Category Archives: Public debt

Will DOGE Hunt? Bond Market Naturally Defers

21 Friday Feb 2025

Posted by in DOGE, Public debt

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Matt Yglesias tweeted on X that “the bond market does not appear to believe in DOGE”. He included a chart much like the updated one above to “prove” his point. Tyler Cowen posted a link to the tweet on Marginal Revolution, without comment … Cowen surely must know that any such conclusion is premature, especially based on the movement of Treasury yields over the past month (or more, since the market’s evaluation of the DOGE agenda preceded Trump’s inauguration).

Of course, there is a difference between “believing” in DOGE and being convinced that its efforts should have succeeded in reducing interest rates immediately amidst waves of background noise from budget and tax legislation, court challenges, Federal Reserve missteps (this time cutting rates too soon), and the direction of the economy in general.

In this case, perhaps a better way to define success for DOGE is a meaningfully negative impact on the future supply of Treasury debt. Even that would not guarantee a decline in Treasury rates, so the premise of Yglesias’ tweet is somewhat shaky to begin with. Still, all else equal, we’d expect to see some downward pressure on yields if DOGE succeeds in this sense. But we must go further by recognizing that DOGE savings could well be reallocated to other spending initiatives. Then, the savings would not translate into lower supplies of Treasury debt after all.

Certainly, the DOGE team has made progress in identifying wasteful expenditures, inefficiencies, and poor controls on spending. But even if the $55 billion of estimated savings to date is reliable, DOGE has a long way to go to reach Musk’s stated objective of $2 trillion. There are some juicy targets, but it will be tough to get there in 17 more months, when DOGE is to stand down. Still, it’s not unreasonable to think DOGE might succeed in accomplishing meaningful deficit reduction.

But if bond traders have doubts about DOGE, it’s partly because Donald Trump and Elon Musk themselves keep giving them reasons. In my view, Musk and Trump have made a major misstep in toying with the idea of using prospective DOGE savings to fund “dividend checks” of $5,000 for all Americans. These would be paid by taking 20% of the guesstimated $2 trillion of DOGE savings. Musk’s expression of interest in the idea was followed by a bit of clusterfuckery, as Musk walked back his proposal the next day even as Trump jumped on board. PLEASE Elon, don’t give the Donald any crowd-pleasing ideas! And don’t lose sight of the underlying objective to reduce the burden of government and the public debt.

Now, Trump proposes that 60% of the savings accomplished by DOGE be put toward paying for outlays in future years. Sure, that’s deficit reduction, but it may serve to dull the sense that shrinking the federal government is an imperative. The mechanics of this are unclear, but as a first pass, I’d say the gain from investing DOGE savings for a year in low-risk instruments is unlikely to outweigh the foregone savings in interest costs from paying off debt today! Of course, that also depends on the future direction of interest rates, but it’s not a good bet to make with public funds.

Nor can the bond market be comforted by uncertainty surrounding legislation that would not only extend the Trump tax cuts, but will probably include various spending provisions, both cuts and increases. As of now, the mix of provisions that might accompany a deal among GOP factions is very much up in the air.

There is also trepidation about Trump’s aggressive stance toward the Federal Reserve. He promises to replace Jerome Powell as Fed Chairman, but with God knows whom? And Trump jawbones aggressively for lower rates. The Fed’s ill-advised rate cuts in the fall might have been motivated in part by an attempt to capitulate to the then-President Elect.

Trump’s Executive Order to create a sovereign wealth fund (SWF), which I recently discussed here, is probably not the most welcome news to bond investors. All else equal, placing tax or tariff revenue into such a fund would reduce the potential for deficit reduction, to say nothing of the idiocy of additional borrowing to purchase assets.

Finally, Trump has proposed what might later prove to be massive foreign policy trial balloons. Some of these are bound up with the creation of the SWF. They might generate revenue for the government without borrowing (mineral rights in Ukraine? Or Greenland?), but at this point there’s also a chance they’ll create massive funding needs (Gaza development?). Again, Trump seems to be prodding or testing counterparties to various negotiations… prodding diplomacy. It’s unlikely that anything too drastic will come of it from a fiscal perspective, but it probably doesn’t leave bond traders feeling easy.

At this stage, it’s pretty rash to conclude that the bond market “doesn’t believe in DOGE”. In fact, there is no doubt that DOGE is making some progress in identifying potential fraud and inefficiencies. However, bond traders must weigh a wide range of considerations, and Donald Trump has a tendency to kick up dust. Indeed, the so-called DOGE dividend will undermine confidence in debt reduction and bond prices.

