Debt's end would spur new problems

Staples of economy, such as savings bonds, would disappear

July 04, 1999|By Jonathan Weisman | Jonathan Weisman,SUN NATIONAL STAFF

WASHINGTON -- Last summer, economist Cynthia Latta was crunching her forecasts for the burgeoning federal budget surplus when her projections reached a landmark simply too mind-boggling to accept: early in the next century, the publicly held federal debt would simply disappear.

In a panic, the principal U.S. economist for Standard & Poors' DRI -- its forecasting division -- did what she expects Congress to do. She threw in some tax cuts, some extra government spending, and to her relief, the debt was back -- that is, until last week, when President Clinton announced that he planned to eliminate it by 2015.

It was a startling announcement, and one that most economists greeted not with hosannas, not with disbelief, but with real concern. As politically popular as it might sound, the elimination of the federal debt would have far-reaching and unexamined consequences for international investors and federal monetary policy, and even for corporate planners and individual investors.

Staples of the American economy -- and of many households -- like savings bonds and the Treasury bonds that provide havens for middle-class investors would simply disappear. Tools the Federal Reserve uses to stabilize the economy would be gone, too. And the government would have to figure out what to do with the extra money.

"I don't think it's a particularly good idea," Latta said of the elimination of the debt, adding that it was time for politicians and economists to take the consequences seriously.

Alan Blinder, a Princeton University economist and former Clinton adviser, agreed: "These 15-year projections are going to be wildly inaccurate, but some people are reading the wrong message and saying this will never happen, that the debt will run back up."

"Really," he said, "the surprises could come the other way," with the debt disappearing even faster.

Dealing with the problem of solvent government is "what the president would call a high-class problem," said Gene Sperling, chairman of the White House's National Economic Council. But it is a problem nonetheless, he acknowledged.

To be sure, with a $3.7 trillion debt still in the hands of foreign and domestic investors, its elimination seems remote. Yet at the rate the surplus is growing, the problem should not be ignored, economists say.

The Congressional Budget Office predicted Thursday that without policy changes, the publicly held debt would dwindle to $865 billion in 10 years, half the debt predicted by the White House for that year.

Safe options

For as long as there has been a federal government, the Treasury Department has financed its debt by issuing Treasury bills, bonds and notes, now considered the safest investment options in the world. In 1791, the debt was more than $75 million, though it dipped to its lowest level, $33,733.05, in 1835.

The Federal Reserve Board tries to control inflation and the money supply by buying and selling hundreds of billions of dollars worth of Treasury bonds a year. It holds $500 billion worth of federal debt in reserve. And because Treasury bonds are so secure, corporations use them as benchmarks to set the interest rates their bonds will pay.

Without them, "the whole credit rating system would have to be changed," said Dimitri Papadimitriou, president of the Jerome Levy Economics Institute at Bard College. "You'd see a complete transformation of the financial markets."

As the federal debt dwindles, the Treasury Department would stop issuing bonds as it pays off those that come due. In the past year, Treasury cut back its bond issuances from $500 billion to $380 billion. The Treasury Department is examining whether it should go into the marketplace within the next year or so to buy back bonds at a premium so it can continue issuing new ones, said Gary Gensler, undersecretary of the Treasury for domestic finance. Only with newly issued bonds can the Treasury Department set interest rates that businesses need as benchmarks to set their own rates.

Outstanding bonds

By 2011, when the administration forecasts the public debt to shrink to $944 billion, all the outstanding bonds will probably be held by the Federal Reserve, state and local governments and savings-bond holders, Gensler said. In other words, in 12 years, no more bonds will be on the public market.

As the supply dwindles, the Federal Reserve would face the biggest problem, Blinder said. The Fed could try to control interest rates by buying and selling relatively safe corporate bonds, but the signal the Fed would send by trading in, say, AT&T Corp. instead of International Business Machines Corp., would almost certainly distort the marketplace, he said.

"If you had the choice between buying some random corporate bond or buying the bond the Fed is buying, which would you buy?" asked Bruce Bartlett, a senior fellow at the National Center for Policy Analysis, a think tank.

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