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An Economic Analysis Of The Problems Of Federal Debt Management

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An Economic Analysis Of The Problems Of Federal Debt Management

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Content This dissertation has been 62— 6086
m icrofilm ed exactly as received
SHOCKET, Sol, 1922-
AN ECONOMIC ANALYSIS OF THE PROBLEMS OF
FEDERAL DEBT MANAGEMENT.
Eniversity of Southern California, Ph.D., 1962
E conom ics, finance
University Microfilms, Inc., Ann Aibor, Michigan
C opyright by
Sol Shocket
19^3
A N ECONOM IC ANALYSIS OF THE PROBLEM S
OF FEDERAL DEBT M A N A G EM EN T
A D is s e rta tio n
P resented to
the F aculty o f the G raduate School
U n iv ersity o f Southern C a lifo rn ia
In P a r t i a l F u lfillm e n t
o f the Requirements fo r th e Degree
Doctor o f Philosophy
(Economics)
by
Sol Shocket
June 1962
UNIVERSITY O F S O U TH ERN CALIFORNIA
GRADUATE SCHOOL
UNIVERSITY PARK
LOS ANGELES 7. CALIFORNIA
This dissertation, written by
SOL SHOCKET
under the direction of his____Dissertation Com
mittee, and approved by all its members, has
been presented to and accepted by the Dean of
the Graduate School, in partial fulfillment of
requirements for the degree of
D O C T O R O F P H I L O S O P H Y
Dean
SERTATION COMMITTEE
Chairman
C - w c - f - J
TABLE OF CONTENTS
CHAPTER PAGE
I. INTRODUCTION ..................................................................... 1
The Problem S tated ................................................... 5
C h aracter o f the problem ................................ 6
Im portance o f the p r o b le m ................................ 10
Economic growth and th e d e b t ................... 11
I n f l a ti o n and the d e b t ................................ 12
D epression and the d e b t ................................ 13
Microeconomic a sp e c ts o f the debt . . . 14
Freedom and the d e b t ..................................... 15
O b jectiv es o f debt m anagem ent....................... 16
Basic Terms and C o n c e p t s ..................................... 20
N atio nal income and n a tio n a l w ealth . . . 20
Government c r e d i t ................................................... 22
F ederal d e b t ............................................................ 24
Debt m anagem ent....................................................... 27
Purposes and O b jectiv es o f th e
D is s e rta tio n ............................................................ 28
ii
iii
CHAPTER PAGE
P ro je c te d O rg an izatio n o f the
D is s e r ta tio n ............................................................ 30
I I . G RO W TH OF THE FEDERAL DEBT OF THE
UNITED STATES ................................................................. 32
H isto ry o f th e Growth o f th e F ed eral Debt . 35
F ed eral d ebt from independence to
World War I ............................................................ 36
The assum ption and e lim in a tio n o f
fe d e ra l d e b t, 1790-1836 ............................ 36
The re-em ergence of fe d e ra l d e b t ,
1836-1916 ............................................................ 38
F ederal d e b t , World War I through
World War I I ....................................................... 40
World War I debt and repaym ent,
1916-1930 ............................................................ 40
D epression d e b t, 1930-1939 43
World War I I d e b t, 1939-1946 44
Post-W orld War I I d e b t, 1946-1962 . . . . 49
Attem pts to P revent th e Accumulation of
F ed eral D e b t ............................................................ 54
The sin k in g fund approach to debt
r e d u c t i o n ................................................................ 55
iv
CHAPTER PAGE
The d eb t c e ilin g approach to debt
containm ent . . . ......................................... 62
H is to ric development o f th e debt
c e i l i n g ................................................................ 62
E v alu atio n o f the debt c e ilin g . . . . 68
Sum m ary.............................................................................. 76
I I I . THE RELATIVE BURDEN OF THE FEDERAL DEBT . . . 79
C ontingent F ed eral L i a b i l i t i e s ....................... 79
P riv a te and F ed eral Debt C o rre la tio n . . . 90
Economic Growth E ffe c ts on th e Burden
o f th e D e b t ................................................................ 97
The c o r r e la tio n between fe d e ra l debt
and n a tio n a l in c o m e .......................................... 98
The c o r r e la tio n between fe d e ra l debt
and p o p u la tio n and n a tio n a l w ealth 103
The e f f e c t o f i n f l a t i o n upon the
burden o f the d e b t ......................................... 106
The Philosophy o f the F ederal Debt . . . . 109
Arguments a g a in s t d e f i c i t fin an c in g . . . 109
Arguments fo r d e f i c i t fin an c in g ................... 110
Sum m ary......................................... 117
V
CHAPTER PAGE
IV. FACTORS AFFECTING THE DISTRIBUTION
OF THE DEBT.................................................................... 120
The O bjectives o f Debt Ownership
D is trib u tio n ........................................................... 121
F ittin g th e in v e s to r s ’ needs ....................... 122
Forced savings ...................................................... 125
Bank r e s t r i c t e d bonds ......................................... 128
Free r i d i n g ............................................................... 132
The Sources o f Funds fo r Debt Ownership . . 135
The bank subsidy c o n t r o v e r s y ....................... 140
T o tal a s s e ts - - f e d e r a l s e c u r itie s
holdings r a t i o .................................................. 145
Reserve c r e d it ...................................................... 148
Methods o f C ategorizin g Debt Ownership . . 150
Summary............................................................................. 154
V. CLASSES OF DEBT OW NERSHIP ....................... 156
Bank I n v e s t o r s ............................... 156
Wartime fa c to rs ...................................................... 157
Post-W orld War I I developments . . . . . 160
Nonbank In v e sto rs ...................................................... 164
In d iv id u a l in v e sto rs ......................................... 166
vi
CHAPTER PAGE
Development o f the savings bond
p r o g r a m ................................................................ 174
S e rie s E savin gs bonds ................................ 175
S e rie s F, G, H, J , and K savings
b o n d s ..................................................................... 182
Insurance c o m p a n ie s ...................... 183
Mutual Savings Banks .......................................... 186
C orp o ratio n s ............................................................ 187
S ta te and lo c a l g o v e rn m e n ts ............................ 190
M iscellaneous in v e s to rs ..................................... 191
Government T ru st Funds .......................................... 193
Sum m ary.............................................................................. 198
VI. MATURITY PATTERN OF THE FEDERAL DEBT . . . . 202
C r i t e r i a o f a D esira b le M aturity
P a t t e r n .......................................................................... 203
M arketable F ed eral Debt .......................................... 207
M arketable fe d e ra l debt o p e ra tio n . . . . 208
O b jec tiv es o f m arketable fe d e ra l
d ebt m anagem ent.............................................. 208
M arketable debt management theory
and p r a c t i c e ................................................... 215
vii
CHAPTER PAGE
S hort-term m arketable fe d e ra l debt . . . 219
Treasury B ills .................................................. 224
T reasury C e r tif ic a te s .................................... 228
In term ed iate-term m arketable fe d e ra l
d e b t ............................................................. 235
Long-term m arketable fe d e ra l debt . . . . 238
Nonmarketable F ederal D e b t .................... 246
Summary................................................................. 248
V II. THE INTEREST RATE A N D THE FEDERAL DEBT . . . 251
D eterm inants o f I n t e r e s t Rates ....................... 251
The com petitive market place and
ra te s o f i n t e r e s t ................................. 252
Types of co m p etitive s e c u r iti e s . . . . 254
Psychology of th e i n v e s t o r ........... 256
A d m in istrativ e p o lic y and th e
r a te o f i n t e r e s t ................................. 258
Treasury techniques and the r a te
o f i n t e r e s t .......................................... 261
F ederal Reserve a c tio n s and the
r a te o f i n t e r e s t ............................. 266
viii
CHAPTER PAGE
L e g is la tiv e p o lic y and the
r a t e o f i n t e r e s t . . . . ............................ 273
D ire c t and in d ir e c t i n t e r e s t
p r e s s u r e s ............................................................ 273
I n t e r e s t r a te c o n t r o l ..................................... 277
E ffe c ts o f I n t e r e s t R ates ..................................... 280
I n t e r e s t r a t e e f f e c ts on th e
d i s t r i b u t i o n o f income ................................ 281
I n t e r e s t r a t e e f f e c t on th e
c y c lic a l flu c tu a tio n s ..................................... 286
Sum mary.............................................................................. 291
V III. THE FISCAL A N D M O N ETARY ASPECTS OF FEDERAL
DEBT M A N A G EM EN T OPERATIONS................................ 296
F is c a l P o licy Aspect o f Debt Management . . 297
A nalysis o f th e budgetary process . . . . 298
Debt management e f f e c ts on ta x a tio n . . . 303
An a n a ly s is o f tax-exem pt s e c u r i t i e s . . 305
Monetary P o lic y A spects o f Debt
M a n a g e m e n t................................................................ 309
D eterm inants o f monetary p o lic y ................... 309
M onetizing th e d e b t ........................... 313
Ix
CHAPTER PAGE
Reducing th e l i q u id i t y o f the debt . . . 320
Secondary re se rv e requirem ents . . . . 324
The T reasu ry -F ed eral Reserve Accord . . 329
Debt Management D i r e c t i o n ..................................... 337
Sum mary.............................................................................. 341
IX. SU M M A R Y OF FINDINGS, CONCLUSIONS, A N D
RECOMMENDATIONS............................................................ 345
Summary o f F i n d i n g s ................................................... 345
R e la tiv e im portance o f th e fe d e ra l debt . 347
D is tr ib u tio n o f fe d e ra l d e b t ....................... 349
M atu rity p a tte r n o f fe d e ra l debt . . . . 355
I n t e r e s t r a te p a tte r n o f fe d e ra l debt . . 358
Debt management r e la tio n s h ip to f i s c a l
and monetary p o l i c y .......................................... 360
C onclusions and Recommendations ....................... 363
C o n tro llin g the l i q u id i t y o f the debt . . 363
Aiding fre e m arket a llo c a tio n o f
r e s o u r c e s ................................................................ 367
F is c a l r e s p o n s ib i l i ty ......................................... 369
BIBLIOGRAPHY ....................................................................................... 372
LIST OF TABLES
TABLE PAGE
I. T o ta l O utstanding P u b lic Debt and Guaranteed
O b lig atio n s Held O utside the T reasury . . . 34
I I . D is trib u tio n o f th e Ownership o f the F ed eral
Debt among th e Major C lasses o f In v e sto rs . 139
I I I . M arketable P o rtio n o f th e F ederal D ebt,
1946-1960 209
IV. D is tr ib u tio n o f I n t e r e s t Payment on th e
F ed eral Debt According to In v e sto r C lasses . 283
x
CHAPTER I
INTRODUCTION
The study o f d eb t management tends to r e f u te th e
c lic h e th a t " h is to r y re p e a ts i t s e l f . " H i s t o r i c a l l y , d eb t
management was m erely a te c h n ic a l p rocess whereby th e
mechanics o f is s u in g , re fu n d in g , and repaying d eb t were
c a r r ie d o u t. I t i s th e d i s t in c ti o n o f th e p re se n t decade,
th e 1 9 6 0 's, to be co n fro n ted w ith a d eb t o f such m agnitude
th a t th e very management o f i t can in flu e n c e d i r e c t l y every
a sp e c t o f economic l i f e .
