U.S. GOVERNMENT PRINTING OFFICE

63–455 WASHINGTON : 2000

MANAGING THE PUBLIC DEBT IN AN ERA OF

SURPLUSES

HEARING

BEFORE THE

COMMITTEE ON WAYS AND MEANS

HOUSE OF REPRESENTATIVES

ONE HUNDRED FIFTH CONGRESS

SECOND SESSION

JUNE 24, 1998

Serial No. 105–104

Printed for the use of the Committee on Ways and Means

(

(II)

COMMITTEE ON WAYS AND MEANS

BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois

BILL THOMAS, California

E. CLAY SHAW, JR., Florida

NANCY L. JOHNSON, Connecticut

JIM BUNNING, Kentucky

AMO HOUGHTON, New York

WALLY HERGER, California

JIM MCCRERY, Louisiana

DAVE CAMP, Michigan

JIM RAMSTAD, Minnesota

JIM NUSSLE, Iowa

SAM JOHNSON, Texas

JENNIFER DUNN, Washington

MAC COLLINS, Georgia

ROB PORTMAN, Ohio

PHILIP S. ENGLISH, Pennsylvania

JOHN ENSIGN, Nevada

JON CHRISTENSEN, Nebraska

WES WATKINS, Oklahoma

J.D. HAYWORTH, Arizona

JERRY WELLER, Illinois

KENNY HULSHOF, Missouri

CHARLES B. RANGEL, New York

FORTNEY PETE STARK, California

ROBERT T. MATSUI, California

BARBARA B. KENNELLY, Connecticut

WILLIAM J. COYNE, Pennsylvania

SANDER M. LEVIN, Michigan

BENJAMIN L. CARDIN, Maryland

JIM MCDERMOTT, Washington

GERALD D. KLECZKA, Wisconsin

JOHN LEWIS, Georgia

RICHARD E. NEAL, Massachusetts

MICHAEL R. MCNULTY, New York

WILLIAM J. JEFFERSON, Louisiana

JOHN S. TANNER, Tennessee

XAVIER BECERRA, California

KAREN L. THURMAN, Florida

A.L. SINGLETON, Chief of Staff

JANICE MAYS, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records

of the Committee on Ways and Means are also published in electronic form. The printed

hearing record remains the official version. Because electronic submissions are used to

prepare both printed and electronic versions of the hearing record, the process of converting

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process

is further refined.

(III)

C O N T E N T S

Page

Advisory of June 16, 1998, announcing the hearing ............................................. 2

WITNESSES

U.S. General Accounting Office, Paul L. Posner, Director, Budget Issues,

Accounting and Information Management Division; accompanied by Thomas

J. McCool, Director, Financial Institutions and Markets Issues, General

Government Division; and Jose R. Oyola, Assistant Director, Budget Issues,

Accounting and Information Management Division .......................................... 7

U.S. Department of the Treasury, Hon. Gary Gensler, Assistant Secretary

of Financial Markets ............................................................................................ 44

Campbell, John Y., Harvard University ................................................................ 75

Fischer, Francis, Trees & Watts, Inc., Stephen C. Francis .................................. 64

J.P. Morgan & Co. Incorporated, Mark B. Werner ............................................... 69

SUBMISSION FOR THE RECORD

Stark, Hon. Fortney Pete, a Representative in Congress from the State of

California .............................................................................................................. 6

(1)

MANAGING THE PUBLIC DEBT IN AN ERA OF

SURPLUSES

WEDNESDAY, JUNE 24, 1998

HOUSE OF REPRESENTATIVES,

COMMITTEE ON WAYS AND MEANS,

Washington, DC.

The Committee met, pursuant to notice at 10 a.m. in room 1100,

Longworth House Office Building, Hon. Philip Crane presiding.

[The advisory announcing the hearing follows:]

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Chairman CRANE. The Committee will come to order, and if everybody will please take seats we can begin.

Today’s hearing will focus on managing the public debt in an era

of surpluses. Frankly, it’s a pleasure to chair this meeting. I was

first elected to the Congress in 1969 and that was the last year we

had a budget surplus. It was $3.6 billion, as I recall, that we came

in in the black that year, but I kind of took it for granted that that

would be an ongoing thing. And we waited until this year before

we were confronted with the possibility of again having a budget

surplus. As a result of last year’s Balanced Budget Act, and with

the help of a strong economy, CBO now projects we are entering

an era of budget surpluses, and last month CBO projected a surplus for the current Fiscal Year of between $43 and $63 billion

with larger budget surpluses as far as the eye can see.

In today’s hearing we will review the debt-management practices

of the U.S. Treasury, including recent changes adopted by the

Treasury Department in response to the budget surplus. For example, last month the Treasury suspended its auctions of 3-year notes

and cut the number of its 5-year note auctions from 12 to 4 each

year. In addition, the Treasury Department also issued inflation-indexed bonds for the first time beginning in January of 1997.

I will now turn to my distinguished colleague Ben Cardin for an

opening statement.

Mr. CARDIN. Thank you, Mr. Chairman, and on behalf of Ranking Member Rangel, let me thank you for holding these hearings.

The Department of Treasury is widely recognized for its excellent

job of managing our public debt soundly and diligently. They do so

in a completely professional manner, devoid of partisan political influence. They do so in a manner that holds the cost of debt management at a prudent level. They are always mindful of the status

of our financial markets and the importance of maintaining their

stability. Let me take this opportunity to congratulate the Treasury

Department on a job very well done.

Mr. Chairman, you have made note of the current budget surplus. Isn’t it wonderful that President Clinton’s economic policies

of the last five years and the bipartisan Balanced Budget Act enacted last year have made it possible for us to regain control of our

fiscal finances. Back in the 1980’s and early 1990’s, we were faced

with deficits well above $100 billion and soaring to $300 billionplus in the worst years. It seemed as if this day may never come.

We should not squander this opportunity to make the future better

for our children and grandchildren.

I must say, though, Mr. Chairman, I don’t see a whole lot of significance that the surplus holds for debt management. Naturally,

if we have a surplus, the Treasury will have to borrow less from

the public in order to fund the operations of government, and so

they will reduce the amount of certain securities they offer to the

public. I’m sure that Assistant Secretary Gensler can describe the

technical details if we are interested in that.

One of the great debt-related opportunities that the surplus provides us is that we can reduce our national debt, thus preserving

our resources to save Social Security first, as the President has so

wisely suggested.

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So, I commend the chairman for convening these hearings today

so we can learn more about how the Treasury Department manages our financial debt and how they are able, in the last few

months, to save some of the government’s money, so that we can

dedicate it to making the Social Security System solvent for many

decades to come.

I look forward to the testimony of all of our witnesses and I

thank you, Mr. Chairman, for this opportunity.

Chairman CRANE. Thank you, Mr. Cardin.

[The opening statement of Mr. Stark follows:]

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Our first witness today is Paul Posner of the General Accounting

Office, and he is accompanied by Thomas McCool and Jose Oyola,

also of GAO. And we’ve asked Mr. Posner to present a primer on

the Federal debt, if you will, as a prelude to the more technical discussion of debt management practices which will follow. Our normal procedure is five minutes in oral presentation and all written

remarks will be made part of the permanent record, but in as much

as you are monopolizing the time for your panel, Mr. Posner, we’ll

yield you additional time, especially since you have these important

charts to present before the committee.

STATEMENT OF PAUL L. POSNER, DIRECTOR, BUDGET ISSUES,

ACCOUNTING AND INFORMATION MANAGEMENT DIVISION,

U.S. GENERAL ACCOUNTING OFFICE; ACCOMPANIED BY

THOMAS J. McCOOL, DIRECTOR, FINANCIAL INSTITUTIONS

AND MARKETS ISSUES, GENERAL GOVERNMENT DIVISION;

AND JOSE R. OYOLA, ASSISTANT DIRECTOR, BUDGET

ISSUES, ACCOUNTING AND INFORMATION MANAGEMENT DIVISION

Mr. POSNER. Thank you very much, Mr. Chairman. It’s a pleasure to be here. I’ll submit my statement for the record. Our role

here, as you indicated, is to set the stage for the subsequent discussions. We at GAO have not yet done any independent analysis of

Treasury’s debt-management operations. What we have done is

substantial amount of work on the meaning of debt and deficits

and we culminated this with a primer that you referred to. We felt

the primer was necessary because, as big as the debt was and as

large as interest is as a share of the budget, there still seemed to

be substantial confusion in the public about such things as the difference between deficits and debt, different kinds of debt, what

does debt mean for our long-term future, what can we do about it.

And that’s what our charts are going to address in the next few

minutes.

The first chart here shows you the total gross Federal debt of

$5.4 trillion and this, with fairly minor exceptions, tracks the limit

on the public debt which is currently $5.9—which, according to

CBO, will be reached sometime in fiscal year 2001.

The chart shows that, essentially, the debt is comprised of two

rather disparate elements that serve very different purposes and

respond in very different ways to a surplus. The first one there on

the bottom is the one we’re all familiar with, on the left side is debt

held by the public which currently stands at $3.8 trillion and this

is really the single best figure that summarizes how much of the

Nation’s wealth is used to finance government’s obligations. Essentially it represents the cumulative total of all past deficits and all

past surpluses in the Nation. The owners of the public debt are

wide-ranging. They include individuals, corporations, banks, pension funds, State and local governments, and, increasingly, foreign

governments and individuals. In fact, foreign holders now comprise

33 percent of the debt held by the public.

The next chart shows the next component of debt which is debt

held by Government accounts, which happens when the government ends up owing money to itself. Essentially what happens, as

you can see in the pie chart there, trust funds take in surpluses

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from the public of revenues over spending and they essentially

park those surpluses in Treasury notes. They essentially accumulate these IOU’s from Treasury, these are not real assets, and

when it comes time for the trust fund’s need to tap those notes, to

pay off benefits, Treasury actually has to go out and get money to

back those. So the special Treasuries that trust funds hold are government debt, the government-held debt, but there really is no

money there. These are really IOU’s that the Treasury will have

to go out and borrow from the public or raise taxes or cut spending

elsewhere to come up with the money to satisfy these future claims

on the budget.

Let me go to the next chart here, and this starts to tell you a

little bit about the trends in the debt over time and shows you how

different the trends are for those two components of the debt I just

talked about. Overall, over the next 10 years, gross debt will rise

by $1.8 trillion, and as the chart shows, this rise in the gross debt

is driven by the government-held debt which is that dotted line

there. That’s the debt driven by the large Social Security surpluses,

primarily, that are accumulating and buying up these Treasury securities. So that kind of debt will be increasing at the same time

as the solid line that you see there, the debt held by the public,

will be dropping as a share of the economy from 47 percent as it

stands today to 24 percent in the next 10 years. And, again, this

largely reflects as you’ve indicated, the surpluses that we’ve

achieved in the budget and the growth of the economy itself. So the

developments with the overall debt held by the public are very salutary; the rising share of debt held by government accounts indicates that there is a cloud on the horizon in the form of potential

future claims on downstream budgets, if you will. And so that’s

what those two lines, essentially, represent.

