[House Hearing, 105 Congress]
[From the U.S. Government Publishing Office]



 
            MANAGING THE PUBLIC DEBT IN AN ERA OF SURPLUSES

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED FIFTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 24, 1998

                               __________

                           Serial No. 105-104

                               __________

         Printed for the use of the Committee on Ways and Means

                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        BARBARA B. KENNELLY, Connecticut
JIM BUNNING, Kentucky                WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
WES WATKINS, Oklahoma
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
                     A.L. Singleton, Chief of Staff
                  Janice Mays, Minority Chief Counsel


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
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current publication process and should diminish as the process is 
further refined.
                            C O N T E N T S

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                                                                   Page
Advisory of June 16, 1998, announcing the hearing................     2

                               WITNESSES

U.S. General Accounting Office, Paul L. Posner, Director, Budget 
  Issues, Accounting and Information Management Division; 
  accompanied by Thomas J. McCool, Director, Financial 
  Institutions and Markets Issues, General Government Division; 
  and Jose R. Oyola, Assistant Director, Budget Issues, 
  Accounting and Information Management Division.................     7
U.S. Department of the Treasury, Hon. Gary Gensler, Assistant 
  Secretary of Financial Markets.................................    44
                                 ------                                
Campbell, John Y., Harvard University............................    75
Fischer, Francis, Trees & Watts, Inc., Stephen C. Francis........    64
J.P. Morgan & Co. Incorporated, Mark B. Werner...................    69

                       SUBMISSION FOR THE RECORD

Stark, Hon. Fortney Pete, a Representative in Congress from the 
  State of California............................................     6


            MANAGING THE PUBLIC DEBT IN AN ERA OF SURPLUSES

                              ----------                              


                        WEDNESDAY, JUNE 24, 1998

                          House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The Committee met, pursuant to notice at 10 a.m. in room 
1100, Longworth House Office Building, Hon. Philip Crane 
presiding.
    [The advisory announcing the hearing follows:]
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    Chairman Crane. The Committee will come to order, and if 
everybody will please take seats we can begin.
    Today's hearing will focus on managing the public debt in 
an era of surpluses. Frankly, it's a pleasure to chair this 
meeting. I was first elected to the Congress in 1969 and that 
was the last year we had a budget surplus. It was $3.6 billion, 
as I recall, that we came in in the black that year, but I kind 
of took it for granted that that would be an ongoing thing. And 
we waited until this year before we were confronted with the 
possibility of again having a budget surplus. As a result of 
last year's Balanced Budget Act, and with the help of a strong 
economy, CBO now projects we are entering an era of budget 
surpluses, and last month CBO projected a surplus for the 
current Fiscal Year of between $43 and $63 billion with larger 
budget surpluses as far as the eye can see.
    In today's hearing we will review the debt-management 
practices of the U.S. Treasury, including recent changes 
adopted by the Treasury Department in response to the budget 
surplus. For example, last month the Treasury suspended its 
auctions of 3-year notes and cut the number of its 5-year note 
auctions from 12 to 4 each year. In addition, the Treasury 
Department also issued inflation-indexed bonds for the first 
time beginning in January of 1997.
    I will now turn to my distinguished colleague Ben Cardin 
for an opening statement.
    Mr. Cardin. Thank you, Mr. Chairman, and on behalf of 
Ranking Member Rangel, let me thank you for holding these 
hearings. The Department of Treasury is widely recognized for 
its excellent job of managing our public debt soundly and 
diligently. They do so in a completely professional manner, 
devoid of partisan political influence. They do so in a manner 
that holds the cost of debt management at a prudent level. They 
are always mindful of the status of our financial markets and 
the importance of maintaining their stability. Let me take this 
opportunity to congratulate the Treasury Department on a job 
very well done.
    Mr. Chairman, you have made note of the current budget 
surplus. Isn't it wonderful that President Clinton's economic 
policies of the last five years and the bipartisan Balanced 
Budget Act enacted last year have made it possible for us to 
regain control of our fiscal finances. Back in the 1980's and 
early 1990's, we were faced with deficits well above $100 
billion and soaring to $300 billion-plus in the worst years. It 
seemed as if this day may never come. We should not squander 
this opportunity to make the future better for our children and 
grandchildren.
    I must say, though, Mr. Chairman, I don't see a whole lot 
of significance that the surplus holds for debt management. 
Naturally, if we have a surplus, the Treasury will have to 
borrow less from the public in order to fund the operations of 
government, and so they will reduce the amount of certain 
securities they offer to the public. I'm sure that Assistant 
Secretary Gensler can describe the technical details if we are 
interested in that.
    One of the great debt-related opportunities that the 
surplus provides us is that we can reduce our national debt, 
thus preserving our resources to save Social Security first, as 
the President has so wisely suggested.
    So, I commend the chairman for convening these hearings 
today so we can learn more about how the Treasury Department 
manages our financial debt and how they are able, in the last 
few months, to save some of the government's money, so that we 
can dedicate it to making the Social Security System solvent 
for many decades to come.
    I look forward to the testimony of all of our witnesses and 
I thank you, Mr. Chairman, for this opportunity.
    Chairman Crane. Thank you, Mr. Cardin.
    [The opening statement of Mr. Stark follows:]
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    Our first witness today is Paul Posner of the General 
Accounting Office, and he is accompanied by Thomas McCool and 
Jose Oyola, also of GAO. And we've asked Mr. Posner to present 
a primer on the Federal debt, if you will, as a prelude to the 
more technical discussion of debt management practices which 
will follow. Our normal procedure is five minutes in oral 
presentation and all written remarks will be made part of the 
permanent record, but in as much as you are monopolizing the 
time for your panel, Mr. Posner, we'll yield you additional 
time, especially since you have these important charts to 
present before the committee.

     STATEMENT OF PAUL L. POSNER, DIRECTOR, BUDGET ISSUES, 
 ACCOUNTING AND INFORMATION MANAGEMENT DIVISION, U.S. GENERAL 
 ACCOUNTING OFFICE; ACCOMPANIED BY THOMAS J. McCOOL, DIRECTOR, 
 FINANCIAL INSTITUTIONS AND MARKETS ISSUES, GENERAL GOVERNMENT 
DIVISION; AND JOSE R. OYOLA, ASSISTANT DIRECTOR, BUDGET ISSUES, 
         ACCOUNTING AND INFORMATION MANAGEMENT DIVISION

