Two of my recommendations for the Biden administration were quoted by Discourse Magazine. Click through to read. My contributions are under “The National Debt” at the bottom. My sincere thanks to Grayson Quay and the Discourse staff for the opportunity to contribute!
In this post, I discuss the details left on the cutting room floor. Topics include the history of the debt limit, the mechanics of debt limit suspension and reinstatement, Treasury’s cash and debt management practices, as well as sources for data and projections.
Renew the Debt Limit Suspension Before It Expires
Congress has always restricted the amount of debt that Treasury can issue. For much of U.S. history, Congress authorized debt on a per-issue basis. Debt was issued up to a specific amount and for a specific purpose, such as financing expenditures related to the Panama Canal. Congress changed this system with the Second Liberty Bond Act of 1917. The act introduced an aggregate limit on federal debt as well as on security types, such as separate limits for bonds and “one-year certificates of indebtedness.” The purpose of these debt limits were to give Treasury more flexibility in the financing of the government’s deficits, including wartime spending. In 1939, these limits were consolidated into today’s single statutory debt limit.
Treasury is required to meet all of the government’s spending obligations but cannot control the path of spending or taxes. Faced with positive and rising deficits, Treasury is dependent on Congress to periodically raise the debt limit. Congress has done so many times before. In the past decade, Congress has instead decided to temporarily suspend the debt limit. If the debt limit suspension expires, then the debt limit is automatically raised to accommodate Treasury’s outstanding debt. At the debt limit, Treasury may then use so-called extraordinary measures to finance the government for a time. To prevent Treasury from building a precautionary balance ahead of time, the suspension law requires that Treasury reduce its cash holdings to the level at the last suspension.
Since at least May 2015, the Treasury has attempted to hold enough cash to cover one week of outlays (net receipts) and principal and interest payments, subject to a 150 billion dollar minimum. This policy rule is an important aspect of their risk management strategy. The rule hedges against errors in the Treasury’s near-term forecasts of outlays and receipts, or loss of market access in an emergency. The law’s requirement that Treasury reduce their cash to the level of the last suspension (below 150 billion dollars) would immediately move balances into dangerous territory. In the 2019 debt limit episode, Treasury benefited from receiving seasonal tax flows in March and April. This time, if the debt limit suspension is allowed to expire, then Treasury will need to shed these trillions of additional dollars before August 1.
Treasury may also have to slash issuance to stay below the debt limit. This would break Treasury’s commitment to issue debt in a “regular and predictable” way, a key principle of their strategy to finance the national debt at the lowest cost. In my quote, I emphasized the experience from 2019 when dramatic increases to Treasury issuance after debt limit resuspension caused market dysfunction. Speculatively, dramatic decreases to Treasury issuance might also cause dysfunction. These issues are due to the plumbing of the dollar financial system, in which investment banks and securities traders finance their Treasury positions through repurchase agreements. Sudden shifts in the relative supply of Treasuries or cash can cause funding issues and rate volatility. Since Treasury yields are closely related to theoretical risk-free rates, this rate volatility can transmit to other financial markets like in banking and derivatives.
The debt limit was most recently suspended by the Bipartisan Budget Act of 2019, enacted on August 2. We can find important information about the suspension in the Daily Treasury Statement. Table I reports the Treasury’s operating cash balance. This allows us to see Treasury’s current cash holdings and their cash holdings at the last suspension. Table III-C includes data on the debt limit and the debt subject to limit. The table will note if the debt limit is suspended and the expiration date.
The Biden administration should work with Congress to renew the debt limit suspension before August 1. Debt limit legislation generally requires bipartisan cooperation to pass the Senate’s 60-vote filibuster threshold. However, certain legislation can bypass this threshold using a process known as budget reconciliation. With only simple majorities in the House and Senate, Democrats may use reconciliation to pass an annual budget resolution. If so, Democrats should include the debt limit renewal in this legislation.
For more information on the debt limit and its history, see this report from the Congressional Research Service. For more information on budget reconciliation, see this report from the House Committee on the Budget.
Lock in Low Borrowing Costs for a Generation
I sourced projections on debt/GDP from the Congressional Budget Office. At the time of writing, their most recent projections are from September 2020. Importantly, the CBO makes these projections under the assumption of current law. For better or worse, the actual debt burden will be influenced by new legislation. Last year, I commented on these issues here and here.
Treasury publishes data on the maturity structure of the national debt as part of their Quarterly Refunding process. See “Quarterly Release Data” on this page. Treasury maintains data on foreign holders of Treasuries, publishing monthly data with the lag. The most recent data can be found here. The Federal Reserve publishes daily data on interest rates in their H.15 statistical release. At the time of writing, 30-year Treasuries are trading below 1.9 percent.
John Cochrane’s work has influenced my views on perpetuities. For an academic treatment, see his paper “A New Structure for U.S. Federal Debt”. For a popular treatment, see John’s blog. My suggestion of a 2 percent coupon stems from Treasury’s preference to issue debt near par, plus a small gross on recent 30-year yields. The actual coupon rate might be higher depending on demand and whether Treasury wants to issue at par. Whatever Treasury’s choice, I think it’s most important to settle on a single coupon rate. If Treasury were to set the coupon rate based on auction bids like they do for other bonds, then the perpetuities are no longer perfect substitutes. This would harm their liquidity, one of their main benefits over 50-year or 100-year bonds
© 2021 Christopher Russo. All rights reserved.