I’m going to turn to the next figure here, 5 and 6, which gives

you a little bit of the history which says a lot about the present

and the future as well. The history we’re portraying is debt is a

share of GDP because that’s really the best measure that tells you

how much the public debt is consuming of our Nation’s economic

resources. And one of the interesting things you can see here is

that, really, in our Nation’s history from 1797, high public debt, exceeding 30 percent of GDP, is an exception essentially—that has

only been broached by the Civil War, World War I, World War II,

and the Great Depression. So, basically what we, as a Nation, have

collectively decided is that it is reasonable to borrow from the public for cataclysmic national events and all of us would probably

agree with that: To save the nation itself and save the economy.

But what you can see is that after those events occur, the Nation’s

debt returns to a fairly low level as a share of the economy after

a number of years. As the economy starts to grow again, as the

government becomes more contractionary in its fiscal policies, the

debt begins to shrink. And that’s what makes the most recent 30

years so unusual in our history, beginning in the 1970’s, because,

as you can see, in the 1970’s, the debt held by the public started

to rise again, above these levels that are only seen in wars and depression, up to 50 percent of GDP in recent years.

And what was unusual about this is, as you know, we did not

have a great war or cataclysmic depression. This was really fueled

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by a kind of chronic deficit period that we entered into during that

time. Now the bottom part of this chart shows the budget deficits

themselves, and the differences between the deficits and debt are

illustrated nicely here. The deficits essentially are related to the

debt in that they essentially are annual events that add to the

stock of debt. Debt, in turn, adds to deficits by requiring interest

payments that are recorded in the budget as outlays. The two

closely track each other.

As you can see, the deficits really sharply grew in the same cataclysmic national events that I just talked about but, as you can

also see, once those events were over, whether as wars or depression, the nation returned very quickly to a policy of budget surplus

or balance which is essentially the norm for the Nation’s fiscal policy in our broad sweep of history. Essentially, conservative fiscal

policy, strong economies, and inflation all succeeded in pulling the

nation back out of the deficit.

But what is interesting is when you look at the debt chart above,

you can see how much more sluggish the debt has been to respond

to those reversals; that while the deficit quickly reverses itself, the

debt is a legacy which is more sluggish to change and whose momentum takes longer to reverse. Essentially, this is because it

takes a longer time for economic growth to take over and a longer

time for the accumulation of budget surpluses to eat into the stock

of debt that we accumulated during these very sharp periods of national crisis.

Let me go to the next chart here and this shows you why the

debt makes a difference. Why should we be worried about the debt?

There are really two reasons. One of them has to do with the economic consequences of our borrowing and the other has to do with

the budgetary consequences of our borrowing. Very simply put, borrowing by the public sector absorbs savings that otherwise would

be available for private investment. That’s a familiar story to many

of you; this bids up the price of capital by Treasury and private investment that might enable us to increase our productivity, wages,

and potential growth in the economy is not as large as it otherwise

would be. The effects, importantly, are cumulative. You are not

going to sometimes see this in a given year or two, but over time,

as the private investment is lower than it otherwise might be, the

Nation’s productivity and growth rate declines. And as Charles

Schultz once said, the debt crisis is not the wolf at the door; it’s

the termites in the basement, and that’s why it is so difficult sometimes to grasp.

What’s most disturbing about the growing debt in recent years

is the low national savings that you see in this chart. The size of

those bars is the total net savings available from the domestic

economy to fund investment. As you can see, the total size of that

bar has been going down and the share absorbed by the deficit

which is the white part has been growing. Now recently that’s reversed, and foreign owners of debt have helped as well by investing

in our economy. But, nevertheless, the size of those bars is something that’s quite worrisome.

Finally, the next chart here, is really what we might call the bottom line. GAO has done a long-term model linking these annual

budgets to long-term economic growth and what we’ve tried to demVerDate 11-MAY-2000 12:58 Aug 03, 2000 Jkt 063455 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 E:\HEARINGS\63455 pfrm07 PsN: 63455
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onstrate is that, short-term aside, the cumulative results of deficits

and debt over time are quite compelling. We have modeled two fiscal policy paths. One is what we call no-action, which is the bottom

line there, which essentially assumes we will just follow the baseline and after a while, after we come out of these periods of surpluses, Social Security, Medicare, and Medicaid are going to kick

us into a deficit again and that is going to lower our real incomes

by 2050.

If we maintain budget balance through this entire period, you

can see that by 2050, we reach a real increase in the per-capita

GDP available for Americans to 25 percent above this baseline. So,

essentially, what we’ve done this modeling for is to help leaders understand the long-term consequences of these budget choices. This

increased income available to Americans is particularly critical because as you know, future generations are going to be much smaller than ours and are going to have to pay for the large retirement

costs of the Baby Boom generation. That generation—those smaller

work forces are going to need higher incomes to be able to afford

these burdens that are going to be foisted on them unless we

change our policies. So, again, this is trying to illustrate how important the deficit and debt are to the future incomes of this country.

And the final point I will make, and will close at this point, is

just to illustrate another familiar story, which is that debt also has

a legacy for the budget itself. In other words, when you see this

chart here, you see the largest outlays in the budget by function

and, net interest on the debt is the third-largest function in the

budget. And unlike any other functions, Social Security, national

defense, Medicare, and whatever, it’s the most uncontrollable. We

can’t do anything directly to reduce this. We can’t trim benefits, we

can’t improve administrative efficiency; essentially this comes right

off the top before we allocate resources to anything else and the

principal way you can really change the interest path in the budget

is by fundamentally doing something about deficits and, ultimately,

going into a surplus that will actually reduce your nominal debt as

a share of the economy.

So, that basically, in a nutshell, summarizes, the broad issues.

We, will hand it off to Treasury to talk more specifically about the

debt management consequences of the budget surpluses.

[The prepared statement and attachments follow:]

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Chairman CRANE. Thank you very much, Mr. Posner.

Turning to chart number two, the ownership of our debt held by

the public. Foreign investors is listed at little over 33 percent. Has

that been affected by any of the panic in the Asian-Pacific region?

Mr. POSNER. I think it is probably safe to say that it has been

affected by those recent trends, that is the dollar’s strength and an

open economy. There’s the flight to safety and Treasury bills are

considered a safe investment. Throughout the world the dollar is

a reserve currency which are invested by many central banks and

governments in Treasuries. Many observers feel, that those events

are related to that spike.

Chairman CRANE. And has it resulted in more investment in our

debt, or less, taking money out?

Mr. POSNER. I think it’s more foreign investment. I believe it’s

grown from something like 25 percent several years ago to 34 percent today, so there’s a greater foreign investment in our debt than

before.

Chairman CRANE. And what percentage of that is held by the

Japanese?

Mr. POSNER. We can provide that for you for the record. We don’t

have it right——

Chairman CRANE. Off the top of your head, do you think it’s a

majority?

Mr. POSNER. No, I don’t think it’s a majority. No.

Chairman CRANE. Who is the biggest investor in our debt?

Mr. MCCOOL. It would most likely be a combination of European

governments, I would expect, governments, individuals, and institutions.

Chairman CRANE. No individual, single government comes to

mind?

Mr. POSNER. The United Kingdom.

Chairman CRANE. The United Kingdom?

Mr. POSNER. Yes.

Chairman CRANE. Another question I would like to put to you is

this booklet that GAO put out in 1996 ‘‘Federal Debt Answers to

Frequently-Asked Questions.’’ Are you contemplating getting a reissue published?

Mr. POSNER. We’re actually contemplating doing that. Mr.

Domenici, the chairman of the Senate Budget Committee, has

asked us to do this and to, essentially, talk about what it means

to run a surplus for the public debt. What are the new issues

raised by the budget surplus, including debt management issues,

the very topic of your hearing, so we are planning on doing that.

Chairman CRANE. Very good, I appreciate that. I’d like to now

yield to our distinguished ranking minority member, Mr. Rangel.

Mr. RANGEL. I have no questions. I want to thank you, Mr.

Chairman, for having these our hearings and our witnesses for

helping us better understand the budget process.

Chairman CRANE. Mr. Camp. Mr. McCrery.

Mr. MCCRERY. Mr. Posner, I just have one question. In the periods of declining debt in our history, what is the process of actually

reducing the debt held by the public? How do we do that?

Mr. POSNER. There’s essentially two ways to think about that.

One is just simply, when a war is concluded, or the Great DepresVerDate 11-MAY-2000 12:58 Aug 03, 2000 Jkt 063455 PO 00000 Frm 00037 Fmt 6633 Sfmt 6602 E:\HEARINGS\63455 pfrm07 PsN: 63455
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sion, for example, was over, just the rise in economic growth

shrinks the proportion of debt to the economy, so that’s one thing

that happens. The other thing that happens is very typically we go

into a budget surplus, which is the only way we can actually reduce the nominal level of debt and that’s been the typical response.

Mr. MCCRERY. How do we reduce the nominal debt?

Mr. POSNER. By any combination of revenue increases or spending cuts that produces an annual budget surplus.

Mr. MCCRERY. Yes, I know, we have to have a surplus to reduce

the debt, I’m with you. But what’s the actual mechanical process

of getting that debt back and extinguishing parts of the debt?

Mr. POSNER. Right. Essentially, the debt mechanically is rolled

over, most of the debt is rolled over so the mechanical process that

happens is you simply have less need to finance debt so you roll

less of it over. That’s essentially the way we reduce the debt. At

least recently, we haven’t bought back any outstanding debt, but

basically the mechanics is you simply roll over less of it.

Mr. MCCRERY. How much of our debt, you know, we hear a lot

of talk about buying down the publicly-held debt. We’ve got this

surplus and we want to use it all to buy down the debt. How easy

is it to buy down the debt? In other words, how much of that debt

rolls over each year which would lend itself to buying back?

Mr. OYOLA. About 50 percent of the debt held by the public will

mature within the next two years, which means that the Treasury

has the ability to roll over less of it. As debt matures, the Treasury

could choose not to issue new debt, so about 50 percent of the debt

held by the public could, potentially, be subject to less reduction.

Mr. MCCRERY. Okay. Thank you.

Chairman CRANE. Let’s see. Mr. Cardin?

Mr. CARDIN. No questions, Mr. Chairman.

Chairman CRANE. Mr. Herger. Oh, wait, I’m sorry, Mr. Portman

is he here? Mr. Herger, then. Mr. Watkins. Is Mr. Watkins here?

Mr. Houghton.

Mr. HOUGHTON. Thank you very much, Mr. Chairman. I have not

been here for this whole discussion, but I do have a question and

I’m not sure that it’s easily answered and if it’s not, then we can

talk about it personally later on. I guess the thing I’ve always worried about is the short-term debt financing long-term objectives.