    Mr. Posner. Thank you very much, Mr. Chairman. It's a 
pleasure to be here. I'll submit my statement for the record. 
Our role here, as you indicated, is to set the stage for the 
subsequent discussions. We at GAO have not yet done any 
independent analysis of Treasury's debt-management operations. 
What we have done is substantial amount of work on the meaning 
of debt and deficits and we culminated this with a primer that 
you referred to. We felt the primer was necessary because, as 
big as the debt was and as large as interest is as a share of 
the budget, there still seemed to be substantial confusion in 
the public about such things as the difference between deficits 
and debt, different kinds of debt, what does debt mean for our 
long-term future, what can we do about it. And that's what our 
charts are going to address in the next few minutes.
    The first chart here shows you the total gross Federal debt 
of $5.4 trillion and this, with fairly minor exceptions, tracks 
the limit on the public debt which is currently $5.9--which, 
according to CBO, will be reached sometime in fiscal year 2001.
    The chart shows that, essentially, the debt is comprised of 
two rather disparate elements that serve very different 
purposes and respond in very different ways to a surplus. The 
first one there on the bottom is the one we're all familiar 
with, on the left side is debt held by the public which 
currently stands at $3.8 trillion and this is really the single 
best figure that summarizes how much of the Nation's wealth is 
used to finance government's obligations. Essentially it 
represents the cumulative total of all past deficits and all 
past surpluses in the Nation. The owners of the public debt are 
wide-ranging. They include individuals, corporations, banks, 
pension funds, State and local governments, and, increasingly, 
foreign governments and individuals. In fact, foreign holders 
now comprise 33 percent of the debt held by the public.
    The next chart shows the next component of debt which is 
debt held by Government accounts, which happens when the 
government ends up owing money to itself. Essentially what 
happens, as you can see in the pie chart there, trust funds 
take in surpluses from the public of revenues over spending and 
they essentially park those surpluses in Treasury notes. They 
essentially accumulate these IOU's from Treasury, these are not 
real assets, and when it comes time for the trust fund's need 
to tap those notes, to pay off benefits, Treasury actually has 
to go out and get money to back those. So the special 
Treasuries that trust funds hold are government debt, the 
government-held debt, but there really is no money there. These 
are really IOU's that the Treasury will have to go out and 
borrow from the public or raise taxes or cut spending elsewhere 
to come up with the money to satisfy these future claims on the 
budget.
    Let me go to the next chart here, and this starts to tell 
you a little bit about the trends in the debt over time and 
shows you how different the trends are for those two components 
of the debt I just talked about. Overall, over the next 10 
years, gross debt will rise by $1.8 trillion, and as the chart 
shows, this rise in the gross debt is driven by the government-
held debt which is that dotted line there. That's the debt 
driven by the large Social Security surpluses, primarily, that 
are accumulating and buying up these Treasury securities. So 
that kind of debt will be increasing at the same time as the 
solid line that you see there, the debt held by the public, 
will be dropping as a share of the economy from 47 percent as 
it stands today to 24 percent in the next 10 years. And, again, 
this largely reflects as you've indicated, the surpluses that 
we've achieved in the budget and the growth of the economy 
itself. So the developments with the overall debt held by the 
public are very salutary; the rising share of debt held by 
government accounts indicates that there is a cloud on the 
horizon in the form of potential future claims on downstream 
budgets, if you will. And so that's what those two lines, 
essentially, represent.
    I'm going to turn to the next figure here, 5 and 6, which 
gives you a little bit of the history which says a lot about 
the present and the future as well. The history we're 
portraying is debt is a share of GDP because that's really the 
best measure that tells you how much the public debt is 
consuming of our Nation's economic resources. And one of the 
interesting things you can see here is that, really, in our 
Nation's history from 1797, high public debt, exceeding 30 
percent of GDP, is an exception essentially--that has only been 
broached by the Civil War, World War I, World War II, and the 
Great Depression. So, basically what we, as a Nation, have 
collectively decided is that it is reasonable to borrow from 
the public for cataclysmic national events and all of us would 
probably agree with that: To save the nation itself and save 
the economy. But what you can see is that after those events 
occur, the Nation's debt returns to a fairly low level as a 
share of the economy after a number of years. As the economy 
starts to grow again, as the government becomes more 
contractionary in its fiscal policies, the debt begins to 
shrink. And that's what makes the most recent 30 years so 
unusual in our history, beginning in the 1970's, because, as 
you can see, in the 1970's, the debt held by the public started 
to rise again, above these levels that are only seen in wars 
and depression, up to 50 percent of GDP in recent years.
    And what was unusual about this is, as you know, we did not 
have a great war or cataclysmic depression. This was really 
fueled by a kind of chronic deficit period that we entered into 
during that time. Now the bottom part of this chart shows the 
budget deficits themselves, and the differences between the 
deficits and debt are illustrated nicely here. The deficits 
essentially are related to the debt in that they essentially 
are annual events that add to the stock of debt. Debt, in turn, 
adds to deficits by requiring interest payments that are 
recorded in the budget as outlays. The two closely track each 
other.
    As you can see, the deficits really sharply grew in the 
same cataclysmic national events that I just talked about but, 
as you can also see, once those events were over, whether as 
wars or depression, the nation returned very quickly to a 
policy of budget surplus or balance which is essentially the 
norm for the Nation's fiscal policy in our broad sweep of 
history. Essentially, conservative fiscal policy, strong 
economies, and inflation all succeeded in pulling the nation 
back out of the deficit.
    But what is interesting is when you look at the debt chart 
above, you can see how much more sluggish the debt has been to 
respond to those reversals; that while the deficit quickly 
reverses itself, the debt is a legacy which is more sluggish to 
change and whose momentum takes longer to reverse. Essentially, 
this is because it takes a longer time for economic growth to 
take over and a longer time for the accumulation of budget 
surpluses to eat into the stock of debt that we accumulated 
during these very sharp periods of national crisis.
    Let me go to the next chart here and this shows you why the 
debt makes a difference. Why should we be worried about the 
debt? There are really two reasons. One of them has to do with 
the economic consequences of our borrowing and the other has to 
do with the budgetary consequences of our borrowing. Very 
simply put, borrowing by the public sector absorbs savings that 
otherwise would be available for private investment. That's a 
familiar story to many of you; this bids up the price of 
capital by Treasury and private investment that might enable us 
to increase our productivity, wages, and potential growth in 
the economy is not as large as it otherwise would be. The 
effects, importantly, are cumulative. You are not going to 
sometimes see this in a given year or two, but over time, as 
the private investment is lower than it otherwise might be, the 
Nation's productivity and growth rate declines. And as Charles 
Schultz once said, the debt crisis is not the wolf at the door; 
it's the termites in the basement, and that's why it is so 
difficult sometimes to grasp.
    What's most disturbing about the growing debt in recent 
years is the low national savings that you see in this chart. 
The size of those bars is the total net savings available from 
the domestic economy to fund investment. As you can see, the 
total size of that bar has been going down and the share 
absorbed by the deficit which is the white part has been 
growing. Now recently that's reversed, and foreign owners of 
debt have helped as well by investing in our economy. But, 
nevertheless, the size of those bars is something that's quite 
worrisome.
    Finally, the next chart here, is really what we might call 
the bottom line. GAO has done a long-term model linking these 
annual budgets to long-term economic growth and what we've 
tried to demonstrate is that, short-term aside, the cumulative 
results of deficits and debt over time are quite compelling. We 
have modeled two fiscal policy paths. One is what we call no-
action, which is the bottom line there, which essentially 
assumes we will just follow the baseline and after a while, 
after we come out of these periods of surpluses, Social 
Security, Medicare, and Medicaid are going to kick us into a 
deficit again and that is going to lower our real incomes by 
2050.
    If we maintain budget balance through this entire period, 
you can see that by 2050, we reach a real increase in the per-
capita GDP available for Americans to 25 percent above this 
baseline. So, essentially, what we've done this modeling for is 
to help leaders understand the long-term consequences of these 
budget choices. This increased income available toAmericans is 
particularly critical because as you know, future generations are going 
to be much smaller than ours and are going to have to pay for the large 
retirement costs of the Baby Boom generation. That generation--those 
smaller work forces are going to need higher incomes to be able to 
afford these burdens that are going to be foisted on them unless we 
change our policies. So, again, this is trying to illustrate how 
important the deficit and debt are to the future incomes of this 
country.
    And the final point I will make, and will close at this 
point, is just to illustrate another familiar story, which is 
that debt also has a legacy for the budget itself. In other 
words, when you see this chart here, you see the largest 
outlays in the budget by function and, net interest on the debt 
is the third-largest function in the budget. And unlike any 
other functions, Social Security, national defense, Medicare, 
and whatever, it's the most uncontrollable. We can't do 
anything directly to reduce this. We can't trim benefits, we 
can't improve administrative efficiency; essentially this comes 
right off the top before we allocate resources to anything else 
and the principal way you can really change the interest path 
in the budget is by fundamentally doing something about 
deficits and, ultimately, going into a surplus that will 
actually reduce your nominal debt as a share of the economy.
    So, that basically, in a nutshell, summarizes, the broad 
issues. We, will hand it off to Treasury to talk more 
specifically about the debt management consequences of the 
budget surpluses.
    [The prepared statement and attachments follow:]
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    Chairman Crane. Thank you very much, Mr. Posner.
    Turning to chart number two, the ownership of our debt held 
by the public. Foreign investors is listed at little over 33 
percent. Has that been affected by any of the panic in the 
Asian-Pacific region?
    Mr. Posner. I think it is probably safe to say that it has 
been affected by those recent trends, that is the dollar's 
strength and an open economy. There's the flight to safety and 
Treasury bills are considered a safe investment. Throughout the 
world the dollar is a reserve currency which are invested by 
many central banks and governments in Treasuries. Many 
observers feel, that those events are related to that spike.
    Chairman Crane. And has it resulted in more investment in 
our debt, or less, taking money out?
    Mr. Posner. I think it's more foreign investment. I believe 
it's grown from something like 25 percent several years ago to 
34 percent today, so there's a greater foreign investment in 
our debt than before.
    Chairman Crane. And what percentage of that is held by the 
Japanese?
    Mr. Posner. We can provide that for you for the record. We 
don't have it right----
    Chairman Crane. Off the top of your head, do you think it's 
a majority?
    Mr. Posner. No, I don't think it's a majority. No.
    Chairman Crane. Who is the biggest investor in our debt?
    Mr. McCool. It would most likely be a combination of 
European governments, I would expect, governments, individuals, 
and institutions.
    Chairman Crane. No individual, single government comes to 
mind?
    Mr. Posner. The United Kingdom.
    Chairman Crane. The United Kingdom?
    Mr. Posner. Yes.
