Last week, the US Treasury announced larger buybacks of longer-term bonds, paid for by increasing the issuance of shorter-term Treasury bills, in what is known as a “Treasury Twist”. In retrospect, more than a few people, me included, were somewhat befuddled by the timing of the decision. Generally, the Twist is viewed as an effort to bail out the long-term bond market and lower 10-year-plus yields, reducing long-term government interest expense at the expense of shorter-term instruments. Since short-term interest rates are currently (and normally) lower than long, “twisting” lowers the near-term expense of paying off the government’s debt.
Twisting doesn’t get pulled out of the Treasury toolkit on a regular basis, however. It’s generally thought of as something reserved for emergency situations. Lately the bond market had shown little evidence of the sort of distress that might merit its use, but the moment that Treasury announced it, folks started to wonder if the government knew something distressing that the markets didn’t.
True, Twisting came as America's national debt hit $40 trillion last week. To small government guys like me that number is certainly distressing. (My every-man mind balks at the thought of being on the hook to repay so many zeros.) But government debt has been in the trillions for decades, We haven’t seen a Federal surplus since 2001. In truth, about $30T or three-fourths of the current damage appeared from 2009 on. Between the financial crisis, the nationalization of health insurers, the shuttering of US energy production, the Covid pandemic, and untold millions of illegal migrants, politicians found government profligacy a much easier sell than responsible stewardship.
Not everyone considers the debt a problem, which is exactly what makes it one. The doom and gloom crowd has been warning about the perils of high debt for years, predicting a devastating fiscal crisis should the government keep spending more than it takes in. Others pooh-pooh that, maintaining that as long as US GDP is growing faster than the interest rate it is paying on its debt, Treasury should be able to keep rolling over its bonds without too much of a problem.
Both sides of the argument demonstrate occasional empirical validity, with economic conditions being the determining factor. The endless rollover hypothesis works best for example, when GDP growth is well below average, interest rates are historically low for an extended period and disinflation is more of a concern than inflation. (e.g., 2009-12). Deficit spending becomes far less attractive when GDP is above average, interest rates are elevated, and supply-side inflation is troublesome (e.g., 2020-21).
At the moment GDP Now is above average, 30-year interest rates are their highest in 19 years, and oil is making supply-side inflation a concern-- conditions that normally mitigate against unbridled deficit spending. A grid-locked Congress has failed to provide the responsible stewardship the situation requires, but even so, we're nowhere near anything resembling a failure of the US Treasury market. The yield curve does not indicate an impending recession, and the SOF-T spread does not indicate a money market system at risk.
If you have to borrow short-term money to buy back long-term debt you may lower long term yields, but in doing so you’ll raise short-term yields. It doesn’t lower the debt or do much of anything in the long run. It’s basically akin to rearranging the deck chairs on the Titanic. So why the Treasury Twist?
Maybe it’s just a coincidence (or maybe not), but President Trump this past week hosted crypto executives at the White House to urge passage of the Clarity Act, which is meant to regulate certain aspects of the crypto markets. The Clarity Act has been caught in a dispute between banks and crypto companies about percentage rewards to hold stablecoins that, to lenders, aim to compete with yields on bank deposits. The Securities and Exchange Commission also proposed a new regulatory framework for crypto assets this past week.
The Clarity Act is a follow-on to the Genius Act passed last year— a crypto regulatory law establishing US-issued “stablecoins” that aim to stay fixed to the value of the dollar. The connection is that under the Genius Act— stablecoins issued in the US can only be backed by certain assets, including US Treasurys that mature within 93 days-- the proverbial three-month T-bill. Treasury Secretary Bessent has mentioned stablecoins as a big potential new source of demand for Treasury bills. Demand that would appreciably lower the yield on short-term debt.
With a market value around $300 billion (and US money-market funds close to $8 trillion) stablecoins are still small potatoes. Bitcoins are mined at data centers, however, and what are we building more of than anything else right now? It has been projected that stablecoins could grow into a nearly $4 trillion market, significantly lowering government borrowing costs on the short end. It could also lead to a shorter weighted average maturity of issuance, the objective of the Treasury Twist.
A recent review published by the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy suggests stablecoins could create substantial net new demand for Treasury bills, particularly if money shifted into stablecoins either from bank accounts or if they were bought by foreigners. Much of the demand might come from savers in countries with less-stable currencies who lack access to US bank accounts. But there is a long row to hoe before we reach that point. The world of digital finance is just getting started. No better time for some clarity.
(Prepared with Grok and Chat GPT AI assistance and edited by a human.)
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