[Congressional Record Volume 141, Number 188 (Tuesday, November 28, 1995)]
[Senate]
[Page S17674]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                 ON THE ADVISABILITY OF NOT DEFAULTING

 Mr. SIMON. Mr. President, we have had a variety of sources 
telling us that the Nation should not default on its obligations 
because of the debt limit.
  It should hardly be necessary to stress that. If we create debt, we 
have to pay for it. For that reason I have consistently--with one 
exception--voted for extending the debt limit whether it was a 
Democratic President or a Republican President. The real choice is when 
we create the debt. Once it is created we have to face up to it.
  But a publication which probably has limited circulation that I have 
come to respect is Grant's Interest Rate Observer, published by James 
Grant.
  His November 10 issue has a front page commentary titled, ``On the 
Advisability of Not Defaulting.''
  It approaches the question of default from a slightly different 
perspective that I believe my colleagues should note.
  I ask that the commentary be printed in the Record.
  The material follows:

          [From Grant's Interest Rate Observer, Nov. 10, 1995]

                 On The Advisability of Not Defaulting

       Over the past 12 months, the 30-year Treasury bond actually 
     delivered a higher total return than the stock market 
     (source: the authoritative center pages of this publication). 
     The margin of outperformance, 32.92% to 29.60%, was 
     remarkably strong for an asset class that is under the cloud 
     of default.
       It would be better if there were no default, we think. Over 
     the past 46 years, according to our friends at Ryan Labs, 
     income contributed a little more than 100% of the total 
     return of the overall Treasury market. Thus, the contribution 
     of capital gains to the same calculation--the bear market 
     lasted for 34\1/2\ years, until September 1981--was less than 
     zero.
       Because the bond is an income security, low interest rates 
     work a hardship on bondholders. Default would work the 
     ultimate hardship. To achieve the identical 32.92% total 
     return in the next 12 months, Ryan calculates, the current 
     30-year Treasury would have to rally to a yield of 4.59%. 
     Over the past five years, the long bond has produced a total 
     return of 12.35%; to reproduce that feat in the next five 
     years would require a rally to 3.60%. To match the past 
     decade's total return of 11.48%, the 30-year Treasury would 
     have to rally to 0.29%. Repeat: 0.29%.
       Since May 1974, bonds have delivered 12-month total returns 
     in excess of those achieved by stocks in no fewer than 110 
     months, a fact almost guaranteed to win a bar bet from any 
     stock market chauvinist who insists that the returns to 
     management, diligence, hard work and ingenuity should, by 
     right, exceed those to coupon clipping.
       Perhaps the creditor class isn't finished yet. As the graph 
     on pages six and seven points up, bond market out-
     performance is rarely a one-month flash in the pan; it 
     tends to roll on. But that is a question of relative 
     return. The immediate risk of default is one of absolute 
     performance, not in the short run but over the long pull. 
     One long-term risk is the precedent of default (to be 
     technical, this would be the second American default; in 
     1933, the government abrogated the contracts under which 
     it had promised to pay gold to its bondholders). A second 
     is that the temporary nonpayment of interest and principal 
     would cause intelligent people to reexamine the nation's 
     monetary institutions. Wondering about the whereabouts of 
     their money, they might turn to the Federal Reserve's 
     balance sheet. Reading it, they would observe: non-
     interest-bearing currency on the liabilities side; 
     Treasury securities on the asset side. Their eyes would 
     flash to a footnote: $484 billion in Treasurys held in 
     custody by the Federal Reserve for the account of foreign 
     central banks.
       A very intelligent American reader would come to appreciate 
     that he or she is the beneficiary of a vast fandango. The 
     world has willingly come to accept the promises of this 
     government, either in interest-bearing or non-interest-
     bearing form. The half-trillion dollars or so worth of dollar 
     securities visibly held by foreign central banks constitute 
     the evidence not of American strength but of weakness. 
     Mainly, they represent the track of currency intervention. 
     Buying dollars, the central banks turn them in for U.S. 
     government securities. It is an indirect gift.
       Another subversive feature of a Treasury default is that it 
     would turn the spotlight on other classes of non-interest-
     bearing investments. Of these, perhaps none is so lowly as 
     gold, which this year has caused even its few remaining 
     friends to despise it. However, notes Peter McTeague, of MCM 
     TradeWatch, Boston, gold option volatility has collapsed, 
     speculators are short the market, central banks are hostile 
     toward it and producers continue to sell the metal forward 
     (the proof of which is a gold lease rate that has surged to 
     2.3% from 1.8% in the past month: even at the lower yield, it 
     would represent towering value in the Japanese bond markets). 
     On Tuesday came news that the output of the South African 
     mining industry is closing in on a 40-year low; a spokesman 
     for the Anglo American Corp. described the country's gold 
     operations as being in a ``state of managed decline.'' The 
     other day, a friend described his own growing, unfashionable 
     bullishness toward gold. However, he added before hanging up: 
     ``I'm not sure I want my name used with this.'' It has been a 
     vale of tears.

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