In g e n e ra l, th e economic o b je c tiv e s o f th e govern
ment o f th e U nited S t a te s , i t s departm ents and a g e n c ie s,
were expressed in th e Employment Act o f 1946:
The Congress hereby d e c la re s th a t i t i s th e con
tin u in g p o lic y and r e s p o n s i b il i ty o f th e F ed eral
Government to use a l l p r a c t i c a l means . . . to
c o o rd in a te and u t i l i z e a l l i t s p l a n s , fu n c tio n s
and re so u rc e s . . . to promote maximum employment,
p ro d u c tio n , and purchasing pow er.1
160 S t a t . (1946) , 23.
1
A fter World War I I , g re a t p o l i t i c a l im portance was
attach ed to th e monetary and economic s t a b i l i t y o f the
United S ta te s . With th e exception o f th e United S ta te s ,
a l l th e major powers o f the world had been d ev a sta te d by
th e war. As the fin a n c ia l p i l l a r o f s tre n g th supporting
th e v ic to rio u s fre e n a tio n s of th e w o rld , i t was necessary
th a t th e soundness o f the American economy be unquestioned.
There is abundant evidence o f the success o f th e United
S ta te s in aid in g the ra p id economic recovery o f th e n atio n s
o f the world d e s p ite the d i f f i c u l t post-W orld War I I
re c o n s tru c tio n problem s. The s ig n if ic a n t economic progress
achieved by the world w ith United S ta te s aid took p lace a t
the same time th a t the United S ta te s i t s e l f was r e g is te r in g
wide gains on the economic fro n t.
The world economy of 1961, six te e n years a f t e r the
end o f the w ar, is co n sid erab ly d i f f e r e n t from th a t o f the
immediate postwar y e a rs. R econstructio n has r e s u lte d in
an improved and enlarged in d u s tr ia l p ro d u ctiv e ca p a c ity
throughout the o th e r in d u s tr ia l n a tio n s o f the w orld. The
end r e s u l t o f the r e b ir th o f in d u s tr ia l p o te n tia l abroad
has been a s ig n if ic a n t in c re a se o f in d u s tr ia l com petition
among the w o rld 's n a tio n s.
C oncurrent w ith in d u s tr ia l r e v it a l i z a ti o n has been
the growth in fo re ig n fin a n c ia l s tre n g th . The d o lla r
sh ortage which predominated th e immediate postwar years has
disappeared. Foreign currency has stren g th en ed rem arkably.
To compete a c tiv e ly in th e fin a n c ia l s e c to r as w ell as in
the pro duction s e c to r o f the world economy today, i t is
im perative th a t the f in a n c ia l s t a b i l i t y o f the United
S ta te s be a t l e a s t on a par w ith th a t e x is tin g in the o th e r
major in d u s tr ia l n a tio n s o f th e world.
I t is apparent th a t economic s tr e n g th , grow th, and
s t a b i l i t y may be the c r u c ia l issu e s in the decade o f the
's i x t i e s . Economic s tr e n g th , grow th, and s t a b i l i t y re q u ire
a foundation o f stro n g f in a n c ia l r e s p o n s ib ility . Three
fa c to rs a re dominant: F i r s t , a sound f i s c a l p o lic y should
determ ine the re la tio n s h ip s between revenues and expendi
tu re s . Second, monetary p o licy must be re sp o n sib le even
though independent. T h ird , debt management p o lic y must
add to and re in fo rc e both monetary and f i s c a l p o licy
ra th e r than weaken them.
The g r e a te s t source o f s tre n g th l i e s in the areas
of monetary and f i s c a l p o lic y . Debt management can do
l i t t l e alone. However, debt management can make a sub
s t a n t i a l c o n trib u tio n when combined w ith e f f e c tiv e f i s c a l
4
and m onetary p o lic y .
S u cce ssfu l management o f th e debt o f th e F ederal
Government is one o f th e most im portant foundation
sto n es o f th e sound f in a n c ia l s tr u c tu r e o f the
n a t i o n .2
Debt management can in c re a se o r d ecrease th e f le x
i b i l i t y o f f i s c a l and m onetary p o lic y . The range o f
in flu e n c e o f f i s c a l and monetary p o lic y is expanded or
c o n tra c te d by d eb t management. Thus , d ebt management
u s u a lly a c ts as th e se rv a n t o f f i s c a l and monetary p o lic y .
At tim e s , however, th e se rv a n t may become th e m aster. For
example, ex p en d itu re a p p ro p ria tio n s favored by f i s c a l
p o lic y may be delayed due to th e e x iste n c e o f a debt c e i l
ing. S im ila r ly , a r e s t r i c t i v e m onetary p o lic y may be
circum vented by th e u se o f h ig h ly liq u id p u b lic debt
s e c u r i t i e s .
T oday's fe d e ra l debt c o n s titu te s a la rg e component
o f the t o t a l d eb t s tr u c tu r e o f our economy. As su ch, i t
becomes a pow erful weapon fo r e it h e r good o r e v i l . The
fe d e ra l d eb t can be m anipulated so th a t i t e it h e r b alan ces
o r unbalances th e economic system . I t s use can h elp o r
2
U.S. , " P re sid e n t Dwight D. E isenhow er's Message to
C ongress," C ongressional R ecord. 86th C ong., 1 s t S ess.
(June 8 , 1959), p. 10163.
5
h in d er th e growth o f th a t system . T hus, debt management
has th e p o te n tia l o f e i t h e r s tre n g th e n in g o r weakening th e
economic system . Since f in a n c ia l m a tte rs l i e n ear the^
h e a r t o f th e modem economy, i t is e s s e n tia l th a t debt
management be conducted w ise ly .
I . THE PROBLEM STATED
The problem may be s ta te d in synopsis form as
follow s: The debt o f th e U nited S ta te s today i s a com
p o s ite o f tru e debt forms and pseudo debt forms which a re
in r e a l i t y in te r e s t- b e a r in g cu rren cy . The management o f
t h i s com posite debt depends upon w hether th e economic
c o n d itio n s p re v a ilin g a re o rie n te d toward w a r, p e a c e , a
"guns and b u tte r " p o lic y , d e p re s s io n , p r o s p e r ity , or
i n f l a t i o n . The com posite d eb t is a f fe c te d throughout th ese
v ary in g economic c o n d itio n s by th e a d m in is tra tiv e a c tio n s
o f numerous governm ental a u th o r it i e s such as th e T re asu ry ,
the F ed eral R eserve, th e C ongress, and th e P re s id e n t o f
the U nited S ta te s . None o f th e se a u th o r i ti e s has chosen
to assume f u l l a u th o r ity fo r th e management o f th e d eb t.
This com posite d eb t i s ad m in iste red w ith i l l- d e f i n e d
a u th o r ity over v arying economic c o n d itio n s w ith o u t th e
6
guidance o f an acknowledged sequence o f economic objectives.
Nor does any s p e c if i c a l l y d efin ed o rd e r o f s te p s e x is t fo r
a tta in in g th o se o b je c tiv e s which a re given l i p s e rv ic e .
This s e t o f circum stances r e s u l t s in problems concerning
th e s i z e , b u rd en , ow nership, m a tu rity p a t te r n , r a t e o f
i n t e r e s t p a t t e r n , and tech n iq u es o f managing th e fe d e ra l
debt in c o o rd in a tio n w ith f i s c a l and monetary p o lic y .
C h aracter o f th e Problem
Each asp e ct o f t h i s problem needs to be analyzed
f u l l y , both in i t s own r i g h t and in i t s r e la tio n s h ip to th e
o th e r a sp e c ts o f th e problem. Because much o f what is
c a lle d fe d e ra l d eb t r e s u lte d from d isg u ise d currency
c r e a tio n , two s e ts o f com parisons must be a p p lie d . The
tru e debt p o rtio n o f th e debt may co n tin u e to be compared
w ith i t s c o u n te rp a rt in the p riv a te s e c to r o f the economy.
However, th e pseudo d eb t p o rtio n re p re s e n tin g currency
c re a tio n must be compared w ith o th e r tru e money forms.
This s e p a ra tio n o f com parisons is of prime im portance in
d isc u ssin g any s o lu tio n to th e debt management problem.
G e n e ra liz a tio n s on th e fa c to rs p e rta in in g to debt
management a re n o t only d i f f i c u l t but a re o fte n a p t to be
m islead in g . Such g e n e ra liz a tio n s must be r e la te d to
s p e c if ic circum stances and p a r t i c u l a r p e rio d s o f tim e,
such as w ar, p eace, i n f l a t i o n , and d e p re ssio n . For
example, th e e n t i r e n a tu re o f th e d ebt management problem
changed d r a s t i c a l l y when th e p o l i t i c a l , s o c i a l , psycho
lo g ic a l , and economic c o n d itio n s surrounding debt manage
ment changed w ith th e o u tb reak o f war in Korea.
Who is to guide the n a tio n through th e se changing
co n d itio n s? Where should th e American people look fo r
d ire c tio n ? This is one o f th e c h ie f co m p lex ities o f th e
debt management problem. Debt management lack s a u th o r ity .
Firm c o n tro l o f th e debt is a n e c e s s ity i f economic o b je c
tiv e s a re to be a tta in e d . A fe d e ra l d eb t o f the p re se n t
s iz e and p ro p o rtio n s c o n s titu te s a m ajor f a c to r a f f e c tin g
th e o p e ra tio n o f th e economic system o f th e n a tio n . Not
only have th e debt management d i f f i c u l t i e s and iss u e s
in c re a se d due to th e growth o f th e d e b t, they have a ls o
changed in c h a ra c te r . At tim es th e q u a n tita tiv e change in
th e fe d e ra l d eb t i s o f le s s s ig n ific a n c e th an th e q u a li
t a t i v e change.
W ho s h a ll be d e le g a te d the f i n a l a u th o r ity in debt
management? The d e c is io n s have tremendous consequences.
G reat is s u e s a re a t s ta k e . The economic w e ll-b e in g o f the
e n t i r e n a tio n i s a f f e c te d . Due to th e te c h n ic a l n a tu re o f
th e d e c is i o n s , i t would appear th a t decision-m aking i s
p ro p e rly th e concern o f h ig h ly tra in e d e x p e rts . Due to th e
consequences o f th e d e c is io n s , i t would appear th a t
decision-m aking is th e p ro p er concern o f a p o l i t i c a l l y
d e le g a te d a u th o r ity . H ere, th e n , is th e crux o f th e p ro b
lem. P o l i t i c a l l y d e le g a te d a u th o r ity and te c h n ic a l ex p e rts
to g e th e r must p ro v id e an e f f e c t i v e p o lic y fo r th e manage
ment o f th e d e b t. This has n o t come to p ass.
Lack o f firm c o n tro l o f the debt has i t s m icro-
economic e f f e c ts as w e ll as i t s macroeconomic e f f e c t s .
In d iv id u a l i n s t i t u t i o n s and in d u s tr ie s a re v i t a l l y
concerned w ith th e course which debt management w ill
follow . Debt management's ap p aren t lack o f governing
p o lic y has c o n s titu te d a m ajor d is tu r b in g elem ent in the
fin a n c ia l s e c to r o f th e economy.
