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Dan Katz: Janet Yellen’s Risky Debt-Management Business



Her overreliance on short-term borrowing sets taxpayers up for a painful economic reckoning. The Biden administration’s profligate spending—driving unprecedented trillion-dollar deficits during a full-employment, peacetime economy—has naturally required an increase in borrowing. But the size of Treasury issuance is only one aspect of U.S. borrowing. The way the U.S. borrows is equally important to market assessments of American financial credibility.

Traditionally, the U.S. funds itself mostly with medium-term notes and long-term bonds. The Treasury Department generally refrains from trying to time the market and has instead sought to issue notes and bonds with a stable and predictable rhythm. This approach helps provide orderly benchmark interest rates and lets markets plan for absorbing the significant interest-rate risk that comes with longer-term Treasury securities. This reinforces market stability.

Short-term debt in the form of Treasury bills has generally made up between 15% and 20% of the total outstanding stock of debt. During recessionary periods, the proportion of bills generally increases as the deficit increases, both because the creation of safer assets helps meet a market need and because of the desire to maintain stable and predictable note and bond issuance. That’s why bills went from approximately 15% of outstanding debt in February 2020 to 25% by May 2020. The government was trying to fund its Covid response during a downturn. As the economy recovered, debt management returned to traditional practice, with bills falling to less than 20% of outstanding debt by July 2021, even amid the blowout spending of the American Rescue Plan.

But in 2023 the Treasury Department significantly boosted bill issuance, raising bills’ share of outstanding debt from approximately 15% at the beginning of the year to approximately 22%, where it remains today. As a result of this shift, Treasury Secretary Janet Yellen issued more than $1 trillion in bills—debt that under normal conditions would have been issued as notes and bonds.

The incremental issuance of bills effectively eased financial conditions by reducing the amount of interest-rate risk markets would have otherwise needed to absorb in the form of higher note and bond issuance. As markets digested smaller than expected note and bond issuance in the fourth quarter of 2023, 10-year Treasury yields fell from nearly 5% at the beginning of November 2023 to less than 4% by the end of December 2023. This helped spark a more than 25% rise in stock prices that stimulated the real economy. Despite yet another $1 trillion deficit projected for 2024, the Treasury Department recently reaffirmed that it doesn’t plan to increase issuance for at least the next several quarters, which conveniently will keep increased note and bond supply off the market through the November election.

But the short-term sugar high comes at a significant cost for taxpayers. The easing of financial conditions has reignited inflationary pressures that may ultimately require more economic pain to cool. The government’s interest expense will increase as a result of the need to roll over short-term financing at elevated rates rather than locking in lower long-term rates as a result of the inverted yield curve. To the extent that long-term interest rates are structurally higher as a result of deglobalization and other macroeconomic trends, Ms. Yellen’s bet will be even more painful for taxpayers.

The biggest threat comes from the erosion of norms regarding prudent public debt management. Markets depend on the credibility of the Treasury secretary. As investors adjust to Ms. Yellen’s unprecedented departure from Treasury issuance practices to a risky new strategy that benefits markets before the election, borrowing costs across the curve will likely rise, further eroding the U.S. fiscal position.

Mr. Katz is an adjunct fellow at the Manhattan Institute and served as a senior adviser at the U.S. Treasury Department, 2019-21.


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Posted: May 16, 2024 Thursday 06:12 PM