In ancient Rome, new emperors who wanted to survive their first few months wearing the imperial purple very quickly paid Legionnaires a “donative” of gold to earn the troops’ good favor, and (hopefully) their respect and loyalty. The “donative” had originally represented a distribution of tribute from successful conquests—note the relationship to our contemporaneous “donation.” Over time, it evolved to become an entitlement charged against the Roman Treasury. In essence, the donative came to serve as a dividend from the State to those who expanded and secured the State.
During Rome’s tumultuous and lengthy decline, the donative increasingly depleted a Treasury already suffering from the effects of war, famine, revolt, corruption, and low productivity. To fill the Treasury, Rome periodically conquered the Goths, Allemani, or Scythians, boosting revenues through simple plunder, extortion, and levies; however, they could not raise capital by selling debt instruments to their willful and fiercely independent neighbors as nations can today.
Currently, thoughtful investors and citizens are asking many questions about the state of the US Treasury. There is widespread recognition that US debt obligations are increasing dramatically at a time when government revenues are under negative pressure due to lower asset values, reduced incomes, and lower corporate earnings, and that this relationship is expected to persist and potentially intensify going forward. Even the most ardent Keynesians at some level recognize that government spending is only stimulative in so much as it inspires greater economic output of goods and services in non-government sectors.
This realization leads some to ask how the US Treasury will continue to finance the operations of our government agencies, backstop our financial system, and fund our ever increasing entitlements. What might happen, they ask, should foreign investors materially reduce their willingness to loan money to the US through the purchase of US Treasury Bonds? What if institutional and retail investors move out of Treasuries due to concerns about risk or rising interest rates, or because they believe other securities provide greater relative value with comparable or even less risk?
Central to any discussion about US Treasury debt must be the recognition that for US taxpayers, Treasuries represent loans that we have taken out to cover the current operation of our government. They are not just random investments like buying stock in Johnson & Johnson or Berkshire Hathaway, but actual liabilities against our shared balance sheet. Sometimes, investment parlance clouds the issue, causing ordinary taxpayers to think that when they buy a US Treasury they are simply making a safe investment, rather than thinking of it as making a loan to meet our collective obligations. With those obligations dramatically exceeding our revenues, it is hard to describe such an investment as “safe” in the way that many people think that means.
One year ago, the US Treasury paid just 2.9% interest to borrow money for 10 years; now, we pay over 3.9%, an increase of 35% in one year. Over the past two weeks alone, the cost of financing 10 year US Treasury debt rose from 3.6% to 3.9%, an increase of 10% in just a handful of days. While still relatively modest compared to historic interest rates, the sharp increases represent changes in lender sentiment. With rates at 3.6% two weeks ago, lenders shied away from the US Treasury auctions, causing rates to move toward 4.0% in order to attract investors. This week’s auctions were once again strong, but cost taxpayers quite a bit more to finance the issues. Will this pattern continue? Can we afford to let it continue?
For the sake of argument and despite Fed Chairman Ben Bernanke’s admonitions, let’s assume that it is unlikely that Congress will materially reduce projected spending. If so, then what are some of the options before the Treasury for ensuring a steady supply of lenders to the US?
- Should Congress compel municipalities (states, cities, special districts, etc.) to hold higher levels of their reserves and pension plans in US Treasury securities? Perhaps they could mandate such a policy in exchange for the implied guarantee that the US will absorb obligations of municipalities in crisis?
- Should Congress, the OCC, and other financial regulators compel banks and insurance companies to hold higher levels of their reserves in US Treasury securities? Perhaps they have already earned the right to make such a demand in exchange for the implied guarantee that the US will bail out, prop up, and otherwise backstop financial services companies?
- Should Congress compel corporate pension plans and union Taft-Hartley plans to hold specific levels of US Treasury securities? How would the beneficiaries of such plans feel (and vote) if they knew that their plans were being used for a purpose other than the benefit of the plan participants? What would be provided in return?
- Should Congress require individual investors to hold certain percentages of their IRA, Roth IRA, and 401k/403b plans in US Treasuries in exchange for the continued tax deferral/tax -exempt status of the investments?
- Should the IRS and Congress demand that Foundations, Endowments and other nonprofit funds be compelled to invest certain percentages in US Treasuries in order to maintain their tax-exempt status?
Obviously, all of these options bear tremendous consequences economically, politically and socially. There would be a heavy price to be paid by the Congress that initiated any of the policies listed above; yet, that price might be easier than the one to be paid by those Representatives who attempt to rein in Social Security, defense spending, foreign aid, education spending or of course, health care.
Regardless of where one stands politically, tough decisions are coming and the longer it takes, the more painful such decisions will be. The Rubicon has been crossed; it remains to be seen how we pay for it.