In the history of public finance going back to the ancient Egyptians, governments have always sought the longest maturities at the lowest interest rates -- if it could get them in that combination. The champ of all time was probably the British government of the late 19th century, which persuaded its creditors to lend it funds at 2% interest rates and NO maturities, paper that paid that rate forever. The Brits could do this because they had maintained the gold value of the pound sterling through the thick and thin for almost 200 years. They did suspend convertibility during a brief period of the Napoleonic wars, but after the war returned to the parity originally set in 1717, which is why creditors were happy to lend for gilt-edged marketable securities without maturities.
The wise guys in our government, on the other hand, believe they should do exactly the opposite -- which is why the U.S. Treasury tomorrow will buy back another $2 billion of our governmentís bonds, with the longest maturities paying the lowest interest rates!! The highest interest rates of government debt are now in the shortest end of the schedule, with the OVERNIGHT rate on fed funds higher at 6.5% than any other bond or bill in the publicís hands. The financial press, which is collectively as befogged as it ever has been, happily retails the fiction that the yield on the 30-year bond is as low as it is because the Treasury is buying those bonds back. That is, the yield curve in Treasury debt is inverted because of the short supply of the long bond. No matter that Treasury has not been buying back the shorter yields, yet they are lower than the overnight rate. No matter that the yield curve of the British debt schedule also is inverted, although the U.K. has not been buying back its long bonds. If the U.S. Treasury Secretary, Larry Summers, says it is a good thing to retire long maturities paying low yields and retain short maturities paying higher yields, and the sovereign pontiff of the Federal Reserve, Alan Greenspan, agrees with him, the case must be closed. No financial reporter or columnist and no member of Congress disagrees. We might expect the WSJournal editorial page to at least scratch its head at these developments, but it still is preoccupied with putting Clinton/Gore in jail and promoting a zillion-dollar ABM system that nobody needs.
We do have clients who tell us how worried they are about the eventual disappearance of the 30-year bond if Treasury continues these reverse auctions. There would be a loss, of course, because there is less risk in a 30-year Treasury than any corporate dollar bond, because there is only the risk of devaluation in the government issue while the corporate issue carries both the risk of government devaluation and actual risk of corporate default. For fixed-income hedge funds, there is a discrete loss with disappearance of the long bond. In other words, in any conceivable way, the Treasury buy-back program is a loser. The likelihood of all long-term public debt disappearing is much less likely. All we need is a recession for that process to be stopped in its tracks, and as I put it to a client who raised this point Tuesday: You don't need a recession to run out of surplus. You can cut tax rates or increase spending, or wait until the actuarial deficit in Social Security and Medicare requires bond finance. The two political parties are going to be competing to see which one cuts tax rates fast enough to satisfy the voters. I know the conventional wisdom is that the 30-year yield has declined because the government is buying back long bonds in the reverse auctions, but I think if the Treasury began buying back the 10-year bonds and let the 30-years alone, the yield curve would look pretty much as it does. The market is capturing the profits that can be locked in with bonds that can't be called, and more can be captured over 30 years than over 10, no matter what the Treasury does.
This is really an evil paradigm our Political Establishment has adopted in order to justify continuance of the floating dollar. The high cost of oil is the result of errors made by the Fed in its management of the slippery greenback and so is the inverted yield curve. More errors and problems will accumulate as the Fed compounds earlier goofs in trying to manage the currency in a world of surplus revenues, but none of them can be avoided unless the gold signals are accepted as being valid, in retrospect as well as in the here and now. The fact that the economy is strong and the nation is enormously wealthy, with revenues flooding the Treasury, means that the government can make mistakes like the buy-back program and get away with them. The Clinton administration stays up all night trying to figure out how to prevent meaningful (supply-side) tax cuts. (The President himself is now working the phones to talk Democrats out of supporting repeal of the estate tax.) This is why it needs the propaganda of the buy-back program -- to persuade the citizenry it really is paying down the national debt. It could do the same thing without causing maturities to shorten by simply allowing short-term bills and bonds to expire at maturity instead of rolling them over at higher rates than the bonds being bought. But it does not have the same rhetorical effect as a buy-back.
If you have further questions on this topic, please let us hear from you as they occur. We are in an interesting period where things could happen fast and act for good or ill, bull or bear.