Saturday, November 19, 2016

Barron's Cover;"Taming Federal Debt: The Case for 100-Year Bonds"

From Barron's:

Why Donald Trump should channel Alexander Hamilton and take advantage of ultralow interest rates.
As Donald J. Trump attempts to assemble his cabinet, he can only look with envy on George Washington, who could tap such towering figures as Thomas Jefferson as secretary of state and Alexander Hamilton as secretary of the Treasury. Long before the hit musical bearing his name, Hamilton’s greatest achievement may have been putting the young nation’s finances in order with an innovative plan to consolidate its debts going back to the Revolutionary War. 

Trump could use a modern Hamilton as he contemplates America’s heavy debt burden and its need for faster economic growth. The federal government today has $14 trillion in debt owed to the public. If the Trump administration were to add no spending programs and cut no taxes, the rising costs of existing programs like Medicare and Medicaid would likely push the national debt to $45 trillion in 20 years’ time. So says the nonpartisan Congressional Budget Office.

The annual interest on a $45 trillion debt load would be about $750 billion at today’s superlow interest rates. If rates rise to a more typical level, the interest on a $45 trillion debt would be about $1.5 trillion a year. That’s right, $1.5 trillion a year in interest payments, as much as the federal government’s total spending over the past five months. 

And that’s before President-elect Trump launches his ambitious spending programs and tax cuts, which are expected to add $6 trillion to the national debt over the coming decade. We expect some, but not all, of those proposals will be blocked by the Republican Congress. 

Given the incoming administration’s ambitious plans, and the nation’s already high debt, the president-elect might ask: What would Hamilton do?

With long-term interest rates hovering near their lowest levels since the founding of the republic, Hamilton might well answer, Take advantage by issuing Treasury bonds now—and for the longest term possible.
In today’s market, that would mean issuing securities far beyond the Treasury’s current lengthiest maturity of 30 years. Unlike his less-hidebound foreign counterparts, Uncle Sam has been resistant to departing from long-established borrowing habits. Meanwhile, governments such as Ireland, Belgium, and even Mexico have been opportunistic by issuing 100-year bonds.

The reason should be clear from a perusal of the nearby chart showing the history of long-term U.S. interest rates going back to Hamilton’s time. Through a civil war, world wars, and depressions, the cost of borrowing has waxed and waned. 

The most recent period has been the most extreme. From a peak of about 14% in 1981, the 30-year Treasury bond’s yield reached a low of 2.09% earlier this year. While the yield has moved back toward 3% with the surge in rates after the U.S. elections, it is still exceptionally low by any criterion. 

Viewed against the sweep of history, the graphic shows that interest rates move in long cycles. The great post–World War II rise in bond yields lasted roughly 35 years, until it peaked after a surge of inflation in the 1970s. Since then, rates have been on a 35-year downward swoon. 
WHETHER BY HISTORICAL coincidence, a shift in central-bank monetary policies, or the populist wave that has shaped both the United Kingdom’s vote to leave the European Union and Trump’s triumph in the U.S. presidential election, interest rates appear to have hit their trough. That, of course, will be known only in retrospect. What seems certain is that today’s interest rates are far closer to their lows than to their highs.

Given that, the call for borrowers should be clear: Go long. It doesn’t take a genius on the order of Hamilton to realize that. U.S. homeowners have been taking advantage by locking in 30-year fixed-rate mortgages in the 3% range. If they haven’t, it’s because they may have opted for shorter-term loans of about 15 years, probably because they are approaching retirement and prefer to spend their golden years debt-free.
For a nation, however, it’s different. One should match one’s liabilities with the life of one’s assets, says James Bianco, head of Bianco Research and one of the most astute observers of financial matters. Given that the United States of America is 240 years old and has an infinite life expectancy, we hope, issuing 50-year or 100-year bonds makes sense....MORE