    Chairman Crane. Another question I would like to put to you 
is this booklet that GAO put out in 1996 ``Federal Debt Answers 
to Frequently-Asked Questions.'' Are you contemplating getting 
a reissue published?
    Mr. Posner. We're actually contemplating doing that. Mr. 
Domenici, the chairman of the Senate Budget Committee, has 
asked us to do this and to, essentially, talk about what it 
means to run a surplus for the public debt. What are the new 
issues raised by the budget surplus, including debt management 
issues, the very topic of your hearing, so we are planning on 
doing that.
    Chairman Crane. Very good, I appreciate that. I'd like to 
now yield to our distinguished ranking minority member, Mr. 
Rangel.
    Mr. Rangel. I have no questions. I want to thank you, Mr. 
Chairman, for having these our hearings and our witnesses for 
helping us better understand the budget process.
    Chairman Crane. Mr. Camp. Mr. McCrery.
    Mr. McCrery. Mr. Posner, I just have one question. In the 
periods of declining debt in our history, what is the process 
of actually reducing the debt held by the public? How do we do 
that?
    Mr. Posner. There's essentially two ways to think about 
that. One is just simply, when a war is concluded, or the Great 
Depression, for example, was over, just the rise in economic 
growth shrinks the proportion of debt to the economy, so that's 
one thing that happens. The other thing that happens is very 
typically we go into a budget surplus, which is the only way we 
can actually reduce the nominal level of debt and that's been 
the typical response.
    Mr. McCrery. How do we reduce the nominal debt?
    Mr. Posner. By any combination of revenue increases or 
spending cuts that produces an annual budget surplus.
    Mr. McCrery. Yes, I know, we have to have a surplus to 
reduce the debt, I'm with you. But what's the actual mechanical 
process of getting that debt back and extinguishing parts of 
the debt?
    Mr. Posner. Right. Essentially, the debt mechanically is 
rolled over, most of the debt is rolled over so the mechanical 
process that happens is you simply have less need to finance 
debt so you roll less of it over. That's essentially the way we 
reduce the debt. At least recently, we haven't bought back any 
outstanding debt, but basically the mechanics is you simply 
roll over less of it.
    Mr. McCrery. How much of our debt, you know, we hear a lot 
of talk about buying down the publicly-held debt. We've got 
this surplus and we want to use it all to buy down the debt. 
How easy is it to buy down the debt? In other words, how much 
of that debt rolls over each year which would lend itself to 
buying back?
    Mr. Oyola. About 50 percent of the debt held by the public 
will mature within the next two years, which means that the 
Treasury has the ability to roll over less of it. As debt 
matures, the Treasury could choose not to issue new debt, so 
about 50 percent of the debt held by the public could, 
potentially, be subject to less reduction.
    Mr. McCrery. Okay. Thank you.
    Chairman Crane. Let's see. Mr. Cardin?
    Mr. Cardin. No questions, Mr. Chairman.
    Chairman Crane. Mr. Herger. Oh, wait, I'm sorry, Mr. 
Portman is he here? Mr. Herger, then. Mr. Watkins. Is Mr. 
Watkins here? Mr. Houghton.
    Mr. Houghton. Thank you very much, Mr. Chairman. I havenot 
been here for this whole discussion, but I do have a question and I'm 
not sure that it's easily answered and if it's not, then we can talk 
about it personally later on. I guess the thing I've always worried 
about is the short-term debt financing long-term objectives. And it 
just seems that when we were in a crunch we tend to shorten up in order 
to reduce the out-of-pocket costs to the government at that particular 
time. So the question really is, are we doing right by that ratio now 
and, also, what might be an ideal ratio?
    Mr. Posner. That is, as you noted, a complicated question 
that I think Treasury may very well address in their remarks 
because there are a number of variables to consider. Cost to 
the government being one, which shorter terms denominations 
generally gets you lower costs. The market conditions and the 
liquidity of the various Treasury notes in maintaining a 
healthy market for Treasuries is another. As they will tell 
you, there are a variety of factors that are considered. We 
have not, again, looked at this in any independent way at this 
point, but my understanding is that the maturities of the 
Treasuries on average have been on the upswing, in the past 20 
years. I think they reached a low in the mid-1970's, and now 
they are averaging a little over five years. But as to how they 
decide the mix of bills and notes and bonds and that kind of 
thing is something I think they will probably be addressing.
    Mr. Houghton. So you haven't done any studies on that?
    Mr. Posner. No, not right----
    Mr. Houghton. Thanks very much.
    Chairman Crane. Mr. Neal.
    Mr. Neal. Thank you, Mr. Chairman. I just bumped into a 
reporter in the hallway and he said that Speaker is very upset 
today with CBO numbers and that he is very upset with the Joint 
Tax Committee's estimates on revenue forecasts. Would you care 
to comment on the role that CBO plays here in offering these 
revenue estimates for us? Any of the panelists?
    Mr. Posner. We have not looked, and do not have the 
responsibility to examine and independently evaluate CBO's 
numbers. They are the, as you know, the forecaster for the 
budget, for the Congress, and they estimate costs, but we at 
GAO do not have the role to examine their assumptions or their 
models.
    Mr. Neal. You wouldn't suggest that they ought to fudge any 
numbers along the way so that they can comply with the request 
of the leadership for tax cuts that may not well be necessary?
    Mr. Posner. All I can offer in response to that is that we 
work very closely with the CBO analysts and they are highly 
professional and I've not known that to be a problem in their 
past history.
    Mr. Neal. Could I ask, do you know who appointed the 
current CBO team?
    Mr. Posner. Well, the current director is appointed by the 
Congress, by the leadership of the House and Senate, I believe, 
three-and-a-half years ago.
    Mr. Neal. Okay. Thank you, Mr. Chairman.
    Chairman Crane. Mr. Collins.
    Mr. Collins. Thank you, Mr. Chairman. Just one question in 
particular. We will see, with the rollover of the private 
sector portion of the debt, a reduction. We will see an 
increase with the public sector portion of it. What will be the 
bottom line as compared to a year ago? Will there be an 
increase or a decrease overall?
    Mr. Posner. Increase over all in the gross Federal debt.
    Mr. Collins. And by how much? I looked for it in some of 
this information and I didn't----
    Mr. Posner. Basically the gross debt in 1997 was $5.3 
trillion; in 1998, it will be $5.5 trillion; 1999, $5.7; and it 
grows to $7.1 trillion by 2008, the gross debt. And, again, the 
net debt to the public goes down; the debt held by the 
government accounts goes up.
    Mr. Collins. Okay. One other question, the chairman 
mentioned foreign investors, particularly in Japan, and Japan 
has quite a bit of accumulated savings in private sector there. 
How does their interest rate for those savings compare to the 
investment in our securities?
    Mr. Posner. I'm sorry, could you repeat that?
    Mr. Collins. In Japan, the private sector has an 
accumulated savings of about $10-$11 trillion. How does the 
interest rate on those savings in Japan compare with the 
interest rates we pay on securities? Or do you know?
    Mr. Posner. Don't know. Tom, do you----
    Mr. McCool. I don't know what longer-term interest rates in 
Japan are. I know that their short-term rates tend to be very 
low and, certainly, in comparison with U.S. rates. But then you 
also have to take into account the potential for currency 
fluctuations, so it's a fairly complicated mix but Japan's 
interest rates are, I think, quite low right now.
    Mr. Collins. Okay. Thank you. Thank you, Mr. Chairman.
    Chairman Crane. Mr. Tanner.
    Mr. Tanner. Thank you, Mr. Chairman. I, like Mr. Houghton, 
haven't been here the entire time. For that, I'm sorry because 
I am very interested in this subject. From the charts that I 
have seen, foreign investors, according to the chart, hold 
about a third of our public debt. Is that an acceptable number 
or should we be concerned or is it something that really 
matters?
    Mr. Posner. It's probably a dual-edged kind of answer to 
that. On the one hand, the foreign investors help us finance 
our investment at levels above that we can finance from our own 
savings because our savings from domestic sources are so low. 
So, on the one hand, foreign investment helps prop up our 
investment. In an open economy, the influx of foreign dollars 
the Treasuries is a reflection of the strength of the dollar, 
the strength of the American economy compared to other 
economies right now, and so it's in some sense a tribute to the 
American economy. On the other hand, the downside of this is 
that the earnings from those investments in our assets flow 
overseas to foreign residents and not to American citizens.
    There is probably no one level that would be--that you can 
say is appropriate. But, certainly by propping up levels of 
investment, they are helping us attain higher levels of 
investment and plant equipment that ultimately helps long-term 
growth, assuming foreign dollars are invested in productive 
assets.
    Mr. Tanner. Well, looking at this chart, from what you say, 
I assume that a third of the $244 billion or thereabouts is 
going overseas, which would be a trade imbalance with regard to 
currency, would it not?
    Mr. Posner. I'm not exactly sure how much of the net 
interest specifically is denominated to foreigners. The foreign 
holdings have just recently climbed to that level, so I'm not 
sure that a third would be the right figurethere but----
    Mr. Tanner. Well, would you have a comment as to whether a-
third, in your opinion, was too high, too low, about right, or 
does it matter? I know that's very subjective--but, at home we 
get asked questions like this and when we say, well, the 
foreigners hold a-third of our debt and people ask if a third 
is too much? Should we be concerned? And I'd just like your 
opinion about it, that's not a----
    Mr. McCool. Well, again, I think part of the issue also is 
it's not just how much they hold of our debt, but how much we 
hold of their debt and the issue is really the net. So you 
would expect in a world where the U.S. is the dominant economy 
and the assets of the U.S. government are the most attractive 
risk-free assets around, that foreigners would want to hold a 
lot of our debt, so that's not really the issue. I think the 
issue is the relative flows and the relative stocks, compared 
with what we hold of theirs. And I think that, recently has, 
been the issue. There's been more of their money investment 
flows coming to the U.S. than vice versa over that time.
    Mr. McCrery. Will the gentleman yield?
    Mr. Tanner. Yes.
    Mr. McCrery. I think the gentleman asked a good question. 
Is it safe to say that in times of surplus here the extent of 
the debt held by foreigners is less of a problem? Let me 
explain. If we're in times of deficit, then we have to actually 
go to the markets and borrow money ourselves, the government, 
to finance our deficit. So, it's possible that if foreigners 
held too high a percent of that debt, that they could kind of 
hold us hostage because we have to go to them in effect to 
borrow money to finance our own operations. Whereas in times of 
surplus, we don't really care who holds the debt or who's 
buying it because we're not issuing new debt, we could be 
actually buying it back, so that's part of my fear when we were 
having high deficits and, as far as the eye could see, as that 
percent of debt grew, held by foreigners, I could see us 
possibly at some point in the future being held hostage by 
those foreign debt holders.
    Mr. Posner. I think certainly when the debt is declining 
and the share that is held by anybody is less--as you indicate 
perhaps less critical. The vulnerability point is something we 
have a little track record on. In the 1980's, there was a 
disinvestment of our bonds by Japanese investors, for example, 
and yet, in fact, many other international investors filled the 
gap. Spain, the United Kingdom, and other nations came in and 
bought Treasuries, and so there's a fairly active diversified 
worldwide market for Treasuries that helps address some of 
those vulnerability concerns. However, the other issue to raise 
here is that other economies are facing a baby boom crisis of 
their own, earlier than ours: Italy, Germany, Japan, France are 
also going to be facing quite a--problems in the public sector 
in the next 30 years, that are going to draw back into those 
nations their investment resources for public sector programs. 
So, the amount of foreign investment we can rely on over time 
may, in fact, decline from those sources at the very least.
    Mr. McCrery. Thank you, I won't ask the gentleman why the 
Italian and the French have a sooner baby-boom problem than we 
do, I'll leave that to others. I thank the gentleman for 
yielding.
    Mr. Tanner. Thank you. Mr. Chairman, could I ask unanimous 
