January 2020

The Treasury Department is the agency assigned the responsibility for issuing government debt, among other varied responsibilities.  Since the financial crisis, the Treasury has been tasked with financing the enormous debt burden of the United States.  Initially, criticism of profligate deficit spending was heard from the “Tea Party” politicians, but over the course of the last few years, that criticism has ceased.  In fact, acceptance of the deficit spending has garnered so much support that it actually briefly created a movement dubbed Modern Monetary Theory (MMT).  The idea behind MMT was that the U.S. enjoys the privilege of being the world’s reserve currency.  The theory holds that because that status creates a seemingly insatiable demand for the greenback, the U.S. should borrow as much as it needs and use the proceeds to reward their citizens.  The proponents of the idea would like to see the proceeds of the borrowing fund a universal basic income for all, universal healthcare for all, forgive student loans, and any number of programs designed to “level the playing field” of the haves and have-nots.  The MMT has lost some momentum as an ideal, but redistribution of income has gained as the Democratic presidential contenders advocate the level the playing field ideas that the MPT crowd had purported last year.  We worry that should the U.S. follow that path it will ultimately have a detrimental impact to our economy that could last for years to come.

That worry took on an added intensification when the Treasury Borrowing Advisory Committee (TBAC) released it most recent quarterly report on February 4^th.  We’ve written about the TBAC on previous occasions.  The committee is comprised of high profile Wall Street Broker-Dealers and a few high profile fixed income asset management firms.  We commend the Treasury Department for keeping a line of communication open with the largest buyers of Treasury debt, but we would caution that Treasury should do so with a degree of skepticism.  Especially with the Broker-Dealers.  The Chair of the committee is Elizabeth Hammack, the Treasurer of Goldman Sachs, the firm unflattering known as Government Goldman because of the seeming revolving door between the firm and the U.S. government.

In the report, the committee suggests that the Federal Reserve and the Treasury Department should adopt a “stylized consolidated balance sheet”, enabling the government to better manage the economy.  Taking a step back to consider the implications of this recommendation; The role of the Treasury Department, in this context, is to issue debt to fund the U.S. government.  The head of the Treasury Department is appointed by the President.  Comparatively, the role of the Federal Reserve is the dual mandate of full employment and steady inflation.  The Chairman of the Federal Reserve is also appointed by the President, but granted a 4-year term and had largely been free from political persuasion in the past.  By following the TBAC’s recommendation, the Fed would face the very real risk of political intervention. 

Historically, when the economy contracts the Fed eases policy to offset that contraction.  In recent history that easing has taken the form of buying Treasury debt in the open market to reduce interest rates.  Also, during contractions, the government has expanded deficit spending in an effort to spur economic activity, thereby tasking the Treasury Department to sell more debt.  In essence, the recommendation of the TBAC is when economic activity contracts the Fed and the Treasury Department work in coordination to spur economic activity and ensure that the deficit spending does not impact interest rates.  The problem with that suggestion is there is no mechanism to unwind the balance sheet once economic activity has returned to prosperity.  As we witnessed when the Fed last tried to shrink its balance sheet, economic activity slowed and the Fed panicked and resumed quantitative easing.  As it currently stands, the unspoken truism is that the Federal Reserve will need to continue to monetize the deficit spending for as long as required until the day comes that it can’t, and when that day arrives, they don’t have a plan to reverse the mess they made. 

Which brings us to the question of why would the TBAC put forth such a reckless suggestion.  The obvious answer is that such a policy would be wildly beneficial to the profitability of the committee member firms.  For the buy-siders the policy would ensure that interest rates would not rise as economic activity accelerated, and their firms would avoid losing assets.  For the broker-dealers, they too would profit from increased trading activity of the Fed purchases as they have done since the financial crisis. 

While we doubt that such a coordination would be formally adopted, in practice it already exists.

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