And it just seems that when we were in a crunch we tend to shorten up in order to reduce the out-of-pocket costs to the government

at that particular time. So the question really is, are we doing right

by that ratio now and, also, what might be an ideal ratio?

Mr. POSNER. That is, as you noted, a complicated question that

I think Treasury may very well address in their remarks because

there are a number of variables to consider. Cost to the government being one, which shorter terms denominations generally gets

you lower costs. The market conditions and the liquidity of the various Treasury notes in maintaining a healthy market for Treasuries is another. As they will tell you, there are a variety of factors

that are considered. We have not, again, looked at this in any independent way at this point, but my understanding is that the maturities of the Treasuries on average have been on the upswing, in

the past 20 years. I think they reached a low in the mid-1970’s,

and now they are averaging a little over five years. But as to how

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they decide the mix of bills and notes and bonds and that kind of

thing is something I think they will probably be addressing.

Mr. HOUGHTON. So you haven’t done any studies on that?

Mr. POSNER. No, not right——

Mr. HOUGHTON. Thanks very much.

Chairman CRANE. Mr. Neal.

Mr. NEAL. Thank you, Mr. Chairman. I just bumped into a reporter in the hallway and he said that Speaker is very upset today

with CBO numbers and that he is very upset with the Joint Tax

Committee’s estimates on revenue forecasts. Would you care to

comment on the role that CBO plays here in offering these revenue

estimates for us? Any of the panelists?

Mr. POSNER. We have not looked, and do not have the responsibility to examine and independently evaluate CBO’s numbers. They

are the, as you know, the forecaster for the budget, for the Congress, and they estimate costs, but we at GAO do not have the role

to examine their assumptions or their models.

Mr. NEAL. You wouldn’t suggest that they ought to fudge any

numbers along the way so that they can comply with the request

of the leadership for tax cuts that may not well be necessary?

Mr. POSNER. All I can offer in response to that is that we work

very closely with the CBO analysts and they are highly professional and I’ve not known that to be a problem in their past history.

Mr. NEAL. Could I ask, do you know who appointed the current

CBO team?

Mr. POSNER. Well, the current director is appointed by the Congress, by the leadership of the House and Senate, I believe, threeand-a-half years ago.

Mr. NEAL. Okay. Thank you, Mr. Chairman.

Chairman CRANE. Mr. Collins.

Mr. COLLINS. Thank you, Mr. Chairman. Just one question in

particular. We will see, with the rollover of the private sector portion of the debt, a reduction. We will see an increase with the public sector portion of it. What will be the bottom line as compared

to a year ago? Will there be an increase or a decrease overall?

Mr. POSNER. Increase over all in the gross Federal debt.

Mr. COLLINS. And by how much? I looked for it in some of this

information and I didn’t——

Mr. POSNER. Basically the gross debt in 1997 was $5.3 trillion;

in 1998, it will be $5.5 trillion; 1999, $5.7; and it grows to $7.1 trillion by 2008, the gross debt. And, again, the net debt to the public

goes down; the debt held by the government accounts goes up.

Mr. COLLINS. Okay. One other question, the chairman mentioned

foreign investors, particularly in Japan, and Japan has quite a bit

of accumulated savings in private sector there. How does their interest rate for those savings compare to the investment in our securities?

Mr. POSNER. I’m sorry, could you repeat that?

Mr. COLLINS. In Japan, the private sector has an accumulated

savings of about $10-$11 trillion. How does the interest rate on

those savings in Japan compare with the interest rates we pay on

securities? Or do you know?

Mr. POSNER. Don’t know. Tom, do you——

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Mr. MCCOOL. I don’t know what longer-term interest rates in

Japan are. I know that their short-term rates tend to be very low

and, certainly, in comparison with U.S. rates. But then you also

have to take into account the potential for currency fluctuations, so

it’s a fairly complicated mix but Japan’s interest rates are, I think,

quite low right now.

Mr. COLLINS. Okay. Thank you. Thank you, Mr. Chairman.

Chairman CRANE. Mr. Tanner.

Mr. TANNER. Thank you, Mr. Chairman. I, like Mr. Houghton,

haven’t been here the entire time. For that, I’m sorry because I am

very interested in this subject. From the charts that I have seen,

foreign investors, according to the chart, hold about a third of our

public debt. Is that an acceptable number or should we be concerned or is it something that really matters?

Mr. POSNER. It’s probably a dual-edged kind of answer to that.

On the one hand, the foreign investors help us finance our investment at levels above that we can finance from our own savings because our savings from domestic sources are so low. So, on the one

hand, foreign investment helps prop up our investment. In an open

economy, the influx of foreign dollars the Treasuries is a reflection

of the strength of the dollar, the strength of the American economy

compared to other economies right now, and so it’s in some sense

a tribute to the American economy. On the other hand, the downside of this is that the earnings from those investments in our assets flow overseas to foreign residents and not to American citizens.

There is probably no one level that would be--that you can say

is appropriate. But, certainly by propping up levels of investment,

they are helping us attain higher levels of investment and plant

equipment that ultimately helps long-term growth, assuming foreign dollars are invested in productive assets.

Mr. TANNER. Well, looking at this chart, from what you say, I as- sume that a third of the $244 billion or thereabouts is going overseas, which would be a trade imbalance with regard to currency,

would it not?

Mr. POSNER. I’m not exactly sure how much of the net interest

specifically is denominated to foreigners. The foreign holdings have

just recently climbed to that level, so I’m not sure that a third

would be the right figure there but——

Mr. TANNER. Well, would you have a comment as to whether athird, in your opinion, was too high, too low, about right, or does

it matter? I know that’s very subjective--but, at home we get asked

questions like this and when we say, well, the foreigners hold athird of our debt and people ask if a third is too much? Should we

be concerned? And I’d just like your opinion about it, that’s not

a——

Mr. MCCOOL. Well, again, I think part of the issue also is it’s not

just how much they hold of our debt, but how much we hold of

their debt and the issue is really the net. So you would expect in

a world where the U.S. is the dominant economy and the assets of

the U.S. government are the most attractive risk-free assets

around, that foreigners would want to hold a lot of our debt, so

that’s not really the issue. I think the issue is the relative flows

and the relative stocks, compared with what we hold of theirs. And

I think that, recently has, been the issue. There’s been more of

37

their money investment flows coming to the U.S. than vice versa

over that time.

Mr. MCCRERY. Will the gentleman yield?

Mr. TANNER. Yes.

Mr. MCCRERY. I think the gentleman asked a good question. Is

it safe to say that in times of surplus here the extent of the debt

held by foreigners is less of a problem? Let me explain. If we’re in

times of deficit, then we have to actually go to the markets and

borrow money ourselves, the government, to finance our deficit. So,

it’s possible that if foreigners held too high a percent of that debt,

that they could kind of hold us hostage because we have to go to

them in effect to borrow money to finance our own operations.

Whereas in times of surplus, we don’t really care who holds the

debt or who’s buying it because we’re not issuing new debt, we

could be actually buying it back, so that’s part of my fear when we

were having high deficits and, as far as the eye could see, as that

percent of debt grew, held by foreigners, I could see us possibly at

some point in the future being held hostage by those foreign debt

holders.

Mr. POSNER. I think certainly when the debt is declining and the

share that is held by anybody is less--as you indicate perhaps less

critical. The vulnerability point is something we have a little track

record on. In the 1980’s, there was a disinvestment of our bonds

by Japanese investors, for example, and yet, in fact, many other

international investors filled the gap. Spain, the United Kingdom,

and other nations came in and bought Treasuries, and so there’s

a fairly active diversified worldwide market for Treasuries that

helps address some of those vulnerability concerns. However, the

other issue to raise here is that other economies are facing a baby

boom crisis of their own, earlier than ours: Italy, Germany, Japan,

France are also going to be facing quite a--problems in the public

sector in the next 30 years, that are going to draw back into those

nations their investment resources for public sector programs. So,

the amount of foreign investment we can rely on over time may,

in fact, decline from those sources at the very least.

Mr. MCCRERY. Thank you, I won’t ask the gentleman why the

Italian and the French have a sooner baby-boom problem than we

do, I’ll leave that to others. I thank the gentleman for yielding.

Mr. TANNER. Thank you. Mr. Chairman, could I ask unanimous

consent for two additional minutes.

Chairman CRANE. Sure thing.

Mr. TANNER. Thank you. Following up on what Mr. McCrery

said, I think the idea here is more maybe in the nature of a political fear or a political problem than it may be in terms of a financial matter. The political fear, of course, is that the fear that some

have that this debt held by foreigners gives them inordinate leverage over what happens internally in America and so that’s the reason for the discussion here about how much is too much. But I

thank you for that.

Going back to one thing that Mr. Houghton said, if I may real

quickly. I, too, have been concerned about the short-term nature of

some structural debt that’s basically built in. We can say we’ll pay

it back some day but the truth is we probably never will, and I’m

not sure financially that it’s necessary. It’s always been my thought

38

that if we could stabilize the debt, and then let the economy double, triple, and quadruple, a $5 trillion debt in an $8 trillion economy is very much a problem, in a $20 trillion economy, it is much

less of a problem. Which brings me to my second question. The interest that we pay on this debt amounts to somewhere around 14

cents out of every dollar that comes to the Treasury. Is that correct?

Mr. POSNER. Yes.

Mr. TANNER. All right, said another way and the way I explain

it to people at home, 25 years ago about 7 cents of every dollar that

came was paid in interest. Now, any business person knows that

if one is paying 7 percent for one’s inventory, if it’s a car dealership

or whatever, you can make a little money. If you’re paying 14 percent interest on your inventory, it becomes very problematic as to

whether or not your business can make it. Now, we have in effect

a 14 percent mortgage on the country, would that be a fair statement in your opinion?

Mr. POSNER. Well, I think it’s 14 percent of spending; it’s roughly

3 percent of the economy, of GDP, but I think it’s a fair way of saying that it’s a concern. As we say, it comes right off the top, you

can’t do anything about it directly unless you reduce the size of the

debt held by the public. The other concern is do we want this overhang from the debt buildups in the past 30 years to be carried forward into the next 30 years when we know that that next generation is going to be struggling to pay for these new bills that are

going to be coming due for Social Security, Medicare, Medicaid that

are also going to be facing them. So that’s another concern and the

question is we have an opportunity now to, reduce that as a share

of the budget, to kind of reduce that legacy.

Mr. TANNER. I certainly thank the gentleman. I’m going to read

this in depth and perhaps maybe we could follow up with a meeting at some point about this and I’d really like to get with Mr.

Houghton and explore the imbalance in the debt versus the structure, particularly with no entitlement reform in sight. Thank you,

very much, Mr. Chairman.

Chairman CRANE. Mr. Christensen.

