US Treasury bonds really aren’t like any other instrument. It’s not just that they set a baseline for risk-free returns, no one really imagines that the debt will go away in our lifetime, and rolling over the bonds and paper of different maturities has more to do with managing duration risk than the possibility of getting back to even. But according to University of Chicago Booth School of Business professor John Cochrane this creates unnecessary inefficiencies that could be eliminated by structuring government debt differently.
“I propose a restructuring of U. S. Federal debt. All debt should be perpetual, paying coupons forever with no principal payment,” Cochrane writes in a recent paper US Federal Debt in the 21st Century.
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Treasury perpetuities as money market funds for the masses
In case it’s not obvious, that doesn’t mean that the US government would be unable to reduce its debt – it could by these treasury perpetuities in the market and retire them, the equivalent of a principal payment but without any specific date attached. Treasury would manage the total volume of treasury perpetuities outstanding, but wouldn’t have to worry about rolling over its debt anymore. This also would improve liquidity since there would be no more worry about one-the-run versus off-the-run Treasuries: a security sold last year would be indistinguishable from the same type sold ten years ago.
“From the customer’s view, this Treasury debt then looks exactly like a money market fund or reserves at the Fed. There is a small gain for the taxpayer that the dealer’s bid-ask spread is not lost every time bills are rolled over. Bond dealers may object,” writes Cochrane. “If banks can have interest-paying reserves, so can the rest of us.”
Allowing people to pay their taxes with this new type of variable interest, fixed-rate bond would further blur the line between it and regular money, but also should increase demand. The interest rate could be a policy instrument of the Fed or Treasury, or set by regularly held auctions, but he’s less concerned with the precise mechanism.
Fleshing out the idea
But that’s just the replacement for short-term debt. To fully flesh out the idea, Cochrane says there would also need to be a couple of other types of bonds. Nominal perpetuities that pay a $1 coupon forever, indexed perpetuities that pay $1 times the consumer price index, variable coupon bonds (with the rate tied to some explicit measure like GDP), and swaps between the different instruments.
“Treasury needs a tool to quickly and cheaply adjust the maturity structure of its debt,” writes Cochrane. “Like any bank desiring to manage its duration exposure, the Treasury should engage in swap transactions. Having defined a large quantity of floating-rate debt and fixed-coupon debt, the Treasury should manage interest rate risk for the government with simple fixed-for-floating swaps.”
Taken together, Cochrane argues that using treasury perpetuities would give Treasury more control over US federal debt with lower costs for taxpayers, while supplying financial markets with a product that plays the same role in a portfolio but without the rollover-arbitrage.
Cochrane isn’t interested in legal and political limitations
“I do not limit analysis of economic possibilities by an amateurish analysis of current legal limitations, or an even more amateurish analysis of current political limitations,” writes Cochrane.
It’s not clear whether Treasury, or the executive branch generally, has the authority to create the treasury perpetuities without legislation, but it does seem like an incredible difficult sell. Budget hawks have used the size of the Federal debt as a bludgeon before, and the expression ‘perpetual debt’ that Cochrane uses repeatedly in his paper is about as catchy as ‘death panels’. If he wants this idea, which does seem interesting on its merits, to become a reality, he may have to stoop to political persuasion.
The full paper can be found here Cochrane_US_Federal_Debt