Too Little Government Debt?

            There was a fascinating little article by Justin Lahart  in the July 2 issue of Wall Street Journal, entitled "Federal Reserve Faces Newfangled Problem:  Too Little Debt."   Let me quote you a couple lines:

            "With the election year approaching,  politicians will be ramping up the rhetoric about America's looming debt problem.   The Federal Reserve, on the other hand, may soon have  a different  worry:   that there is too little government debt to go around for long-term rates to rise meaningfully."

            Right now,  real interest rates, after inflation, are near zero, and have been so for a long time.  While this helps crank up the economy and helps buoy up stock prices,  it can be dangerous if it persists too long, in that it can trigger an asset bubble of some kind.   The housing bubble was mainly caused by keeping interest rates too low for too long.  And we may now be in a stock price bubble.    So the Fed would really like to get off the zero interest rate.  When the newspapers  speculate about when the Fed will begin to raise interest rates,  the  rate in question is the Prime Rate---the rate at which the Federal Reserve loans money to banks.   But, as a practical matter, this rate can never get too far from the rate at which the government borrows money---- the rate commanded by treasury bills.  So for the prime rate to go up very much, the rate paid on Treasury bills would have to rise also, and that's the problem.  These rates are not set by executive fiat---they are set by public auction.   When T-bills are auctioned off, the discount from face value at which they trade determines the actual interest rate.   And right now, buyers are bidding for them so aggressively that they have bid the interest rate to zero.

            Debt is a commodity-- especially safe, secure sovereign debt like U.S. T-Bills.    From time to time,  investors need a safe place to park their money---and T-Bills provide such a place.  But the supply of U.S. T-Bills has been shrinking.  Under the Obama administration,  the economy has improved, so tax collections are rising.  At the same time, the administration  has cut back on spending, so the amount of new debt being issued is shrinking.   And most of the new debt is issued simply to redeem existing notes.   So the net new supply of U.S. sovereign debt is only about 50 billion dollars per month,  which falls way short of demand.    And to make matters worse,  western European central banks have finally decided to do a little quantitive easing, so they are printing money and buying their own sovereign debt.  This means that European investors who would normally be buying their own government debt are now buying ours, which makes the bidding even more aggressive.   The only solution would be to persuade the Obama administration to do more borrowing and spending, but Democrats have become such deficit hawks that this is not likely to happen.