The world wants more US government debt. The US Treasury should supply it.

This fascinating story came out during the psychodrama of the US debt ceiling:

U.S. Treasury debt prices soared on Friday on fears a U.S. default could trigger a shortage of Treasuries and even push the world's largest economy back into recession.

On the face of it, this makes no sense. The market's reaction to a higher perceived probability that the US would default on its debt was to demand more US debt? If the markets behaved this way with Greece, there'd be no Eurozone debt crisis.

But of course, the US isn't Greece; US debt is special:

The potential that the Treasury might postpone debt sales in the event the debt ceiling is not extended by next Tuesday bolstered Treasuries on concerns fund managers and short-term traders might have to compete for tight supply for their everyday operations. 

"There's a lot of demand for these issues, just kind of a natural demand that always comes up," said Kim Rupert, managing director of global fixed income analysis at Action Economics LLC in San Francisco. "So with less or truncated supply you have a lot more demand chasing less supply."

So long as investors want to shift to liquid assets during episodes of uncertainty and so long as US Treasuries are perceived as being among the most liquid assets, then there's going to be a strong demand for them. And if the only way to acquire US debt is to acquire USD, then we'll also see a pattern of USD appreciating on bad news - even if the bad news is about the US economy. (This sometimes sets up some odd market story narratives.)

The price of 10-year Treasuries has increased by 14% since January 2011. If there's such a strong demand for Treasuries, then why not produce and sell more of them?

• Financial markets would be happier with a greater supply of liquid assets in turbulent times
• The US federal government can use the proceeds to do, well, almost anything, really.

There is the possibility that the market will lose its taste for US government debt, but it's hard to see how that could happen until after financial markets return to normal. And if that happens, then the selloff of Treasuries would likely result in

• inflation (thus helping debt-strapped households who are struggling with their balance sheets in a low-inflation environment), and/or
• a USD depreciation (thus helping it rebalance the US current account).

The world wants more US Treasuries. The US should supply them. Win-win, all around.

(This written with tongue slightly in cheek. But only slightly.) 

Comments

[Nick Rowe]

Suppose the US government issues a (say) 20 year bond, and use the proceeds to finance an investment that will pay the interest and principal on that bond over the same 20 years. (A toll bridge, or investment in education or infrastructure that will raise future incomes and tax revenues). Then it doesn't matter if financial markets do return to normal. The only danger is if it borrows short and invests long.

[Determinant]

Sense, reason and intelligence left the US budget process a long time ago.

It makes you want to get down on your knees and give thanks that we live in a country with a sensible Westminster-style budget process and Public Service.

Even with Stephen Harper in charge.

[JW Mason]

Now we're making progress.

The next step is to ask, should we wait for a crisis caused by excess demand for US debt to supply more of it? Or should we make sure there's adequate supply in advance?

Or: What are the implications of this post for claims that the US has a long-term deficit problem?

[Too Much Fed]

"If there's such a strong demand for Treasuries, then why not produce and sell more of them?"

because the solution to too much debt is not more debt

Specifically, the solution to too much lower and middle class debt owed to the rich is not more gov't debt owed to the rich.

savings of the rich = dissavings of the gov't (preferably with debt) plus the dissavings of the lower and middle class (preferably with debt)

[Too Much Fed]

"There is the possibility that the market will lose its taste for US government debt, but it's hard to see how that could happen until after financial markets return to normal."

It could happen if someone told the mostly rich bond holders that if real GDP does not grow fast enough, the USA isn't going to cut Social Security, Medicaid, and Medicare (mostly retirement programs) to keep them satisfied. Also, we are not going to use the currency printing entity to bail them out. When the default risk then becomes real, let's see where interest rates go.

[Patrick]

TMF: If US Gov't does as Nick says: essentially borrowing from the rich to raise the incomes of the poor and middle class (because the rich won't lend to them directly), what exactly is the problem?

[Too Much Fed]

"And if that happens, then the selloff of Treasuries would likely result in

•[price] inflation (thus helping debt-strapped households who are struggling with their balance sheets in a low-inflation environment), and/or
•a USD depreciation (thus helping it rebalance the US current account)."

What if prices rise, but wages do not? How does that help with debt?

What if almost all of the current account adjustment happens thru lower consumption?

[Dan Kervick]

If there are important things on which the US government should be spending more money than it is currently spending - and there are; and if additional US aggregate government spending would be beneficial to the US economy to boost aggregate demand - and it would be; then why not try a different approach:

The US Congress can pass a bill commanding the Federal Reserve to use its pure money-creating powers simply to credit the accounts of the US Treasury at the Fed by some $X billion. No purchase of a bond or other asset by the Fed: they just credit the account - end of story. Congress then passes another bill authorizing an additional $X billion in federal spending.