F in a lly , a f t e r c o n sid e rin g th e p o l i t i c a l and te c h
n ic a l a sp e c ts o f debt management, as w ell as th e macro-
economic and microeconomic a s p e c ts o f debt management,
a t t e n t io n focuses on th e in trag o v ern m en tal a s p e c ts . This
i s a r e p r e s e n ta tiv e democracy o p e ra tin g under a "checks
and b alan ces" system . The T reasury D epartm ent, which is
directly responsible to the President, has been delegated
c o n tro l over th e a d m in is tra tiv e a sp e c ts o f managing th e
d eb t o f th e government o f th e U nited S ta te s . The F ed eral
R eserve, which is an independent a d m in is tra tiv e agency
c re a te d by Congress and th e re fo re re sp o n s ib le to Congress ,
has been d e le g a te d the a u th o rity to c o n tro l and r e g u la te
th e m onetary p o lic y o f th e U nited S ta te s . What should be
th e r e la tio n s h ip among th e se four h o ld ers o f governm ental
a u th o r ity - - th e P r e s id e n t, th e C ongress, th e T re asu ry , and
th e F ed eral Reserve System? How a re the c o n f li c ts in
a u th o rity to be re so lv e d i f debt management d is p u te s
a ris e ? For example, according to Chairman E ccles o f th e
F ed eral Reserve Board o f G overnors, one r e s u l t o f debt
management has been th a t:
The F ed eral Reserve System has not in f a c t , been
f re e to use i t s "powers” under circum stances
when a r e s t r i c t i v e m onetary p o lic y was h ig h ly
e s s e n ti a l in th e p u b lic i n t e r e s t . 3
The lack o f an accepted sequence o f d ebt management p r i n
c ip le s and o b je c tiv e s f u r th e r ag g rav ates th e se c o n f li c ts .
3
U .S ., S en ate, Subcommittee on M onetary, C r e d it,
and F is c a l P o lic ie s o f th e J o in t Committee on th e Economic
R e p o rt, H earin g s, M onetary, C r e d it, and F is c a l P o lic ie s ,
8 1 st C ong., 1 st S e s s ., September-December, 1949, 1950,
p. 223.
10
Importance o f th e Problem
The f u l l Impact o f the d i f f i c u l t i e s o f o p eratin g an
economy w hile managing a la rg e debt is f e l t upon the
r e a liz a tio n th a t th e problems c re a te d by th e debt a re not
o f a temporary n a tu re . The evidence o f re c e n t prosperous
years in d ic a te s th a t th e re is l i t t l e hope o f accum ulating
any s iz a b le budget su rp lu se s. Few people d e s ire d e f i c i t
spending during p erio d s o f peacetim e p ro s p e rity . However,
in the l a s t decade the e x iste n c e o f a "guns and b u tte r"
p o lic y combined w ith the lack o f f i s c a l f o r titu d e necessary
to produce the taxes re q u ire d by such expenditures has
re s u lte d in d e f i c i t s r a th e r than su rp lu se s. A debt th a t
stood a t a high o f $280 b i l l i o n on February 28, 1946, was
reduced to i t s low est p o in t, $251.5 b i l l i o n , on A p ril 30,
4
1949. Since then i t has rebounded to a new high o f $293
b i l l i o n as o f Ju ly 26, 1961, w ith an a n tic ip a te d fu rth e r
r i s e to $298 b i l l i o n in the f i s c a l year 1962.^
Today the e f f e c t o f th e fe d e ra l debt on economy is
th re e fo ld . F i r s t , th e re are the e f f e c ts achieved by the
4
U .S ., T reasury, Annual Report o f the S ecretary o f
th e T re a su ry » 1960 (Washington: Government P rin tin g
O ffic e , 1960), p. 26.
5Wall S tre e t J o u r n a l. August 1, 1961, p. 3.
11
o r ig in a l c r e a tio n o f th e d e b t. New e f f e c ts develop as
refund in g provides fo r the co ntinuance o f th e d e b t.
F in a lly , th e repayment o f the d eb t c r e a te s e f f e c ts a l l i t s
own. To com p licate f u r th e r th e p re se n t-d a y problem , a l l
th re e p ro cesses o f c r e a tio n , re fu n d in g , and repayment o f
debt a re o c c u rrin g a t one and th e same tim e.
Economic growth and th e d e b t. I t i s d i f f i c u l t to
th in k o f an a re a o f th e economy in to which th e e f f e c ts o f
th e debt do not p e n e tr a te . The in te n tio n a t t h i s p o in t is
m erely to in tro d u ce th e many fa c e ts o f th e im portance o f
th e d e b t, and then to d e a l w ith them more f u lly l a t e r .
The debt can a f f e c t th e macroeconomic a sp e c ts o f
th e economy in th e follow ing manner: I t can in flu e n c e th e
d i s t r i b u t i o n o f income and the amount o f income, the le v e l
o f p ric e s and th e c o s t o f liv in g . The debt can a c t upon
the amount o f savings and th e v alu e o f th o se s a v in g s , th e
e x te n t o f employment and th e t o t a l p ro d u ctio n . I t can
modify th e amount o f investm ent and th e p ro p e n sity to
i n v e s t, th e r a t e o f i n t e r e s t and th e t o t a l amount o f
w ealth. A lso , debt h elp s to determ ine th e e x te n t o f gov
ernment involvem ent in and c o n tro l o f th e economic system
through ta x a tio n and ex p e n d itu re . This p a r t i a l l i s t i n g o f
12
e f f e c t s makes i t obvious t h a t th e management o f th e d eb t
has a tremendous impact upon th e dynamic elem ents in a
modem w ell-developed economy.
ir
I n f la tio n and th e d e b t. The use o f d e f i c i t fin a n
cin g may r e s u l t in in f la tio n a r y p re ssu re s as in cre ased
demand r e a c ts upon lim ite d s u p p lie s . In th e p r iv a te
s e c to r , when debt is the le g itim a te re p r e s e n ta tiv e o f
fin a n c ia l s tr e n g th , i t serv es to f o s t e r a wholesome
in c re a s e in economic w e ll-b e in g . When d eb t ceases to be a
re p re s e n ta tiv e o f f in a n c ia l s tr e n g th , i t f o s te r s an
unwholesome s t a t e in th e economy o f th e n a tio n based on
overinvestm ent and e x c ite d s p e c u la tio n .
In th e p u b lic s e c to r th e mere s iz e o f th e d ebt
re q u ire s sound management to avoid ag g rav atin g i n f l a t i o n
ary p re ss u re s in th e economy. The p la c in g , tim in g , and
type o f fe d e ra l debt a c t i v i t y may r e s u l t in in f la tio n a r y
p re s s u re s . However, no s e t p a tte r n o f e f f e c t s should be
expected autoir t i c a l l y from d eb t management. In c re a sin g
fe d e ra l debt may, under c e r ta in c irc u m sta n c e s, be a n t i -
in f la tio n a r y . For example, d eb t flo a te d m erely to in c re a s e
the T re a s u ry 's cash b alance would be a n t i - i n f l a t i o n a r y .
On th e o th e r h an d , debt re d u c tio n t h a t was accom plished by
13
reducing the T re a su ry 's cash balance would be In fla tio n a r y
I f I t tended to s tim u la te p riv a te spending.
D epression and the d e b t. I t was during the d ep res
sio n p erio d o f the 1930's th a t arguments on th e b e n e fits
to be derived from th e fe d e ra l debt gained prominence.
The emphasis was upon the p ro d u c tiv ity o f the d e f i c i t
ex p en d itu re. I t was held th a t the b e n e fits th a t could be
achieved by using unemployed reso u rces overwhelmed the
debt c o s ts . T h e o r e tic a lly , I t was claim ed, I f a r a tio n a l
p o lic y o f Issu in g n o n -in te re s t-b e a rin g money in ste a d o f
in te r e s t- b e a r in g s e c u r i ti e s was follow ed, i t would even be
p o s s ib le to put unemployed reso u rces to work a t zero c o s t.
The opposing view o f d e f i c i t spending, very b r ie f ly
s ta te d , emphasized th a t such expenditure may p revent a
n ecessary d e f la tio n o f c o s ts . Government a c t i v i t y re s u lte d
in unnecessary re g u la tio n which im paired th e fre e m a rk e t's
re tu r n to p ro s p e rity . F in a lly , th e fe a r e x iste d th a t
d e f i c i t spending, even i f j u s t i f i e d in a severe re c e s s io n ,
opened the door to abuses o f sound budgetary p o lic y a f t e r
th e emergency had receded. This was p a r ti c u l a r ly tru e i f
th e d e f i c i t financing had been accomplished through the
use o f n o n -in te re s t-b e a rin g currency. A more d e ta ile d
exam ination o f both p o s itio n s w i l l follow l a t e r .
14
Microeconomic a sp e c ts o f th e d e b t. The d eb t and
i t s management perm eate throughout th e microeconomic
segments o f th e economy. I t touches anyone who pays tax es
o r u ses money. Problems a re c re a te d fo r a l l kinds o f
peop le. In some microeconomic s e c to r s , however, th e
e f f e c ts o f debt management a re o f e x c e p tio n a l im portance.
The management o f th e fe d e ra l d eb t makes i t n e c e s
sary t h a t th e government assume a p o s itio n o f le a d e rs h ip
in th e c a p it a l and c r e d i t m arkets o f th e n a tio n .
F ed eral o b lig a tio n s have become th e overwhelmingly
dominant type o f paper in bo th th e long- and
sh o rt-te rm money m a rk e ts , overshadowing a l l o th e r
kinds o f c r e d i t in s tru m e n ts .6
Because a s iz a b le re d u c tio n o f fe d e ra l debt is not a n t i c i
pated in th e immediate f u tu r e , th e fe d e ra l impact on the
c a p it a l m arkets can be expected to co n tin u e.
Ours is a fre e m arket economy. An e n tre p re n e u r is
expected to come to the c a p ita l m arket p lace and compete
fo r funds. T h e o r e tic a lly , th e e n tre p re n e u r re c e iv e s funds
C harles C ortez A b b o tt, Management o f th e F ed eral
Debt (New York: McGraw-Hill Book Company, I n c . , 1946),
p . 5.
15
according to the c o n trib u tio n th a t he makes to so c ie ty as
measured by d o lla r v o te s. When the fe d e ra l government
chooses to dominate th e c a p ita l m arkets in th e i n t e r e s t o f
debt management, the process o f a llo c a tin g c a p ita l accord
ing to the b e s t i n t e r e s t o f s o c ie ty through fre e market
com petition may be sev erely hampered. An example o f such
peacetim e fe d e ra l dominance was th e p eriod from th e end of
World War I I up to the F ederal R eserve-T reasury Accord of
March 4 , 1951.
Freedom and th e d e b t. The magnitude o f the debt
management problem is g re a te r than the tendency to
r e s t r i c t freedom o f o p eratio n in the f in a n c ia l market
p lace . There a re fe a rs th a t a high le v e l o f n a tio n a l debt
may lead to excessive governmental c o n tro ls . On one hand,
th e growth and acceptance o f government c o n tro ls combined
w ith p riv a te ownership o f p ro p erty may lead toward Fascism.
On the o th e r hand, ex cessiv e expansion of debt may lead
toward Socialism as government ex penditu res re p la c e p riv a te
e x p e n d itu re s. "What we do about debt management and the
budget is an in d ic a tio n of whether we s h a ll r e s i s t the
tren d toward s t a t e c o n tro l and c o lle c tiv is m over so much
16
o f th e w o rld ."^
With th e h elp o f d e f i c i t wartim e e x p e n d itu re s , th e
American way o f l i f e was in su red . This must be kept in
mind d u rin g any d is c u s s io n o f freedoms l o s t as a r e s u l t o f
the growth o f fe d e ra l d eb t. The r e a l t e s t o f a debt
management p o lic y is i t s e f f e c ts upon our democracy and
th e e x is tin g economic system . To safeg u ard b o th , i t is
n ec essary th a t th e o b je c tiv e s o f d ebt management be w ell
d efin e d .