consent for two additional minutes.
    Chairman Crane. Sure thing.
    Mr. Tanner. Thank you. Following up on what Mr. McCrery 
said, I think the idea here is more maybe in the nature of a 
political fear or a political problem than it may be in terms 
of a financial matter. The political fear, of course, is that 
the fear that some have that this debt held by foreigners gives 
them inordinate leverage over what happens internally in 
America and so that's the reason for the discussion here about 
how much is too much. But I thank you for that.
    Going back to one thing that Mr. Houghton said, if I may 
real quickly. I, too, have been concerned about the short-term 
nature of some structural debt that's basically built in. We 
can say we'll pay it back some day but the truth is we probably 
never will, and I'm not sure financially that it's necessary. 
It's always been my thought that if we could stabilize the 
debt, and then let the economy double, triple, and quadruple, a 
$5 trillion debt in an $8 trillion economy is very much a 
problem, in a $20 trillion economy, it is much less of a 
problem. Which brings me to my second question. The interest 
that we pay on this debt amounts to somewhere around 14 cents 
out of every dollar that comes to the Treasury. Is that 
correct?
    Mr. Posner. Yes.
    Mr. Tanner. All right, said another way and the way I 
explain it to people at home, 25 years ago about 7 cents of 
every dollar that came was paid in interest. Now, any business 
person knows that if one is paying 7 percent for one's 
inventory, if it's a car dealership or whatever, you can make a 
little money. If you're paying 14 percent interest on your 
inventory, it becomes very problematic as to whether or not 
your business can make it. Now, we have in effect a 14 percent 
mortgage on the country, would that be a fair statement in your 
opinion?
    Mr. Posner. Well, I think it's 14 percent of spending; it's 
roughly 3 percent of the economy, of GDP, but I think it's a 
fair way of saying that it's a concern. As we say, it comes 
right off the top, you can't do anything about it directly 
unless you reduce the size of the debt held by the public. The 
other concern is do we want this overhang from the debt 
buildups in the past 30 years to be carried forward into the 
next 30 years when we know that that next generation is going 
to be struggling to pay for these new bills that are going to 
be coming due for Social Security, Medicare, Medicaid that are 
also going to be facing them. So that's another concern and the 
question is we have an opportunity now to, reduce that as a 
share of the budget, to kind of reduce that legacy.
    Mr. Tanner. I certainly thank the gentleman. I'm going to 
read this in depth and perhaps maybe we could follow up with a 
meeting at some point about this and I'd really like to get 
with Mr. Houghton and explore the imbalance in the debt versus 
the structure, particularly with no entitlement reform in 
sight. Thank you, very much, Mr. Chairman.
    Chairman Crane. Mr. Christensen.
    Mr. Christensen. Thank you, Mr. Chairman. Mr. Posner, I've 
got just a couple of questions. One is that as director of your 
Division of Accounting and Information Management, how are you 
guys prepared for the Y2K problems and, as the manager, are you 
up to speed on getting ready for the Year 2000?
    Mr. Posner. Well, in terms of--GAO has done--is making a 
major investment in analyzing the Federal agency's readiness 
for the Y2K. As a matter of fact, we have a request to look at 
the Bureau of Public Debt and those operations to make sure 
that they are Y2K compliant, which we have not yet begun but 
are about to begin. Is the question about our own operations?
    Mr. Christensen. Your own division.
    Mr. Posner. That's not in my bailiwick, but I know the GAO 
has been undertaking a review of our systems and that kind of 
thing to ascertain----
    Mr. Christensen. Do you know how far along you are?
    Mr. Posner. I really don't. We could certainly get back to 
you with information on that for the record.
    Mr. Christensen. I'd like to know that.
    Mr. Posner. Sure.
    [The folllowing was subsequently received:]
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    Mr. Christensen. At what phase of review you are, at what 
percentage completion, and if it was tomorrow, what kind of 
catastrophe we would have in your division. Another thing I'd 
like to ask is what effects, if we were to significantly reduce 
the debt, will it have on our markets, and what effects has the 
Treasury's sale of the 4-, 7-, and 20-year had on our markets? 
The 20-year securities.
    Mr. Posner. Well, we have not really looked at the effects 
that individual denominations have had on markets of Treasury 
notes. What we have done is we've modeled the results for the 
economy for the long-term of debt reduction and what do you get 
in terms of long-term growth dividends from that? And that's 
the chart that we had up there before that shows that if, in 
fact, we reduce debt, essentially by following a balanced 
budget, once the baby boom bills come due, our per capita GDP 
would be much higher than it would be if we just followed the 
current course. And that's pretty much what we've done to try 
to illustrate the benefits of doing something about this. But 
we have not followed individual bills and issues.
    Mr. Christensen. That's all, Mr. Chairman.
    Chairman Crane. Mr. Hulshof.
    Mr. Hulshof. No questions, Mr. Chairman.
    Chairman Crane. Mr. English.
    Mr. English. Thank you, Mr. Chairman. This is a very 
distinguished panel. I really only have one question having to 
do with what is owed by the General Fund to Social Security. 
Social Security has over time accumulated nonnegotiable 
Treasuries as, in effect, a collection of IOU's against the 
$700 billion that the General Fund has taken out of the Social 
Security System. I know I am not describing this precisely, 
but, in effect, I am describing it accurately. In your view, is 
there a meaningful difference between negotiable and 
nonnegotiable government securities and is, simply if we were 
to try to compare their value, would it not be fair to say that 
a nonnegotiable Treasury security, by virtue of being 
nonnegotiable, inherently would have an inferior position 
because it can't be offered in the market. Do you care to 
comment?
    Mr. Posner. Well, the nature of these debt instruments is 
very, very different. Social Security has some advantage in 
that it gets unlike other trust funds, it gets redemption at 
par regardless of the market value or the change in the market.
    Mr. English. That's true.
    Mr. Posner. And that is an advantage that the Social 
Security fund has specifically by law. The whole question of 
even calling these securities is something that is problematic 
because it kind of leads to the impression that there's a 
funded portion that's available to be culled. And, as you know, 
these are IOUs, as you said, that, when the time comes, when 
Social Security runs out of surplus and has to dip into this 
reservoir of ``assets,'' there really is no money there. And 
Treasury has to go out, unlike a State and local government 
pension fund, which has, you know, money that it can tap in the 
market, Treasury has to go out and either borrow it or raise 
taxes or cut spending somewhere else, as we're currently doing 
with Medicare, which has a $5 billion cash deficit. Medicare is 
starting to call back some of its treasuries on a net basis, 
although it's hard to tell the impact of that on a $1.7 
trillion budget; nevertheless, Medicare is becoming a net drain 
on the Federal budget. And that's the kind of thing that will 
happen with Social Security around 2014.
    Mr. English. I think that's actually a wonderful summary, 
Mr. Posner, and I thank you for it. What you've made clear in 
your statement is that a non-negotiable treasury is not like a 
standard negotiable security. And what seniors and others have 
in their name posted, wherever it is in West Virginia, really 
does not have the same value as the security. Although, as 
you've noted, there are some legal protections built in to make 
sure there's a payment. And I thank you for it, and I yield 
back the balance of my time.
    Chairman Crane. Mrs. Thurman?
    Mrs. Thurman. Mr. Posner, I am like Mr. Tanner--sorry I 
wasn't here for the full explanation--but I'm just trying to 
catch up and read through this by looking at your charts, and 
particularly the conversation that took place on the foreign 
investments. You made a statement where it says, ``the United 
States benefits from foreign purchase of government bonds 
because as foreign investors fill part of our borrowing''--I 
can't even say the word--``more domestic saving is available 
for private investment, and interest rates are lower than they 
otherwise would be.''
    Based on the conversation, as you said, as France and 
others start to need these dollars, what happens then to our 
economy in the United States based on that statement?
    Mr. Posner. Well, several things could happen. One that you 
might hope is that our own domestic savings might grow so that 
we can finance more of our investment from our own sources.
    Another scenario might be that as these advanced nations 
reach their own public sector crisis or challenge, if you will, 
that other nations throughout the world might find treasuries 
and our investments to be, a good investment. So it's hard to 
tell what will actually happen there.
    Mrs. Thurman. But is it something we should be watching and 
be concerned about, based on that?
    Mr. Posner. A number of economists would argue that yes, in 
some sense, it is; and that it's generally preferable to 
increase the national savings rate from domestic sources.
    Anybody? Thanks.
    I will yield back the balance of my time.
    Chairman Crane. Mrs. Johnson.
    Mrs. Johnson of Connecticut. Thank you very much.
    I don't know whether it's fair to ask these questions of 
the next panel or your work enables you to answer them. But 
over, say, the last six months, how much debt have we actually 
retired as notes have come due, and we have just not refinanced 
them because we had surplus dollars? And of that debt, how much 
was high-cost and how much was low-cost? The gradations and----
    Mr. Posner. I think because they have some of the figures 
there we can----
    Mr. Oyola. We have some of the figures here. As of 
September 30, 1997, the total marketable debt, which is 
comprised of bills, notes, bonds, and the Federal Financing 
Bank, was $3.4 trillion. As of May 30, 1998, the total 
marketable debt was $3.3 trillion. So there has been a slight 
decrease, from $3.439 trillion to $3.353 trillion. That's $86 
billion less in marketable debt--bills, notes, and bonds.
    Mrs. Johnson of Connecticut. And of that, how much was what 
you would categorize as high-cost debt?
    Mr. Oyola. The bills, which will be normally lower-cost 
debt, in September were $702 billion. And in May 31, it was 
$648 billion. So there has been a reduction in the bills.
    Mrs. Johnson of Connecticut. And that's the lower-cost 
debt?
    Mr. Oyola. Yes.
    Mrs. Johnson of Connecticut. And a higher-cost debt?
    Mr. Oyola. Higher-cost debt would normally be bonds. And in 
the case of bonds, on September 30, there were $576 billion; 
and on May 31, there were $599 billion.
    Mrs. Johnson of Connecticut. So actually there's more high-
cost debt?
    Mr. Oyola. There has been an increase in the amount of 
long-term debt.
    Mrs. Johnson of Connecticut. So the--all of the drop has 
been in the lower-cost debt?
    Mr. Oyola. There has been a decrease in the bills, which 
are lower cost. There has been an increase in the bonds, which 
are long-term; and in the present environment, they are higher 
cost. There has also been an increase in the amountof inflation 
indexed securities, which are notes and bonds.
    Mrs. Johnson of Connecticut. Did--did--were the bonds that 
came due during that period were they retired? I'm finding it a 
little hard to understand why the amount of bonded indebtedness 
went up so significantly, and the amount of short-term debt 
went down. Was is that longer-term high-cost debt didn't come 
due. Or did they choose not to pay it off?
    Mr. Oyola. We don't have the amounts that came due in that 
period of time, but we can certainly find the information for 
you. What probably happened is that the bills, which are short-
term in nature, came due at a higher volume than any bonds. So, 
naturally, the bills will have been retired.
    Mrs. Johnson of Connecticut. And I didn't understand you 
correctly that the inflation-indexed debt went up?
    Mr. Oyola. Excuse me.
    Mrs. Johnson of Connecticut. The inflation-indexed debt 
went up?
    Mr. Oyola. Yes.
    Mrs. Johnson of Connecticut. Thank you.
    Chairman Crane. Ms. Dunn.
    Ms. Dunn. No questions.
    Chairman Crane. Well, with that, I want to express 
appreciation to our panel for their presentation this morning, 
and we look forward to working with you in the future. You may 
be excused, and we shall invite next the Honorable Gary 
Gensler, Assistant Secretary of Financial Markets for the U.S. 
Department of the Treasury.
    Mrs. Johnson of Connecticut. Mr. Gensler. Welcome.

