FROM THE OFFICE OF PUBLIC AFFAIRS

Good afternoon. I would like to thank CFO magazine for offering this opportunity to speak with you on the topic of government borrowing.  I will use my time to make three related points; first, yes deficits matter but focusing merely on current and forecast deficits is focusing on the symptom and not the disease. Second, Treasury’s debt management policy is well positioned to manage the challenges of aiding economic recovery and fighting the war on terrorism and lastly, the enactment of the Administration’s policies over the past two years have indeed facilitated the emerging economic recovery.

Financing outlook:

The recession, corporate scandals and continuing war on terrorism all played a part in slowing the growth of our economy and increasing the deficit.  In the spring of 2001, the forecast for FY2003 was for a surplus of $334 billion. The Office of Management and Budget’s (OMB) most recent forecast for FY2003 was for a deficit of $455 billion – a $789 billion adverse swing in 2 years. OMB has forecast deficits, although declining after FY2004, for the next five years.  Secretary Snow has said deficits matter but there are times when they are unavoidable, especially when we face critical needs. Further, let’s put the current deficit outlook into perspective. When viewed beyond a simplistic and often misleading “nominal” measure, it remains at a manageable level relative to the size of the US economy at 4.2% of GDP.

Managing these unwelcome deficits is an Administration priority. But effectively managing deficits can only be done by not confusing the cause with the cure. Let’s do some simple math. In the 2 year FY2003 forecast swing of -$789 billion, approximately 22% is a “static” accounting result of the President’s tax cuts, 24% for Homeland Security cost. But 53% or approximately -$418 billion of that was due to lower economic growth than originally forecast.  Clearly, even without the President’s tax cut package passed in 2001, the economic growth and jobs package, spending on homeland security and the war on terrorism, we would have deficits now because of the downturn in the economy.

The obsession some have today with focusing on projected deficits, especially long-term, brings up another important issue. The most frequent conceptual error I see committed by Capital Hill watchers and Wall Street analysts, with respect to the government’s financing needs, is to over-rely on official budget “point” forecasts, and to under-invest in understanding the likely scope of deviation in these projections. As Yogi Berra said – “It’s tough to make predictions, especially about the future”.

Over the past 10 years, the average error in Administration budget forecasts, realized four months into the fiscal year, is approximately +/- $70 billion and the Congressional Budget Office (CBO) and Wall Street get it just as wrong.  OMB, the Council of Economic Advisors (CEA), and other Administration officials strive to improve our economic forecasting and thus our borrowing projections. However, the underlying problem is that our financing needs, driven by a $2 trillion budget, are constantly shifting in response to numerous dynamic, ever-evolving variables such as seasonal changes in cash flows, structural changes in tax and expenditure policies and the level of US economic activity. 

But striving towards better forecasting is only part of the answer. In preparing for battle, General Eisenhower observed, “I have always found that plans are useless, but planning is indispensable.”  So to manage the government’s borrowing requirements, Treasury debt managers must constantly ask those fundamental risk management questions, “What is?  What was?  What if?  And How?”  What is our up-to-date borrowing estimate? What was the market response to changes in previous borrowing quarters? What if we vary the assumptions driving future borrowing needs? How can we better prepare the market for changes in our borrowing pattern when – not if – the future does not fit our forecast. We have to look at a range of futures and test how our decisions would turn out in each.

Deficits are manageable:

Treasury’s single objective in managing its marketable debt is just like that of a private sector chief financial officer; our objective is to achieve the lowest cost, over time, for the federal government’s financing needs.  But we have constraints unlike those of a private sector CFO, most notably that a Treasury debt manager does not, and must not attempt to “time the market”.  Providing investors and financial intermediaries with confidence that the value of their holdings will not change due to unforeseen changes in the amounts we have issued, lowers our cost of borrowing.  Ten-year yields are still low by historical standards for example, but we aren’t holding impromptu auctions.  We don’t even take the yield curve into account when we allocate how much to raise by different maturities.  Nor do we cancel auctions due to spikes in our cash balances.  Instead, to achieve our objective of lowest cost over time, the Treasury commits to regular and predictable issuance across a range of securities. This regularity and predictability gives investors certainty that they can get our securities if they need them.  We’re always there.

Market participants knowing of our stable issuance patterns have thus grown habituated to using Treasuries for pricing, hedging, and cash management.    There is ongoing and increasing demand for our issuance. In 2001, the volume of transactions in the Treasury market averaged almost $300 billion a day. That was over three times the average daily volume for each of corporate debt, agency debt, mortgage-related securities, and even the New York Stock Exchange.  In 2002, we averaged close to $350 billion and in 2003 we are averaging over $400 billion a day.  Over time, we believe this regularity and predictability cuts our financing costs more than market-timing moves ever could.

However “regular and predictable” does not mean static, inflexible or never changing.  It means factoring “variance” into our debt management policies.  It means reducing the uncertainty where we can and planning for where we cannot. It means preparing the market, as much as possible, when we do have to make policy changes.
 
