Last Thursday, Federal Reserve Board Chairman Alan Greenspan testified before the Senate Budget Committee. Opponents of tax cuts were dismayed to find Greenspan supporting reductions in the federal tax burden. Perhaps even more important was his reasoning, which implies that paying off the national debt is not a good idea.
Greenspan's principal concern is that if budget surpluses continue as projected by the Office of Management and Budget and Congressional Budget Office, then within a decade not only will the debt disappear, but the federal government will accumulate close to $2 trillion in net financial assets. In other words, the federal government will have more revenue than needed to pay for projected spending even after the debt is paid off. The government will therefore need to start acquiring private financial assets, such as stocks and bonds.
Greenspan rightly cautions against this. "The federal government should eschew private asset accumulation," he said, "because it would be exceptionally difficult to insulate the government's investment decisions from political pressures." It is inevitable, in short, that government investment decisions will not be dictated solely by economic considerations, but by politics. The result, in Greenspan's view, will be to lower the standard of living.
Although he did not say so, another of Greenspan's concerns must be how the Federal Reserve will function in the absence of any Treasury securities. Throughout its history, the Fed has always conducted monetary policy by buying and selling Treasury bonds, notes and bills. When it wishes to lower interest rates, it expands the money supply by buying Treasury securities and creating the money to pay for them. When it wishes to raise interest rates, it sells securities and withdraws money from circulation.
Thus, in the course of conducting monetary policy, the Fed has come to own more than $500 billion of the public debt. This debt is considered part of the debt "held by the public." Thus, long before the national debt is paid off, the Fed will be forced to start buying corporate bonds and other private securities in order to do its job. This raises the same problem of corporate governance Greenspan raised earlier for the government as a whole.
The great virtue of buying and selling Treasury securities, from the Fed's point of view, is that its actions generally do not affect the yield curve, that is the relative price of securities of different maturities. That is because, historically, the Treasury market was so large that the Fed could buy and sell even very large blocks of securities without disrupting the market.
The same is not likely to be true in terms of corporate bonds. Although the corporate debt market as a whole is quite large -- about $5 trillion -- unlike Treasury debt it is not homogeneous. It will be very hard for the Fed to avoid giving a boost to, say, Ford or General Electric if it buys their bonds. Even if the amount of Fed purchases is small, markets will undoubtedly view the Fed's action as a seal of approval. Companies with equally good credit will undoubtedly view this as unfair.
Thus if only for the Fed's own purposes, the existence of a fairly substantial national debt is a good thing. This will also be true for individuals who want to be able to continue buying savings bonds, and businesses, such as insurance companies, that like to buy Treasury bonds to help match their assets with their liabilities. Foreign central banks are also large owners of Treasuries, using them to back the value of their currencies.
All of this led Greenspan to suggest that it is not an unmitigated blessing for the nation to pay off its debt as soon as possible, to the exclusion of all other fiscal measures. Slowing the growth of surpluses, in his view, is both prudent and necessary. This could take the form either of increased federal spending or tax cuts.
Greenspan made it abundantly clear, as he has in the past, that there is no contest in deciding between the two: tax cuts unquestionably are superior to spending increases. "If long-term fiscal stability is the criterion," he told the senators, "it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases." He added that the orgy of spending that accompanied the close of the last two sessions of Congress was ample proof that failure to cut taxes will inevitably lead to unproductive spending increases.
Indeed, some forecasters believe that OMB and CBO are greatly overestimating future surpluses precisely because they have underestimated the likely outpouring of new spending. Economist Brian Nottage of Dismal.com, for example, notes that discretionary outlays were higher last year than any year since 1991. If such outlays were to continue growing at the same rate, projected surpluses will be almost $1 trillion lower over the next decade, he estimates.
With Greenspan's support for tax reduction, the last substantive barrier to tax reduction has evaporated. And with Sen. Zell Miller, D-Ga., endorsing a clone of George W. Bush's tax proposal, the political barrier is coming down, too. And markets are noticing. Forecaster Jude Wanniski believes that this improving climate for tax cuts, more so than the Fed's interest rate cut, is responsible for the recent run-up in the stock market.