Mr. CHRISTENSEN. Thank you, Mr. Chairman. Mr. Posner, I’ve

got just a couple of questions. One is that as director of your Division of Accounting and Information Management, how are you guys

prepared for the Y2K problems and, as the manager, are you up

to speed on getting ready for the Year 2000?

Mr. POSNER. Well, in terms of—GAO has done—is making a

major investment in analyzing the Federal agency’s readiness for

the Y2K. As a matter of fact, we have a request to look at the Bureau of Public Debt and those operations to make sure that they

are Y2K compliant, which we have not yet begun but are about to

begin. Is the question about our own operations?

Mr. CHRISTENSEN. Your own division.

Mr. POSNER. That’s not in my bailiwick, but I know the GAO has

been undertaking a review of our systems and that kind of thing

to ascertain——

Mr. CHRISTENSEN. Do you know how far along you are?

Mr. POSNER. I really don’t. We could certainly get back to you

with information on that for the record.

39

Mr. CHRISTENSEN. I’d like to know that.

Mr. POSNER. Sure.

[The folllowing was subsequently received:]

40

41

Mr. CHRISTENSEN. At what phase of review you are, at what percentage completion, and if it was tomorrow, what kind of catastrophe we would have in your division. Another thing I’d like to

ask is what effects, if we were to significantly reduce the debt, will

it have on our markets, and what effects has the Treasury’s sale

of the 4-, 7-, and 20-year had on our markets? The 20-year securities.

Mr. POSNER. Well, we have not really looked at the effects that

individual denominations have had on markets of Treasury notes.

What we have done is we’ve modeled the results for the economy

for the long-term of debt reduction and what do you get in terms

of long-term growth dividends from that? And that’s the chart that

we had up there before that shows that if, in fact, we reduce debt,

essentially by following a balanced budget, once the baby boom

bills come due, our per capita GDP would be much higher than it

would be if we just followed the current course. And that’s pretty

much what we’ve done to try to illustrate the benefits of doing

something about this. But we have not followed individual bills and

issues.

Mr. CHRISTENSEN. That’s all, Mr. Chairman.

Chairman CRANE. Mr. Hulshof.

Mr. HULSHOF. No questions, Mr. Chairman.

Chairman CRANE. Mr. English.

Mr. ENGLISH. Thank you, Mr. Chairman. This is a very distinguished panel. I really only have one question having to do with

what is owed by the General Fund to Social Security. Social Security has over time accumulated nonnegotiable Treasuries as, in effect, a collection of IOU’s against the $700 billion that the General

Fund has taken out of the Social Security System. I know I am not

describing this precisely, but, in effect, I am describing it accurately. In your view, is there a meaningful difference between negotiable and nonnegotiable government securities and is, simply if we

were to try to compare their value, would it not be fair to say that

a nonnegotiable Treasury security, by virtue of being nonnegotiable, inherently would have an inferior position because it can’t

be offered in the market. Do you care to comment?

Mr. POSNER. Well, the nature of these debt instruments is very,

very different. Social Security has some advantage in that it gets

unlike other trust funds, it gets redemption at par regardless of the

market value or the change in the market.

Mr. ENGLISH. That’s true.

Mr. POSNER. And that is an advantage that the Social Security

fund has specifically by law. The whole question of even calling

these securities is something that is problematic because it kind of

leads to the impression that there’s a funded portion that’s available to be culled. And, as you know, these are IOUs, as you said,

that, when the time comes, when Social Security runs out of surplus and has to dip into this reservoir of ‘‘assets,’’ there really is

no money there. And Treasury has to go out, unlike a State and

local government pension fund, which has, you know, money that

it can tap in the market, Treasury has to go out and either borrow

it or raise taxes or cut spending somewhere else, as we’re currently

doing with Medicare, which has a $5 billion cash deficit. Medicare

is starting to call back some of its treasuries on a net basis, alVerDate 11-MAY-2000 12:58 Aug 03, 2000 Jkt 063455 PO 00000 Frm 00045 Fmt 6633 Sfmt 6602 E:\HEARINGS\63455 pfrm07 PsN: 63455
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though it’s hard to tell the impact of that on a $1.7 trillion budget;

nevertheless, Medicare is becoming a net drain on the Federal

budget. And that’s the kind of thing that will happen with Social

Security around 2014.

Mr. ENGLISH. I think that’s actually a wonderful summary, Mr.

Posner, and I thank you for it. What you’ve made clear in your

statement is that a non-negotiable treasury is not like a standard

negotiable security. And what seniors and others have in their

name posted, wherever it is in West Virginia, really does not have

the same value as the security. Although, as you’ve noted, there

are some legal protections built in to make sure there’s a payment.

And I thank you for it, and I yield back the balance of my time.

Chairman CRANE. Mrs. Thurman?

Mrs. THURMAN. Mr. Posner, I am like Mr. Tanner—sorry I

wasn’t here for the full explanation—but I’m just trying to catch up

and read through this by looking at your charts, and particularly

the conversation that took place on the foreign investments. You

made a statement where it says, ‘‘the United States benefits from

foreign purchase of government bonds because as foreign investors

fill part of our borrowing’’—I can’t even say the word—‘‘more domestic saving is available for private investment, and interest rates

are lower than they otherwise would be.’’

Based on the conversation, as you said, as France and others

start to need these dollars, what happens then to our economy in

the United States based on that statement?

Mr. POSNER. Well, several things could happen. One that you

might hope is that our own domestic savings might grow so that

we can finance more of our investment from our own sources.

Another scenario might be that as these advanced nations reach

their own public sector crisis or challenge, if you will, that other

nations throughout the world might find treasuries and our investments to be, a good investment. So it’s hard to tell what will actually happen there.

Mrs. THURMAN. But is it something we should be watching and

be concerned about, based on that?

Mr. POSNER. A number of economists would argue that yes, in

some sense, it is; and that it’s generally preferable to increase the

national savings rate from domestic sources.

Anybody? Thanks.

I will yield back the balance of my time.

Chairman CRANE. Mrs. Johnson.

Mrs. JOHNSON of Connecticut. Thank you very much.

I don’t know whether it’s fair to ask these questions of the next

panel or your work enables you to answer them. But over, say, the

last six months, how much debt have we actually retired as notes

have come due, and we have just not refinanced them because we

had surplus dollars? And of that debt, how much was high-cost and

how much was low-cost? The gradations and——

Mr. POSNER. I think because they have some of the figures there

we can——

Mr. OYOLA. We have some of the figures here. As of September

30, 1997, the total marketable debt, which is comprised of bills,

notes, bonds, and the Federal Financing Bank, was $3.4 trillion. As

of May 30, 1998, the total marketable debt was $3.3 trillion. So

43

there has been a slight decrease, from $3.439 trillion to $3.353 trillion. That’s $86 billion less in marketable debt—bills, notes, and

bonds.

Mrs. JOHNSON of Connecticut. And of that, how much was what

you would categorize as high-cost debt?

Mr. OYOLA. The bills, which will be normally lower-cost debt, in

September were $702 billion. And in May 31, it was $648 billion.

So there has been a reduction in the bills.

Mrs. JOHNSON of Connecticut. And that’s the lower-cost debt?

Mr. OYOLA. Yes.

Mrs. JOHNSON of Connecticut. And a higher-cost debt?

Mr. OYOLA. Higher-cost debt would normally be bonds. And in

the case of bonds, on September 30, there were $576 billion; and

on May 31, there were $599 billion.

Mrs. JOHNSON of Connecticut. So actually there’s more high-cost

debt?

Mr. OYOLA. There has been an increase in the amount of longterm debt.

Mrs. JOHNSON of Connecticut. So the—all of the drop has been

in the lower-cost debt?

Mr. OYOLA. There has been a decrease in the bills, which are

lower cost. There has been an increase in the bonds, which are

long-term; and in the present environment, they are higher cost.

There has also been an increase in the amount of inflation indexed

securities, which are notes and bonds.

Mrs. JOHNSON of Connecticut. Did—did—were the bonds that

came due during that period were they retired? I’m finding it a little hard to understand why the amount of bonded indebtedness

went up so significantly, and the amount of short-term debt went

down. Was is that longer-term high-cost debt didn’t come due. Or

did they choose not to pay it off?

Mr. OYOLA. We don’t have the amounts that came due in that

period of time, but we can certainly find the information for you.

What probably happened is that the bills, which are short-term in

nature, came due at a higher volume than any bonds. So, naturally, the bills will have been retired.

Mrs. JOHNSON of Connecticut. And I didn’t understand you correctly that the inflation-indexed debt went up?

Mr. OYOLA. Excuse me.

Mrs. JOHNSON of Connecticut. The inflation-indexed debt went

up?

Mr. OYOLA. Yes.

Mrs. JOHNSON of Connecticut. Thank you.

Chairman CRANE. Ms. Dunn.

Ms. DUNN. No questions.

Chairman CRANE. Well, with that, I want to express appreciation

to our panel for their presentation this morning, and we look forward to working with you in the future. You may be excused, and

we shall invite next the Honorable Gary Gensler, Assistant Secretary of Financial Markets for the U.S. Department of the Treasury.

Mrs. JOHNSON of Connecticut. Mr. Gensler. Welcome.

44

STATEMENT OF HON. GARY GENSLER, ASSISTANT SECRETARY

OF FINANCIAL MARKETS, U.S. DEPARTMENT OF THE TREASURY

Mr. GENSLER. Thank you, Madam Chairperson, and distinguished members of the committee. It is an honor to be here today

in front of this committee to talk about debt management and the

Treasury.

With the Clinton administration’s policy of fiscal discipline and

its fostering of a strong U.S. economy, we have experienced our

first budget surplus since 1969. The administration welcomes the

challenge of managing a surplus rather than financing a deficit.

If I could just submit for the record my written testimony, I’m

going to just briefly summarize in some oral remarks.

It is important in this endeavor for the government to have goals

and principles. And I’d like to just lay out some of those goals and

principles that guide treasury and its debt management.

First, in terms of our goals, we broadly have three goals that

drive our debt management. The first is sound cash management.

That is to say, that we want to ensure that our cash balances at

all time are sufficient to meet our obligations.

Second, is achieving low-cost financing for the taxpayers. We look

at this over time, both in the short-term and the long-term. And

we consider risk, as many of the members had mentioned earlier,

with the earlier panel.

And third is the promotion of efficient capital markets, to ensure

that the U.S. capital markets continue to be the strongest around

the globe.

In achieving these goals, five interrelated principles guide us.

First is maintaining the risk-free status of Treasury securities.

This is accomplished through prudent fiscal discipline and timely

increases in debt limits.

Second is maintaining consistency and predictability in our financing. Treasury issues securities on a regular schedule, with set

auction procedures. This reduces uncertainty in the markets and

helps minimize our overall cost of borrowing.

Third, Treasury is committed to ensuring market liquidity. Liquidity promotes efficient capital markets and, again, lowers the

cost of borrowing over time.