    STATEMENT OF HON. GARY GENSLER, ASSISTANT SECRETARY OF 
       FINANCIAL MARKETS, U.S. DEPARTMENT OF THE TREASURY

    Mr. Gensler. Thank you, Madam Chairperson, and 
distinguished members of the committee. It is an honor to be 
here today in front of this committee to talk about debt 
management and the Treasury.
    With the Clinton administration's policy of fiscal 
discipline and its fostering of a strong U.S. economy, we have 
experienced our first budget surplus since 1969. The 
administration welcomes the challenge of managing a surplus 
rather than financing a deficit.
    If I could just submit for the record my written testimony, 
I'm going to just briefly summarize in some oral remarks.
    It is important in this endeavor for the government to have 
goals and principles. And I'd like to just lay out some of 
those goals and principles that guide treasury and its debt 
management.
    First, in terms of our goals, we broadly have three goals 
that drive our debt management. The first is sound cash 
management. That is to say, that we want to ensure that our 
cash balances at all time are sufficient to meet our 
obligations.
    Second, is achieving low-cost financing for the taxpayers. 
We look at this over time, both in the short-term and the long-
term. And we consider risk, as many of the members had 
mentioned earlier, with the earlier panel.
    And third is the promotion of efficient capital markets, to 
ensure that the U.S. capital markets continue to be the 
strongest around the globe.
    In achieving these goals, five interrelated principles 
guide us.
    First is maintaining the risk-free status of Treasury 
securities. This is accomplished through prudent fiscal 
discipline and timely increases in debt limits.
    Second is maintaining consistency and predictability in our 
financing. Treasury issues securities on a regular schedule, 
with set auction procedures. This reduces uncertainty in the 
markets and helps minimize our overall cost of borrowing.
    Third, Treasury is committed to ensuring market liquidity. 
Liquidity promotes efficient capital markets and, again, lowers 
the cost of borrowing over time.
    Fourth, Treasury finances across the yield curve. What this 
means is we not only borrow money for short-term periods, like 
90 days or 6 months in what we call the Treasury Bill market, 
but we also finance over the long term, as long as 30 years. 
This appeals to the broadest range of investors. And we feel 
that by appealing to a broad range of investors, we, again, 
help lower the cost of financing and promote an important goal 
of having the most efficient capital markets in the globe.
    And then fifth, Treasury employs unitary financing. We 
aggregate virtually all of the government's financing needs and 
finance as one nation. Thus, all programs of the Federal 
Government can benefit from Treasury's low borrowing rate 
rather than competing in the marketplace with smaller, more 
costly issuances.
    We have been responding to dramatic changes in our 
financing needs. At the start of the Clinton administration 
estimates were that the level of privately held debt today 
would be approximately $4\1/2\ trillion. As you can see from 
this exhibit--and I apologize if the print is a little hard to 
see--that currently there's about $3.4 trillion of privately 
held debt. That includes marketable debt of about $3 trillion 
and $400 billion of non-marketable securities--savings bonds, 
State and local government series, and the like.
    In addition, the Federal Reserve holds a little over $400 
billion of debt; and then, of course, the government accounts 
and trust funds hold $1.7 trillion.
    But the $1 trillion less debt today than was estimated just 
five years ago is a remarkable accomplishment, which has 
benefitted all Americans through higher national savings and 
lower interest rates.
    Exhibit D shows how the components of our financing needs 
have changed over the last several years. The unified budget 
deficit, which historically drove our borrowing needs, has 
decreased dramatically and finally has become a surplus. Just 
three years ago, the unified budget deficit of $164 billion 
really drove our needs. And this year, OMB estimates a $39 
billion surplus.
    Moreover, an increasing share of our financing needs come 
from non-marketable securities, this is the sale of securities 
to State and local governments, to small investors, through 
savings bond programs and other programs. This year, we 
estimate that over $50 billion of our financing needs will come 
through non-marketable securities.
    Thus, in Fiscal Year 1998, with all these factors, we will 
pay down approximately $79 billion in marketable securities, 
which is our last component.
    I would like just to discuss for one brief moment the May 
announcements. First, we stopped offering three-year notes, 
and, second, we reduced the frequency of our offerings of five-
year notes. In formulating this strategy, there were three 
questions, all of which are more detailed in the prepared 
testimony that we've submitted. But all of them were meant to 
promote the efficient capital markets, lowest-cost financing, 
and cash management goals that Ireferred to earlier.
    In addition, the Clinton administration has made 
innovations that this committee had asked us to address, one in 
particular in terms of the inflation index program. The 
securities diversify the government's financing sources, and we 
believe that this will lower Treasury's borrowing costs over 
the long run. In addition, they provide inflation protection 
for investors and help promote savings.
    Other innovations have been the innovations in State and 
local government series. We have innovated in savings bonds to 
make them more attractive to American savers. And in addition, 
we are making our securities more accessible to small 
investors--putting savings bonds on the Internet and making 
enhancements to our Treasury Direct program for small 
investors.
    I believe the committee had some questions on the Year 2000 
that I would be glad to take, and there's more in the prepared 
testimony.
    In conclusion, as I said earlier, the administration 
welcomes the challenge of managing a surplus rather than 
financing a deficit. I would also like to mention my deep 
appreciation and respect for the career staff at Treasury, who 
have done such excellent work on these issues for so many 
years.
    Mr. Chairman, I will be happy to answer any questions you 
may have regarding Treasury debt management in this new era of 
budget surpluses.
    [The prepared statement and attachments follow:]
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    Chairman Crane. Thank you, Mr. Gensler.
    Mr. Rangel.
    Mr. Rangel. Treasury now has a history of selling 
inflation-indexed bonds. Could you summarize how this new 
policy has unfolded?
    Mr. Gensler. We introduced the inflation indexed bonds just 
about a year and a half ago, and since then have had six 
issuances. And we're about to announce our next issue--I 
believe it's next week. We've been very satisfied with the 
inflation indexed program to date, and we feel it's an 
important innovation, again broadening out the access that the 
Treasury has to markets. Some have said that this is a new 
asset class. We believe that it brings new investors into the 
Treasury. And importantly, as we said, it offers inflation 
protection for investors and a way for the economy as a whole 
to see inflation signals. So we're quite pleased.
    It still, though, of course, is embryonic. We only have a 
little--about $50 billion of our financing through this 
program, which is a small portion of our program at this time.
    Mr. Rangel. Thank you.
    Chairman Crane. Mr. McCrery.
    Mr. McCrery. Mr. Gensler, if we were to drastically reduce, 
or even eliminate, the debt. What effect would that have on 
capital markets? Since you can imagine that.
    Mr. Gensler. No, it's a very good question, and hopefully 
not just a hypothetical question. Over the long term, we think 
that it would have an effect of most likely lowering interest 
rates. And more specifically to your question about capital 
markets, there is a very important function that Treasury 
securities serve: to be the benchmark or the--if I may use a 
technical term--the hedge security for the markets. That means, 
whether it's corporations' borrowing, or mortgage borrowing, 
many people use the Treasury securities as a benchmark for 
pricing that borrowing.
    There would be effects on capital markets if there were no 
Treasuries, and the market would have to find another hallmark 
or benchmark security n that hypothetical case. But, again, I 
think that would be an interesting and good challenge.
    Mr. McCrery. Thank you.
    Chairman Crane. Mr. Herger.
    Mr. Collins.
    Mr. Collins. Thank you, Mr. Chairman.
    Mr. Gensler, in the previous panel it was estimated that in 
2008 the debt would be somewhere around $7 trillion. Do you 
know what percentage of ratio that will be at that time as 
projected based on private versus public?
    Mr. Gensler. And was this in the year 2000, sir?
    Mr. Collins. 2008.
    Mr. Gensler. 2008, I see.
    Mr. Collins. I was going to ask the other panel, but I 
didn't.
    Mr. Gensler. I don't know the specifics of their model, 
sir, but currently the privately held debt, as we showed in the 
earlier table, is $3.4 trillion. And that, in fact, through 
2008 will decline as the unified budget balances in surplus. So 
one would--we could get back to you specifically, but it would 
be well less than half of that $7 trillion that you referred 
to.
    [The following was subsequently received:]

    In the May Midsession Review of the Budget, the Office of 
Management and Budget estimated that the U.S. Government debt 
held by the public will total $2.1 trillion at the end of FY 
2008. That figure includes holdings of the Federal Reserve 
System, which were not estimated for FY 2008, but which totaled 
$424 billion of the $3.7 trillion of debt held by the public at 
the end of FY 1997.

    Mr. Collins. Well, one other question pertaining to the $7 
trillion, too. I'd like to know what the projected percentage 
of that public debt would be Social Security, because that's 
just before the Baby Boom generation is hitting the eligibility 
rolls.
    Mr. Gensler. We could get back to you, sir, with the 
specific number on what the Social Security Trust Fund balance 
would be in ten years time.
    [The following was subsequently received:]

    Based upon the 1998 Social Security Trust Fund Trustee's 
Report, it is estimated that the Social Security Trust Fund 
will hold $1.964 trillion at the beginning of 2008.

    Mr. Collins. Okay. There's one other thing: In your opening 
comment, you mentioned that due to the Clinton administration's 
policy, fiscal policy, that it's fostered the strongest economy 
and experienced the first balanced budget surplus since 1969. 
You know, it just gets to be a point that it seems like some 
people like to stand up andsay, look what we did. Look what I 
did. You know, I want to point out to you that in 1993 and 1994, the 
Clinton administration policy to deal with the budget and the deficit 
was to raise taxes, increase entitlements, interest rates went up, the 
stock market kind of held stable.
    But you look at what happened in 1995, 1996, and 1997. It 
had to be signed by the president. It was a joint effort. The 
budget has been balanced, erasing the deficit. Tax reduction. 
Entitlement reform in the era of welfare and Medicare. Interest 
rates are down. The stock market's more than doubled. It wasn't 
all the Clinton fiscal policy. A lot of it came from Congress. 
It had to originate in Congress, in cooperation with the 
president and his signature.
    So it wasn't one of these I did it, Mr. Gensler. It was a 
we did it. Thank you.
    Mr. Gensler. If I might say, I think the bipartisan 
cooperation has been very, very positive.
    Mr. Collins. Good. Then maybe you should change your 
opening statement.
    Chairman Crane. Mrs. Johnson. Oh, wait. I'm sorry, Mrs. 
Johnson. Mr. Hulshof.
    Mr. Hulshof. Thank you, Mr. Chairman.
    Mr. Gensler, how does your statement and the charts you 
brought us on debt management square with the Clinton 
administration's call that every penny of the surplus should go 
to save Social Security?
    Mr. Gensler. Congressman, as you've said, the President 
called in his State of the Union address to save Social 
Security first, and reserve the surpluses until a long-term 
solution is, on a bipartisan basis, sorted through on Social 
Security. What we have done is--on a basis of financing, as 
opposed to budget--borrowed less money in this period of time. 
But we have not used those dollars for any spending or tax 
programs. And, in fact, just as I believe one of the earlier 
panelists said, we have borrowed less money in this period of 
time as we've had stronger fiscal results.
    Mr. Hulshof. Because you were running out of time, let me 
invite you to expand a bit, if you want to, on some of the May 
announcements. I know one of the first questions was whether to 
further decrease the issuance of Treasury bills and the 
response in May was what? And I'll give you chance to expand a 
bit.
    Mr. Gensler. Well, we looked at three questions, that I 
believe Congresswoman Johnson had asked in the earlier panel. 
We had experienced a decrease in the shorter-term offerings of 
Treasury securities over the past 18 months of about 23 
percent, as the fiscal picture continued to improve. Rather 
than decreasing short-term securities issuance further, we 
chose to instead, in May, decrease the amount of longer-term 
debt. And, in fact, our hope is to increase the offerings of 
the shorter-term, and, as the Congresswoman had pointed out, 
less costly debt. That was our first desire.
    The second question was, now that we would do that, how 
would we best do that? How would we best shrink the longer-term 
offerings? And we thought it best to concentrate the offerings 
in fewer offerings, again to promote liquidity and promote 
lower cost borrowings for the taxpayers.
    And then lastly, it was a more technical question as to, 
well, if we're going to concentrate, at which ones?
    Mr. Hulshof. Elimination of the three-year T-bill, and 
again, the reason you mentioned was market response? Was that 
because of the two-year maturity----
    Mr. Gensler. That's right, Congressman.
    Mr. Hulshof [continuing]. Being close enough or--or----
    Mr. Gensler. We surveyed the market. We talked to many 
market participants. Because we also offer two-year securities, 
and five-year securities, we felt that the three-year security 
was the least demanded by the marketplace.
    Mr. Hulshof. Thank you, sir. Nothing further. I yield back.
    Chairman Crane. Mr. Cardin.
    Mr. Cardin. Thank you, very much. Thank you, Mr. Gensler, 
for your testimony.
    As the projections indicate, although debt will be 
increasing over the next decade, the amount held by the public 
will actually be decreasing and that they'll be more 
interagency debt. And, as I look at one of the charts that was 
prepared by GAO, it shows that the debt held by the public as a 
percentage of GDP is declining significantly between 1997 and 
the year 2020. And I guess my question--I'll appreciate your 
observations on it--would it, therefore, be a good time for us 
to consider investing some of the Social Security Trust Funds 
in the private market by the trustees. That would trigger more 
debt held by the public, keeping it more constant in our 
economy, allowing the Social Security Administration to have a 
more diversified investment return for the recipients under our 
Social Security system, and it seems to me--and you look at the 
projections going into the year 2050, with public debt, again, 
with there being no changes, would then tend to increase. So 
that, therefore, we try to keep it more level in our economy--
the amount of debt held by the public as a percentage of GDP. 
Any thoughts on that?
    Mr. Gensler. Congressman, it's a very good question and an 
important question of great national import. And the President 
has suggested that he look to 1998 as a year of debate and 
dialogue with this Congress and with Americans broadly about 
Social Security. And so I would not want to, in essence, 
comment on that great national debate about which I think there 
will be many hearings.
    Mr. Cardin. I appreciate your candor on that. I thought we 
were supposed to start the debate this year, and resolve it 
next year. So I thought it was a fair question to ask.
    Mr. Gensler. I think it's a very fair question, a very 
important question. But as a representative of the Treasury, 
focused on debt management, I feel it's best to allow others to 
engage in that broader, very important debate.
    Mr. Cardin. And I won't press you anymore on that question, 
except to say that perhaps you could get us some figures, or 
get me some figures, as to how much of the debt held by--how 
much of the securities held by SSA could be invested privately 
to be able to maintain a constant amount of publicly held debt 
as a percentage of GDP over the next decade. That might be an 
interesting number for us to be able to take a look at for some 
of us who are trying to project ways of solving the Social 
Security issue.
    Mr. Gensler. Congressman, it would be our pleasure to get 
you those figures. It's also a great honor to be here as I was 
born and raised in your district.
    [The following was subsequently received:]

    In the May Midsession Review of the Budget, the Office of 
Management and Budget projects that the GDP will increase by 
4\1/2\ to 5 percent per year over the next decade a period of 
time in which OMB projects budget surpluses. Therefore, OMB 
projects that the Federal debt held by the public will decline 
from 45 percent of GDP in FY 1998 to 16 percent of GDP in FY 
2008--a decline of 29 percent of GDP.