O b jectiv es o f Debt Management
The p re se rv a tio n o f th e f a i t h and confidence o f the
people in the c r e d i t o f t h e i r government i s a prim ary
o b je c tiv e o f debt management. P u b lic con fidence is th e
p sy ch o lo g ical co rn e rsto n e o f th e f in a n c ia l s tre n g th o f th e
American economy. However, th e re is no g e n e ra l agreement
upon the manner in which c e r ta in economic fa c to rs a f f e c t
p u b lic psychology. Some econom ists supp ort th e view th a t
the country should
. . . avoid th e accum ulation o f d e b t , n o t only by
sp u m in g occasions o f expense, b u t by vigorous
^Committee on P u b lic Debt P o lic y , Our N atio n al
Debt (New York: H a rc o u rt, Brace and Company, Inc. , 1949),
p. 146.
17
e x e rtio n s in tim e o f peace to d isc h a rg e th e deb ts
which unavoidable wars may have o ccasio n ed , not
ungenerously throw ing upon p o s te r it y th e burdens
which we o u r s e lf [o u rse lv es] ought to b e a r .8
Other econom ists emphasize th a t p u b lic confidence can b e s t
be fu rth e re d by in c u rrin g d eb t when n ecessary as a to o l of
compensatory f i s c a l p o lic y .
Another o b je c tiv e o f th e d eb t manager i s to con
t r i b u t e in every way p o s s ib le to th e achievem ent o f dynamic
economic growth. In o rd e r to f a c i l i t a t e grow th, th e d eb t
management program must c o n trib u te to th e a l l e v i a t i o n o f
c y c lic a l f lu c tu a tio n s in to d a y 's modem in d u s tr ia liz e d
s o c ie ty . Issu a n c e , re fu n d in g , o r repayment o f d eb t should
be conducted in such a way as to m inim ize th e r i s k o f
i n f l a t i o n o r th e th r e a t o f d e p re ssio n .
The d ebt manager is no t alon e in h is d e s ir e to p ro
v id e fo r dynamic growth in th e economy. This i s a ls o the
prim ary purpose o f monetary p o lic y . In our economy, th e
T reasury a c ts as d eb t manager and the F ed eral Reserve
System Board o f Governors d eterm in es'm o n etary p o lic y . I t
is th e re fo re e s s e n tia l th a t th e se two groups work in
harmony to promote th e g e n e ra l p u b lic w e lfa re . P roviding
g
George W ashington, W ashington's F arew ell Address
(New York: D u ffie ld and Company, 1907), pp. 40-41.
18
fo r dynamic economic growth is a lso th e m ajor goal o f
f i s c a l p o lic y . Congress determ ines f i s c a l p o lic y a c tin g
upon recommendations o f th e P re s id e n t o f th e United S ta te s .
Both debt management p o lic y and monetary p o lic y can be
o rie n te d to a s s i s t s k i l l f u l l y th o se employing f i s c a l
p o lic y . Proper c o o rd in a tio n and d ir e c tio n o f a l l th re e
p o l i c i e s - - f i s c a l , m onetary, and d eb t m anagement--are th e
keys to ach iev in g the e lu s iv e n a tio n a l o b je c tiv e o f
dynamic economic growth co n c u rren t w ith f u l l employment
and p ric e s t a b i l i t y .
In accom plishing h is prim ary o b je c tiv e s o f (1) m ain
ta in in g confidence in th e c r e d i t o f th e government; and
(2) a id in g f i s c a l and monetary p o lic y to promote economic
grow th, s tr e n g th , and s t a b i l i t y , th e debt manager must
e s ta b lis h a s e t o f supplem entary o b je c tiv e s . At t h i s
p o in t, th e se o b je c tiv e s w ill only be enum erated; l a t e r
they w ill be d iscu ssed more f u ll y .
The debt manager endeavors to conduct d a ily fin a n
c i a l o p e ra tio n s so as to avoid d is r u p tiv e e f f e c ts in the
f in a n c ia l m arkets. B alancing th e m a tu rity s tr u c tu r e o f
the debt h elp s to a t t a i n a d e s ir a b le m arket s t a b i l i t y .
Market s t a b i l i t y is fu rth e re d by a wide d i s t r i b u t i o n o f
19
the ownership o f th e d e b t. This can be achieved by f i t t i n g
s e c u r i ti e s to th e needs o f in v e s to r s . F in a lly , on b e h a lf
o f th e taxpaying p u b l i c , th e s e rv ic e c o s t o f th e debt
should be minimized by h o ld in g down i n t e r e s t c o s ts whenever
p o s s ib le .
Upon what b a s is s h a ll th e d ebt manager c o o rd in a te
th e se vary in g and p o s s ib ly c o n f lic tin g o b je c tiv e s ? To
h elp e lim in a te th e p o te n tia l dangers o f a la rg e d e b t , i t
i s n ecessary th a t a sound p r in c ip le be a p p lie d to debt
management. The p r in c ip le o f maximizing s o c ia l u t i l i t y is
a p p lic a b le . P u b lic d eb t has two s i d e s - - s o c i a l c o s t and
s o c ia l u t i l i t y . The p r in c ip le o f maximizing s o c ia l u t i l i t y
re q u ire s th a t th e m arginal s o c ia l u t i l i t y from th e l a s t
debt in stru m en t should be a t l e a s t equal to th e m arginal
s o c ia l c o s t o f th e l a s t debt in stru m en t. The m arginal
s o c ia l c o st can be measured in th e a d d itio n a l d eb t s e rv ic e
c o s t s , th e e f f e c t o f i n t e r e s t r a t e changes upon th e v alu e
o f in v e ste d c a p it a l funds , th e e f f e c t o f i n t e r e s t r a t e
changes upon th e p ro p e n sity to i n v e s t, th e tr a n s f e r
f r i c t i o n s , and any added w ealth r e d i s t r i b u t i v e e f f e c t s .
The m arginal s o c ia l u t i l i t y should be measured by the
e f f e c t o f m arginal debt upon economic grow th, s tr e n g th ,
20
and s t a b i l i t y . Granted the co m p lex ities o f th e p r a c t ic a l
a p p lic a tio n o f th e p r in c ip le o f maximizing s o c ia l u t i l i t y ,
i t s t i l l serv e s as th e b e s t rough guide a v a ila b le to th e
debt manager in th e a tta in m e n t o f h is o b je c tiv e s .
I I . BASIC TERM S A N D CONCEPTS
The fe d e ra l debt is based upon th e n a tio n a l incom e,
n a tio n a l w e a lth , and th e governm ent's c r e d i t . F r u i t f u l
d isc u ss io n o f d ebt management n e c e s s ita te s a c le a r concept
o f th e term s n a tio n a l incom e, n a tio n a l w e a lth » government
c r e d i t , fe d e ra l d e b t, and d eb t management.
N atio n al Income and N atio n al Wealth
The incom e-producing p o te n tia l o f a n a tio n is o f
prime im portance in c o n sid e rin g the a b i l i t y o f th a t n a tio n
to s e rv ic e and repay a d e b t. In th e p u b lic s e c to r , as in
th e p r iv a te s e c to r , th e a b i l i t y to produce w ealth has more
b e a rin g on th e c r e d i t stan d in g o f th e d eb to r than th e
a c tu a l accum ulation o f w ealth to d a te . N atio n al income
s t a t i s t i c s measure th e c o u n try 's earn in g power. N atio n al
income is d efin e d as th e money value o f a l l goods and
s e rv ic e s produced in a n a tio n in one y ea r.
21
N atio n al w ealth measures th e accum ulation o f a s s e ts .
N atio n al w ealth Is d efin e d as the sum t o t a l d o lla r v alu e
o f a l l ta n g ib le a s s e ts owned c o l l e c t iv e l y o r In d iv id u a lly
In a p o l i t i c a l su b d iv isio n .
The n a tio n a l w ealth and n a tio n a l Income a re macro-
economic co n cep ts. The fe d e ra l d eb t re p re s e n ts a l i a b i l i t y
a g a in s t th e n a tio n a l w ealth and the fu tu re n a tio n a l Income.
From th e microeconomic v ie w p o in t, in d iv id u a ls and
b u sin e sse s f a i l to c o n sid e r t h e i r f u l l sh are o f the fe d e ra l
debt as a p erso n a l l i a b i l i t y . This r e s u l t s in an i l l u s i o n
o f g r e a te r n a tio n a l w ealth than a c tu a lly e x i s t s . An i n d i
v id u a l len ding money to the government fe e ls much le s s
compulsion to save than an in d iv id u a l who i s taxed an
e q u iv a le n t amount. The w ealth e f f e c t r e s u ltin g from the
e x iste n c e o f a la rg e fe d e ra l debt could r e s u l t in reduced
in c e n tiv e to save. This would a f f e c t c a p i t a l accum ulation.
I t could a ls o reduce the w illin g n e s s to work, thereby
low ering th e le v e l o f n a tio n a l income. F in a lly , th e
w ealth e f f e c t may in c re a s e th e p ro p e n sity to consume,
Q
thereby a f f e c tin g th e growth and s t a b i l i t y o f th e economy.
9
Gardner A ckley, "The W ealth-Saving R e la tio n s h ip ,"
Jo u rn al o f P o l i t i c a l Economy. XIV (A pril 1951), 154.
Government C red it
The governm ent's c r e d i t depends upon i t s a b i l i t y
and w illin g n e s s to compel payments from th e n a tio n a l
w ealth and th e n a tio n a l earn in g power. The government i s
a so v ereig n power. I t s c r e d i t "cannot r e s t on c o l l a t e r a l
or on le g a l enforcem ent o f c o n tra c t but must r e s t on con
fid en ce o f len d ers in th e tax in g power and p o lic ie s o f the
„ „10
government.
Even the governm ent's c r e d i t is lim ite d . P ublic
d e f i c i t s cannot be continued i n d e f i n i t e l y w itho ut u n d er
mining th e f in a n c ia l and economic system o f th e n a tio n .
What i s th e lim it o f th e p u b lic debt? This depends on
many f a c to r s . The most im portant f a c to r is th e r a t i o o f
debt to n a tio n a l income. The r a t e o f growth o f d eb t com
pared to th e r a te o f growth o f th e economy is s i g n i f i c a n t .
C onditions in th e p r iv a te d eb t s e c to r w ill have a b e a rin g .
The s t a t e o f th e f in a n c ia l mechanism o f the n a tio n and the
d i s t r i b u t i o n o f th e d eb t must a ls o be co n sid ered in
attem p tin g to d e lin e a te the lim its o f th e governm ent's
c r e d i t .
"^T w entieth Century Fund, I n c . , The N atio n al Debt
and Government C re d it (New York: T w entieth Century Fund,
I n c . , 1937) , p. 22.
23
To a l l th e se ta n g ib le c o n sid e ra tio n s must be added
the p e r tin e n t in ta n g ib le fo rc e s. The lim it o f debt a ls o
depends upon th e p re v a ilin g mass psychology o f the p u b lic .