Our planning is further aided by offering as broad a product range as we can, consistent with minimizing cost to the taxpayer over time.  Our current calendar has roughly 195 auctions per year: 3 bill auctions per week (4-week, 13-week, and 26-week bills), monthly 2-year & 5-year note auctions, quarterly 3-year notes, quarterly 10-year notes with re-openings one month later, and quarterly auctions for inflation-indexed securities.

Occasional policy changes occur when our borrowing needs exceed the flexibility built into our auction schedule. Over the last three decades, Treasury has introduced, withdrawn and re-introduced numerous securities. These include the 52-week bill, 3-year note, 4-year note, 5-year inflation indexed note, 7-year note, 20-year bond, 30-year bond, 30-year callable bond, 30-year inflation indexed bond, foreign targeted and foreign currency denominated securities.

We signal our deliberations well ahead of time through our refunding statements, the questions we ask of primary dealers and the publicly reported discussions we have with our private sector advisory committee made up of fixed income “buy” and “sell” side participants.  We have worked hard to improve communications with investors, both so that you know what to expect from Treasury debt management and so that you have more opportunities to tell us what we should expect from you.  When we make a decision, we announce it at a quarterly refunding as early as we can.  We want you to have substantial lead-time for any specific changes to our offerings as well as an awareness of the problems or choices we face.

But is current and prospective issuance “crowding out” the other fixed income issuers? Answering this first requires a measure of the market. Today’s total value of major US dollar credit markets is about $21 trillion.  Of that, Treasury marketable debt is $3.5 trillion. The mortgage backed securities market is nearly $5 trillion. The asset-backed securities market is $1.6 trillion.  The corporate bond market is $4.1 trillion. The agency debt market is $2.4 trillion and other offerings (such as municipal securities and money market instruments) account for $4.3 billion. Over the last 10 years, Treasury marketable debt has net increased by approximately $389 billion while the other markets have grown by a combined $10.8 trillion.

Yet another perspective on Treasury’s size in the market is to see that Treasury notes and bonds account for only 10% of the afore mentioned long-term credit market debt compared to 18% ten years ago. Further, this 10% level is a 22-year low as a percentage of long-term debt securities.  Indeed, even looking at short-term issuance – i.e., short-term commercial paper plus Treasury bills - “T-bill” issuance is at 41% of open market paper compared to 54% 10-years ago. Evidence of any “crowding out” effect is lacking.

US economic outlook:

It’s most likely that only returning to balanced budgets will eliminate questions and concerns over the myth of “crowding out”. The prescription for returning to balanced budgets is straightforward: hold the line on spending and grow the economy. The CEA has estimated that for every increase of 1% in the economic growth rate, the budget outlook improves by $1 trillion over 10 years.  It is economic growth that corrected the economic problems and closed budget gaps over the last 30 years. The President put forth and signed legislation that is encouraging consumer spending and promoting investment by individuals and businesses that will lead to economic growth and job creation. Positive economic developments are occurring. Housing starts recently reached a 17-year high. Retail sales have been robust over the summer and disposable personal income, helped by recent tax cuts, has been strong as well. Business investment in equipment and software in the second quarter posted the largest increase in three years. While employment numbers remain weak and a concern, improved economic growth will restore job gains.  The private sector consensus forecast is that real growth will exceed 4 percent in the second half of this year and average just under 4 percent next year. In addition, the President has recently announced a six-point plan to build employer confidence and create momentum to hire new workers.
 
Confidence that the Administration’s plans have played a significant part in the recovery can be found in testing the “null hypothesis” – “ What would be US economic performance without the fiscal stimulus measures implemented through the President’s leadership?”, i.e., eliminate the tax and spending provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001- June 2001-, the Job Creation and Worker Assistance Act of 2002 –March 2002 - and the Jobs and Growth Tax Relief Reconciliation Act of 2003 – May 2003. Treasury’s Office of Economic Policy estimates that through first half of this year:

• The unemployment rate would have been nearly 1 percentage point higher
• The economy would have created as many as 1.5 million fewer jobs.
• Real GDP would have been as much as 2 percent lower.

The President’s actions, along with the impact of accommodative monetary policy, low inflation, low interest rates and necessary adjustments by US businesses helped make the recession one of the shallowest in our nation’s history.

Conclusion:

Yes, deficits matter but the need to implement policies that encourage and support economic growth is what’s important. Treasury’s debt issuance calendar is well positioned to manage the ongoing obligations from past decades of Congressional decisions on taxes and spending, any new additional requirements to support the economic recovery and war needs, and any further negative or positive variance in budget forecast. In doing so, Treasury issuance will continue to support the broader functioning and growth of the fixed income market. 

America’s economy is showing signs of promise. But there are still Americans out of work today; there are still American businesses struggling.  Partial success will not be sufficient. As the President has stated, we can and must do better for all Americans. The Administration’s economic policies are helping to move the economy in the right direction and improved growth and opportunity can be expected.

Thank you.