The case against using US surplus to pay off debt

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Economist A. Gary Shilling recalls getting a call from TV evangelist Robert Schuller about a decade ago regarding a book Dr. Schuller was writing on "The Power of Being Debt Free."

The Rev. Mr. Schuller noted how the Crystal Cathedral in Garden Grove, Calif., had been built from contributions, without incurring any debt.

That's the way the federal government should be - debt free, Schuller told the Springfield, N.J., consultant.

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For some decades, it appeared unlikely that Washington would reach a budget surplus, let alone wipe out the federal debt piling up.

"I thought there would be an infinite supply of Treasury issues," recalls David Jones, board chairman of Aubrey G. Lanston & Co., a New York-firm that deals in government debt.

Now the budget is in surplus - $5.6 trillion over the next 10 years, the Congressional Budget Office (CBO) projected last week. Already, since 1998, $600 billion of the federal debt has been repaid. And Federal Reserve Chairman Alan Greenspan says the debt - about $3 trillion still owed to the public - could be eliminated this decade.

Hallelujah!

Wait, though. Mr. Greenspan and other economists are raising questions about whether full debt repayment makes sense.

Sure it would ease the interest payments that Uncle Sam must pay each year to owners of "Treasuries" with money from American taxpayers. Federal surpluses mean lower interest rates for private debtors as well.

But if the debt vanishes, this also creates problems.

Greenspan worries that even before the debt is entirely gone, the federal government might use its surplus revenues to buy private assets - perhaps stocks and bonds.

With an accumulation of private assets, "it would be exceptionally difficult to insulate the government's investment decisions from political pressures," Greenspan told Congress.

In other words, politicians might use the economic power accompanying massive purchases and holdings of stocks, bonds, etc. for political purposes. A senator, facing a tough election, might persuade a friendly Treasury official to buy stock or debt of a development company in his state to bolster his political prospects.

That could diminish economic efficiency, Greenspan noted, and hit living standards.

Full debt repayment could cause other difficulties.

At present, the Fed conducts monetary policy by selling or buying Treasuries. Treasuries also "lubricate" capital markets, making trading in financial instruments easier. These are "good reason to preserve a cushion of federal debt," says Tom Schlesinger, director of the Financial Markets Center in Philomont, Va.

Last Wednesday, because of the surplus, the Treasury Department announced it would eliminate one of several types of Treasury debt issues, the 52-week bill, at the end of this month. An advisory panel called for scrapping the 30-year bond as expensive and inconsistent with expectations of wiping out the debt. Some other maturities have already disappeared, such as two-year notes.

If Treasuries completely dried up, the Fed could instead buy and sell debts of government-sponsored enterprises, such as the home-mortgage securities put together by Fannie Mae and Freddie Mac. These are assumed to have a federal guarantee, though less firm than for Treasuries. Fed policymakers reportedly were considering such untested ideas last week, just before slashing interest rates another half a percentage point.

And what will private financial institutions and some individuals do without those safer-than-safe Treasury bonds, bills, and notes?

With the present short supply of Treasuries, commercial banks, insurance companies, and other financial fiduciaries are paying a premium for Uncle Sam's debts.

Without Treasuries, money managers will need to find substitute debt instruments. Mr. Shilling suspects this will be a special problem for "run-of-the-mill money managers" with little experience in other debt markets.

Already, major corporations, such as the finance arms of General Motors and Ford, are trying to make their riskier bonds a favorite substitute for Treasuries.

A decade ago, there were 44 so-called "primary dealers," such as Aubrey G. Lanston, who bought Treasuries from the government for resale. Now there are about half that many dealers.

Some liberal economists say the surplus offers an opportunity to tackle social needs. "Education, transportation, voting technology," suggests Mr. Schlesinger.

If a recession occurs, the surplus will melt - "like ice cream on the pavement in August," says Shilling. The CBO, though, reckons the 10-year surplus would shrink just $133 billion.

(c) Copyright 2001. The Christian Science Publishing Society

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