I f the American people understand a problem , they can
u su a lly be counted upon to cooperate in the s o lu tio n . The
fe d e ra l debt is a major problem which demands enlig h ten ed
pu b lic o pinion. U n fo rtu n a te ly , debt problems a re o rie n te d
toward macroeconomic re a s o n in g , w hile th e p u b lic is in
c lin e d to reason in microeconomic term s. T h erefo re, debt
problems a re d i f f i c u l t fo r th e layman to comprehend.
I t is not s u rp ris in g th a t the astronom ical fig u re s
o f the fe d e ra l debt c r e a te a
. . . m ental hazard which e v e n tu a lly leads to
f e a r - - f e a r o f heavy ta x e s , fe a r o f i n f l a t i o n ,
fe a r o f c o lla p s e o f government c r e d i t , and
fe a r o f lo sin g freedom o f e n te r p ris e . This
t e r r i f i c fe a r is th e essence o f the psycho
lo g ic a l burden o f th e p u b lic d e b t.H
The p sy ch o lo g ical fe a r o f th e p u b lic o f fe d e ra l debt is
one o f the lim itin g fa c to rs o f government c r e d it.
Nien Min Sun, "An Economic A nalysis o f the
Burdens o f the P ublic Debt" (unpublished Ph.D. d i s s e r t a
tio n , The U n iv ersity of Southern C a lif o r n ia , Los A ngeles,
1950), p. 35.
F e d e ra l Debt
F e d e ra l d e b t I s d e fin e d as th e sum t o t a l o f th e
i n t e r e s t - b e a r i n g o b lig a tio n s is s u e d by th e U nited S ta te s
governm ent. Debts o f lo c a l and s t a t e go vernm en ts, which
a r e a ls o p u b lic d e b t s , a re s e p a ra te d from f e d e r a l d e b t by
t h i s d e f i n i t i o n . F e d e ra l d e b t is so d e fin e d to d i f f e r
e n t i a t e i t s p e c i f i c a l l y from f i a t money. F i a t money
r e p r e s e n ts a n o n - in t e r e s t- b e a r i n g form o f d e b t.
I n t e r e s t - b e a r i n g forms o f d e b t may be e i t h e r f r e e l y
c o n tra c te d o r fo rc e d upon an u n w illin g h o ld e r. Forced
loans r e p r e s e n t i n t e r e s t - b e a r i n g borrow ing which i s
e n t i r e l y a t th e d i s c r e t i o n o f th e governm ent. The manage
ment problem s o f t h i s ty p e o f d eb t a re q u ite d i f f e r e n t
from th o se posed by a d e b t composed o f f r e e l y c o n tr a c te d
i n t e r e s t - b e a r i n g o b l i g a t io n s . T his d is c u s s io n o f f e d e r a l
d e b t d e a ls m ainly w ith f r e e l y c o n tra c te d i n t e r e s t - b e a r i n g
o b l i g a t io n s . I t i s to be u n d e rsto o d t h a t o th e r forms o f
d e b t can have an e f f e c t on d e b t management sho uld th ey
o c c u r. '
In a p p r a is in g th e economic s ig n if i c a n c e o f th e
f e d e r a l d e b t, no a tte m p t w i l l be made to c o n s tr u c t a
b a la n c e s h e e t o f a s s e t s to co rresp o n d w ith l i a b i l i t i e s .
25
Good accou nting procedure u t i l i z e s such a co u rse o f a c tio n
in an aly zin g p r iv a te in d e b te d n e ss. With re g ard to the
f e d e ra l d e b t , some rough e stim a te s have been made o f a s s e ts
which c o l l a t e r a l i z e l i a b i l i t i e s :
An in v en to ry o f U nited S ta te s Government p ro p e rty on
June 30, 1958 amounted to 262 b i l l i o n , a fig u r e th a t
a d m itte d ly un dervalues much land and o th e r p ro p e rty .
The Hope Diamond, fo r example w i l l be c a r r ie d a t no
v alu e because i t was a g i f t to th e g o v e r n m e n t . 3-2
Much d e f i c i t spending a ls o added i n d i r e c t l y to th e w ealth
o f th e n a tio n . P u b lic works d e f i c i t sp en d in g , to a la rg e
e x t e n t , r e s u lte d in in c re a se s in th e m onetary v alu e o f the
p h y sic a l a s s e ts o f th e co u n try .
In a d d itio n , th e fe d e ra l government owns c o n s id e r
a b le q u a n titie s o f p r iv a te d eb t o b lig a tio n s . R a ilro a d s ,
fa rm e rs , sh ip o w n ers, and homeowners who a re indebted to
government agencies and government c o rp o ra tio n s a re r e a l l y
indebted to th e fe d e ra l government which owns th e c a p it a l
sto ck o f th e se m iscellan eo u s government c o rp o ra tio n s and
ag e n cies. A lso , as o f June 30, 1960, fo re ig n c o u n trie s
are indebted to th e United S ta te s government fo r th e sum
o f $12.9 b i l l i o n under v a rio u s loan and c r e d i t agreem ents
U .S ., House, Committee on Government O p e ra tio n s,
F ed eral Real and P erso n al P ro p erty Inventory Report as o f
6/30/58 , Committee P r i n t , 85th C ong., 2d S e s s ., p. 11.
26
13
concluded p r in c ip a lly sin c e th e end o f World War I I .
As World War I I came to an end, c o n sid e ra b le con
tro v e rs y aro se as to th e proper d is p o s a l o f government-
owned war p la n ts . These p l a n t s , which were th e r e s u l t o f
wartim e d e f i c i t spending, c o n s titu te d about o n e - f if th o f
the t o t a l i n d u s t r ia l c a p a c ity o f th e U nited S ta te s . The
government could have chosen to co n tin u e to run them and
apply th e p r o f i t s o r lo s s e s toward th e d e b t. This was
opposed as an unw arranted ex ten sio n o f government a c t i v i t y
during peacetim e. The government could have lease d the
p la n ts to p riv a te o p e ra to rs . However, the government
chose to d isp o se o f th e p la n ts d e s p ite low s a le s p ric e s
and remove i t s e l f e n t i r e l y from th is area o f p ro d u ctio n .
S im ila rly , wartim e d e f i c i t spending had enabled
p r iv a te b u sin ess to c r e a te new c a p i t a l equipment which
could be converted to peacetim e u se . This meant th a t $20
b i l l i o n o f p r iv a te ly owned war p la n ts could a ls o be con-
14
stru e d to re p re s e n t r e a l c a p it a l behind th e d eb t.
13
Annual Report o f th e S e c re ta ry o f th e T re a su ry ,
1960. p. 62.
14
W illiam W ithers , The P u b lic Debt (New York: The
John Day Company, 1945), p. 57.
27
F in a lly , equipm ent, m a te r ia ls , and s u p p lie s rem ain
ing unused a f t e r th e war could have been used in a
p ro d u ctiv e manner by th e government i t s e l f in s te a d o f
engaging as i t d id in a g ig a n tic give-away under th e g u ise
o f a u c tio n s e l l i n g . A ll o f th e se a s s e t s , r e a l and p o ten
t i a l , w ill not be co n sid ered f u r th e r in analy zin g th e debt
management problem s, although from a b u sin e ss accounting
view point they re p re s e n t a p o te n tia l source o f debt re p ay
ment. The tru e backing fo r the d eb t w ill be co n sid ered to
be th e n a tio n a l income and the degree o f ta x in g power
a p p lie d to such income.
Debt Management
Debt management sim ply d efin e d would in clu d e a l l
measures re g a rd le s s o f the p o in t o f o r ig in th a t a ffe c te d
the amount an d /o r th e com position o f th e debt o f th e
government o f th e U nited S ta te s . Under t h i s d e f in i t i o n ,
the T re asu ry , th e F ed eral Reserve Board o f G overnors, the
Congress , and the P re s id e n t can and do make th e major
debt management d e c is io n s .
Debt management d e c is io n s a re r e la te d to th e
is s u in g , re fu n d in g , and repayment o f d eb t. L is te d b r i e f l y ,
debt management concerns i t s e l f w ith d e c isio n s as to th e
28
choice o f debt forms to be used to finance budget d e f i c i t s ,
to b u ild up cash balances , to be used in re fu n d in g , o r to
be used in open market o p e ra tio n s. Debt management d e te r
mines th e m a tu rity p a t t e r n , th e p a tte r n o f i n t e r e s t r a t e s ,
and th e ownership d i s t r i b u tio n o f th e fe d e ra l d eb t. The
s p e c ia l p ro v isio n s in co rp o rated in each s e c u r ity , such as
m a rk e ta b ility , r e s t r i c t i o n s on p u rch ase, and o p tion s
g ran ted to the p urch aser an d /o r rese rv ed fo r th e govern
ment are decided by the debt managers.
I I I . PURPOSES A N D OBJECTIVES
OF THE DISSERTATION
This d i s s e r t a t i o n is designed to f i l l th e need so
fo rc e fu lly o u tlin e d by S ecretary o f the Treasury Anderson
in the follow ing q u o tatio n s:
The economics p ro fe ss io n is today confronted w ith
a ch allen g e o f re stu d y in g and a r riv in g a t sound and
c o n s tru c tiv e conclusions w ith re sp e c t to n a tio n a l
fin a n c ia l problems. . . .15
Address b efo re the American Finance A sso ciatio n
and th e American Economic A sso ciatio n a t W ashington, D.C. ,
December 29, 1959, by S ecretary o f th e T reasury Anderson,
c ite d in Annual Report o f the S ecretary o f the T re a su ry ,
I9 6 0 , pp. 288-289.
29
I t is your d u ty --b o th to your co u n try and to
your p r o f e s s io n - - to examine c r i t i c a l l y and o b je c
t i v e l y a l l o f th e economic p o lic y a c tio n s in
government and to speak out fo r c e f u lly on what
you c o n sid e r to be t h e i r m e rit o r la c k o f
m e rit. . . .
The s k i l l and o b j e c t i v i ty w ith which econom ists
f u l f i l l th e se v i t a l o b lig a tio n s may w e ll be th e
determ ining f a c to r in th e w orld-w ide s tru g g le
between economic systems and id e o lo g ie s .
The problems th a t have surrounded debt management
have been unique in many re s p e c ts . Through a c a re fu l
a n a ly tic a l study o f th e o b je c tiv e s , a c tio n s , and r e s u l t s
achieved by re c e n t d eb t managers , i t is hoped th a t u s e fu l
g u id e lin e s can be e s ta b lis h e d fo r th e p re se n t and the
fu tu re .
Ignorance o f th e e f f e c ts o f d eb t management in the
modem economy is a grave d isad v an tag e. This study aims a t
promoting g r e a te r u n d ersta n d in g . The purpose is to
reassem ble in an a n a ly tic a l p re s e n ta tio n th e f a c ts and
fig u re s o f debt management found in many v a rie d so u rces.
In c o n c lu sio n , a number o f recommendations w ill be
form ulated. In a world o f d iv id ed id e o lo g ie s i t is e sse n
t i a l to our form o f government th a t the n e c e s s a rily
16I b i d . , p. 283.
17I b i d . , p. 289.
30
enlarged scope o f fe d e ra l a c t i v i t i e s be perform ed s k i l l
f u lly . Such s k i l le d perform ance w i ll minimize th e
in te r f e r e n c e o f government in the fre e m arket economy o f a
dem ocratic n a tio n , w hile a t the same tim e a id in p re se rv in g
our p o l i t i c a l system .
