CEPR - Center for Economic and Policy Research

Multimedia

En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press Allan Sloan Explains the Relationship Between Interest Rates and Bond Prices and How the Government Can Costlessly Eliminate Large Amounts of Debt

Allan Sloan Explains the Relationship Between Interest Rates and Bond Prices and How the Government Can Costlessly Eliminate Large Amounts of Debt

Print
Friday, 15 February 2013 06:35

Allan Sloan used his column today to explain a simple but often overlooked point, when interest rates rise, bond prices fall. This means that if long-term interest rates rise substantially in a few years, as the Congressional Budget Office predicts, then the bonds issued at very low interest rates today will be selling at large discounts.

The implication of this fact is that in 2015 or 2016, the Treasury would be able to purchase back much of the debt issued today at substantial discounts. This would allow it to drastically reduce the government's debt at no cost. For example, if it bought back debt with a face value of $4 trillion at an average discount of 20 percent, it could instantly eliminate $800 billion in debt, reducing the debt to GDP ratio by almost 5 percentage points.

This step would be pointless from either an economic or financial standpoint since it would not change the interest burden facing the country, but it should make many of the deficit cultists happy. Since these cultists, who largely control the economic debate in the United States, assign some mystical power to specific debt to GDP ratios, they should be pacified by the knowledge that we can buy bonds back at a discount to keep the debt burden under their magic number. This route is much simpler than raising taxes or cutting spending.

Comments (11)Add Comment
...
written by beowulf, February 15, 2013 9:03
Would be easier to pay debt service off-budget with trillion dollar coin ($5T in net interest saved over next decade, even more for gross interest). Since apparently nobody likes the simplest solution to these sorts of things (Secretary of the Treasury could do this himself), Congress could enact a financial transaction tax with adjustable % rate pegged at one-tenth of 3 month T-bill rate. Whenever, if ever, the Fed raised rates, Tsy would receive more in taxes than it paid in additional interest. Thanks to the magic of the Constitution's fourth branch of government (which apparently only economists are aware of, maybe its written in algebra), adjusting monetary policy in the wake of either of these is the Fed's problem.


The Coin is Dead! Long Live the Coin!
written by Peter K., February 15, 2013 11:02
The problem is that the coin would weigh as much as a ballistic submarine.

http://www.slate.com/blogs/moneybox/2013/01/10/fox_news_coin_ignorance.html
ballistic missile submarine, that is.
written by Peter K., February 15, 2013 11:17
What would be the sign that the first sign that the CBO's predictions are turning out to be true? Sloan writes "The CBO is predicting that 10-year Treasury notes — which, remember, are currently yielding 2 percent — will yield 3.2 percent in 2015."

So the 10-year note yields would rise from 2 percent in 2013 to around 2.6 in 2014 and keep rising? And their price would fall? Would their be an earlier signa? Stupid question, I know.
...
written by Bloix, February 15, 2013 12:09
Doesn't this imply that the market thinks that the CBO is wrong about future interest rates?
...
written by JSeydl, February 15, 2013 12:20


Dean, can you clarify something here? This only works if the cash obtained from issuing debt today is held. But that's not what's currently happening. The cash obtained from issuing debt today is being used to fund, for example, income security. If rates rise in 2015, the Treasury won't be able to buy back the debt at a discount, because the Treasury won't have the cash on hand. You could say that the Treasury could issue more debt today for the purposes of building up a cash position for when rates do rise, but that's a slightly different argument -- because investors might behave differently today if they suddenly saw the Treasury hoarding massive amounts of cash.
...
written by Mark Jamison, February 15, 2013 12:41
John Lounsperry has an interesting post up regarding a Martin Wolff article on a parallel topic:
http://econintersect.com/b2evo...thinkable

Dr. Baker, I wonder if you would be interested in talking about some of the new discussion about monetizing the debt.
...
written by Chris Engel, February 15, 2013 1:05
The CBO never predicts recessions and is always wrong on medium- to long-term horizons.

Just thought i'd throw that in there.

But you're 100% right -- yes it won't do anything but change the duration risk of the Treasury's portfolio, but it would be an easy way to manipulate the debt/gdp ratio to assuage the panic of frantic policymakers
the CBO's been wrong, the market's been wrong many a time
written by Peter K., February 15, 2013 2:28
Who do you believe? @ Bloix

What makes you say that that the market doesn't agree with the CBO's forecasts?

Isn't this the WaPo columnist's ostensible point, that if the CBO is correct than a lot of people will lose money?

The market was wrong about housing prices never going back down.
Mechanics of purchase
written by Dean, February 15, 2013 2:37
Joe,

On your question, the government just has to be able to borrow in 2016. Suppose the market value of 30 year bonds issued today has fallen by 30 percent. If it borrow $700 billion in 2016, it can buy back bonds with a face value of $1 trillion, leading to a net reduction of $300 billion in outstanding debt.

It's simple, fun, and easy.
"I am a chimera"
written by David, February 15, 2013 4:38
...
written by JSeydl, February 15, 2013 12:20


Dean, can you clarify something here? This only works if the cash obtained from issuing debt today is held. But that's not what's currently happening. The cash obtained from issuing debt today is being used to fund, for example, income security. If rates rise in 2015, the Treasury won't be able to buy back the debt at a discount, because the Treasury won't have the cash on hand. You could say that the Treasury could issue more debt today for the purposes of building up a cash position for when rates do rise, but that's a slightly different argument -- because investors might behave differently today if they suddenly saw the Treasury hoarding massive amounts of cash.

What cash? The Treasury issues $700 billion in new debt to buy back $1 trillion in old debt and, voila!, the debt is reduced $300 billion. The interest burden hasn't really changed, but if the deficit hawks were concerned about that then they wouldn't be concerned now, would they? But they love their little chimera
...
written by JSeydl, February 15, 2013 4:46
OK, I see. What's funny is that you could imagine a situation in which the government has funding problems even with a very low debt-to-GDP ratio - namely, if the interest burden was already high before the debt was bought back.

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.

busy
 

CEPR.net
Support this blog, donate
Combined Federal Campaign #79613

About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

Archives