Wednesday, June 20, 2012

Government Borrowing Opportunity Due to Current Historically Low Interest Rates

Interest rates on U.S. government borrowings are at historical lows. As a nation we owe close to $16 trillion and counting.

As a result, that indebtedness presents our government officials with a unique opportunity to do future U.S. taxpayers a valuable service. Since future generations are going to be saddled with so many bills that they will have had no role in accumulating, it's the least we should do, or so it seems to me.

That said, politics is politics, and, unfortunately, political decisions which immediately impact the very short term are deemed by the political class to be more important than doing the right thing for tomorrow's taxpayers, since future taxpayers aren't even voters yet. Politics sucks.

So while we don't recommend that individual buy bonds, we should urge the government to replace short term debt with long term debt to the fullest extent possible. And for as long as possible, too.

It would save U.S. taxpayers trillions of dollars in interest expense in the decades to come. So why aren't we doing just that?

Well, it's all about politics again and the difference in focus between the short and long term. Politicians look short term only, since that's when elections are held. To repeat, politics sucks.

Washington Should Lock In Low Rates is subtitled 'With the fed pushing yields near zero, there's no excuse for not issuing long-maturity bonds."

Here's the editorial's compelling argument for extending maturities to as long as 100 years:

"America has long been the land of the game show. And at some point just about all of us have screamed at a contestant: "Don't be stupid—take the money!"

That's what American citizens should be screaming at the United States Treasury today. The government has racked up $5 trillion of debt since President Obama moved into the White House. We don't know how we're going to pay it back. Yet the world is willing to lend us 10-year money at rates substantially below 2%.

So why not give our kids a break by issuing 50- or 100-year bonds, locking in today's puny rates? Corporations do it. In 1993, Disney issued $300 million in "Sleeping Beauty" bonds, and the market scooped them up. Last year, Norfolk Southern sold $400 million in 100-year bonds despite the obvious uncertainty: Will railroads be spaceships in 100 years?

Other governments are issuing long-term bonds, too. In 2011, buyers grabbed Mexico's 100-year bonds, despite that country's pockmarked history of devaluations and defaults. The average maturity of U.K. debt is three times longer than ours.

Instead of following these examples, the U.S. Treasury recklessly borrows short-term funds that must be rolled over. The Obama administration claims that it has taken advantage of low yields and extended the average duration of debt. But it's a flimsy boast. Yes, duration has moved up to 63.9 months but that is still short of the 2001 record of 70 months. And let's put the 2001 comparison in perspective. In 2001, 10-year Treasurys yielded 5.16%. Today, the 10-year rate is 1.62%. A more prudent administration would smash the 2001 record, not gaze up at it.

So why has the administration chosen to play the role of the feebleminded game-show contestant? The short answer is: out of shrewd political self-interest. Because short-term debt yields are typically the lowest on the yield curve, borrowing short gives the illusion of a lower budget deficit, flattering President Obama's fiscal profile—if anything can flatter a deficit-to-GDP ratio approaching 9%.

With a generous Federal Reserve squeezing short rates down to zero, the interest cost of existing debt looks pretty meager at 1.4% of GDP. But this is a terrible trade-off that makes President Obama look better while almost guaranteeing that our children are worse off. Issuing 100-year bonds, or at least 50-year bonds, would require a higher interest rate, perhaps 3%. Sure, that would put more pressure on near-term deficit reports. But leaders should be willing to let their personal image take a dent if it clearly helps the American people. . . .

The lesson in all this: Smart finance requires tough, long-range investments—not quick calculations to make deficit snapshots look rosier.

President Obama should admit that our relatively short-term debt imperils us. Former Federal Reserve Governor Lawrence Lindsey calculated on these pages in June 2011 that if yields jumped back to normal levels, deficit estimates would soar by $4.9 trillion over the next 10 years. One of these days when the government tries to roll over America's paper, rates will have catapulted much higher, and the world's financial system will look at the U.S. taxpayer and announce: "Game over. You lose."

My Take

The concept of the yield curve is real and simply means that rates increase as maturities lengthen. Thus, interest rates are higher for long term loans than they are for short term borrowings.

But also real is the fact that today's rates won't likely be this low again in any of our lives, no matter how old we are today. And five years from now, if not before, they'll likely be considerably higher than they are presently.

Simply put, the sloping yield curve means that interest rates are higher as the term of the loan is longer. So today yields for one month U.S. government bills are essentially zero, 0.3% for 2 year notes, 1.6% for 10 year notes and 2.7% for 30 year bonds. Thus, the slope of the yield curve means only that rates rise as loan maturities lengthen.

All that said, the low rates of today are not going to be this low forever. And they can't go much lower than they are currently.

Accordingly, it's time to take advantage of the favorable borrowing environment for U.S. securities and issue trillions of 30, 50 and even 100 year bonds. Stretch our average duration from 63.9 months currently to 15, 20 or even 25 years or so in the near future. From 5 today to 25 tomorrow sounds good to me.

Of course, borrowing at 3% to 4% or more is more costly than borrowing for 2% or less. At least in the short haul.

That said, it's all but an absolute certainty that paying 3% to 4% for really long term borrowings today would save U.S. taxpayers trillions of dollars over a long period of time.

All the politicians have to do now is act in their designated capacity as "public servants," including within that meaning even and perhaps especially that part of the public that has yet to be born.

Doing the right thing shouldn't be such a hard thing to get done in America.

Thanks. Bob.

No comments:

Post a Comment