IV. PROJECTED ORGANIZATION OF THE DISSERTATION
In d isc u s s in g th e economic e f f e c t s o f managing th e
p re se n t d e b t , i t would be h e lp fu l to sk etch th e growth o f
th a t d eb t and the a ttem p ts to reduce i t o r to p la c e a
c e ilin g on i t . This is th e purpose o f C hapter I I .
The im portance o f th e s iz e o f the d eb t is a m a tte r
o f r e l a t i v i t y . The aim o f C hapter I I I is to analyze fe d
e r a l d ebt fig u re s in con n ectio n w ith c o n tin g e n t fe d e ra l
l i a b i l i t i e s , t o t a l d e b t , and o th e r p e r tin e n t f a c to r s such
as n a tio n a l income, p o p u la tio n , and n a tio n a l w ealth . In
th is way a b e t t e r knowledge o f th e r e a l burden o f th e debt
can be o b tain ed .
C hapter IV d e a ls w ith the d i s t r i b u t i o n o f th e
ownership o f the debt as e ffe c te d by the sources o f funds
and debt management o b je c tiv e s ; C hapter V w ith th e
s e p a ra te c la s s e s o f d eb t ow nership; C hapter VI w ith th e
31
m a tu rity p a tte r n ; and C hapter VII w ith th e p a tte r n o f
i n t e r e s t r a t e s .
Having e s ta b lis h e d th e economic e f f e c ts o f th e
growth o f th e d e b t, i t s r e l a t i v e s iz e and b u rden, i t s
ow nership, i t s m a tu rity p a tt e r n , and th e i n t e r e s t r a te
p a t t e r n , i t i s th e ta s k o f C hapter V III to in v e s tig a te th e
economic e f f e c ts o f th e tech n iq u es o f debt management on
monetary and f i s c a l p o lic y d uring v ary in g economic co n d i
tio n s , w ith s p e c ia l emphasis on th e a c tu a l p o lic y
decision-m aking p ro c ess.
C hapter IX concludes w ith th e s tu d y 's summary,
f in d in g s , co n clu sio n s , and proposed recommendations fo r
th e s o lu tio n o f th e debt management problem.
CHAPTER II
G R O W TH OF THE FEDERAL DEBT OF THE UNITED STATES
The enormous in c re a se in th e fe d e ra l d eb t w ith in th e
l a s t f i f t y y ears has placed g re a t emphasis upon th e manage
ment of th e d eb t. The mere s iz e o f th e d eb t i s very
im p o rtan t. However, i t is n o t th e s o le c r i t e r i o n . A
badly handled sm all debt can have more d e v a s ta tin g e f f e c ts
than a well-managed la rg e d eb t. The g r e a te r th e d e b t, the
more im portant pro per debt management becomes as a d e t e r
mining f a c to r o f economic grow th, s tr e n g th , and s t a b i l i t y .
M istakes in managing a la rg e debt may prove to be exceed
in g ly c o s tly . I t would be w ell to avoid " th e p i t f a l l of
denying th a t the s iz e o f th e debt is o f any im portance."^
The purpose o f th is c h a p te r is f i r s t to tra c e
b r i e f l y the growth o f th e d eb t. The debt has undergone
c o n sid e ra b le f lu c tu a tio n sin c e th e i n i t i a l passage o f the
A u reliu s Morgner, "The N atio n al Debt and Economic
S ta b ility " (unpublished Ph.D. d i s s e r t a t i o n , U n iv e rsity o f
M innesota, 1956), p. 62.
32
33
Assumption Act in 1790, which e s ta b lis h e d th is c o u n try 's
d eb t. The C iv il War, World War I , the D epression, World
War I I , and the p resen t-d ay cold war p erio d debt changes
a re examined a n a ly tic a lly .
Having e s ta b lis h e d th e growth p a tte r n , the second
ta sk is to analyze the attem p ts to prevent th e accum ulation
o f d eb t. The e a rly and continued use o f the sin k in g fund
is d iscu ssed . A lso, both sid e s o f th e c u rre n t debate over
a le g a l debt c e ilin g a re p resen ted .
In th is c h a p te r, d isc u ssio n c e n te rs on the fe d e ra l
debt o f f i c i a l l y d esignated as the " t o t a l o u tstan d in g p u b lic
debt and guaranteed o b lig a tio n s held o u tsid e the T reasu ry ,"
which is shown in Table I. The fe d e ra l debt is a com posite
o f th re e sums. F i r s t , th e face v alu e o f a l l o u tstan d in g
o b lig a tio n s is to ta le d . This is th e amount the government
must repay when the o u tstan d in g o b lig a tio n s m ature. With
th e exception of s e c u r itie s such as Treasury B ills , which
are sold through au ctio n a t a d is c o u n t, the m a tu rity value
is th e sum th a t the government o r ig in a lly receiv ed when the
s e c u rity was issu ed .
Second, the face valu e o f a l l guaranteed o b lig a
tio n s o f th e United S ta te s held o u tsid e th e T reasury is
34
TABLE I
TOTAL OUTSTANDING PUBLIC DEBT A N D GUARANTEED
OBLIGATIONS HELD OUTSIDE THE TREASURY
June
30
(Year) B illio n s
Net In crease
or
Decrease (-)
June
30
(Year) B illio n s
Net In c rease
o r
D ecrease (-)
1916 $1.2 1941 $55.3 $6.8
1917 3.0 $1.8 1942 77.0 21.7
1918 12.5 9.5 1943 140.8 63.8
1919 25.5 13.0 1944 202.6 61.8
1920 24.3 - 1.2 1945 259.1 56.5
1921 24.0 - 0.3 1946 269.9 10.8
1922 23.0 - 1.0 1947 258.4 -11.5
1923 22.3 - 0.7 1948 252.4 - 6.0
1924 21.3 - 1.0 1949 252.8 0.4
1925 20.5 - 0.8 1950 25 7.4 4.6
1926 19.6 - 0.9 1951 255.3 - 2.1
1927 18.5 - 1.1 1952 259.2 3.9
1928 17.6 - 0.9 1953 266.1 6.9
1929 16.9 - 0.7 1954 271.3 5.2
1930 16.2 - 0.8 1955 274.4 3.1
1931 16.8 0.6 1956 272.8 - 1.6
1932 19.5 2.7 1957 270.6 - 2.2
1933 22.5 3.0 1958 276.4 5.8
1934 27.3 4.8 1959 284.8 8.4
1935 32.8 5.5 1960 286.5 1.7
1936 38.5 5.7 1961 289.2 2.7
1937 41.1 2.6
1938 42.0 0.9
1939 45.9 3.9
1940 48.5 3.6
Source: U .S ., T reasu ry , Annual Report o f the
S ecretary o f the T re a su ry « fo r the years 1916-1960
(Washington: Government P rin tin g O ffic e , 1916-1960);
Survey o f C urrent B u sin e ss. February 1962, p. S-18.
35
to ta le d . This in clu d es the o u tstan d in g issu es o f such
government co rp o ratio n s as the F ederal N ational Mortgage
A s s o c ia tio n , the Commodity C re d it C o rp o ra tio n , and th e
Export-Im port Bank o f Washington.
T h ird , the c u rre n t redem ption value o f a l l saving
bonds is to ta le d . Before 1946 th e m a tu rity value o f saving
bonds was used in c a lc u la tin g the fe d e ra l d eb t. However,
th e P ublic Debt Act o f 1946 provided th a t
. . . th e c u rre n t redem ption valu e o f any o b lig a tio n
issued on a d isco u n t b a s is which is redeemable p rio r
to m a tu rity a t the o p tio n o f th e h o ld er th e re o f
s h a ll be considered to be the face value of such
o b lig a tio n .2
I. HISTORY OF THE G R O W TH OF THE FEDERAL DEBT
The v a c il l a t io n o f the s iz e o f the debt o f the
United S ta te s is examined in th re e major time p eriods:
(1) independence to World War I , (2) World War I through
World War I I , and (3) post-W orld War I I to the p re se n t day.
In analyzing the flu c tu a tio n s o f the fe d e ra l d e b t, i t
should be remembered th a t
U.S. , T reasu ry , Annual Report o f the S ecretary o f
the T reasury . 1946 (Washington: Government P rin tin g
O ffic e , 1946), p. 66.
36
. . . th e n a tio n a l debt o f th e U nited S ta te s has
had a g r e a te r e l a s t i c i t y than tho se o f G reat
B r ita in and F ra n c e , th a t is th e United S ta te s
government debt expands and c o n tra c ts more ra p id ly
than th o se o f the o th e r two c o u n t r ie s .3
F ed eral Debt from Independence to World War I
The i n i t i a l re a c tio n s o f a new n a tio n to i t s debt
o b lig a tio n s a re worthy o f c lo se s c r u tin y , fo r they a re
in d ic a tiv e o f fu tu re fe d e ra l f in a n c ia l developm ents.
The assum ption and e lim in a tio n o f fe d e ra l d e b t ,
1790-1836. The p u b lic debt o f th e fe d e ra l government had
i t s in c e p tio n in th e Assumption Act o f 1790. Under th e
guidance o f Alexander H am ilton, th re e s e p a ra te areas o f
debt were combined. These were (1) th e o u tstan d in g fo re ig n
debt o f $12 m illio n ; (2) the in te r n a l debt o f $40 m illio n ,
which had been in cu rred by th e U nited S ta te s under the
Second C o n tin e n ta l Congress and the A rtic le s o f C onfedera
tio n governments; and (3) th e rem aining unpaid $21 m illio n
re v o lu tio n a ry debt o f the s e v e ra l s t a t e s . The t o t a l o f
th e se d e b ts , roughly $73 m illio n , was assumed by the new
3
Nien Min Sun, "An Economic A nalysis o f th e Burdens
o f the P u b lic Debt" (unpublished Ph.D. d i s s e r t a t i o n ,
U n iv e rsity o f Southern C a lif o r n ia , 1950), p. 125.
37
government e s ta b lis h e d under th e C o n s titu tio n o f the
i ±
United S t a t e s .
This i n i t i a l indebtedness slow ly ro se to a high
p o in t o f $86 m illio n by 1804, but in th e next seven y ears
th e debt was reduced to $45 m illio n . However, th e n e c e s
s i t y o f fin an c in g the War o f 1812 r e s u lte d in a resurgence
o f d e f i c i t spending. By the y ea r 1816 th e d eb t had
clim bed to $127 m illio n .
In the peacetim e p erio d follow ing th e War o f 1812
th e debt slow ly d ec rease d , reach in g $91 m illio n in 1820
and $48 m illio n in 1830. By 1836 th e debt had d e c lin e d to
$.04 m illio n , which was to remain th e a ll- tim e low fo r the
United S ta te s to d a te .
During th e p erio d from 1789 to 1836, th e U nited
S ta te s had paid the sum of $257 m illio n on the p r in c ip le
o f the d eb t. A fu rth e r sum o f $28 m illio n , re p re s e n tin g
p a r t o f th e e x is tin g su rp lu s o f 1836, was d is tr ib u te d
according to e le c to r a l v o te among th e tw e n ty -fiv e s ta t e s
Wesley M . Gewehr and o th e r s , The U nited S t a t e s . A
H isto ry o f a Democracy (second e d itio n ; New York: McGraw-
H ill Book Company, I n c ., 1960), p. 122.
