ern­ment’s in­abil­ity to ac­count prop­erly for the ben­e­fits of new goods causes it to over­state in­fla­tion). One hopes that the next pres­i­dent will create an in­fra­struc­ture task force with sub­stan­tial in­de­pen­dence and tech­no­cratic ex­per­tise to help cu­rate pro­ject pro­pos­als, as the United King­dom’s pre-Brexit gov­ern­ment did.

With control of the global re­serve cur­rency, the US has room to bor­row; nonetheless, it should struc­ture its bor­row­ing wisely. Sev­eral years ago, it still made sense for the Fed to do cart­wheels to bring down long-term bor­row­ing costs. Today, with the econ­omy nor­mal­is­ing, the case for creative poli­cies like QE, which ef­fec­tively short­ens gov­ern­ment debt by suck­ing long-term bonds out of the mar­ket, seems much weaker.

That is why the time has come for the US Trea­sury to con­sider bor­row­ing at longer hori­zons than it has in re­cent years. Today, the long­est ma­tu­rity debt is­sued by the US gov­ern­ment is the 30-year bond. Yet Spain has suc­cess­fully is­sued 50-year debt at a very low rate, while Ire­land, Bel­gium, and even Mex­ico have is­sued 100-year debt. Sure, there is no guar­an­tee that rates won’t drop even more in the fu­ture, but the point is to have a less risky stream of fu­ture in­ter­est obli­ga­tions.

Many left-lean­ing polemi­cists point to Ja­pan, where net debt is about 140% of GDP, as proof that much higher debt is a great idea, de­spite the coun­try’s ane­mic growth record. The im­pli­ca­tion is that there is lit­tle need to worry about debt at all, much less its ma­tu­rity struc­ture. In fact, Ja­panese pol­i­cy­mak­ers and econ­o­mists are plenty wor­ried and do not rec­om­mend that other coun­tries em­u­late their coun­try’s debt po­si­tion. Europe is ad­mit­tedly in a very dif­fer­ent place, with much higher un­em­ploy­ment, and a much stronger ar­gu­ment for con­tin­u­ing to pur­sue stim­u­lus at the risk of higher debt-ser­vice costs in the fu­ture. But with the US econ­omy now en­joy­ing a solid re­cov­ery, the best ap­proach may be to move faster to­ward nor­mal­is­ing debt pol­icy, and not to as­sume that for­eign lenders will be pa­tient, re­gard­less of the di­rec­tion of US pol­i­tics.

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