The Dangerous Shortage of Government Bonds

Here’s an interesting sidebar to the current hissy fit roiling financial markets:  It has turned out that Canada’s public debt is now dangerously low.

Huh?

We all know that where debt is concerned, private is good and public is bad.  That’s why we cheer on consumers as they pump up their indebtedness to a record ratio (over 100%) of disposable income, and cheer on businesses when they borrow to invest in real capital and technology.  But governments shuldn’t borrow to invest, because that is “unfair to future generations” and would create risk and uncertainty in financial markets.  To fund badly-needed and highly-productive public infrastructure, therefore, we play a silly fiscal shell game called P3’s — in which debt is transferred from low-cost public sources to high-cost (but out-of-sight) private sources.

Progressives have always argued, rightly, that long-lived productive public capital can and should be financed with long-term public debt.  There are limits to that debt, of course.  But rightly managed, public debt is economically (as well as socially) efficient — just as well-managed private debt is essential to investment and economic growth.

But there’s another “good side” to public debt that isn’t often talked about: its role in stabilizing financial markets.  Government bonds, for all the slurs about profligate politicians playing Rusian Roulette with our fiscal future, are viewed as the most reliable of all financial assets.  That’s why their interest rates are virtually always lower than private-sector bonds (and that’s why public infrastructure should be funded with public debt, not private debt).  Financial professionals agree that every investor’s portfolio should include a good chunk of rock-steady government bonds, to provide a foundation of security and predictability.  This is all the more important when investors get closer to retirement (and hence are less able to tolerate big fluctuations in their asset values).

When private finance goes into a tizzy (a regular and predictable occurrence), they tend to look for more of that government debt to hold onto.  Today, however, they can’t find it.

Reports over the weekend indicate that the market for short-term Canadian treasury-bills (government bonds that last only a short period of time, usually 90 days, before they are repaid) has literally “sold out”.  Investors wanting to buy those bonds, as a safe place to park their money during the current storm, can’t find any.  They are bidding up the price of those bonds (and hence driving down their interest rates — which fell a third of a point on Friday alone).  The difference between T-bill yields and equivalent term commercial bonds (even to credit-worthy borrowers, like big banks) has quadrupled (to 1.5 percentage points) in the last 10 days.

In other words, investors are clamoring for more government debt.  These are the ones, remember, who allegedly forced us to tighten our fiscal belts in the 1990s, for fear of hitting a mythical “debt wall.”  The wall we’re confronting, however, is of entirely private pedigree: a crunch in private lending caused by the outbreak of fear that (predictably) followed yet another greed-inspired bubble.

If Canada’s public debt were larger (and if a bit more of it were allocated to short-term, rather than long-term, bonds), it could play an even larger stabilizing role in the current crisis.  Of course, public debt can be destabilizing when it gets too big: but with federal debt currently equal to 30 percent of GDP (the lowest since neoliberalism hit our shores in the early 1980s), we are a long, long way away from that constraint.

Private financiers talk a good talk about the virtues of private enterprise.  But whenever trouble hits, they run quickly back to mommy: crying for the publicly-run central bank to bail out their liquidity problems, and crying for more safe government bonds to provide a safe haven.  I’m all for doing more of both: more public influence over the pace of credit-creation (to smooth out the regular swings of the private banking cycle), and more public bonds to pay for public investments — which, as a side benefit, will slightly stabilize the manias of private finance.

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