International Market Implications of Declining Treasury Debt

Abstract

This article argues that international financial markets could take declining net U.S. Treasury debt in stride under normal circumstances. First, declining net U.S. government debt does not force U.S. Treasuries to be retired. Instead, Asia-Pacific governments have established or sustained government securities markets despite fiscal surpluses. Second, developments in the U.S. dollar money market show that fixed income markets can generate their own private benchmarks. Finally, the world's central banks are well along in shifting their portfolios away from U.S. Treasury to other instruments. Questions remain about market functioning under stress without the typhoon harbor that Treasury securities have provided.

In altering the outlook for the U.S. budget, the horrors of September 2001 have provided an opportunity for reasoned debate about policy in the event that chronic surpluses return. Prior to September, paying down the debt had almost come to define good policy rather than to be a consequence of good policy.

The previous discussion had confused three separate, or at least separable, issues. First, there was a macroeconomic question about the appropriate path of underlying fiscal surpluses and deficits. Second, there was a financial question of the optimal Treasury debt policy, that is, the appropriate path of Treasury debt outstanding and its mix between straight and indexed debt and its maturity profile. Finally, there were financial and governance questions regarding the appropriate financial assets for the U.S. official sector to accumulate, whether the Treasury, the Federal Reserve, and/or some new Asset Management Corporation (AMCO).

Working in the Asia-Pacific region, which contains some of the financially wealthiest governments on earth, it is appropriate for me to focus on the international aspects of these questions. The Asia-Pacific region offers examples of governments with chronic surpluses that nevertheless have government securities markets and of governments that are paying down their net debt while maintaining their government securities markets.

What follows attempts to answer these questions: What lessons can be learned in Asia and the Pacific about the reconciliation of budget surpluses and a government debt market? How well can the fixed income markets do without Treasury obligations? How can foreign central banks manage their portfolios without Treasury securities?

Maintaining Government Bond Markets by Accumulating International Assets

One thinks in this connection of countries enjoying a windfall of oil revenues, which often set up special funds to manage a fund for a future generation. Resource-poor but locationally rich Hong Kong and Singapore have each cumulated fiscal surpluses into more than $15,000 in foreign assets for every man, woman, and child.

Hong Kong and Singapore: Building Debt Markets in the Presence of Surpluses

The Hong Kong and Singapore governments have found it convenient to issue debt securities, notwithstanding their chronic fiscal surpluses. In Hong Kong the Monetary Authority has issued bills and notes in the amount of $14 billion, equivalent to less than a tenth of GDP. Singapore has issued S$50 billion (about $30 billion) of government securities, equivalent to almost a third of GDP, in a bid to build a government yield curve to serve as a base of pricing for corporate issues, swap yields, and so on. These wealthy governments have chosen to build up a stock of government debt notwithstanding surpluses by further building up foreign assets.

These governments entrust their foreign assets with various institutions. In Singapore there are three. The Monetary Authority of Singapore manages some of the Lion City's foreign assets, and it distinguishes between a liquidity portfolio and an investment portfolio. Then there is the Government Investment Corporation, which invests in foreign bonds and equities. Finally, there is Temasek, which holds the government's equity stakes in Singaporean firms and also stakes in real estate and companies abroad. Hong Kong formerly divided its foreign assets between the Exchange Fund managed by the Monetary Authority and the separately managed Land Fund. Recently the two portfolios were merged. The Monetary Authority's portfolio is also divided along liquidity and investment lines.

In an important respect, Singapore and Hong Kong do not provide appropriate analogies for the United States...