Treasury Shifts Toward Short-Term Financing

A BET ON FUTURE RATES

WHERE will interest rates be 30 years from today?

Obviously, no one knows the answer to this question. But last week, Treasury Secretary Lloyd Bentsen in essence made a bet that interest rates will stay the same or be lower than today on average over 30 years. The Treasury, Mr. Bentsen announced, would shift 45 percent of its financing from long-term bonds to short-term securities.

The immediate effect of this shift is to lower the cost of financing the deficit since short-term interest rates are much lower than long-term rates. The Clinton administration estimates this shift will save $16 billion over the next four years.

While the lower cost will benefit the taxpayers in the short run, will it benefit them over the longer pull?

Economists are not certain.

Robert Brusca, chief economist at Nikko Securities Company International, believes the move will help President Clinton more than the taxpayer. "What is everyone else doing?" asks Mr. Brusca. "They are refinancing their mortgages to lock in low long-term rates. The government is saying, `Not me,' " he says.

The timing of the government move is wrong, agrees David Wyss, research director at DRI/McGraw-Hill in Lexington, Mass. Sometimes such a move can work. If the Treasury, through the 1980s, had kept the same maturity as the 1970s (2.5 years), DRI calculates the government would be paying $100 billion per year less in interest. "The Treasury's funding has been screwed up - it's the longest funding of any government debt," he argues. Today, the average maturity is six years.

Economist Brian Keyser of CRT Government Securities Ltd. says the government merely has to have short-term interest rates remain at an average lower than the average long-term rate.

"History says that will happen," he says.

He compares the government's move to decisions individuals face when offered a floating-rate mortgage or a fixed-rate mortgage with a higher interest cost. "There is obviously more risk for financing short term, but you get paid for the risk if you are right," he says. The risk is that once the short-term securities mature, interest rates will rise, costing more in the future.

Some economists believe the government's decision will be beneficial to the economy. "There is an argument it will make it easier for corporations to borrow" long term, says Bruce Steinberg, manager of macroeconomic analysis at Merrill Lynch & Co.

In a newspaper article, economist Henry Kaufman, president of Henry Kaufman & Co., argues such long-term borrowing would make US corporations less short-term oriented. "That will stimulate business to make long-term commitments in the form of plant and equipment investments, research, and new product development," wrote Mr. Kaufman last week.

There are risks to the government decision. If inflation soars, short-term interest rates would rise, costing the US government billions in extra interest payments. When short-term rates move higher than long term rates, economists term it an "inverted yield curve." This happened in 1987-88 when the Federal Reserve Board started tightening interest rates dramatically. It also happened during President Jimmy Carter's term when short-term rates shot as high as 21 percent, reflecting soaring inflation.

At the moment, economists don't see signs of economic overheating or a return of the Carter inflation days. The government releases April producer and consumer price numbers this week.