Former Treasury Secretary Henry Paulson suggested US authorities prepare a back-up plan in order to avert a potential future collapse in demand for Treasuries resulting from long-running concerns over the federal debt load — an event that he warned would have “vicious” effects.
“We need an emergency break-the-glass plan, which is targeted and short-term, on the shelf, so it’s ready to go when we hit the wall,” Paulson said in comments during an interview for Bloomberg Television’s Wall Street Week with David Westin that ranged from the impact of the Iran conflict to prospects for US-China relations.
In the immediate term, the US is positioned to weather the disruption from the Iran war “better than anyone else,” Paulson said. He also said that, with regard to the broader US competition with China, “we have far less economic challenges” than those faced in Beijing.
“We’ve got the biggest, most innovative, diverse economy; we’ve got the strongest, best-governed, most profitable companies; we live in a safe neighborhood; we’re energy independent,” Paulson said. “Our challenges are debt, fiscal and political polarization.”
With regard to any breakdown in the $31 trillion market for US government debt, Paulson said that would pose a different case from the financial crisis he dealt with while at the Treasury’s helm two decades ago.
“As bad as it was,” the government had fiscal firepower to address the credit meltdown, he said. “You can come in and clean up the mess.” But in the event of a US public debt crisis, “when you hit the wall and you’re trying to issue Treasuries and the Fed is the only buyer and the prices of the Treasuries are going down and interest rates are up, that’s a dangerous thing.”
US budget experts have for years warned of the potential for a “doom loop,” where investors start demanding higher yields on Treasuries due to risks tied to the government’s swelling debt burden, which then causes an increase in the government’s interest payments — in turn widening the deficit.
In an extreme scenario where the Treasury proves unable to raise all it needs to pay for interest or principal payments, many assume the Federal Reserve would have to step in as an emergency buyer.
“People say, when are you going to hit the wall? I obviously don’t know, it’s impossible to know,” Paulson said. “When we hit it, it will be vicious, so we have to prepare for that eventuality.”
The former Treasury secretary noted that fiscal issues are one among many on US policymakers’ plates, including the situations in Ukraine and Iran.
“There’s a lot of stuff going on. But we should not forget the deficit,” Paulson said.
He didn’t lay out the specifics for a potential break-the-glass plan. But he said “there is good news — we’re a rich country, and so there’s plenty we could do if we begin to act” on the fiscal deficit.
“It’s going to take increased revenues, taxes, and dealing with expenses,” he said. It would also mean overhauling Social Security and health care programs, he said. “You can raise the revenues without a big drag on growth, if you close preferences and loopholes in the tax code.”
The challenge is marshaling lawmakers behind such an effort, Paulson said. “I’ve worked with Congress before, and Congress doesn’t like to do unpleasant things until there is an immediate crisis.”
The US budget deficit has averaged roughly 6% of gross domestic product over the past three years — a historically large shortfall rarely seen outside of wartime or recessions and their aftermath. The gap is expected to stay around those levels throughout the coming decade, according to the Congressional Budget Office. The nonpartisan agency projects the US debt-to-GDP ratio will hit a record high in 2030, at 108%.
What Bloomberg Strategists Say…
“We believe higher debt-to-GDP will mean shallower rallies and more pronounced selloffs” in US Treasuries than during periods when the ratio was lower.
“Based on forecasts, it’s impossible to determine what these moves might look like with precision, but we can model this using our quarterly nominal GDP growth-based 10-year Treasury model. As debt-to-GDP grows, so does the sensitivity to higher debt.”
— Ira Jersey
Written by: Chris Anstey @Bloomberg
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