38
5
then in th e Union. Using 1836 as a b a s e , f a n ta s ti c com
p a riso n s can be made o f th e r e l a t i v e changes in d eb t. For
example, "over a p erio d o f a hundred y e a rs (1836-1936) the
fe d e ra l d eb t in th e U nited S ta te s ro se roughly a m illio n
tim e s." I t i s d i f f i c u l t to see th e v alu e o f such r e l a t i v e
com parisons o f debt s t a r t i n g from such a low base.
The re-em ergence o f fe d e ra l d e b t, 1836-1916. The
land s p e c u la tio n o f th e 1 8 3 0 's, which was t h r o t t le d by th e
issu an ce o f the Specie C irc u la r and the p o l i t i c a l campaign
o f 1832 in v o lv in g th e re c h a r te r in g o f th e Second Bank o f
th e U nited S ta te s , helped b rin g on th e d e p re ssio n o f 1837.
The d e p re ssio n r e s u lte d in a d ecrease in fe d e ra l revenues
and an in c re a se in fe d e ra l ex p en d itu res which once more
n e c e s s ita te d d e f i c i t spending and a new p u b lic d eb t.
A fte r 1837 the n a tio n a l debt hovered around $12 m illio n
u n t i l the Mexican War. As a r e s u l t o f a $49 m illio n
Mexican War d e f i c i t , the debt in 1848 stood a t $66 m illio n .
^C. F. C h ild s , Concerning U nited S ta te s Government
S e c u r itie s (Chicago: C. F. C hilds and Company, 1947),
p. 25.
6
Seymour E. H a r r is , The N atio n al Debt and th e New
Economics (New York: McGraw-Hill Book Company, I n c . ,
1947), p. 3.
39
T h e re a fte r i t was reduced s te a d ily u n t i l on th e eve o f th e
C iv il War i t stood a t $28 m illio n . By th e end o f th e C iv il
War th e d e b t, however, had reached a new h ig h -w ater mark o f
$2 ,756 m illio n .^
A fte r th e C iv il War h ig h , th e d eb t was slow ly
reduced. The b ig g e s t fa c to r in debt re d u c tio n was th e high
t a r i f f p o lic y o f th e U nited S ta te s . In creased customs
d u tie s accompanied a growing economy. The r e s u l ta n t
d ecrease in the p u b lic debt w as, th e r e f o r e , " in a la rg e
p a r t an in c id e n ta l r e s u l t o f o th e r p o lic ie s th a t were
adopted alm ost e n ti r e l y fo re ig n o f f i s c a l c o n s id e ra tio n s .
By 1893 th e debt had dropped to $961 m illion."**
The Spanish American War r e s u lte d In an in c re a se o f
th e debt to $1,437 m illio n . T h e r e a fte r , u n t i l World War I ,
the debt remained r e l a t i v e l y s t a b l e , f lu c tu a tin g above and
below th e one b i l l i o n d o lla r mark. The ou tb reak o f World
War I marked a new era in the d eb t h is to r y o f th e United
S t a t e s .
^C hilds, op. c i t . , p. 50.
8
C harles C ortez A bbott, The F ed eral Debt (New York:
The T w entieth Century Fund, 1953), p. 185.
40
F ed eral D eb t. World War I through
World War I I
The fe d e ra l d ebt o f th e U nited S t a t e s , to ta lin g
$1.2 b i l l i o n in 1916, experienced a tw entyfold in c re a se in
th e subsequent World War I y e a rs . A m ajor c o n s id e ra tio n in
an alyzing t h i s d eb t in c re a s e is th e change o f th e United
S ta te s ' p o s itio n in th e world fam ily o f n a tio n s . Before
the o u tb reak o f World War I , th e U nited S ta te s had r e lie d
upon th e a s s is ta n c e o f fo re ig n c a p it a l fo r prom oting i t s
economic growth. During th e n ext few y ea rs the U nited
S ta te s became th e m ajor c r e d ito r n a tio n o f th e w orld.
Government loans abroad d u rin g World War I and th e postw ar
re c o n s tru c tio n p erio d were r e f le c te d in th e r i s i n g debt a t
home.
World War I debt and repaym ent. 1916-1930. The
m ajor im petus to d e f i c i t spending was th e involvem ent of
the U nited S ta te s in World War I . The goal s e t fo r the
F i r s t L ib e rty Loan was $2 b i l l i o n . This was g r e a te r than
the e n t ir e debt had been a few months e a r l i e r . However,
more than
. . . 4 m illio n men and women su b scrib ed fo r 3
b i l l i o n d o lla r s w orth o f,b o n d s. Of th is number
an estim ated 3,960,000 people o r 99 p er cent
41
su b scrib ed in amounts ranging from $50 to
$10 ,000.9
The most im portant f a c to r c o n trib u tin g to the
success o f th e F i r s t and subsequent L ib e rty Loan D rives
was the p a trio tis m o f th e American p eople. Another f a c to r
was th e o rg a n iz a tio n o f th e war bond campaigns under th e
d ir e c tio n o f th e S e c re ta ry o f th e T reasury. These cam
paigns were su p erv ised by th e F ederal Reserve System which
was re sp o n s ib le fo r th e success o f n e g o tia tin g a l l govern
ment lo a n s . ^
An im portant in n o v atio n in World War 1 was th e
d e sig n a tio n o f q u a lif ie d commercial banks as d e p o s ito rie s
o f th e U nited S ta te s T reasury. W ithout such an a rra n g e
m ent, tr a n s f e r r in g th e la rg e sums o f money r a is e d in the
bond d riv e s to th e T reasury would have d is ru p te d th e
economy.
The success o f th e F i r s t L ib e rty Loan was symbolic
of the f a te of a l l th e rem aining lo a n s , in c lu d in g the
V ictory Loan o f 1919. The Second, T h ird , and Fourth
L ib e rty Loans were a l l h e a v ily o v ersu b sc rib ed . The la r g e s t
^ C h ild s, op. c i t . , p. 118.
10Ib id . , p. 122.
42
of the d r iv e s , the Fourth L ib e rty Loan, w ith a goal of
$6 b i l l i o n , receiv ed s u b s c rip tio n s fo r alm ost $7 b i l l i o n ,
which c o n s titu te d the g r e a te s t fin an cin g achievement o f
th a t tim e. The V ictory L ib e rty Loan was a lso oversub
s c rib e d , but th e excess s u b s c rip tio n s were r e j e c t e d . ^
A fte r the term in atio n o f World War I , the fe d e ra l
debt stood a t $25.5 b i l l i o n on June 30, 1919. Of the
World War I expenditures , borrowing had covered 72 per
12
c e n t, whereas ta x a tio n had met only 28 per c e n t.
World War I government c o n tro ls were quickly removed
as p a r t o f a p o lic y designed to r e s to r e p r iv a te i n i t i a t i v e .
The p eriod o f t r a n s i t i o n from wartime to peacetim e was
marked by an in f la tio n a r y boom follow ed by a sharp re v e rs a l
in th e 1920's. By 1922 th e economy s ta r te d i t s long upward
p u ll which was to continue fo r alm ost a decade.
During th is decade, Andrew W illiam Mellon was th e
S ecretary o f th e T reasury. He served under H arding,
C oolidge, and Hoover. Under h is le a d e rsh ip the public
debt was refunded and p a r t i a l l y r e t i r e d . Refunding was
11I b i d . , p. 129.
12
Committee on P ublic Debt P o lic y , Our N ational
Debt (New York: H a rc o u rt, Brace and Company, I n c ., 1949),
p. 8.
43
designed to a ssu re an adequate supply o f m aturing se c u r
i t i e s to which a v a ila b le funds could be a p p lie d .
R etirem ent o f th e d eb t was accom plished by a steady
p ro c essio n o f budget s u rp lu se s which were a p p lie d according
to th e p ro v isio n s o f the Sinking Fund A ct. In a d d itio n ,
debt payments o f one b i l l i o n d o lla r s re ceiv ed from fo re ig n
13
n a tio n s were a p p lie d toward d eb t repaym ent.
Each f i s c a l y ear from 1919 to 1930 re s u lte d in some
debt re d u c tio n . In eleven f i s c a l years th e debt had
dropped from $25.5 b i l l i o n to $16.2 b i l l i o n , o r a t o t a l o f
$9.3 b i l l i o n . This re p re se n te d a debt re d u c tio n o f 36%
p er ce n t.
D epression d e b t, 1930-1939. D e f ic it spending
d uring th e g re a t d ep ressio n was to re v e rse com pletely th e
tren d o f th e previous decade. From 1930 through 1939 th e
debt was in cre ased from $16.2 b i l l i o n to $45.9 b i l l i o n , o r
a t o t a l o f $29.7 b i l l i o n . This re p re se n te d an in c re a se o f
183 per c e n t. The d o lla r v alu e o f th e d ep ressio n debt
exceeded the t o t a l d o lla r v alu e o f th e debt e x is tin g
b e fo re World War I , plus th a t c re a te d by the f i r s t world
^ C h i l d s , op. c i t . „ p. 175.
44
war. The average annual in c re a s e in th e debt over th e
n in e -y e a r p erio d was $3.3 b i l l i o n d o ll a r s . The la r g e s t
in c re a s e in a s in g le y ea r o ccu rred in f i s c a l 1936, when th e
d eb t in c re a se d by $5.7 b i l l i o n . In c re a se s o f under one
b i l l i o n d o lla r s occu rred in only two y e a rs —$0.6 b i l l i o n
in 1931 and $0.9 b i l l i o n in 1938.
On September 3 , 1939, World War I I o f f i c i a l l y began
in Europe. An uneasy peace had been m aintained by a
r e t r e a t from p r in c ip le s d u rin g th e Japanese a tta c k on
Manchuria in 1931, the I t a l i a n s e iz u re o f E th io p ia in 1935,
th e Spanish C iv il War in 1936, and the dismemberment o f
C zechoslovakia in 1938.
World War I I d e b t, 1939-1946. As war clouds became
more om inous, th e p u b lic debt r e f l e c t e d th e in cre ased
d e f i c i t ex p en d itu res n e c e s s ita te d by n a tio n a l d efen se.
The 1940 and 1941 p erio d of U nited S ta te s war preparedness
saw the debt in c re a se w ith growing r a p id ity .
With the advent o f P e a rl Harbor on December 7, 1941,
th e U nited S ta te s changed to a wartim e f in a n c ia l b a s is .
D e f ic it spending was accepted and u n q u estio n ed . However,
the degree to which th e government would tax and th e types
o f tax es i t would use d u rin g wartim e were h o tly deb ated .
45
From Ju ly 1, 1940 to June 30, 1946 th e government spent
$387 b i l l i o n . These expenditures fo r World War I I were ten
times those o f World War I. The governm ent's n e t budgetary
re c e ip ts to ta le d $176 b i l l i o n , leav in g a d e f i c i t o f $211
b i l l i o n . This meant th a t 46 per cen t o f the needed funds
in World War I I were ra is e d by ta x a tio n as c o n tra ste d to
14
28 per cen t during World War I.
The problem remained of o f f s e ttin g the $211 b i l l i o n
d e f i c i t th a t was c ir c u la tin g throughout the economy. Those
re c e iv in g the d e f i c i t funds could e ith e r spend them or
save them. The wartime ra tio n in g program provided a power
fu l d e te r re n t a g a in st spending. The wartime bond program
provided a powerful stim ulus fo r saving. The $211 b i l l i o n
d e f i c i t , th e r e f o r e , measured the amount th a t the government
had to borrow and the p o te n tia l from which i t could be
borrowed.