Fourth, Treasury finances across the yield curve. What this

means is we not only borrow money for short-term periods, like 90

days or 6 months in what we call the Treasury Bill market, but we

also finance over the long term, as long as 30 years. This appeals

to the broadest range of investors. And we feel that by appealing

to a broad range of investors, we, again, help lower the cost of financing and promote an important goal of having the most efficient

capital markets in the globe.

And then fifth, Treasury employs unitary financing. We aggregate virtually all of the government’s financing needs and finance

as one nation. Thus, all programs of the Federal Government can

benefit from Treasury’s low borrowing rate rather than competing

in the marketplace with smaller, more costly issuances.

We have been responding to dramatic changes in our financing

needs. At the start of the Clinton administration estimates were

that the level of privately held debt today would be approximately

45

$41⁄2 trillion. As you can see from this exhibit—and I apologize if

the print is a little hard to see—that currently there’s about $3.4

trillion of privately held debt. That includes marketable debt of

about $3 trillion and $400 billion of non-marketable securities—

savings bonds, State and local government series, and the like.

In addition, the Federal Reserve holds a little over $400 billion

of debt; and then, of course, the government accounts and trust

funds hold $1.7 trillion.

But the $1 trillion less debt today than was estimated just five

years ago is a remarkable accomplishment, which has benefitted all

Americans through higher national savings and lower interest

rates.

Exhibit D shows how the components of our financing needs have

changed over the last several years. The unified budget deficit,

which historically drove our borrowing needs, has decreased dramatically and finally has become a surplus. Just three years ago,

the unified budget deficit of $164 billion really drove our needs.

And this year, OMB estimates a $39 billion surplus.

Moreover, an increasing share of our financing needs come from

non-marketable securities, this is the sale of securities to State and

local governments, to small investors, through savings bond programs and other programs. This year, we estimate that over $50

billion of our financing needs will come through non-marketable securities.

Thus, in Fiscal Year 1998, with all these factors, we will pay

down approximately $79 billion in marketable securities, which is

our last component.

I would like just to discuss for one brief moment the May announcements. First, we stopped offering three-year notes, and, second, we reduced the frequency of our offerings of five-year notes.

In formulating this strategy, there were three questions, all of

which are more detailed in the prepared testimony that we’ve submitted. But all of them were meant to promote the efficient capital

markets, lowest-cost financing, and cash management goals that I

referred to earlier.

In addition, the Clinton administration has made innovations

that this committee had asked us to address, one in particular in

terms of the inflation index program. The securities diversify the

government’s financing sources, and we believe that this will lower

Treasury’s borrowing costs over the long run. In addition, they provide inflation protection for investors and help promote savings.

Other innovations have been the innovations in State and local

government series. We have innovated in savings bonds to make

them more attractive to American savers. And in addition, we are

making our securities more accessible to small investors—putting

savings bonds on the Internet and making enhancements to our

Treasury Direct program for small investors.

I believe the committee had some questions on the Year 2000

that I would be glad to take, and there’s more in the prepared testimony.

In conclusion, as I said earlier, the administration welcomes the

challenge of managing a surplus rather than financing a deficit. I

would also like to mention my deep appreciation and respect for

46

the career staff at Treasury, who have done such excellent work on

these issues for so many years.

Mr. Chairman, I will be happy to answer any questions you may

have regarding Treasury debt management in this new era of

budget surpluses.

[The prepared statement and attachments follow:]

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Chairman CRANE. Thank you, Mr. Gensler.

Mr. Rangel.

Mr. RANGEL. Treasury now has a history of selling inflation-indexed bonds. Could you summarize how this new policy has unfolded?

Mr. GENSLER. We introduced the inflation indexed bonds just

about a year and a half ago, and since then have had six issuances.

And we’re about to announce our next issue—I believe it’s next

week. We’ve been very satisfied with the inflation indexed program

to date, and we feel it’s an important innovation, again broadening

out the access that the Treasury has to markets. Some have said

that this is a new asset class. We believe that it brings new investors into the Treasury. And importantly, as we said, it offers inflation protection for investors and a way for the economy as a whole

to see inflation signals. So we’re quite pleased.

It still, though, of course, is embryonic. We only have a little— about $50 billion of our financing through this program, which is

a small portion of our program at this time.

Mr. RANGEL. Thank you.

Chairman CRANE. Mr. McCrery.

Mr. MCCRERY. Mr. Gensler, if we were to drastically reduce, or

even eliminate, the debt. What effect would that have on capital

markets? Since you can imagine that.

Mr. GENSLER. No, it’s a very good question, and hopefully not

just a hypothetical question. Over the long term, we think that it

would have an effect of most likely lowering interest rates. And

more specifically to your question about capital markets, there is

a very important function that Treasury securities serve: to be the

benchmark or the—if I may use a technical term—the hedge security for the markets. That means, whether it’s corporations’ borrowing, or mortgage borrowing, many people use the Treasury securities as a benchmark for pricing that borrowing.

There would be effects on capital markets if there were no Treasuries, and the market would have to find another hallmark or

benchmark security n that hypothetical case. But, again, I think

that would be an interesting and good challenge.

Mr. MCCRERY. Thank you.

Chairman CRANE. Mr. Herger.

Mr. Collins.

Mr. COLLINS. Thank you, Mr. Chairman.

Mr. Gensler, in the previous panel it was estimated that in 2008

the debt would be somewhere around $7 trillion. Do you know what

percentage of ratio that will be at that time as projected based on

private versus public?

Mr. GENSLER. And was this in the year 2000, sir?

Mr. COLLINS. 2008.

Mr. GENSLER. 2008, I see.

Mr. COLLINS. I was going to ask the other panel, but I didn’t.

Mr. GENSLER. I don’t know the specifics of their model, sir, but

currently the privately held debt, as we showed in the earlier table,

is $3.4 trillion. And that, in fact, through 2008 will decline as the

unified budget balances in surplus. So one would—we could get

back to you specifically, but it would be well less than half of that

$7 trillion that you referred to.

58

[The following was subsequently received:]

In the May Midsession Review of the Budget, the Office of Management and

Budget estimated that the U.S. Government debt held by the public will total $2.1

trillion at the end of FY 2008. That figure includes holdings of the Federal Reserve

System, which were not estimated for FY 2008, but which totaled $424 billion of

the $3.7 trillion of debt held by the public at the end of FY 1997.

Mr. COLLINS. Well, one other question pertaining to the $7 trillion, too. I’d like to know what the projected percentage of that

public debt would be Social Security, because that’s just before the

Baby Boom generation is hitting the eligibility rolls.

Mr. GENSLER. We could get back to you, sir, with the specific

number on what the Social Security Trust Fund balance would be

in ten years time.

[The following was subsequently received:]

Based upon the 1998 Social Security Trust Fund Trustee’s Report, it is estimated

that the Social Security Trust Fund will hold $1.964 trillion at the beginning of

2008.

Mr. COLLINS. Okay. There’s one other thing: In your opening

comment, you mentioned that due to the Clinton administration’s

policy, fiscal policy, that it’s fostered the strongest economy and experienced the first balanced budget surplus since 1969. You know,

it just gets to be a point that it seems like some people like to

stand up and say, look what we did. Look what I did. You know,

I want to point out to you that in 1993 and 1994, the Clinton administration policy to deal with the budget and the deficit was to

raise taxes, increase entitlements, interest rates went up, the stock

market kind of held stable.

But you look at what happened in 1995, 1996, and 1997. It had

to be signed by the president. It was a joint effort. The budget has

been balanced, erasing the deficit. Tax reduction. Entitlement reform in the era of welfare and Medicare. Interest rates are down.

The stock market’s more than doubled. It wasn’t all the Clinton fiscal policy. A lot of it came from Congress. It had to originate in

Congress, in cooperation with the president and his signature.

So it wasn’t one of these I did it, Mr. Gensler. It was a we did

it. Thank you.

Mr. GENSLER. If I might say, I think the bipartisan cooperation

has been very, very positive.

Mr. COLLINS. Good. Then maybe you should change your opening

statement.

Chairman CRANE. Mrs. Johnson. Oh, wait. I’m sorry, Mrs. Johnson. Mr. Hulshof.

Mr. HULSHOF. Thank you, Mr. Chairman.

Mr. Gensler, how does your statement and the charts you

brought us on debt management square with the Clinton administration’s call that every penny of the surplus should go to save Social Security?

Mr. GENSLER. Congressman, as you’ve said, the President called

in his State of the Union address to save Social Security first, and

reserve the surpluses until a long-term solution is, on a bipartisan

basis, sorted through on Social Security. What we have done is—

on a basis of financing, as opposed to budget—borrowed less money

in this period of time. But we have not used those dollars for any

spending or tax programs. And, in fact, just as I believe one of the

59

earlier panelists said, we have borrowed less money in this period

of time as we’ve had stronger fiscal results.

Mr. HULSHOF. Because you were running out of time, let me invite you to expand a bit, if you want to, on some of the May announcements. I know one of the first questions was whether to further decrease the issuance of Treasury bills and the response in

May was what? And I’ll give you chance to expand a bit.

Mr. GENSLER. Well, we looked at three questions, that I believe

Congresswoman Johnson had asked in the earlier panel. We had

experienced a decrease in the shorter-term offerings of Treasury securities over the past 18 months of about 23 percent, as the fiscal

picture continued to improve. Rather than decreasing short-term

securities issuance further, we chose to instead, in May, decrease

the amount of longer-term debt. And, in fact, our hope is to increase the offerings of the shorter-term, and, as the Congresswoman had pointed out, less costly debt. That was our first desire.

The second question was, now that we would do that, how would

we best do that? How would we best shrink the longer-term offerings? And we thought it best to concentrate the offerings in fewer

offerings, again to promote liquidity and promote lower cost borrowings for the taxpayers.

And then lastly, it was a more technical question as to, well, if

we’re going to concentrate, at which ones?

Mr. HULSHOF. Elimination of the three-year T-bill, and again,

the reason you mentioned was market response? Was that because

of the two-year maturity——

Mr. GENSLER. That’s right, Congressman.

Mr. HULSHOF [continuing]. Being close enough or—or——

Mr. GENSLER. We surveyed the market. We talked to many market participants. Because we also offer two-year securities, and

five-year securities, we felt that the three-year security was the

least demanded by the marketplace.

Mr. HULSHOF. Thank you, sir. Nothing further. I yield back.

Chairman CRANE. Mr. Cardin.

Mr. CARDIN. Thank you, very much. Thank you, Mr. Gensler, for

your testimony.