    Mr. Cardin. See, if I knew that. You still vote in my 
district? [Laughter.]
    Thank you very much. Thank you, Mr. Chairman.
    Chairman Crane. Mr. Houghton.
    Mr. Houghton. Yes, good morning. I want to ask a question 
of comparison or contrasts. In taking a look at the average 
length of privately held marketable debt, how do we compare in 
our planning with, let's say, Germany or Great Britain or 
Japan? Are we more or less conservative?
    Mr. Gensler. It's a very good question. What we find 
actually, sir, is that many of these nations look to us for our 
debt management principles and skills and guidance. And many 
Treasury representatives actually are called upon and asked to 
speak at international conferences about our approach to 
markets.
    Having spent much of my career in the financial markets, 
and only joining Treasury nine months ago--I actually lived in 
Asia for three years, trading Japanese government bonds. I 
would say we have the most efficient, broadest markets. And, in 
part, that is because of Treasury policies over many 
administrations. We look overseas also to see if they have 
innovations that we might adopt. We recently adopted inflation-
indexed securities which were offered in England and Canada and 
elsewhere.
    But I'd say, broadly speaking, we're at the cutting edge or 
the forefront of innovation in our markets.
    Mr. Houghton. Yes, I'm not quite sure that's what I was 
searching for. You know, when you try to make money on money, 
sometimes you do things on a national scale which are inimical 
to a very sort of conservative, basic Treasury policy on bond 
management. So, I just wondered, how on a rating of between one 
and ten, ten being the most conservative, one being the most 
liberal, how do we rate with other countries? I know we're 
innovative. I know we've got a broad market. There's no market 
like it in the world. But how are we in terms of our 
conservative policy?
    Mr. Gensler. Congressman, I take your question to be about 
our debt management. And within our debt management, I think 
that we benefit from being conservative in many aspects of what 
we do.
    We are conservative in cash management. We feel, foremost, 
it is our job at Treasury to make sure we have sufficient cash. 
I think, though, we benefit in a way that other countries can't 
by borrowing longer term. Our economy is stronger, more stable, 
over two centuries. And so many other nations cannot borrow as 
long term--out to 30 years--as we can, because we're such a 
strong and viable economy.
    I view that as conservative, but other nations can't do 
that. And so for many of them, it would be risky to try to 
borrow that long. But I would think that overall, our debt 
management does have some conservatism in it that I would think 
this Congress would want us to have.
    Mr. Houghton. Okay. Thank you very much.
    Chairman Crane. Mrs. Johnson.
    Mrs. Johnson of Connecticut. Thank you.
    You mentioned in your earlier comments that, you know, you 
were looking at working down the long-term, more costly debt. 
Are you succeeding in doing that because it doesn't show up in 
the figures yet?
    Mr. Gensler. Well, with three trillion plus dollars of 
debt, it takes a little time to steer this thing. The changes 
that we announced in May will first begin to take place in July 
1998 and moving forward. We were trying to arrest the 
lengthening of the average maturity of the debt that you've 
rightly pointed out.
    I would say also just to possibly address your earlier 
question to the earlier panel, the debt that we're retiring was 
issued at much higher interest rates than we are issuing debt 
today. So, in fact, the American people are saving money as we 
retire close to a half a trillion dollars of older, longer-term 
coupon debt. And we're borrowing today fortunately at some of 
the lowest interest rates in the last 30 years.
    Mrs. Johnson of Connecticut. I agree, absolutely. And 
that's why I was really surprised at this drop in short-term 
debt, and the actual increase in long-term debt. It seems to me 
that from the very beginning, the Treasury would have focused 
on, you know, really working down that long-term debt. And 
while I understand maturity times vary, it does seem to me in 
the period that we've had surplus that there would have been 
more evidence of a reduction in long-term debt burden.
    Mr. Gensler. In 1993, at the start of the administration, 
there was a decision to do precisely what the Congresswoman 
suggests and shorten the maturity, from about a six-year 
average maturity to a little over five-year average maturity. 
In the last 18 months, as you rightly point out, there's a bit 
of a gradual creep the other way, as we reduced Treasury bills 
to manage the very strong cash flows that were coming in, and 
sometimes unexpected cash flows. And now we feel we've had time 
to reflect on that and address it again.
    Mrs. Johnson of Connecticut. Well, thank you. I appreciate 
those comments very much.
    I also would like to just comment on the part of your 
testimony in which you address the year 2000. And I'm 
particularly pleased that you expect to complete coding and 
testing. Is that end to end testing, is that complete testing 
of all but one system by the end of 1998?
    Mr. Gensler. It is. We're looking at both code testing and 
interface testing. There are 14 critical systems that we look 
at, and all but one of them will be tested by the end of 1998.
    Ms. Johnson of Connecticut. So those would be system-wide 
tests that you'd have confidence in? I'm looking--there's a lot 
of different kind of tests you can do along the way. We 
certainly want to be sure the equipment works. We want to be 
sure it works within an office. But the important thing is it 
works throughout the system. And the end testing----
    Mr. Gensler. That's right. And for many of our systems, 
we're testing the interface with the dealer community and 
investor community, and we're working with them on what's 
called end to end testing, literally. How they enter a trade 
and the cash movements and the flow of all the documents.
    Mrs. Johnson of Connecticut. When will you be able to start 
that level of testing?
    Mr. Gensler. Well, in fact, because there are 14 systems, 
much of that has started. Some of it this summer. Some of it 
through the fall. I believe the bulk of those 14 systems will 
have been tested by October, if I recall the specific dates.
    Mrs. Johnson of Connecticut. I was also very pleased that 
you have been having conferences to raise the issue of 
readiness with all market participants. And are you satisfied 
that you are reaching the major market participants and what 
are you doing to reach the minor market participants, the 
smaller ones?
    Mr. Gensler. This, as the Congresswoman points out, is a 
challenging task, and it is one that is not without risk. But 
we're reaching out--and the New York Federal Reserve is working 
with us. We're working with The Bond Market Association. We're 
also, I should say, working through the various international 
organizations--the G-7 and G-10 and other organizations, 
reaching out internationally, to highlight this very critical 
issue.
    Mrs. Johnson of Connecticut. Since so much of our debt is 
held by foreigners, it is very critical that at least some 
portion of the international community be well prepared. What 
is your sense of their preparedness? Has Europe's preoccupation 
with the Euro and its other issues diverted it from this? Has 
the Asian financial problems diverted the Asian community from 
the year 2000 compliance attention?
    Mr. Gensler. While I'm not an expert on some of those 
matters, I think the Congresswoman is correct. The challenges 
in Europe, given their integration, are very real. They 
understand the year 2000, but this administration and the 
Federal Reserve, I know, have highlighted those issues around 
those international conferences. Asia, of course, hasgreat 
other challenges.
    Mrs. Johnson of Connecticut. Thank you. I would just say I 
appreciate having you testify. Mr. Chairman, I appreciate your 
having this hearing. I think it's a very important one, but I 
also think the public ought to understand that we--our 
obligation is to manage to debt to minimize taxpayer costs. And 
that all the rhetoric around Social Security and all those 
things is actually just rhetoric. That as long as Social 
Security is running the potential deficit that it is running, 
it is in everyone's interest, people of ages, that we reduce 
the national debt and the carrying costs.
    Thank you.
    Chairman Crane. Ms. Thurman.
    Ms. Thurman. I have no questions.
    Chairman Crane. Mr. Gensler, before you leave, I was just 
told that the British have issued debt in perpetuity. Are you 
familiar with that?
    Mr. Gensler. I must--I can get back to the Chairman and 
give you and your staff more details on the British perpetuity 
debt.
    [The following was subsequently received:]

    Prior to 1948, the British Government had issued some debt 
instruments without a maturity date that required only the 
payment of interest. These perpetual bonds were known as 
consols.

    Chairman Crane. Yes, I'm curious as to what the advantages 
would be of that. I mean, to me, we should be focused on total 
elimination of debt if possible. And to make that a permanent 
component of your national budget? The service on a debt in 
perpetuity would put people on the dole. I guess, that is the 
rationale behind it. But I was curious--I had not heard of that 
before either. I thought maybe you could fill me in.
    Mr. Gensler. No, I hadn't. There are some studies as to how 
long a maturity debt should be for low-cost financing. The 30-
year horizon is one that the Treasury has studied at times 
whether to go further, and we have been comfortable that, for 
promoting our goals over time and given risk, 30 years is 
probably the most appropriate horizon. But you raise an 
additional point of fiscal discipline.
    Chairman Crane. Well, we thank you very much, Mr. Gensler. 
And we look forward to continuing to work with you. With that, 
I would like to call our final panel: Stephen Francis, Vice 
Chairman of Fischer, Francis, Trees and Watts, Inc.; Mark 
Warner, Managing Director, Interest Rate Markets of North 
America; Dr. John Campbell, Otto Eckstein Professor of Applied 
Economics at Harvard University.
    And if our panel will take their seats. We shall start with 
Mr. Francis, and then Mr. Werner, and then Dr. Campbell. If you 
gentleman can try and keep your presentations--your oral 
remarks to five minutes or less, any printed statements will be 
made a part of the permanent record. Mr. Francis?

