Why not 100-year bonds?
If President-elect Donald Trump’s economic growth plan – slashing business and personal marginal tax rates, and rolling back costly business regulations – is achieved next year, the economy could break out with 4 to 5 percent growth. And that means much higher interest rates.
This rate rise will be growth-induced – a good thing. Higher real capital returns will drive up real interest rates. And inflation will likely remain minimal, around 2 percent, with more money chasing even more goods alongside a reliably stable dollar exchange rate.
We’re already seeing some of this with the big post-election Trump stock rally occurring alongside a largely real-interest-rate increase in bonds.
However, looking ahead, 4 percent real growth plus 2 percent inflation could imply 6 percent bond yields in the coming years. That’s a big jump from the 2 percent average of most of the past 10 years.
And what that says is, the time to act is now.
The average duration of marketable Treasury bonds held by the public has been five years for quite some time. Almost incredibly, Treasury Department debt managers have not substantially lengthened the duration of bonds to take advantage of generationally low interest rates. It’s hard to figure.
Treasuries held in public hands have moved up from 32 percent of gross domestic product back in 2008 to nearly 77 percent today. Interest expense for the 2016 fiscal year is nearly $250 billion. So if Treasury debt managers had significantly lengthened their bond maturities, they would have saved taxpayers a bundle.
Now, with new economic growth policies poised to drive up average Treasury rates to, perhaps, 6 percent, the Treasury folks better get moving fast to capture today’s historically low yields. Up till now they’ve been sleeping at the switch. The key point is to start issuing longer bond maturities – much longer. If possible, the U.S. should experiment with 50-year debt issuance, and maybe as long as a 100-year issuance.
And this better happen fast. According to economist Conrad Dequadros, other countries have been smarter than us. Ireland and Belgium issued 100-year debt. Austria issued 70-year debt. Italy, France and Spain issued 50-year debt. Japan pushed out a 40-year maturity, and there are rumors that it’s considering 50 years.
And Mexico, incredibly enough, has done three 100-year issues since 2010. The sizes were small, and the bonds were sold in foreign currencies. But it can be done.
Britain is probably the best benchmark. HM Treasury has issued 40- to 50-year bonds seven times. The latest auction occurred in Oct. 2015, with the issuance of 50-year debt with a coupon of 2.5 percent.
Dequadros says the Congressional Budget Office estimates that interest costs over the next 10 years will total $4.8 trillion, and the debt will rise from the current $14 trillion to $23.1 trillion by 2026.
Additionally, it expects the 10-year Treasury rate to average 3.3 percent and the rate on all debt to average 2.6 percent.
Now, with some very rough back-of-the-envelope calculations, under Trump’s growth program, suppose 10-year Treasury rates rise to average 5 percent over the next 10 years, rather than the CBO’s 3.3 percent guess. The average interest rate for all debt would increase to 4 percent over that period, rather than CBO’s estimated 2.6 percent. The total interest rate expense would be around $7 trillion, rather than the CBO’s $5 trillion baseline.
However, if the U.S. issued 50-year debt with the same rate as Britain’s 2.5 percent, by front-loading some longer-term issuance to hold the average interest rate to 3.5 percent, there would be a $1 trillion savings on budget-interest expense over the 10-year horizon.
That’s not chump change.
Skeptics will ask who would buy 50-year U.S. paper. It’s a good question. But remember, insurance companies and pension funds need long-dated liabilities to match long-duration assets. And foreign institutions might also be interested in ultralong U.S. Treasuries, provided the U.S. dollar is reliably stable.
This is entirely new ground for U.S. debt management. But since a lot of foreign countries have successfully sold 50-year paper, we know it can be done.
And for the U.S. it must be done.
If we sell out a bunch of 50-year offerings, why not try a 100-year paper? The budget savings would be incalculable. And under new policies, if the U.S. returns to its long-term annual growth trend of 3.5 percent, which prevailed in the prior century, America’s debt-to-GDP ratio could plunge to 30 or 40 percent, instead of skyrocketing to 150 percent or more.
Stronger growth and much longer bond-maturity issuance will snatch fiscal victory from the jaws of defeat.
To find out more about Lawrence Kudlow and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate webpage at www.creators.com.