As the projections indicate, although debt will be increasing over

the next decade, the amount held by the public will actually be decreasing and that they’ll be more interagency debt. And, as I look

at one of the charts that was prepared by GAO, it shows that the

debt held by the public as a percentage of GDP is declining significantly between 1997 and the year 2020. And I guess my question—

I’ll appreciate your observations on it—would it, therefore, be a

good time for us to consider investing some of the Social Security

Trust Funds in the private market by the trustees. That would

trigger more debt held by the public, keeping it more constant in

our economy, allowing the Social Security Administration to have

a more diversified investment return for the recipients under our

Social Security system, and it seems to me—and you look at the

projections going into the year 2050, with public debt, again, with

there being no changes, would then tend to increase. So that, therefore, we try to keep it more level in our economy—the amount of

debt held by the public as a percentage of GDP. Any thoughts on

that?

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Mr. GENSLER. Congressman, it’s a very good question and an important question of great national import. And the President has

suggested that he look to 1998 as a year of debate and dialogue

with this Congress and with Americans broadly about Social Security. And so I would not want to, in essence, comment on that great

national debate about which I think there will be many hearings.

Mr. CARDIN. I appreciate your candor on that. I thought we were

supposed to start the debate this year, and resolve it next year. So

I thought it was a fair question to ask.

Mr. GENSLER. I think it’s a very fair question, a very important

question. But as a representative of the Treasury, focused on debt

management, I feel it’s best to allow others to engage in that

broader, very important debate.

Mr. CARDIN. And I won’t press you anymore on that question, except to say that perhaps you could get us some figures, or get me

some figures, as to how much of the debt held by—how much of

the securities held by SSA could be invested privately to be able

to maintain a constant amount of publicly held debt as a percentage of GDP over the next decade. That might be an interesting

number for us to be able to take a look at for some of us who are

trying to project ways of solving the Social Security issue.

Mr. GENSLER. Congressman, it would be our pleasure to get you

those figures. It’s also a great honor to be here as I was born and

raised in your district.

[The following was subsequently received:]

In the May Midsession Review of the Budget, the Office of Management and

Budget projects that the GDP will increase by 41⁄2 to 5 percent per year over the

next decade a period of time in which OMB projects budget surpluses. Therefore,

OMB projects that the Federal debt held by the public will decline from 45 percent

of GDP in FY 1998 to 16 percent of GDP in FY 2008—a decline of 29 percent of

GDP.

Mr. CARDIN. See, if I knew that. You still vote in my district?

[Laughter.]

Thank you very much. Thank you, Mr. Chairman.

Chairman CRANE. Mr. Houghton.

Mr. HOUGHTON. Yes, good morning. I want to ask a question of

comparison or contrasts. In taking a look at the average length of

privately held marketable debt, how do we compare in our planning with, let’s say, Germany or Great Britain or Japan? Are we

more or less conservative?

Mr. GENSLER. It’s a very good question. What we find actually,

sir, is that many of these nations look to us for our debt management principles and skills and guidance. And many Treasury representatives actually are called upon and asked to speak at international conferences about our approach to markets.

Having spent much of my career in the financial markets, and

only joining Treasury nine months ago—I actually lived in Asia for

three years, trading Japanese government bonds. I would say we

have the most efficient, broadest markets. And, in part, that is because of Treasury policies over many administrations. We look

overseas also to see if they have innovations that we might adopt.

We recently adopted inflation-indexed securities which were offered

in England and Canada and elsewhere.

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But I’d say, broadly speaking, we’re at the cutting edge or the

forefront of innovation in our markets.

Mr. HOUGHTON. Yes, I’m not quite sure that’s what I was searching for. You know, when you try to make money on money, sometimes you do things on a national scale which are inimical to a very

sort of conservative, basic Treasury policy on bond management.

So, I just wondered, how on a rating of between one and ten, ten

being the most conservative, one being the most liberal, how do we

rate with other countries? I know we’re innovative. I know we’ve

got a broad market. There’s no market like it in the world. But how

are we in terms of our conservative policy?

Mr. GENSLER. Congressman, I take your question to be about our

debt management. And within our debt management, I think that

we benefit from being conservative in many aspects of what we do.

We are conservative in cash management. We feel, foremost, it

is our job at Treasury to make sure we have sufficient cash. I

think, though, we benefit in a way that other countries can’t by

borrowing longer term. Our economy is stronger, more stable, over

two centuries. And so many other nations cannot borrow as long

term—out to 30 years—as we can, because we’re such a strong and

viable economy.

I view that as conservative, but other nations can’t do that. And

so for many of them, it would be risky to try to borrow that long.

But I would think that overall, our debt management does have

some conservatism in it that I would think this Congress would

want us to have.

Mr. HOUGHTON. Okay. Thank you very much.

Chairman CRANE. Mrs. Johnson.

Mrs. JOHNSON of Connecticut. Thank you.

You mentioned in your earlier comments that, you know, you

were looking at working down the long-term, more costly debt. Are

you succeeding in doing that because it doesn’t show up in the figures yet?

Mr. GENSLER. Well, with three trillion plus dollars of debt, it

takes a little time to steer this thing. The changes that we announced in May will first begin to take place in July 1998 and moving forward. We were trying to arrest the lengthening of the average maturity of the debt that you’ve rightly pointed out.

I would say also just to possibly address your earlier question to

the earlier panel, the debt that we’re retiring was issued at much

higher interest rates than we are issuing debt today. So, in fact,

the American people are saving money as we retire close to a half

a trillion dollars of older, longer-term coupon debt. And we’re borrowing today fortunately at some of the lowest interest rates in the

last 30 years.

Mrs. JOHNSON of Connecticut. I agree, absolutely. And that’s why

I was really surprised at this drop in short-term debt, and the actual increase in long-term debt. It seems to me that from the very

beginning, the Treasury would have focused on, you know, really

working down that long-term debt. And while I understand maturity times vary, it does seem to me in the period that we’ve had

surplus that there would have been more evidence of a reduction

in long-term debt burden.

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Mr. GENSLER. In 1993, at the start of the administration, there

was a decision to do precisely what the Congresswoman suggests

and shorten the maturity, from about a six-year average maturity

to a little over five-year average maturity. In the last 18 months,

as you rightly point out, there’s a bit of a gradual creep the other

way, as we reduced Treasury bills to manage the very strong cash

flows that were coming in, and sometimes unexpected cash flows.

And now we feel we’ve had time to reflect on that and address it

again.

Mrs. JOHNSON of Connecticut. Well, thank you. I appreciate

those comments very much.

I also would like to just comment on the part of your testimony

in which you address the year 2000. And I’m particularly pleased

that you expect to complete coding and testing. Is that end to end

testing, is that complete testing of all but one system by the end

of 1998?

Mr. GENSLER. It is. We’re looking at both code testing and interface testing. There are 14 critical systems that we look at, and all

but one of them will be tested by the end of 1998.

Ms. JOHNSON of Connecticut. So those would be system-wide

tests that you’d have confidence in? I’m looking—there’s a lot of different kind of tests you can do along the way. We certainly want

to be sure the equipment works. We want to be sure it works within an office. But the important thing is it works throughout the

system. And the end testing——

Mr. GENSLER. That’s right. And for many of our systems, we’re

testing the interface with the dealer community and investor community, and we’re working with them on what’s called end to end

testing, literally. How they enter a trade and the cash movements

and the flow of all the documents.

Mrs. JOHNSON of Connecticut. When will you be able to start

that level of testing?

Mr. GENSLER. Well, in fact, because there are 14 systems, much

of that has started. Some of it this summer. Some of it through the

fall. I believe the bulk of those 14 systems will have been tested

by October, if I recall the specific dates.

Mrs. JOHNSON of Connecticut. I was also very pleased that you

have been having conferences to raise the issue of readiness with

all market participants. And are you satisfied that you are reaching the major market participants and what are you doing to reach

the minor market participants, the smaller ones?

Mr. GENSLER. This, as the Congresswoman points out, is a challenging task, and it is one that is not without risk. But we’re reaching out—and the New York Federal Reserve is working with us.

We’re working with The Bond Market Association. We’re also, I

should say, working through the various international organizations—the G–7 and G–10 and other organizations, reaching out

internationally, to highlight this very critical issue.

Mrs. JOHNSON of Connecticut. Since so much of our debt is held

by foreigners, it is very critical that at least some portion of the

international community be well prepared. What is your sense of

their preparedness? Has Europe’s preoccupation with the Euro and

its other issues diverted it from this? Has the Asian financial probVerDate 11-MAY-2000 12:58 Aug 03, 2000 Jkt 063455 PO 00000 Frm 00066 Fmt 6633 Sfmt 6602 E:\HEARINGS\63455 pfrm07 PsN: 63455
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lems diverted the Asian community from the year 2000 compliance

attention?

Mr. GENSLER. While I’m not an expert on some of those matters,

I think the Congresswoman is correct. The challenges in Europe,

given their integration, are very real. They understand the year

2000, but this administration and the Federal Reserve, I know,

have highlighted those issues around those international conferences. Asia, of course, has great other challenges.

Mrs. JOHNSON of Connecticut. Thank you. I would just say I appreciate having you testify. Mr. Chairman, I appreciate your having this hearing. I think it’s a very important one, but I also think

the public ought to understand that we—our obligation is to manage to debt to minimize taxpayer costs. And that all the rhetoric

around Social Security and all those things is actually just rhetoric.

That as long as Social Security is running the potential deficit that

it is running, it is in everyone’s interest, people of ages, that we

reduce the national debt and the carrying costs.

Thank you.

Chairman CRANE. Ms. Thurman.

Ms. THURMAN. I have no questions.

Chairman CRANE. Mr. Gensler, before you leave, I was just told

that the British have issued debt in perpetuity. Are you familiar

with that?

Mr. GENSLER. I must—I can get back to the Chairman and give

you and your staff more details on the British perpetuity debt.

[The following was subsequently received:]

Prior to 1948, the British Government had issued some debt instruments without

a maturity date that required only the payment of interest. These perpetual bonds

were known as consols.

Chairman CRANE. Yes, I’m curious as to what the advantages

would be of that. I mean, to me, we should be focused on total

elimination of debt if possible. And to make that a permanent component of your national budget? The service on a debt in perpetuity

would put people on the dole. I guess, that is the rationale behind

it. But I was curious—I had not heard of that before either. I

thought maybe you could fill me in.

Mr. GENSLER. No, I hadn’t. There are some studies as to how

long a maturity debt should be for low-cost financing. The 30-year

horizon is one that the Treasury has studied at times whether to

go further, and we have been comfortable that, for promoting our

goals over time and given risk, 30 years is probably the most appropriate horizon. But you raise an additional point of fiscal discipline.

Chairman CRANE. Well, we thank you very much, Mr. Gensler.

And we look forward to continuing to work with you. With that, I

would like to call our final panel: Stephen Francis, Vice Chairman

of Fischer, Francis, Trees and Watts, Inc.; Mark Warner, Managing

Director, Interest Rate Markets of North America; Dr. John Campbell, Otto Eckstein Professor of Applied Economics at Harvard University.

And if our panel will take their seats. We shall start with Mr.

