International Market Implications of Declining Treasury Debt

Abstract

This article argues that international financial markets could take de- clining net U.S. Treasury debt in stride under normal circumstances. First, declining net U.S. government debt does not force U.S. Trea- suries to be retired. Instead, Asia-Pacific governments have estab- lished 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 instru- ments. Questions remain about market functioning under stress with- out 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 wealth- iest governments on earth, it is appropriate for me to focus on the international as- pects 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.