NCPA - National Center for Policy Analysis

Effects Of Cutting The National Debt

February 3, 2000

Treasury officials intend to reduce publicly-held federal debt by $17 billion in the current quarter and $152 billion in the following quarter -- the largest debt reduction in U.S. history. They'll accomplish that by reducing the number of bond auctions held each year.

Experts say the new scenario represents a mixed blessing -- with good implications for some, bad for others.

  • The announcement sent bond traders scurrying yesterday to buy up government securities -- which pushed interest rates on long-term bonds down, just as the Federal Reserve was nudging short-term rates up.
  • Reducing the number of bonds available is expected to reverse investors' lack of interest in recent years as they chased stocks.
  • Because the Treasury market is smaller, investors are increasingly buying corporate bonds -- keeping the rates that corporations must pay lower than they would otherwise be and helping corporate profits.
  • More investors are also switching to mortgage-backed securities -- thereby helping keep a lid on mortgage rates for homeowners.

While these developments are obviously good news for some, bond traders aren't cheering. A number of firms which employ bond traders have cut their operations and their trading personnel.

Nor are bond investors cheering. Treasuries have long appealed to conservative investors since they are considered about the safest investment around. With fewer available, the risk-averse investor may have to settle for opportunities carrying greater risks.

Foreign investors may be most affected. Foreigners, including central banks, own about 40 percent of Washington's $3.2 trillion in accumulated marketable debt -- up from just 20 percent five years ago.

Source: Gregory Zuckerman and John D. McKinnon, "Cutting National Debt Sounds Cool but Upsets Some Well-Laid Plans," Wall Street Journal, February 3, 2000.

 

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