Francis, and then Mr. Werner, and then Dr. Campbell. If you gentleman can try and keep your presentations—your oral remarks to

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five minutes or less, any printed statements will be made a part

of the permanent record. Mr. Francis?

STATEMENT OF STEPHEN C. FRANCIS, VICE CHAIRMAN,

FISCHER, FRANCIS, TREES & WATTS, INC., NEW YORK, NY,

AND MEMBER, TREASURY BORROWING ADVISORY COMMITTEE

Mr. FRANCIS. Thank you, Mr. Chairman. Mr. Chairman and distinguished members of the committee on Ways and Means, I am

pleased to have been invited to appear before you today.

You are reviewing in this hearing the debt management practices

of the U.S. Department of Treasury in an era of budget surpluses.

In my judgment, the objectives and principles of debt management

should be largely unaffected by whether the budget is in deficit or

in surplus. Building on the Treasury’s public statements repeated

here today by Assistant Secretary Gary Gensler, I believe there are

three main objectives of debt management.

The first objective is to raise whatever cash is required to ensure

that the Government’s functions smoothly everyday and meets

every financial commitment on time.

The second objective is to keep the cost of borrowing and hence

the cost of the debt to the taxpayers as low over time as is possible

and with due regard to risk.

The third objective is to promote an efficient market for the Government’s debt.

The first two objectives—raising the cash required and minimizing the cost over time—are necessarily overriding. The third—

promoting an efficient market for the Government’s debt—furthers

the first two objectives and in addition has significant ancillary

benefits for the national and international capital markets.

To translate these objectives of debt management into practice,

the Treasury has adopted some important operating principles.

One is to issue securities on a consistent and predictable basis.

This is an extremely potent principle for it reduces uncertainty. Reduced uncertainty about the Treasury’s future borrowing plans

means lower borrowing costs.

The second operating principle is to issue securities across a

broad spectrum of maturities. Offering a wide choice of investment

alternatives encourages participation in the Treasury market from

all types of fixed income investors around the world. Enlarging the

pool of investors fosters liquidity. Liquidity is a valuable attribute

because it makes Treasury securities more attractive to investors

which has the consequence of lowering borrowing costs. A broad

spectrum of maturities also diversifies the Treasury’s financial liabilities, providing resilience in changing financial conditions and

a solid financial platform for any future change in debt management strategies.

The third operating principle is to introduce innovations after

ample time for discussion and evaluation. Change in debt management as in all areas of finance is inevitable. The opportunity for

improvements is always present. Many changes are technical refinements, but some are innovations. Among the important innovations during the span of my own career are the replacement of

fixed price offerings by competitive auctions, the supplementing of

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multiple price auctions by single price auctions, and the issuance

of inflation-indexed securities. All innovations are accompanied by

some degree of uncertainty. The aim is to keep any potential cost

associated with the uncertainty as low as feasible.

The Treasury has done this by airing prospective changes it is

considering publicly over comparatively long periods so that the

market has an opportunity to digest the changes and adapt. To my

mind, these objectives and operating principles of debt management are important constants which are essentially unaffected by

whether the budget is in deficit or in surplus.

Periods of budget surpluses do, however, raise one specific challenge to debt management. That challenge is one of ensuring that

the new issues of Treasury securities sold to redeem and refund

maturing issues are large enough to be liquid. In periods of surplus, the concern is that the smaller sizes of new issues compared

to the levels to which the market is accustomed may result in a degree of illiquidity for the new issues. Illiquidity deters investors

and consequently raises the cost of borrowing and reduces the efficiency of the market.

The solution to this problem is fairly straightforward although

the scheduling steps can be intricate. Essentially, it is a matter of

consolidating a larger number of issues of declining size into a

smaller number of so-called benchmark issues whose size are each

sufficiently large to ensure superior liquidity. In its announcement

last month in connection with the regular quarterly funding, the

Treasury set forth such a program of issue consolidation.

In my judgment, debt management is functioning effectively—

now and, in fact, throughout the past few administrations. During

this period, debt management has adapted to changing budget considerations in a manner that has avoided surprises and consequently helped keep borrowing costs to a minimum. Credit for

the success, it should be noted, belongs both to the official appointees and to the Civil Service employees who together are responsible for debt management at the Treasury.

What should be addressed? While still in our minds, I would urge

Congress to find a way in the present benign budget environment

to eliminate the delays in passing the debt limit that we endured

in the past. These episodes are shameful and costly, and they damage our country’s standing among advanced nations. I do not disparage the political aims behind the delays and I find it difficult

to blame politicians for using tactical tools which are available. But

as the world of finance becomes more open and more global, our

competitive state becomes increasingly important to the future

growth of our economy. Now, it seems to me, is a propitious time

to move up a rung on the ladder of fiscal responsibility.

That concludes my statement. I would be pleased to respond to

any questions.

[The prepared statement follows:]

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Chairman CRANE. Thank you, Mr. Francis.

Mr. Werner.

STATEMENT OF MARK B. WERNER, MANAGING DIRECTOR, INTEREST RATE MARKETS NORTH AMERICA, J.P. MORGAN &

CO. INCORPORATED, NEW YORK, NY

Mr. WERNER. Mr. Chairman and members of the committee,

thank you for giving me this opportunity to share my views with

you on this very important topic for all of us today.

To put my views in context, please consider the following: The

federal budget picture has shifted dramatically over the past few

years. Going from a deficit of $255 billion just 5 years ago to what

we at J.P. Morgan estimate will be a surplus of $60 billion in the

current fiscal year. Moreover, we would expect a surplus of $50 billion in the 1999 fiscal year. You should all be commended for this

dramatic improvement and grateful for the extraordinary economic

environment which helped make it possible.

While the Government will not be likely to need to raise new

cash for the next year or longer, the U.S. Treasury will still face

the daunting task of managing over $3.4 trillion of total publiclyheld debt outstanding, which arguably forms the most important

fixed-income securities market in the world. I would like to make

four points with regard to the U.S. Treasury’s financing needs.

First of all, the U.S. Treasury will need to retain a high degree

of flexibility going forward due to our extraordinary current environment. The forecast for financing needs have often been subject

to wide margins of error. For instance, the mid-session review of

the Fiscal Year 1998 budget made last Fall, called for a deficit of

$121 billion. It is now widely acknowledged that the budget will be

in substantial surplus. These divergences stem only in a small degree from fiscal policy actions, rather they are primarily due to

miscalculations and forecasting of overall course of the economy

and its precise impact on the various components of Government

revenues and expenditures.

In recent years, budget performance has benefitted enormously

from what Fed Chairman Alan Greenspan has called a virtuous

cycle affecting the economy. Robust payroll tax increases reflecting

the strongest labor market in 30 years and capital gains receipts

resulting from 3 successive years of sharply rising stock prices have

been particularly important in this regard. It is important to remember that changes in the economic or market environment can

produce negative, as well as positive surprises with little notice,

and a corresponding risk that budget performance may be considerably less favorable than the current best forecast. Sensitivity to actual budget performance and to actual cash flow and a willingness

to make small financing adjustments in the absence of formal forecast revisions, is likely to produce more favorable borrowing rates

for the Treasury than abrupt changes. To repeat, a high degree of

flexibility will be key.

My second point is that the U.S. Treasury, as a large issuer of

securities, will be rewarded by predictability and transparency in

its offerings to market participants. Over the years, Treasury has,

for the most part, observed a set of debt management principles

that allow the markets to make informed judgments regarding reVerDate 11-MAY-2000 12:58 Aug 03, 2000 Jkt 063455 PO 00000 Frm 00073 Fmt 6633 Sfmt 6602 E:\HEARINGS\63455 pfrm07 PsN: 63455
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sponse to changes in the size of its borrowing need. I think the

Treasury would benefit by continuing to observe these principles,

which I would summarize as follows:

One, the changes in the composition of the Treasury’s cycle of offering, that is the timing and frequency of various maturities, are

far less frequent than changes in offering sizes of individual maturities.

Two, gradual changes in the offering size of individual maturities, even when frequent, are preferable to abrupt changes.

Three, note and bond offering sizes should be less volatile than

bill offering sizes.

Four, seasonal and other large temporary cash needs should be

met, to the maximum extent feasible, by issuance of off-cycle cash

management bills, thereby minimizing impacts on regular cycle

issues.

If the dealers are to maintain the excellent depth, breadth, and

liquidity that the Treasury securities market currently enjoys, then

changes in the issuance pattern should be rare, well advertised,

and gradual.

My third point is that the Treasury will benefit by anything that

enhances liquidity. That is to say, prefer large benchmark issues.

Reduce the number of issues, but raise the outstanding sizes of

those issues. Liquidity in secondary markets and financing markets

is of major importance in eliciting the broadest possible investor interest and participation in the Treasury market, and has become

a more critical issue in the context of reduced overall debt issuance.

In general, liquidity is enhanced by opting for fewer, but larger, individual debt offerings. Treasury’s recent revamping of its auction

cycle should go a long way towards improving liquidity in several

sectors. Larger individual issues should benefit the intermediate

sector, while the bill sector should benefit from increased overall

issuance.

My final point is that the U.S. Treasury market is the benchmark for interest rate capital markets around the globe. In this capacity, U.S. Treasuries function as benchmarks and hedging vehicles for a wide variety of markets around the world. The benchmark status not only enhances the overall demand for Treasuries,

but also may be vital for the efficient functioning of markets such

as corporate bonds, Federal agency securities, mortgage-backed securities, and interest rate swap transactions. All of these securities

trade at a spread relative to U.S. Treasuries. In making financing

decisions, Treasury officials must consider factors such as this that

potentially impact all the closely linked dollar denominated capital

markets.

Ours is the most efficient debt market in the world. It got that

way through the extraordinary cooperation of the Congress, the

Treasury, the Federal Reserve, and the dealer community. This fortunate period of budget surplus requires that this cooperation and

flexibility continues. Thank you.

[The prepared statement follows:]

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Chairman CRANE. Thank you, Mr. Werner.

Dr. Campbell.

STATEMENT OF JOHN Y. CAMPBELL, OTTO ECKSTEIN PROFESSOR OF APPLIED ECONOMICS, HARVARD UNIVERSITY,

CAMBRIDGE, MA

Mr. CAMPBELL. Mr. Chairman and distinguished members of the

committee, I’m honored to have been asked to give you an economist’s perspective on the Treasury’s task of managing the public

debt.

I’d like to begin by questioning the assumption that the Treasury’s job is simply to minimize the average cost of financing the

debt. While this assumption is a natural one, it omits two critically

important factors. The Treasury must also consider the risk of the

debt and its role as a form of infrastructure for private financial

markets.

First, the Treasury must take account of the risk of alternative

financing strategies. If the Treasury were to disregard risk—I

should say that I’m not suggesting that the Treasury does disregard risk—it could reduce the average cost of financing the debt

to any desired level by including desirable insurance features in

the claims it sells to the public. For example, the Treasury could

issue bonds that would pay extra in the event of a stock market

crash. Such bonds would be highly attractive to investors, and

would have a low cost on average since stock market crashes rarely

occur. Of course, no responsible person would advocate the issue of

such bonds since they would involve extreme risk to the Treasury,

and hence to the American taxpayer.

