While President Trump’s tweet calling the members of the Federal Reserve “boneheads” for failing to cut interest rates as low as Trump wants them grabbed the financial headlines, his suggestion that the government “refinance” its enormous $22.5 trillion debt got less attention. At the most, it was dismissed as undoable.
It’s hard to believe that the smartest people on Wall Street and at the U.S. Treasury can’t come up with some kind of scheme that would take advantage of today’s – and probably tomorrow’s – historically low bond yields and save taxpayers some money. This job would fall to Treasury Secretary Steve Mnuchin – himself a former Goldman Sachs investment banker – and not the Fed.
On Thursday, Mnuchin told CNBC that Treasury is “very seriously considering” issuing a 50-year bond next year. “We think there is some demand for it. There are some technology issues we need to make sure we have in place; there are market issues. But we would do this in a way that if there is demand, it’s something that we would meet.”
If Walt Disney and several European countries can sell 100-year bonds, certainly the United States of America can.
The initial reaction to Trump’s suggestion about refinancing Treasury debt was met with derision and skepticism.
“It’s not viable and could be a significant problem for investors, financial markets and ultimately the economy,” Mark Zandi, chief economist at Moody’s Analytics, told CNBC, which said the idea is “without any modern precedent.”
“The debt is not prepayable,” Zandi continued. “There’s a contractual relationship the Treasury has with investors. This isn’t a mortgage; this is U.S. Treasury debt. I think it would be incredibly disruptive to financial markets, and interest rates would ultimately rise, not fall.”
Well, yes and no. The Treasury refinances or rather rolls over, its debt constantly. That’s how the federal government runs, after all: Most of the debt it issues simply replaces – but doesn’t retire – old debt as it comes due, with a little (okay, a lot) extra for new spending (and more debt). While that’s not technically a refinancing, it comes pretty close.
But there is a precedent in the municipal bond market, although there are special circumstances there. For years state and local governments have sold “prerefunding” bond issues to pay off their old, higher-yielding ones. The proceeds from the new issues are used to buy specially tailored U.S. Treasury bonds called State and Local Government Series, or SLGs – pronounced “Slugs” – which are used to pay interest on the old muni bonds until they mature. That gives them an automatic triple-A rating because they’re now backed by the federal government. Neat, huh?
Now, SLGs are a unique animal, so duplicating them in the Treasury market would be a lot trickier. What makes SLGs doable is the fact that most of the time, Treasury securities yield more than comparable muni bonds because the latter are usually exempt from federal taxes. So there’s enough extra yield to pay off the older debt.
To do the same thing in the Treasury market would presumably require the government to issue vastly more and longer debt – albeit at lower rates – to pay off older debt. Or maybe not. Again, I’m sure the smartest people on Wall Street would be happy to come up with some workable ideas.
The problem is that the Treasury is selling too much debt at today’s relatively high short-term rates and not enough at lower long-term rates. What the Treasury needs is better debt and yield curve management, not artificially lower rates.
That’s why the rest of Trump’s tweet storm should be dismissed as nonsense, such as his suggestion that “the Federal Reserve should get our interest rates down to ZERO, or less.” This would drag us down to the level of the European and Japanese economies, which have been trailing U.S. economic growth badly for the past 10 years despite much lower – even negative – interest rates and all kinds of quantitative easing. The U.S. doesn’t need to go down that road.
Of course, the only real solution to Mr. Trump’s problem is for the federal government is to stop spending and borrowing so much money. Unfortunately, that’s the one issue that draws bipartisan support – against it. There is no appetite, desire, or even inclination in Washington to stop spending. Most Democrats have never pretended to be fiscally responsible, while Republicans talk the talk but never seem to walk the walk. Now Trump has united both parties in unconstrained spending.
As one of Trump’s predecessor’s recognized a long time ago: “We are all Keynesians now.” If that’s the case, a 30-year bond just isn’t long enough.
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George Yacik
INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.
