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Debt Has Its Virtue
Subject Government Securities
Topic Money and the Financial System
Key Words Money, Financial Markets, Government Securities, Budget Surplus
News Story

The U. S. government finances its debt largely by issuing bonds called Treasuries. The Treasury securities market is very active and interest rates determined by sales and purchases of these securities are used as benchmarks for the pricing of other government and corporate bonds. Treasury securities serve still other functions. They provide a financial haven for investors in times of financial turmoil and allow investors to hedge risks. If the government uses its projected budget surplus to pay off the U.S. debt, the Treasury securities market may disappear.

The latest projection from the Congressional Budget Office predicts a $5.61 trillion surplus over the next decade. Based upon that estimate, the Treasury could buy back enough debt by fiscal year 2006, to close the Treasury market. President Bush's proposed $1.6 trillion tax cut in conjunction with increased spending for a prescription drug plan, defense and education will likely reduce the surplus and delay the market's demise - but not for very long.

Alan Greenspan, chairman of the Federal Reserve, in testimony before Congress said, "it would be better to have a large Treasury debt outstanding so that those of us who deal in the financial markets have easy benchmarks and easy means of pricing and of funding." However, he did add that by far the most important thing is to get the debt down. Greenspan believes that the Fed can handle any problems that arise.

James R. Capra, the chairman of the Treasury borrowing advisory committee of the Bond Market Association, concluded in a report to the Treasury that the 30-year bond would have to be eliminated if the budget outlook does not change. Most of the committee members agreed that the Treasury should stop issuing the 30-year Treasury inflation protected security.

Wall Street professionals have argued that the bond market will be able to adapt to the absence of Treasury securities. Bond markets, it is argued, should be able to develop new benchmarks and other ways to hedge risk.

(Updated March 1, 2001)

Questions
1. What is a bond? What determines the price of a bond?
2. How does the government finance its debt? Why does it issue securities of differing maturity?
3. What determines the size of the federal budget surplus? What do you think projections of the budget surplus to be based upon?
Source Jonathan Fuerbringer, "U.S. May Not Need to Borrow, but it May Still Need to Be in Debt," The New York Times, February 15, 2001.

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