How should the Treasury measure the risk of a financing strategy? It should consider alternative plausible scenarios, and in each

scenario it should calculate the long-run tax burden of servicing the

public debt. If the tax burden is much greater in some scenarios

than in others, the financing strategy is a risky one; the burden is

stable across the scenarios, the strategy is relatively safe.

Now this procedure is very different from calculating the shortrun variability of the market value of the debt. Treasury bills have

stable market value in the short run, but they involve risk to the

Treasury because they must be rolled over at uncertain future interest rates. If interest rates rise in the future, for example, because there’s a financial crisis or because the Federal Reserve is

forced to raise rates to control inflation, then short-term financing

with Treasury bills becomes expensive. For this reason, it would

not be prudent for the Treasury to rely exclusively on short-term

debt.

Long-term bonds, on the other hand, have unstable market value

in the short run, but they protect the Treasury against the risk of

interest rate movements. When the Treasury borrows long, it can

avoid expensive refinancing if interest rates rise in the future. This

advantage of long-term financing is especially pronounced for inflation-indexed bonds which stabilize the tax burden of the public

debt even in the face of uncertain future inflation. I and many

other economists therefore applaud the Treasury’s move last year

to begin issuing inflation-protected securities—known as TIPS.

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A second important consideration for the Treasury is that public

debt instruments provide infrastructure for financial markets,

analogous to the infrastructure of the Internet or the highway system. The Treasury should manage this infrastructure to maintain

liquidity, to provide information, and to stimulate innovation in

U.S. financial markets.

An important attribute of our financial markets is liquidity—the

ability of investors to trade at low cost and with confidence that

trading costs will remain low in the future. Markets for Treasury

debt securities are liquid because these securities are issued in

large quantities, in standardized form, and with essentially no risk

of default. Investors are willing to pay a premium for this liquidity,

bidding up the prices particularly of Treasury benchmark bonds

which are the most actively traded. If the Treasury sought to minimize its financing costs, it might be able to exploit its position as

a monopoly supplier by restricting the supply of benchmark bonds

in order to receive the scarcity premium. But this would be an inappropriate policy in light of the Treasury’s responsibility to act on

behalf of the public.

Treasury debt markets also provide information about investors’

expectations of future interest rates. The issue of TIPS, together

with conventional bonds is particularly helpful in this regard because it makes it possible to measure investors’ expectations of future inflation. This information is valuable for private market participants, and also for policymakers at the Federal Reserve who can

evaluate the credibility of their anti-inflationary stance.

Finally, Treasury innovations promote beneficial innovations in

the private sector. TIPS issues have been followed by some private

issues of inflation-protected debt, and the existence of TIPS will

make it much easier for pension funds and insurance companies to

offer inflation-protected annuities. Such products will become increasingly important as the U.S. population ages in the early part

of the next century.

In conclusion, the Treasury should consider far more than just

average cost when managing the public debt. I believe it has done

so in a highly competent fashion. Recent developments in Treasury

policy, including the gradual lengthening of the average debt maturity since the low point reached in the mid-1970’s and the issue of

inflation-protected bonds, are justified both as prudent risk management and as a form of infrastructure provision to U.S. financial

markets.

[The prepared statement follows:]

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Chairman CRANE. Thank you, Dr. Campbell. Generically, for all

of you, what are the characteristics of past debt reductions and are

there any lessons for the present?

Mr. FRANCIS. Trying to think of when there was a period of past

debt reduction. [Laughter.]

It’s certainly beyond my career.

Chairman CRANE. Well, let’s see before World War I we got down

from that slide from the Civil War. Then after World War II, we

went from roughly 100 percent of debt held by the public during

the war, as late as 1947; down to—the lowest figure here looks to

be about 25 percent in roughly 1970; and it’s gone up since that

time.

Mr. FRANCIS. There’re two dimensions. One is the nominal reduction and the other is relative to the size of GNP. As GDP grows,

the relative size of debt declines if the total remains constant. The

nominal amount can decline when fewer securities are sold—when

the refunding amounts are smaller than the maturing amounts.

That’s the process which has begun in this period.

Chairman CRANE. Anyone else have any observations?

Mr. CAMPBELL. Well perhaps, I could bring in the experience in

some other parts of the world which have faced declining debt. An

issue that’s arisen in some places is whether to continue issuing

long-term debt given very minor financing needs. Nations have

made different choices. For example, in New Zealand, I understand

they’re planning simply to eliminate borrowing altogether. Whereas

in Hong Kong, the decision has been to maintain long-term borrowing in order to provide a benchmark for the financial markets

even though frankly speaking their financing needs don’t require

such borrowing. I would support the Hong Kong approach on the

grounds that benchmark issues are important for financial markets. However, of course, we’re nowhere near that point yet and the

debt will remain out there for a very long time to come.

Chairman CRANE. Mr. Werner, do you have any observations?

Mr. WERNER. I guess I would reiterate what my colleague, Mr.

Campbell, has just said that the benchmark status of the U.S.

Treasury market is a reserve holding, or dollar denominated reserve, that many countries hold U.S. Treasuries in. Many markets

trade at a relative spread to the U.S. interest rate benchmark. I

think it’s probably very important for our capital markets in this

country to maintain that status.

Chairman CRANE. Thank you. Mrs. Thurman.

Mrs. THURMAN. Thank you, Mr. Chairman. Mr. Francis, in your

short statement, you mention at the very end that quite frankly

you think Treasury is doing well in handling and all of those things

are going pretty good. But you said that one of the things that you

suggested for Congress was to not delay the raising of the debt

limit. Is that correct?

Mr. FRANCIS. Yes, that’s correct.

Mrs. THURMAN. Okay. Are there other things that Congress

should be doing, as well? I mean, you mentioned that as one. Are

there other issues that we should also be looking at that could put

us into some kind of turmoil, or cause us some problems that you

could give us some examples of?

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Mr. FRANCIS. Well, I think that first of all, that Congress is obviously part of the political process in the Nation and there has to

be give and take and a lot of debate. Occasionally statements made

in the debates have some effect on the market, but the markets

have to live with that. I put Congress’s role higher in importance

than market stability day-by-day. I do think there is something

that Congress has done—or put it the other way around—hasn’t

done that is useful with respect to debt management and that is

by and large it hasn’t interfered. Debt management is a fairly technical area. And, a lot of people would consider debt management

fairly boring. It certainly hasn’t engendered the impassioned statements that occur sometimes before the Ways and Means Committee. I think there’s a reason for that. Not just in this administration but also in past administrations, debt management has

functioned quite effectively. I think it’s not a bad idea to let it continue to work the way it has.

Mrs. THURMAN. What about the debate that’s going on now as

we’re putting our budgets together and looking at issues and the

surplus, of course? We all go home and talk about how wonderful

this is. Then the next question is what do we do with these surpluses? Do we look at the Social Security? You hear Greenspan say

that’s the best thing you can do because then you give more private

probability to have more borrowing. I mean, if I’m stepping out of

line here—but I’m just kind of curious to find out where and what

your thinking is as far as the debate that is going on in Congress

today.

Mr. FRANCIS. Well, Congressman Thurman, you’re—yes, we’re

going beyond debt management here to views on what the Nation’s

finances ought to be. I have, of course, my own views and everyone

else in this room does, too.

Mrs. THURMAN. But you get an opportunity to tell us those views

now if you’d like. [Laughter.]

Mr. FRANCIS. As I recall, the government spending in the United

States amounts to something like 40 percent of the GDP? That’s a

lot. Wouldn’t it be nice to see that trailing off over time? That’s my

view.

Mrs. THURMAN. Would any—Mr. Werner, Dr. Campbell? Come

on.

Mr. CAMPBELL. Congressman Thurman, perhaps I could add a

word. In thinking about Social Security, the Social Security system

has large future liabilities. Now the accounting system under

which we operate doesn’t record that as a form of debt, but in economic terms, it has perhaps equivalent meaning. The existence of

these future liabilities—the future retirement of the baby boom

generation is a serious issue. We should all be concerned about promoting national savings in order to build up the capital that we

need to cover these liabilities. So this switch to a period of surpluses, I think is very appropriate seen in that light.

Mrs. THURMAN. Okay. Mr. Werner?

Mr. WERNER. I don’t have any further comments on it.

Mrs. THURMAN. That’s fair enough. Thank you, Mr. Chairman.

Chairman CRANE. Mr. McCrery.

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Mr. MCCRERY. Thank you, Mr. Chairman. I have no questions

but I appreciate the panel dealing with such an arcane and boring

subject so well today.

Chairman CRANE. Mr. Houghton?

Mr. HOUGHTON. Yes, just a couple of quick questions. I guess the

issues that I’m always wrestling with is should we try to pay down

or grow out of our debt? Because that will come into consideration

in terms of our budget consideration. Also, if you had a different

scenario, the surplus dipped—maybe went into deficit, inflation

were up, more borrowings—would you suggest the same policies

under those conditions that you’re suggesting now? Those are the

two questions.

Mr. FRANCIS. I’m pleased to respond to the second question that

you asked—and my answer is yes. I think the same objectives and

the same operating principles that the Treasury is following and

has been following in greater or lesser degree for the past decade

or so would be the correct objectives and practices to follow if the

surplus were to turn to deficit. I think with respect to your first

question, I’ve said about as much as I can on that. My own belief

is that the Government’s portion—claim on GDP is larger than it

ought to be and it ought to be declining over time. But that again,

is just a personal view.

Mr. CAMPBELL. Perhaps I could add a word. I basically endorse

Mr. Francis’ answer with one qualification which is that if the Government could anticipate a particular moment in the future when

revenues would be particularly robust, it might be appropriate to

structure the debt in such a way that more of it becomes due at

that time. Now this is more of a theoretical issue in most countries.

I think that the forecast for the U.S. fiscal position are very smooth

over time, so it just doesn’t suggest lumping—concentrating a debt

on any particular maturity. But there are circumstances where a

government may have a major asset which is going to throw off a

lot of cash at a particular time. For example, the UK at one point

had tremendous North Sea oil which had a very predictable revenue pattern. In managing that, it was appropriate to have debt

come due at a time when the oil revenues would be there to pay

it off. But as I say, in the U.S. situation with a very diversified tax

base and smooth forecast, what we should try to do is have a

smooth pattern of maturing debt in the future.

Chairman CRANE. Well, we want to express appreciation to all of

our panelists for their patience and participation today. Please continue to provide ongoing input to all of us here on the committee.

We need your assistance. Thank you so much. With that the committee stands adjourned.

[Whereupon, at 11:54 a.m., the hearing was adjourned subject to

the call of the Chair.]