   STATEMENT OF STEPHEN C. FRANCIS, VICE CHAIRMAN, FISCHER, 
    FRANCIS, TREES & WATTS, INC., NEW YORK, NY, AND MEMBER, 
             TREASURY BORROWING ADVISORY COMMITTEE

    Mr. Francis. Thank you, Mr. Chairman. Mr. Chairman and 
distinguished members of the committee on Ways and Means, I am 
pleased to have been invited to appear before you today.
    You are reviewing in this hearing the debt management 
practices of the U.S. Department of Treasury in an era of 
budget surpluses. In my judgment, the objectives and principles 
of debt management should be largely unaffected by whether the 
budget is in deficit or in surplus. Building on the Treasury's 
public statements repeated here today by Assistant Secretary 
Gary Gensler, I believe there are three main objectives of debt 
management.
    The first objective is to raise whatever cash is required 
to ensure that the Government's functions smoothly everyday and 
meets every financial commitment on time.
    The second objective is to keep the cost of borrowing and 
hence the cost of the debt to the taxpayers as low over time as 
is possible and with due regard to risk.
    The third objective is to promote an efficient market for 
the Government's debt.
    The first two objectives--raising the cash required and 
minimizing the cost over time--are necessarily overriding. The 
third--promoting an efficient market for the Government's 
debt--furthers the first two objectives and in addition has 
significant ancillary benefits for the national and 
international capital markets.
    To translate these objectives of debt management into 
practice, the Treasury has adopted some important operating 
principles. One is to issue securities on a consistent and 
predictable basis. This is an extremely potent principle for it 
reduces uncertainty. Reduced uncertainty about the Treasury's 
future borrowing plans means lower borrowing costs.
    The second operating principle is to issue securities 
across a broad spectrum of maturities. Offering a wide choice 
of investment alternatives encourages participation in the 
Treasury market from all types of fixed income investors around 
the world. Enlarging the pool of investors fosters liquidity. 
Liquidity is a valuable attribute because it makes Treasury 
securities more attractive to investors which has the 
consequence of lowering borrowing costs. A broad spectrum of 
maturities also diversifies the Treasury's financial 
liabilities, providing resilience in changing financial 
conditions and a solid financial platform for any future change 
in debt management strategies.
    The third operating principle is to introduce innovations 
after ample time for discussion and evaluation. Change in debt 
management as in all areas of finance is inevitable. The 
opportunity for improvements is always present. Many changes 
are technical refinements, but some are innovations. Among the 
important innovations during the span of my own career are the 
replacement of fixed price offerings by competitive auctions, 
the supplementing of multiple price auctions by single price 
auctions, and the issuance of inflation-indexed securities. All 
innovations are accompanied by some degree of uncertainty. The 
aim is to keep any potential cost associated with the 
uncertainty as low as feasible.
    The Treasury has done this by airing prospective changes it 
is considering publicly over comparatively long periods so that 
the market has an opportunity to digest the changes and adapt. 
To my mind, these objectives and operating principles of debt 
management are important constants which are essentially 
unaffected by whether the budget is in deficit or in surplus.
    Periods of budget surpluses do, however, raise one specific 
challenge to debt management. That challenge is one of ensuring 
that the new issues of Treasury securities sold to redeem and 
refund maturing issues are large enough to be liquid. In 
periods of surplus, the concern is that the smaller sizes of 
new issues compared to the levels to which the market is 
accustomed may result in a degree of illiquidity for the new 
issues.Illiquidity deters investors and consequently raises the 
cost of borrowing and reduces the efficiency of the market.
    The solution to this problem is fairly straightforward 
although the scheduling steps can be intricate. Essentially, it 
is a matter of consolidating a larger number of issues of 
declining size into a smaller number of so-called benchmark 
issues whose size are each sufficiently large to ensure 
superior liquidity. In its announcement last month in 
connection with the regular quarterly funding, the Treasury set 
forth such a program of issue consolidation.
    In my judgment, debt management is functioning 
effectively--now and, in fact, throughout the past few 
administrations. During this period, debt management has 
adapted to changing budget considerations in a manner that has 
avoided surprises and consequently helped keep borrowing costs 
to a minimum. Credit for the success, it should be noted, 
belongs both to the official appointees and to the Civil 
Service employees who together are responsible for debt 
management at the Treasury.
    What should be addressed? While still in our minds, I would 
urge Congress to find a way in the present benign budget 
environment to eliminate the delays in passing the debt limit 
that we endured in the past. These episodes are shameful and 
costly, and they damage our country's standing among advanced 
nations. I do not disparage the political aims behind the 
delays and I find it difficult to blame politicians for using 
tactical tools which are available. But as the world of finance 
becomes more open and more global, our competitive state 
becomes increasingly important to the future growth of our 
economy. Now, it seems to me, is a propitious time to move up a 
rung on the ladder of fiscal responsibility.
    That concludes my statement. I would be pleased to respond 
to any questions.
    [The prepared statement follows:]
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    [GRAPHIC] [TIFF OMITTED] T3455A.039
    
    Chairman Crane. Thank you, Mr. Francis.
    Mr. Werner.

 STATEMENT OF MARK B. WERNER, MANAGING DIRECTOR, INTEREST RATE 
  MARKETS NORTH AMERICA, J.P. MORGAN & CO. INCORPORATED, NEW 
                            YORK, NY

    Mr. Werner. Mr. Chairman and members of the committee, 
thank you for giving me this opportunity to share my views with 
you on this very important topic for all of us today.
    To put my views in context, please consider the following: 
The federal budget picture has shifted dramatically over the 
past few years. Going from a deficit of $255 billion just 5 
years ago to what we at J.P. Morgan estimate will be a surplus 
of $60 billion in the current fiscal year. Moreover, we would 
expect a surplus of $50 billion in the 1999 fiscal year. You 
should all be commended for this dramatic improvement and 
grateful for the extraordinary economic environment which 
helped make it possible.
    While the Government will not be likely to need to raise 
new cash for the next year or longer, the U.S. Treasury will 
still face the daunting task of managing over $3.4 trillion of 
total publicly-held debt outstanding, which arguably forms the 
most important fixed-income securities market in the world. I 
would like to make four points with regard to the U.S. 
Treasury's financing needs.
    First of all, the U.S. Treasury will need to retain a high 
degree of flexibility going forward due to our extraordinary 
current environment. The forecast for financing needs have 
often been subject to wide margins of error. For instance, the 
mid-session review of the Fiscal Year 1998 budget made last 
Fall, called for a deficit of $121 billion. It is now widely 
acknowledged that the budget will be in substantial surplus. 
These divergences stem only in a small degree from fiscal 
policy actions, rather they are primarily due to 
miscalculations and forecasting of overall course of the 
economy and its precise impact on the various components of 
Government revenues and expenditures.
    In recent years, budget performance has benefitted 
enormously from what Fed Chairman Alan Greenspan has called a 
virtuous cycle affecting the economy. Robust payroll tax 
increases reflecting the strongest labor market in 30 years and 
capital gains receipts resulting from 3 successive years of 
sharply rising stock prices have been particularly important in 
this regard. It is important to remember that changes in the 
economic or market environment can produce negative, as well as 
positive surprises with little notice, and a corresponding risk 
that budget performance may be considerably less favorable than 
the current best forecast. Sensitivity to actual budget 
performance and to actual cash flow and a willingness to make 
small financing adjustments in the absence of formal forecast 
revisions, is likely to produce more favorable borrowing rates 
for the Treasury than abrupt changes. To repeat, a high degree 
of flexibility will be key.
    My second point is that the U.S. Treasury, as a large 
issuer of securities, will be rewarded by predictability and 
transparency in its offerings to market participants. Over the 
years, Treasury has, for the most part, observed a set of debt 
management principles that allow the markets to make informed 
judgments regarding response to changes in the size of its 
borrowing need. I think the Treasury would benefit by 
continuing to observe these principles, which I would summarize 
as follows:
    One, the changes in the composition of the Treasury's cycle 
of offering, that is the timing and frequency of various 
maturities, are far less frequent than changes in offering 
sizes of individual maturities.
    Two, gradual changes in the offering size of individual 
maturities, even when frequent, are preferable to abrupt 
changes.
    Three, note and bond offering sizes should be less volatile 
than bill offering sizes.
    Four, seasonal and other large temporary cash needs should 
be met, to the maximum extent feasible, by issuance of off-
cycle cash management bills, thereby minimizing impacts on 
regular cycle issues.
    If the dealers are to maintain the excellent depth, 
breadth, and liquidity that the Treasury securities market 
currently enjoys, then changes in the issuance pattern should 
be rare, well advertised, and gradual.
    My third point is that the Treasury will benefit by 
anything that enhances liquidity. That is to say, prefer large 
benchmark issues. Reduce the number of issues, but raise the 
outstanding sizes of those issues. Liquidity in secondary 
markets and financing markets is of major importance in 
eliciting the broadest possible investor interest and 
participation in the Treasury market, and has become a more 
critical issue in the context of reduced overall debt issuance. 
In general, liquidity is enhanced by opting for fewer, but 
larger, individual debt offerings. Treasury's recent revamping 
of its auction cycle should go a long way towards improving 
liquidity in several sectors. Larger individual issues should 
benefit the intermediate sector, while the bill sector should 
benefit from increased overall issuance.
    My final point is that the U.S. Treasury market is the 
benchmark for interest rate capital markets around the globe. 
In this capacity, U.S. Treasuries function as benchmarks and 
hedging vehicles for a wide variety of markets around the 
world. The benchmark status not only enhances the overall 
demand for Treasuries, but also may be vital for the efficient 
functioning of markets such as corporate bonds, Federal agency 
securities, mortgage-backed securities, and interest rate swap 
transactions. All of these securities trade at a spread 
relative to U.S. Treasuries. In making financing decisions, 
Treasury officials must consider factors such as this that 
potentially impact all the closely linked dollar denominated 
capital markets.
    Ours is the most efficient debt market in the world. It got 
that way through the extraordinary cooperation of the Congress, 
the Treasury, the Federal Reserve, and the dealer community. 
This fortunate period of budget surplus requires that this 
cooperation and flexibility continues. Thank you.
    [The prepared statement follows:]
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    Chairman Crane. Thank you, Mr. Werner.
    Dr. Campbell.