Only a Statist Could Love a Sovereign Wealth Fund

12 Wednesday Feb 2025

Posted by in Central Planning, Public debt

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I want a federal government with a less pervasive presence in the private sphere. That’s why I oppose a U.S. sovereign wealth fund (SWF), but President Trump issued an executive order (EO) on February 3 setting in motion the creation of an SWF. It would hold various assets with the ostensible intent to earn a return benefiting American taxpayers.

Here are a few comments on the form an SWF might take:

1) How would the SWF be funded?

—Sales of federal assets like federal land, buildings, and the sale of extraction rights? These are probably the least offensive possibilities for funding an SWF, but the proceeds, if and when they materialize, should be used to pay off our massive federal debt, not to fund a governmental piggy bank.

—Taxes/Tariffs? Funding an SWF via taxes or tariffs would be contrary to the EO’s stated objective to “lessen the burden of taxes on American families and small businesses”. Moreover, it would be contrary to a pro-growth agenda, undermining any gains an SWF might produce.

—Borrowing? Another contradiction of a basic rationale for the SWF, which is “to promote fiscal sustainability”. It would mean more debt on top of a mountain of debt that is already growing at an unsustainable rate.

—“Deals” that might place assets under government ownership? Already, potential buyers of TikTok are singing the praises of a partnership with the SWF. Trump seems to think the government can acquire interests in certain enterprises in exchange for allowing them to operate in the U.S. He also believes that federal dollars can be used for development in order to acquire ownership capital. The federal government should not engage in the development of private resources. Business enterprises should remain private or be privatized, to the extent that their ownership has nothing to do with the provision of public goods.

2) What kinds of investments would be held in the SWF? Stocks and bonds? TikTok shares? Private equity? Crypto? The Gaza Riviera REIT?

These are all terrible ideas. Government ownership of the means of production, or socialism, virtually guarantees underperformance and subservience to political objectives. Federal acquisition of private businesses is not a legitimate function of the state.

There is no point in having the government hold a Bitcoin or crypto reserve. First, giving the U.S. government an interest in the private blockchain undermines the very purpose that most users feel gives the blockchain value. Second, the return on crypto depends only on price changes, and most forms of crypto are volatile. It is a stretch to believe that crypto assets have value in promoting “fiscal sustainability” or national security.

3) How would the SWF’s assets and earnings ultimately be used?

The EO plainly states that earnings in the SWF are to be used to promote fiscal sustainability and benefit taxpayers. In the presence of a large and growing national debt, the best path toward those objectives would be to use any and all spare funds to pay off debt and limit the explosive interest burden it imposes. This puts the funds back into hands of private investors, who will respond to market incentives by deploying the capital as they see fit. Does anyone truly think government planners know better how to put those funds to use?

SWF and Future Debt Service

Just to clarify matters, let’s quantify two alternatives: 1) pay off debt immediately; 2) create an SWF to invest funds and pay off debt later. Suppose the government stumbles upon a spare $100. It can immediately pay off $100 of debt and avoid a certain $3.50 in interest expense in year one. If instead an SWF invests the funds at an expected (but uncertain) return of 7%, then perhaps a greater reduction in the debt can be made a year later. How much? Not $107, but only $103.50 (assuming the 7% return is realized) because the $3.50 interest expense on the debt was not avoided in year one. The SWF must earn twice the interest cost on debt to break even on the proposition. That might be possible for an average return over many years, but the returns will vary and the government is likely to botch the job in any case.

An Itch For Intervention

The SWF is subject to dangers inherent in many government activities. One is that the funds held in reserve might be used as a tool of market intervention and/or political mischief, much as Joe Biden attempted to tamp down oil prices by releasing millions of barrels from the Strategic Petroleum Reserve. An administration having available a large pool of financial assets might be tempted to use it to intervene in various markets to manipulate asset prices. And even if you happen to like the interventions of one administration, you might hate the interventions of another.

The Scratch That Corrupts

In testament to the inefficacy and corruption inherent in government intervention in private markets, Peter Earle offers a number of examples of government planning gone awry. It’s not difficult to understand the dysfunction:

“A sovereign wealth fund would not, whatever the intentions of its government administrators, be guided purely by market signals but rather by political interests. That virtually ensures poor investment choices, investments in politically favored industries, and/or wasteful subsidies tending to yield subpar returns. 

“Government officials will not have the same rigorous concern for opportunity costs that drives private investors and for-profit managers, as bureaucratic decision-making is often guided by political priorities and budget cycles rather than the disciplined allocation of capital to its most productive use. The Knowledge Problem is real — and ignoring it is expensive.“

Big money in government is an invitation to corruption, and an SWF is no exception. According to the Carnegie Endowment for International Peace:

“…there are systemic governance issues and regulatory gaps that can enable SWFs to act as conduits of corruption, money laundering, and other illicit activities.“

Therefore, the management and operations of an SWF require great transparency as well as strong governance and oversight. This obviously adds a layer of cost as well.

