Why the Trump Administration’s calls for lengthening bond maturity make no sense

The problem with the Trump administration’s talk about lengthening the maturity of debt issuance is that it confuses the future path of interest rates with the steepness of the yield curve. They talk about locking in low rates. And what they mean is locking in low nominal rates today for fear that interest rates will rise in the future. But what you want to do is issue bonds at the lowest possible rate that you can while still supplying the market with the liquidity — the slug of safe assets — it needs to function properly.

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The problem with the Trump administration’s talk about lengthening the maturity of debt issuance is that it confuses the future path of interest rates with the steepness of the yield curve. They talk about locking in low rates. And what they mean is locking in low nominal rates today for fear that interest rates will rise in the future. But what you want to do is issue bonds at the lowest possible rate that you can while still supplying the market with the liquidity — the slug of safe assets — it needs to function properly.

The fallacy in the Trump argument is that longer maturity bonds issued today replace higher yielding bonds issued tomorrow. They don’t. Longer maturity Treasuries issued today replace shorter maturity ones issued today. And longer maturity ones issued tomorrow replace shorter maturity Treasuries issued tomorrow. So the Treasury issuance swap is not inter-temporal – tomorrow’s bonds for today’s; it’s purely a swap of short for long-dated paper at each discrete point in time.

And we know that because the only time Treasuries are issued is when the Treasury’s accounts are in jeopardy of shortfall. The Treasury is mandated by Congress to cover all expenses not met by tax receipts by issuing bonds. Taxes come in and the Treasury credits its accounts accordingly. Expenses are created and the Treasury debits the government’s accounts accordingly. When the Treasury is about to have a shortfall in its accounts, it issues bonds. Otherwise, it would have to credit bank accounts directly or default on its own obligations. And the Treasury is legally forbidden from simply crediting accounts without first raising the funds from elsewhere. 

And the reality is this: because the yield curve is usually upward sloping, short term rates are almost always lower than long-term rates. Increasing maturity will INcrease the Treasury’s interest expense, not decrease it.

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Take a look at this chart:

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It shows you how steep the yield curve is by measuring the yield difference between 2-year Treasuries and 10-year Treasuries. About 95% of the time, 2-year rates are lower than 10-year rates. And the only time when that ISN’T true is when the economy is about to tip into recession. The chart says that if Trump were to swap out issuance of 2-year Treasuries for 10-year Treasuries, or even still 50- or 100-year Treasuries, he would be paying at least 1% more interest for every dollar he swapped out.

The only plausible way that the Trump administration could avoid increasing its debt service costs is by swapping out issuance of shorter maturity debt tomorrow for the issuance of longer maturity debt today (or by somehow lowering the yield of all future Treasuries simply because it had changed the maturity structure of issuance). That means the Trump administration would be issuing a massive slug of 30, 50, and 100-year bonds today and future administrations wouldn’t be issuing the same massive slug of 1-, 2- or 3-year bonds in 5 or 10 years’ time exactly because Trump had already collected the revenue. How likely is that?

Basically, the only time Treasuries are issued is when the Treasury’s accounts are in jeopardy of shortfall. So the concept that Trump would issue a lot of bonds today that aren’t necessary to meet today’s expenses in excess of taxes — in order to help diminish future debt issuance at a potentially HIGHER nominal yield doesn’t fly. Basically it won’t happen.

What WILL happen under this plan is that the Trump Administration will issue less short-dated paper and more long-dated paper, today, to meet incoming expenses in excess of tax receipts, today. And in doing so, because of an upward sloping yield curve, it will be increasing its debt service costs.

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