If it is deemed necessary or advisable to offset excessive inflationary impacts of the additional spending by subtracting at least some amount of purchasing power from certain sectors of the economy, then Congress can pass another bill exacting a new set of taxes to remove that purchasing power directly. The taxpayer receives no future rebates - especially no rebates with interest.

The fact that the US government can now borrow money at extremely low rates of interest to finance its spending is sometimes represented as a situation in which the government can now get "a great deal" on the funds for additional spending. But this is a dubious mindset that confuses the situation of the US government and public sector with the situation of households and businesses. Borrowing funds and then paying them back, even at very low rates off interest, is never as good a deal for the US taxpayer as simply taking the funds directly from the savings surpluses of the wealthy via taxation - and not paying anybody back.

And if the spending can be funded by pure money creation without adverse economic effects, then it is an even better deal for all concerned to create the money out of thin air rather than acquire it either by taxation or borrowing.

A household or business, which lacks the power to command the transfer of funds from the accounts of others to its own accounts, must either sell something it already owns or borrow in order to acquire desired monetary funds. But the government has powers that households and businesses lack, so it is strange for a government to decline to exercise those powers, and constrain itself by the rules limiting households and businesses, and then to crow about the great deal it got on its wholly unnecessary borrowing arrangements.

Of course there is strong demand for the secure interest income that comes from US Treasuries. But why is it the role of US taxpayer to supply whatever interest income others might want, especially when the US public can acquire at a lower price the same amount of money the prospective bond purchasers are willing to exchange for the bonds? (That lower price = free.)

There is also no doubt strong global demand for oral sex from US pop stars and cheerleaders. But it is not the role of US citizens to supply whatever is desired.

[Determinant]

Is it just me or do Canadians not fret over Medicare, OAS and CPP disappearing like Americans do with Medicare and Social Security? I don't think anyone chews their fingernails off worrying about those programs up here.

[Too Much Fed]

Patrick, because when it is debt, it is only temporary and may not pay for itself or be unneeded.

The toll bridge is a perfect example. There are 3 small bridges near where I live that I use that are in good condition. I don't want or need another one (the local economy does not need another one either). If the gov't builds another one with a toll I won't use it. Next, I suppose they will put a toll on the other ones. I don't want my cost of living increased just for a few temporary jobs building it (the "toll booths" will be automated) so some rich bond holders can sit around and collect interest and have a bond that won't default or a bridge that will be privatized in the future so some company with a stock price can raise tolls even more.

Also, if the lower and middle class are making enough in wages, why should they need to borrow? And, I don't see that borrowing from the rich is necessary to raise the (wage?) incomes of the lower and middle class.

[Too Much Fed]

Determinant, I don't know the debt stats for Canada.

However, let's assume Canada got into a too much gov't debt problem even if it was caused by too much private debt.

All the economists and bond market participants come along and say if you don't cut retirement benefits and health care then we will raise interest rates at least 2% and probably 4% or 5%. What do you think the elected officials will do? Hint: see just about every other country except Iceland (and that was mostly only because of the voters).

[Too Much Fed]

Dan Kervick, I believe you are assuming the currency printing entity is owned and controlled by the gov't.

I'd rather see this:

savings of the rich plus savings of the lower and middle class = the balanced budget(s) of the various level(s) of gov't plus the dissavings of the currency printing entity with currency and no loan/bond attached

My apologies to Stephen Gordon for so many posts in a short period of time.

[Neil]

Determinant - No one in Canada worries about CPP because in the mid-90's, CPP was reformed to a more sustainable funding model. Before that, it was much like Social Security, where current contributions were directly used to pay current beneficiaries. Demographic change means that at some point, this model will either require larger contributions or a reduction/elimination of benefits. In Canada, our contributions were hiked, and a larger portion of proceeds are saved to cover future liabilities, so we know which option this country has taken, the US has not been able to make that move.

Now you can think all you want about better leaders, a more forward thinking electorate, or whatever, but in the end, the fact is that we were able to make that change - short term pain for long term gain - because the Reform/PC split gave the Liberals breathing room where they were pretty much guaranteed reelection no matter who they pissed off. With only two parties, the US doesn't have this breathing room, so nobody wants to go there until it's a full-on crisis.
------------
On the original subject of auctioning more bonds, it seems clear that additional bond issues by the US treasury shouldn't be used to further goose government spending. They should raise taxes for that, since there's no exit strategy from borrow-and-spend. Additional borrowing should be used to invest in other fairly secure investments. As long as they stick to a broad portfolio of liquid assets, they can invest the profit margin into public works, and if the appetite for US debt does dry up, they can sell their investments and buy back their own debt at lower prices. Add a couple more wins to the pile.