   STATEMENT OF JOHN Y. CAMPBELL, OTTO ECKSTEIN PROFESSOR OF 
      APPLIED ECONOMICS, HARVARD UNIVERSITY, CAMBRIDGE, MA

    Mr. Campbell. Mr. Chairman and distinguished members of the 
committee, I'm honored to have been asked to give you an 
economist's perspective on the Treasury's task of managing the 
public debt.
    I'd like to begin by questioning the assumption that the 
Treasury's job is simply to minimize the average cost of 
financing the debt. While this assumption is a natural one, it 
omits two critically important factors. The Treasury must also 
consider the risk of the debt and its role as a form of 
infrastructure for private financial markets.
    First, the Treasury must take account of the risk of 
alternative financing strategies. If the Treasury were to 
disregard risk--I should say that I'm not suggesting that the 
Treasury does disregard risk--it could reduce the average cost 
of financing the debt to any desired level by including 
desirable insurance features in the claims it sells to the 
public. For example, the Treasury could issue bonds that would 
pay extra in the event of a stock market crash. Such bonds 
would be highly attractive to investors, and would have a low 
cost on average since stock market crashes rarely occur. Of 
course, no responsible person would advocate the issue of such 
bonds since they would involve extreme risk to the Treasury, 
and hence to the American taxpayer.
    How should the Treasury measure the risk of a financing 
strategy? It should consider alternative plausible scenarios, 
and in each scenario it should calculate the long-run tax 
burden of servicing the public debt. If the tax burden is much 
greater in some scenarios than in others, the financing 
strategy is a risky one; the burden is stable across the 
scenarios, the strategy is relatively safe.
    Now this procedure is very different from calculating the 
short-run variability of the market value of the debt. Treasury 
bills have stable market value in the short run, but they 
involve risk to the Treasury because they must be rolled over 
at uncertain future interest rates. If interest rates rise in 
the future, for example, because there's a financial crisis or 
because the Federal Reserve is forced to raise rates to control 
inflation, then short-term financing with Treasury bills 
becomes expensive. For this reason, it would not be prudent for 
the Treasury to rely exclusively on short-term debt.
    Long-term bonds, on the other hand, have unstable market 
value in the short run, but they protect the Treasury against 
the risk of interest rate movements. When the Treasury borrows 
long, it can avoid expensive refinancing if interest rates rise 
in the future. This advantage of long-termfinancing is 
especially pronounced for inflation-indexed bonds which stabilize the 
tax burden of the public debt even in the face of uncertain future 
inflation. I and many other economists therefore applaud the Treasury's 
move last year to begin issuing inflation-protected securities--known 
as TIPS.
    A second important consideration for the Treasury is that 
public debt instruments provide infrastructure for financial 
markets, analogous to the infrastructure of the Internet or the 
highway system. The Treasury should manage this infrastructure 
to maintain liquidity, to provide information, and to stimulate 
innovation in U.S. financial markets.
    An important attribute of our financial markets is 
liquidity--the ability of investors to trade at low cost and 
with confidence that trading costs will remain low in the 
future. Markets for Treasury debt securities are liquid because 
these securities are issued in large quantities, in 
standardized form, and with essentially no risk of default. 
Investors are willing to pay a premium for this liquidity, 
bidding up the prices particularly of Treasury benchmark bonds 
which are the most actively traded. If the Treasury sought to 
minimize its financing costs, it might be able to exploit its 
position as a monopoly supplier by restricting the supply of 
benchmark bonds in order to receive the scarcity premium. But 
this would be an inappropriate policy in light of the 
Treasury's responsibility to act on behalf of the public.
    Treasury debt markets also provide information about 
investors' expectations of future interest rates. The issue of 
TIPS, together with conventional bonds is particularly helpful 
in this regard because it makes it possible to measure 
investors' expectations of future inflation. This information 
is valuable for private market participants, and also for 
policymakers at the Federal Reserve who can evaluate the 
credibility of their anti-inflationary stance.
    Finally, Treasury innovations promote beneficial 
innovations in the private sector. TIPS issues have been 
followed by some private issues of inflation-protected debt, 
and the existence of TIPS will make it much easier for pension 
funds and insurance companies to offer inflation-protected 
annuities. Such products will become increasingly important as 
the U.S. population ages in the early part of the next century.
    In conclusion, the Treasury should consider far more than 
just average cost when managing the public debt. I believe it 
has done so in a highly competent fashion. Recent developments 
in Treasury policy, including the gradual lengthening of the 
average debt maturity since the low point reached in the mid-
1970's and the issue of inflation-protected bonds, are 
justified both as prudent risk management and as a form of 
infrastructure provision to U.S. financial markets.
    [The prepared statement follows:]
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    Chairman Crane. Thank you, Dr. Campbell. Generically, for 
all of you, what are the characteristics of past debt 
reductions and are there any lessons for the present?
    Mr. Francis. Trying to think of when there was a period of 
past debt reduction. [Laughter.]
    It's certainly beyond my career.
    Chairman Crane. Well, let's see before World War I we got 
down from that slide from the Civil War. Then after World War 
II, we went from roughly 100 percent of debt held by the public 
during the war, as late as 1947; down to--the lowest figure 
here looks to be about 25 percent in roughly 1970; and it's 
gone up since that time.
    Mr. Francis. There're two dimensions. One is the nominal 
reduction and the other is relative to the size of GNP. As GDP 
grows, the relative size of debt declines if the total remains 
constant. The nominal amount can decline when fewer securities 
are sold--when the refunding amounts are smaller than the 
maturing amounts. That's the process which has begun in this 
period.
    Chairman Crane. Anyone else have any observations?
    Mr. Campbell. Well perhaps, I could bring in the experience 
in some other parts of the world which have faced declining 
debt. An issue that's arisen in some places is whether to 
continue issuing long-term debt given very minor financing 
needs. Nations have made different choices. For example, in New 
Zealand, I understand they're planning simply to eliminate 
borrowing altogether. Whereas in Hong Kong, the decision has 
been to maintain long-term borrowing in order to provide a 
benchmark for the financial markets even though frankly 
speaking their financing needs don't require such borrowing. I 
would support the Hong Kong approach on the grounds that 
benchmark issues are important for financial markets. However, 
of course, we're nowhere near that point yet and the debt will 
remain out there for a very long time to come.
    Chairman Crane. Mr. Werner, do you have any observations?
    Mr. Werner. I guess I would reiterate what my colleague, 
Mr. Campbell, has just said that the benchmark status of the 
U.S. Treasury market is a reserve holding, or dollar 
denominated reserve, that many countries hold U.S. Treasuries 
in. Many markets trade at a relative spread to the U.S. 
interest rate benchmark. I think it's probably very important 
for our capital markets in this country to maintain that 
status.
    Chairman Crane. Thank you. Mrs. Thurman.
    Mrs. Thurman. Thank you, Mr. Chairman. Mr. Francis, in your 
short statement, you mention at the very end that quite frankly 
you thinkTreasury is doing well in handling and all of those 
things are going pretty good. But you said that one of the things that 
you suggested for Congress was to not delay the raising of the debt 
limit. Is that correct?
    Mr. Francis. Yes, that's correct.
    Mrs. Thurman. Okay. Are there other things that Congress 
should be doing, as well? I mean, you mentioned that as one. 
Are there other issues that we should also be looking at that 
could put us into some kind of turmoil, or cause us some 
problems that you could give us some examples of?
    Mr. Francis. Well, I think that first of all, that Congress 
is obviously part of the political process in the Nation and 
there has to be give and take and a lot of debate. Occasionally 
statements made in the debates have some effect on the market, 
but the markets have to live with that. I put Congress's role 
higher in importance than market stability day-by-day. I do 
think there is something that Congress has done--or put it the 
other way around--hasn't done that is useful with respect to 
debt management and that is by and large it hasn't interfered. 
Debt management is a fairly technical area. And, a lot of 
people would consider debt management fairly boring. It 
certainly hasn't engendered the impassioned statements that 
occur sometimes before the Ways and Means Committee. I think 
there's a reason for that. Not just in this administration but 
also in past administrations, debt management has functioned 
quite effectively. I think it's not a bad idea to let it 
continue to work the way it has.
    Mrs. Thurman. What about the debate that's going on now as 
we're putting our budgets together and looking at issues and 
the surplus, of course? We all go home and talk about how 
wonderful this is. Then the next question is what do we do with 
these surpluses? Do we look at the Social Security? You hear 
Greenspan say that's the best thing you can do because then you 
give more private probability to have more borrowing. I mean, 
if I'm stepping out of line here--but I'm just kind of curious 
to find out where and what your thinking is as far as the 
debate that is going on in Congress today.
    Mr. Francis. Well, Congressman Thurman, you're--yes, we're 
going beyond debt management here to views on what the Nation's 
finances ought to be. I have, of course, my own views and 
everyone else in this room does, too.
    Mrs. Thurman. But you get an opportunity to tell us those 
views now if you'd like. [Laughter.]
    Mr. Francis. As I recall, the government spending in the 
United States amounts to something like 40 percent of the GDP? 
That's a lot. Wouldn't it be nice to see that trailing off over 
time? That's my view.
    Mrs. Thurman. Would any--Mr. Werner, Dr. Campbell? Come on.
    Mr. Campbell. Congressman Thurman, perhaps I could add a 
word. In thinking about Social Security, the Social Security 
system has large future liabilities. Now the accounting system 
under which we operate doesn't record that as a form of debt, 
but in economic terms, it has perhaps equivalent meaning. The 
existence of these future liabilities--the future retirement of 
the baby boom generation is a serious issue. We should all be 
concerned about promoting national savings in order to build up 
the capital that we need to cover these liabilities. So this 
switch to a period of surpluses, I think is very appropriate 
seen in that light.
    Mrs. Thurman. Okay. Mr. Werner?
    Mr. Werner. I don't have any further comments on it.
    Mrs. Thurman. That's fair enough. Thank you, Mr. Chairman.
    Chairman Crane. Mr. McCrery.
    Mr. McCrery. Thank you, Mr. Chairman. I have no questions 
but I appreciate the panel dealing with such an arcane and 
boring subject so well today.
    Chairman Crane. Mr. Houghton?
    Mr. Houghton. Yes, just a couple of quick questions. I 
guess the issues that I'm always wrestling with is should we 
try to pay down or grow out of our debt? Because that will come 
into consideration in terms of our budget consideration. Also, 
if you had a different scenario, the surplus dipped--maybe went 
into deficit, inflation were up, more borrowings--would you 
suggest the same policies under those conditions that you're 
suggesting now? Those are the two questions.
    Mr. Francis. I'm pleased to respond to the second question 
that you asked--and my answer is yes. I think the same 
objectives and the same operating principles that the Treasury 
is following and has been following in greater or lesser degree 
for the past decade or so would be the correct objectives and 
practices to follow if the surplus were to turn to deficit. I 
think with respect to your first question, I've said about as 
much as I can on that. My own belief is that the Government's 
portion--claim on GDP is larger than it ought to be and it 
ought to be declining over time. But that again, is just a 
personal view.
    Mr. Campbell. Perhaps I could add a word. I basically 
endorse Mr. Francis' answer with one qualification which is 
that if the Government could anticipate a particular moment in 
the future when revenues would be particularly robust, it might 
be appropriate to structure the debt in such a way that more of 
it becomes due at that time. Now this is more of a theoretical 
issue in most countries. I think that the forecast for the U.S. 
fiscal position are very smooth over time, so it just doesn't 
suggest lumping--concentrating a debt on any particular 
maturity. But there are circumstances where a government may 
have a major asset which is going to throw off a lot of cash at 
a particular time. For example, the UK at one point had 
tremendous North Sea oil which had a very predictable revenue 
pattern. In managing that, it was appropriate to have debt come 
due at a time when the oil revenues would be there to pay it 
off. But as I say, in the U.S. situation with a very 
diversified tax base and smooth forecast, what we should try to 
do is have a smooth pattern of maturing debt in the future.
    Chairman Crane. Well, we want to express appreciation to 
all of our panelists for their patience and participation 
today. Please continue to provide ongoing input to all of us 
here on the committee. We need your assistance. Thank you so 
much. With that the committee stands adjourned.
    [Whereupon, at 11:54 a.m., the hearing was adjourned 
subject to the call of the Chair.]
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