Sound Planning

There is an economic rationale for holding funds in reserve for certain, earmarked purposes. For example, private businesses usually maintain reserves for the upkeep or replacement of physical capital. Shouldn’t the government do the same for public infrastructure such as highways or harbors? Public investments in physical capital should be planned such that the flow of tax revenue is adequate to replenish infrastructure from wear and tear. To the extent that the necessary expenditures are “lumpy”, however, a maintenance reserve fund is sound practice, as long as its management is transparent and accountable, and its holdings represent prudent risks.

Another example is the maintenance of a reserve fund for pension payments. This is a reasonable and even necessary practice under traditional defined benefit plans, but those plans have often fallen short of their obligations in practice. The private sector stayed ahead of this risk by shifting overwhelmingly to defined contribution plans. As part of this shift, the existing pension obligations of many private entities were converted to vested “cash value” balances. The public sector should do the same, putting employees in charge of their own retirement savings.

Countries with SWFs tend to be small and also tend to run budget surpluses. Very often, they are funded with revenue earned from abundant natural resources. But even those governments short-change their citizens by failing to reduce tax rates, which would promote growth.

Nonsensical Appeal to Nationalism

Why does the creation of an SWF sound so good to people who should know better? I think it has something to do with the nationalist urge to embrace symbols of patriotic strength. An SWF might evoke the emotive impact of phrases like “sound money” or “a strong dollar”. But in the presence of a large public debt and large, continuing budget deficits, the kind of SWF envisioned by Trump would be counterproductive. Future obligations to pay down the public debt are better addressed in the present, to the extent possible. The government has no business hoarding private financial assets as a means of outrunning debt. Sure, the return on equity usually exceeds the interest rate on public debt, but private investors are better at allocating capital than government, so government should not attempt to take on that role.

Debt Ceiling Stopgaps and a Weak Legal Challenge

07 Sunday May 2023

Posted by in Federal Budget, Public debt

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Long-awaited developments in the federal debt limit standoff shook loose in late April when Republicans passed a debt limit bill in the House of Representatives. Were it signed into law, the bill would extend the debt ceiling by about $1.5 trillion while incorporating elements of spending restraint. That approach is highly unpopular with democrats, but the zero-hour looms: Treasury Secretary Janet Yellen says the Treasury will run out of funds to pay all of the government’s obligations in early June. Soon we’ll have a better fix on President Biden’s response to the republicans, as he’s invited congressional leaders to the White House this Tuesday, May 8th to discuss the issue.

Biden wants a “clean” debt limit bill without changes impacting the budget path or existing appropriations. Senate Majority Leader Chuck Schumer would like to see a “clean” suspension of the debt limit. Republicans would like to use a debt limit extension to impose some spending restraint. They’ve focused only on the discretionary side of the budget, however, while much-needed reforms of mandatory programs like Social Security and Medicare were left aside. In fairness, both political parties have made massive contributions over the years to the burgeoning public debt, so not many are free of blame. But any time is a good time to try to enforce some fiscal discipline.

The Extraordinary Has Its Limits

Three months ago I wrote that the Treasury’s “extraordinary measures” to avoid breaching the debt limit would probably allow adequate time to break the impasse. In other words, accounting maneuvers allowed spending to continue without the sale of new debt. That bought some time, but perhaps not as much as hoped … tax filing season has revealed that revenue is coming in short of expectations, probably because weak asset markets have not generated anticipated levels of taxable capital gains income. In any case, very little progress was made over the past three months on settling the debt limit issue until the House passed the plan pushed by McCarthy. So we await the results of the pow-wow at the White House this week.

A Legislative Trick?

There’s been talk that House democrats will try to push through a “clean” debt limit bill of one sort or another by using a so-called discharge petition. They conveniently snuck this measure into an unrelated piece of legislation back in January. The upshot is that a bill meeting certain conditions must go to the floor for a vote if the discharge petition on the issue has at least 218 signatures. That means at least five republicans must join the democrats to force a vote and then join them again to pass a clean debt limit bill. That’s a long shot for democrats. Given the odds, will Biden deign to negotiate with House Speaker Kevin McCarthy? Even if he does, Biden will probably stall a while longer to extend the game of chicken. His hope would be for a few House republicans to lose their resolve for budget discipline in the face of looming default.