[Dan Kervick]

TMF, I believe that among the powers possessed by the US government, and delegated to the monetary authority, is the power to create money directly by crediting Fed-held accounts with higher balances, without at the same time diminishing balances in any other accounts or currency stocks. And I think that at the present time, it is advisable for the government to employ this kind of debt-free deficit expansion to boost spending and production.

I do worry that the process might be too inflationary in the long run, however, so another approach is to offset the added spending by extinguishing some surplus savings through taxation - which also does not increase the Federal debt.

[anon]

Dan, you're making a distinction without a difference. The US could just as easily issue more debt, roll it over indefinitely, and retire it in future by raising taxes or curtailing spending.

[Patrick]

TMF: Lost me on the first sentence.

"The toll bridge is a perfect example ... "

Then don't build a toll bridge. Maybe your community needs something else? If not, then no soup for you. Spend it on R&D instead. R&D spending has a pretty good track record e.g. the Internet.

"if the lower and middle class are making enough in wages, why should they need to borrow"

The poor and middle class are not borrowing, the Gov't is (yeah, I we're all on the hook for some portion of the taxes depending on democgaphics and income), The idea is that the Gov't borrow cheaply long term and invest long term in stuff that increases wages - like education, R&D etc. It's a free lunch. Why not eat it? (Yes, I'm being a little flip)

FWIW, it seems to me that there are many other options that would work equally well. Treasury could mint a couple of $1 trillion dollar platinum coins, put them on deposit at the Fed, and write every American tax filer a check for $14K. Recession over. Or Congress/Treasury/Fed could print a trillion or two and start buying stocks. Or Ben could be caught on video hanging out the roof of a limo with a bottle of Dom Perignon in one hand and a pornstar in the other, while TImmy threw bundles of benjamins at the passers by (Peter Schiffs head would explode). WINNING!

[Max]

I don't think it's helpful to think of rising bonds as being caused by "strong demand". That makes it sound like the price movements are driven by price insensitive buyers, as opposed to being driven by interest rate speculation.

[Dan Kervick]

anon,

I don't see why the distinction lacks a difference. If the government raises money by issuing bonds, then it makes a commitment to send money on a pre-determined schedule to the people who purchased the bonds. If it fulfills those commitments by either raising taxes or cutting spending, then it will be reducing the income of either those specific taxpayers or the specific recipients of the spending that is cut.

If the government raises the money by printing it, it makes no such commitments, and reduces nobody's income.

I'm not concerned about default or insolvency due to government debt. I'm concerned about income distribution.

[JKH]

A US default would have been voluntary – a political act – associated with a voluntary, contractionary fiscal impulse coming from the political right. That would result in a shortage of dollar assets compared to economic demand. But the default is unrelated to the actual fiscal position or the bond market in any fundamental way – not at this stage anyway.

A Greek default would not be voluntary in the same sense. The fiscal position and the bond market drive the default primarily as an economic necessity rather than a political choice.

And the comparative economics are a function of the fundamentally different relationship between the bond issuer and its central bank - unique sovereign relationship versus currency union, etc.

Yes, there is currently an excess demand for US Treasuries.

[Ralph Musgrave]

I see nothing tongue in cheek about Nick’s post. He makes a good point. To re-phrase it, much of the world wants the US to act as the world’s central bank, and supply monetary base as required. So the US should do this. As to how the US can profit in the process, that is easy: just make sure that the interest the US pays is below the likely level of inflation over the time to maturity of bonds issued. That means the REAL rate of interest paid is NEGATIVE.

As far as I can see the real rate of interest on UK debt is significantly more negative than on US debt. Clearly the US has some lessons to learn from the UK on the subject of ripping off one’s creditors. But I’m sure the US will soon learn.

[Lorenzo from Oz]

Regarding who is doing better than whom, I am an Australian: I live in the country where the Great Moderation still hasn't ended. Consider the comparative employment growth data, for example. But our public debt is low, our central bank hasn't gone mad and the Chinese are still buying what we dig up. It's a different place.

[Bob Smith]

Neil said: "No one in Canada worries about CPP because in the mid-90's, CPP was reformed to a more sustainable funding model."

Agreed, but no one in Canada worries about health care because we live in a fool's paradise. Canadians, for some reason, accept that a health care system that grows faster than nominal GDP and is slowly gobbling-up provincial budgets is sustainable. And politicians, no fools they, aren't inclined to disabuse them of that notion. At this rate, in a few decades , we'll no longer have provincial governments, we'll just have provincial health insurers(in much the same way that some US cities are now little more than vehicles for the pensions of their former employees). Canada's social systems are in better shape than those in the US or Europe (although the US, unlike Europe, at least has spare fiscal capacity, even if it lacks the political will to use it), but it's a relative measure.

[Nick Rowe]

Lorenzo: Canada is like Oz, only a bit less so. But watch out. Your housing market looks dodgy, from what I hear. And China looks dodgy too, from what I hear. Canada has to worry about those two same things, only perhaps a little less so.

[Determinant]

The world has asked the US to be the world's central banker since WWII. The story of the world's macroeconomy has been the story of the varying US policy response to that role.

Lorenzo:

Canada has a larger manufacturing base than Australia, particularly in the Great Lakes region which is much more like another US state economically than the rest of Canada. Rising commodities and a rising Canadian dollar gives this region Dutch Disease which we have now. Conversely the low Canadian/US exchange rate in the late 1990's led to a manufacturing boom in Southern Ontario. I have seen both sides of the coin.

Low exchange rates were the crack-cocaine of the Canadian business world. A great high, very addictive but a fickle friend and withdrawal is oh so painful.

[Min]

Too Much Fed: ""If there's such a strong demand for Treasuries, then why not produce and sell more of them?"

"because the solution to too much debt is not more debt

"Specifically, the solution to too much lower and middle class debt owed to the rich is not more gov't debt owed to the rich."

I think that's partly why Stephen Gordon said he had tongue slightly in cheek. ;) I don't think he means that the solution is debt. Rather, the solution is gov't spending, while the gov't pays less interest on the new debt. Now, if that gov't spending allows the lower and middle classes to reduce their debt to the rich, that's good for them, and it also reduces the interest paid to the rich.

[David]

Stephen: I've been saying the same thing for quite some time now. The logic is compelling. Why tongue-in-cheek?

[Stephen Gordon]

You're right; I tacked on the disclaimer because I hadn't spent much time thinking the matter through.

Too Much Fed: Not all debt is the same. I'm not aware of any explanation of the current crisis that revolves around the fact that there is "too much" US govt debt.

[Determinant]

US gov't debt in my view is related tangentially in that Treasuries were a repository for the US capital account surplus that fuelled the boom. The chronic capital account surplus/current account deficit was the problem.

Really, can't current account surplus countries go send their savings to Africa where actual investment like roads, railways, bridges and factories would be much more appreciated?

[Too Much Fed]

Stephen Gordon said: "Too Much Fed: Not all debt is the same. I'm not aware of any explanation of the current crisis that revolves around the fact that there is "too much" US govt debt."

The last "crisis" was mostly about U.S. private debt that did not produce price inflation or prevented price deflation in tradable finished goods (clothing, electronics, tools, etc.) with some U.S. gov't debt. Will the next "crisis" be about too much U.S. gov't debt in the same manner?

I'd like to go over the not all debt is the same. I assume that means private debt vs. gov't debt. If so, going over the differences would be helpful, but going over the similarities would be better.

As far as trying to make sure U.S. gov't debt is not the next "crisis", here is bernanke:

http://www.federalreserve.gov/newsevents/testimony/bernanke20111004a.htm

Chairman Ben S. Bernanke Economic Outlook and Recent Monetary Policy Actions
Before the Joint Economic Committee, U.S. Congress, Washington, D.C.
October 4, 2011

"To be sure, fiscal policymakers face a complex situation. I would submit that, in setting tax and spending policies for now and the future, policymakers should consider at least four key objectives. One crucial objective is to achieve long-run fiscal sustainability. The federal budget is clearly not on a sustainable path at present. The Joint Select Committee on Deficit Reduction, formed as part of the Budget Control Act, is charged with achieving $1.5 trillion in additional deficit reduction over the next 10 years on top of the spending caps enacted this summer. Accomplishing that goal would be a substantial step; however, more will be needed to achieve fiscal sustainability.

A second important objective is to avoid fiscal actions that could impede the ongoing economic recovery. These first two objectives are certainly not incompatible, as putting in place a credible plan for reducing future deficits over the longer term does not preclude attending to the implications of fiscal choices for the recovery in the near term. Third, fiscal policy should aim to promote long-term growth and economic opportunity. As a nation, we need to think carefully about how federal spending priorities and the design of the tax code affect the productivity and vitality of our economy in the longer term. Fourth, there is evident need to improve the process for making long-term budget decisions, to create greater predictability and clarity, while avoiding disruptions to the financial markets and the economy. In sum, the nation faces difficult and fundamental fiscal choices, which cannot be safely or responsibly postponed."