An Aside On Some Falsehoods

There’s a good measure of jingoistic BS surrounding the public debt. For example, you’ve probably heard from prominent voices in the debate that the U.S. has never defaulted on its debt and dad-gummit, it won’t start now! But the federal government has defaulted on its debt four times in the past! In three of those cases, the government reneged on commitments to convert bills or certificates into precious metals. The first default occurred during the Civil War, however, when the Union was unable to pay its war costs and subsequently went on a money printing binge. Unfortunately, we’re now engaged in a civil war of public versus private claims on resources, but the government can’t pay its bills without piling on debt. The statist forces now in control of the executive branch continue to insist that every American should demand more federal borrowing.

Here’s more BS in the form of linguistics that seemingly pervade all budget discussions these days: the House bill includes modest spending restraints, but mostly these are reductions in the growth of spending. Yet these are routinely described by democrats and the media as spending cuts. We could use another bill in the House demanding clear language that abides by the commonly accepted meaning of words. Fat chance!

The Trillion Dollar Coin

In my earlier debt limit post, I discussed two unconventional solutions to the Treasury’s financing dilemma. Both are conceived as short-term workarounds.

One is the minting of a $1 trillion platinum coin by the Treasury, which would deposit the coin at the Federal Reserve. The Fed would then sell back to the public (banks) existing Treasury bonds out of its massive holdings (> $8 trillion). The Treasury could then use the proceeds to pay the government’s bills. Thus, the Fed would do what the Treasury is prohibited from doing under the debt ceiling: selling debt.

When the debt ceiling is ultimately lifted, the “coin” process would be reversed (and the coin melted) without any impact on the money supply. As described, this is wholly different from earlier proposals to mint coins that would feed growth in the stock of money. Those were the brainchildren of so-called Modern Monetary Theorists and a few left-wing members of Congress.

There hasn’t been much discussion of “the coin” in recent months. In any case, the Fed would not be obligated to cooperate with the Treasury on this kind of workaround. The Fed has urged fiscal discipline, and it could simply refuse to take the coin if it felt that debt limit negotiations should be settled between Congress and the President.

Premium Bonds

The other workaround I discussed earlier is the sale by the Treasury of premium bonds or even perpetuities. This involves a little definitional trickery, as the debt limit is expressed in terms of the par value of debt. An example of premium bonds is given at the link above. High interest, low par bonds could be issued by the Treasury with the proceeds used to pay off older discounted bonds and pay the government’s bills. Perpetuities are an extreme case of premium bonds because they have zero par value and would not count against the debt limit at all. They simply pay interest forever with no return of principle. Paradoxically, perpetuities might also be less controversial because they would not involve payments to retire older debt.

Constitutional Challenge

The Biden Administration has pondered another way out of the jam, one that is perhaps more radical than either premium bonds or minting a big coin: challenge the debt ceiling on constitutional grounds. The idea is based on a clause in the Fourteenth Amendment stating that the: “validity of the public debt of the United States… shall not be questioned.” That’s an extremely vague provision. Presumably, as an amendment to the Constitution, this “rule” applies to the federal government itself, not to anyone dumping Treasury debt because its value is at risk. Any fair interpretation would dictate that the government should do nothing to undermine the value of outstanding public debt.

Let’s put aside the significant degree to which the real value of the public debt has been eroded historically by inflationary fiscal and monetary policy. That leaves us with the following questions:

  • Does a legislated debt limit (in and of itself) undermine the value of the public debt? Why would restraining the growth of debt or setting a limit on its quantity do such a thing?
  • Would a refusal to legislate an increase in the debt limit undermine or “question” the debt’s value? No, because belt-tightening is always a valid alternative to default. The Fourteenth Amendment is not a rationale for fiscal over-extension.
  • If we frame this as a question of default vs. fiscal restraint, only the former undermines the value of the debt.

From here, it looks like the blame for bringing the value of the public debt into question is squarely on the spendthrifts. Profligacy undermines the value of one’s commitments, so one can hardly blame those wishing to use the debt ceiling to promote fiscal responsibility. Any challenge to the debt ceiling based on the Fourteenth Amendment is likely to be guffawed out of court.

The Market’s Likely Rebuke

The market will probably react harshly if the debt ceiling impasse continues. That would bring higher yields on outstanding Treasury debt and a sharp worsening of the liquidity crisis for banks holding devalued Treasury debt. Naturally, Biden will attempt to blame the GOP for any bad outcome. His Treasury could attempt to buy more time by announcing the minting of a large coin or the sale of premium bonds, including perpetuities. Ultimately, neither of those moves would do much to stem the damage. The real problem is fiscal incontinence.