IMO, that is fedspeak for I'm 100% sure this is an aggregated demand shock (see bernanke's deflation speech). Since private debt is not working to fix it, then more gov't debt is needed until the economy "snaps back" with everyone believing in supply constraints again. Real GDP will then grow but not enough to lower the gov't debt to GDP ratio. While some tax increases can be tolerated without stopping aggregate supply from growing, most of it should come from reducing the time spend in retirement by cutting Social Security, Medicare, and Medicaid. We at the fed don't want aggregate supply put in place and then have too many people retire creating a labor shortage.

[Too Much Fed]

Determinant said: "US gov't debt in my view is related tangentially in that Treasuries were a repository for the US capital account surplus that fuelled the boom. The chronic capital account surplus/current account deficit was the problem."

Throw AAA rated mortgage debt in there too. The "dollar pegers" had to buy some financial asset in U.S dollars to keep their currency from rising. They wanted the highest yielding asset that would not default and not go down in value. For china and when interest rates in the USA were higher, this allowed them to issue "sterilization bonds" instead of doing something else like raising the reserve requirement.

[Too Much Fed]

Min said: "I think that's partly why Stephen Gordon said he had tongue slightly in cheek. ;) I don't think he means that the solution is debt. Rather, the solution is gov't spending, while the gov't pays less interest on the new debt. Now, if that gov't spending allows the lower and middle classes to reduce their debt to the rich, that's good for them, and it also reduces the interest paid to the rich."

I'd have to check, but it seems to me the amount of interest might be around the same because so much gov't debt has been issued even though interest rates have come down. The big problem is if real GDP doesn't grow fast enough (I don't believe it will). The rich still own bonds (gov't now), and they will "want their investment protected". That means don't tax them. My best guess is they want a VAT (tax increase) and "changes" to Social Security, Medicare, and Medicaid that will amount to cuts. If they don't get what they want, they will sell the gov't bonds and/or not roll them over and buy real assets to drive up prices.

[Too Much Fed]

Lorenzo from Oz said: "But our public debt is low, our central bank hasn't gone mad and the Chinese are still buying what we dig up. It's a different place."

How about private debt levels (I thought Steve Keen was showing high levels)? If the private debt starts going bad, what are the chances of it becoming public debt to "save the financial system" (bail out bankers again)?

[Min]

@Too Much Fed:

It seems like you are assuming an unbreakable plutocracy. It will take some doing, but I have hope that we can break it. :)

[Too Much Fed]

Min, it is not unbreakable but extremely difficult to break. It starts with the fed. I can't remember the last time congress actually said no to the fed (I mean a real NO). Anybody?

[Too Much Fed]

Patrick said: "The idea is that the Gov't borrow cheaply long term and invest long term in stuff that increases wages - like education, R&D etc. It's a free lunch. Why not eat it? (Yes, I'm being a little flip)"

It seems to me you are assuming a new industry/product comes along that would be supply constrained. I know most people want/hope it/it is that way, but it is still a big assumption and not necessarily a free lunch.

And, "FWIW, it seems to me that there are many other options that would work equally well. Treasury could mint a couple of $1 trillion dollar platinum coins, put them on deposit at the Fed, and write every American tax filer a check for $14K. Recession over."

Now, you are talking about medium of exchange changes. Good! However, higher taxes on some people will probably be necessary. I agree with Dan Kervick above about taxes.

And, "Or Congress/Treasury/Fed could print a trillion or two and start buying stocks."

That doesn't directly help those who don't own stocks, and I doubt companies like Intel will expand just because of something like that. Intel will be looking more at demand for their products, which they can produce from earnings. There could be some effect, but the biggest problem is most of the market of stocks are owned by the few who probably spend what they want already.

[Too Much Fed]

Dan Kervick said: "TMF, I believe that among the powers possessed by the US government, and delegated to the monetary authority, is the power to create money directly by crediting Fed-held accounts with higher balances, without at the same time diminishing balances in any other accounts or currency stocks. And I think that at the present time, it is advisable for the government to employ this kind of debt-free deficit expansion to boost spending and production.

I do worry that the process might be too inflationary in the long run, however, so another approach is to offset the added spending by extinguishing some surplus savings through taxation - which also does not increase the Federal debt."

I'd rather call it a debt-free expansion in the amount of medium of exchange along with the idea of "spinning off" the currency printing entity from the gov't.

I like the idea of surplus savings being taxed, if necessary.

Have you ever been over to http://www.interfluidity.com/?