At the on set o f World War I I , the Treasury chose
not to adopt the bond campaign tech n iq u e, although i t had
been h ig h ly su c c e ssfu l in fip an cin g World War I. Nearly a
year a f t e r P earl H arbor, the T reasu ry , staggered by the
14
Annual Report of the Secretary of the Treasury,
1946j p. 68.
m agnitude o f the funds needed, accepted th e in e v ita b le
appeal to the p a trio tis m o f the American p eop le. Funds
which th e p u b lic chose not to lend to th e government but
to p lace w ith v a rio u s types o f savings i n s t i t u t i o n s a lso
were in v e ste d in fe d e ra l bonds. This fa c t was r e f le c te d
by the in c re a s e o f fe d e ra l o b lig a tio n s h eld in th e s e c u rity
p o r tf o lio s o f f in a n c ia l i n s t i t u t i o n s . The o r ig in a l c r e a
tio n o f a p o rtio n o f th e d e f i c i t funds was accom plished
through bond s a le s to th e F ed eral R eserve. This i n i t i a t e d
th e re se rv e s used by banks to c r e a te demand d e p o sits
s u f f i c ie n t to purchase the rem aining government bonds.
Before May 1942 the m ajor problem had been th a t o f
holding bond custom ers back. A government bond s a le s
o rg a n iz a tio n did not even e x is t. By May 1942 a gradual
t r a n s i t i o n took p lace and V icto ry Fund Committees were
organized in each o f the F ed eral Reserve D i s t r i c t s . These
committees were unable to o p e ra te e f f e c tiv e ly u n t i l the
beginning o f the f i r s t war loan d riv e in December because
"th e sh o rt time fo r which is s u e s were open provided l i t t l e
o p p o rtu n ity fo r in te n s iv e s a le s e f f o r t and th e p r a c tic e o f
a l l o t t i n g s u b s c rip tio n s o ffe re d l i t t l e in c e n tiv e fo r s a le s
47
p re ssu re .
The f i r s t war loan had a goal o f $9 b i l l i o n . Sub
s c r ip tio n s by commercial banks were lim ite d to $5 b i l l i o n .
S u b sc rip tio n s from nonbank in v e s to rs were to be a l l o t t e d
in f u l l . V ictory Fund Committees, a j o i n t F ed eral R eserve-
T reasury group organized along F ed eral Reserve d i s t r i c t
l i n e s , were aided by 44,000 v o lu n te e rs . The War Savings
S t a f f , a T reasury group organized along s t a t e l i n e s , was
aided by 300,000 v o lu n te e rs . Together they succeeded in
s e llin g $13 b i l l i o n in government s e c u r i t i e s . ^
In th e second war lo a n , r i v a l r y developed between
th e two v o lu n te e r s a le s fo rc e s . Although th e goal o f $13
b i l l i o n was o v ersu b scrib ed by $5.5 b i l l i o n , i t was n ec es
sary to re o rg a n iz e in to a u n ifie d s a le s fo rc e b u i l t along
s t a t e and lo c a l government lin e s . There was " s u b s ta n tia l
disagreem ent" between th e T reasury and th e F ed eral Reserve
Board o f Governors on th is d e c isio n to merge the two r i v a l
fo rc es under a new group d i r e c tl y re sp o n s ib le to th e
Henry C. Murphy, The N atio n al Debt in War and
T ra n s itio n (New York: McGraw-Hill Book Company, I n c . ,
1950), p. 134.
16
Childs, op. cit. » p. 287.
48
S e c re ta ry o f th e T reasury. However, the new o rg a n iz a tio n
worked smoothly and w ith l i t t l e f r i c t i o n fo r th e rem ainder
o f th e war bond campaigns. In each campaign a d e ta ile d
survey o f funds a v a ila b le fo r government borrow ing was
made. This survey aided in s e tt i n g quotas and in a p p r a is
ing p ro g ress d uring th e d riv e and r e s u l t s a f t e r th e d riv e .
During th e p erio d from the a tta c k on P earl
Harbor to th e f i n a l re o rg a n iz a tio n o f th e T re a su ry 's
bond s e l l in g o rg a n iz a tio n in l a t e sp rin g o f 1943,
th e wartime tax s tr u c tu r e was d eterm in ed , th e war
tim e p ric e c o n tro l and ra tio n in g p o lic ie s fix e d ,
in n o v atio n s such as th e spending tax and purchasing
power r a tio n in g , r e je c te d , com plete r e lia n c e on th e
"v o lu n ta ry way" fo r war borrow ing decided upon, th e
p a tte r n o f i n t e r e s t r a te s s e t , a la rg e p a r t o f th e
government bond m arket com p artm en talized , excess
re se rv e s d r a s t i c a l l y re d u c e d , and a p r in c ip a l
re lia n c e on th e d riv e tech nique fo r s e l l i n g govern
ment s e c u r i ti e s determ ined u p o n .18
With th e wartime fin a n c in g d e c is io n s made, the s ix
rem aining war bond campaigns proceeded sm oothly. The
seventh war loan was the l a r g e s t. Im m ediately a f t e r V-J
Day th e e ig h th and f i n a l V icto ry Loan took p la c e . The
V icto ry Loan was designed to c a rry th e government through
a d i f f i c u l t reco n v ersio n p e rio d . The funds ra is e d proved
17
Annual Report o f the S e c re ta ry o f th e T re a su ry ,
1951, p. 275.
18
Murphy, op. cit. , p. 2.
49
to be unnecessary. This r e s u lte d in a la rg e cash b alance
in th e T reasury which was used in th e immediate postw ar
y ears to reduce th e d eb t.
Each y ear o f th e war th e government had succeeded in
adding $50 to $60 b i l l i o n to th e t o t a l d e b t. The peak
World War I I d ebt o f $279.8 b i l l i o n was reached on February
28, 1946. This re p re se n te d a 500 p er cen t in c re a se in
debt from June 30, 1941 to February 28, 1946. Of th e t o t a l
amount sp en t by the government d uring t h i s tim e , approx
im ately 95 p er ce n t was e i t h e r d i r e c t l y fo r war and
n a tio n a l defense o r fo r item s d i r e c t l y connected w ith the
w ar, such as i n t e r e s t on th e p u b lic debt and v e te ra n s '
b e n e f i t s . ^
Post-W orld War I I D ebt, 1946-1962
The post-W orld War I I p erio d re p re s e n ts a re v e r s a l
o f th e e s ta b lis h e d fe d e ra l d eb t t r a d i t i o n . A fte r each war
p erio d in the p a s t, a determ ined s u sta in e d e f f o r t was made
to e f f e c t a re d u c tio n in the t o t a l fe d e ra l d eb t. World
War I was follow ed by a decade o f balanced budgets y ie ld in g
19
Annual Report of the Secretary of the Treasury,
1946, p. 68.
50
s i g n i f i c a n t su rp lu se s which reduced th e d eb t by 36% p er
c e n t. The q u estio n o f tax c u ts a f t e r World War I was n ot
s e rio u s ly co n sid ered u n t i l 1927. Only then d id S e c re ta ry
o f th e T reasury Mellon s t a t e t h a t he
. . . did not b e lie v e in th e payment o f a p u b lic
d eb t to th e undue burdening o f p ro d u c tiv e in d u s try .
A b alan ce should be m aintained fo r debt re d u c tio n
and ta x re d u c tio n which i s f a i r to a l l i n t e r e s t s
in our c o u n try .20
This philosophy o f a b alan c e between th e goals of
tax re d u c tio n and debt re d u c tio n has n o t c h a ra c te riz e d th e
World War I I p e rio d . For th e f i r s t time in our c o u n try 's
h is to r y th e re has been no continuous d ecrease in th e
p u b lic d eb t a f t e r a war.
The post-W orld War I I d ebt peak o f $279.8 b i l l i o n
on February 28, 1946 included a T reasury cash b alan ce o f
$24.4 b i l l i o n . This money was on d e p o sit in war loan
accounts a t d e p o sito ry banks throughout th e n a tio n . By
December 31, 1946 th e debt had been reduced $20.3 b i l l i o n
to $259.5 b i l l i o n m erely by drawing down most o f the
e x is tin g cash b a la n c e s. At th e end o f f i s c a l 1947 the
^Childs , op. cit. , p. 174.
debt stood a t $258.4 b i l l i o n . ^
The sa fe re d u c tio n o f T reasury cash b alan ces was
made p o s s ib le by the ra p id con version from a wartim e to a
peacetim e economy. High government ex p en d itu res were
q u ick ly dispensed w ith a t th e same tim e th a t tax r e c e ip ts
were m aintained a t n e a r wartim e le v e ls . The high tax
r e c e ip t le v e l was due to th e ra p id in c re a se o f a c t i v i t y in
th e p riv a te economy. The funds which had been accum ulated
during wartim e were a v a ila b le fo r consumption and in v e s t
ment a t th e end o f th e war. Demand from th e p riv a te
s e c to r rushed in to f i l l th e vacuum caused by reduced
government defense spending. Reconversion unemployment,
which had been a n tic ip a te d throughout th e w a r, f a ile d to
m a te r ia liz e . In ste a d o f a postw ar d e p re s sio n , a postw ar
boom developed. Thus, the f i r s t postw ar adjustm ent was
s u c c e s s fu lly w eathered. The country appeared econom ically
s tro n g e r than ever.
In th e follow ing f i s c a l y e a r, 1948, th e p u b lic d ebt
was reduced $6 b i l l i o n . This was made p o s s ib le by a la rg e
f i s c a l budget su rp lu s. However, th e continued postw ar tax
21
Annual Report of the Secretary of the Treasury.
I960, p. 26.
r e c e ip t p le th o ra was too much fo r Congress. Three tim es
Congress passed a tax re d u c tio n b i l l only to have i t vetoed
by P re s id e n t Truman. Both the P re s id e n t and th e S e cretary
o f the T reasury s ta te d th a t they f e l t th e re was a g r e a te r
need fo r debt re d u c tio n than th e re was fo r tax re d u c tio n
in tim es o f p ro s p e r ity . F in a lly th e Congress was not to
be d e n ie d , and th e Revenue Act o f 1948 was passed over the
22
P r e s id e n t's v e to . The r e s u l t was an end to d ebt red u c
tio n . Six o f th e next seven f i s c a l y ea rs ended w ith debt
growth r a th e r than debt re d u c tio n .
In 1950 the Communist cold war exploded in to the
Korean War. This occasioned new and la r g e r ex p en d itu res
fo r m ilita r y rearmament and fo r fo re ig n a id . These
e x p en d itu res were designed to thw art Communist ag g ressio n
throughout the w orld. However, a l l o f th e new debt growth
cannot be blamed on th e in t e r m i tt e n tl y h o t and cold war
atm osphere. "From 1953 to 1961 defense ex p en d itu res went
down about 4 b i l l i o n , w hile n o n se c u rity cash ex p en d itu res
ro se about 25 b i l l i o n . " ^
22
Annual Report o f th e Secr e ta r y o f th e T reasu ry ,
1950, p. 159.
U.S. , Senator Strom Thurmond, Congressional
Record, 87th Cong., 1st Sess. (March 16, 1961), p. 3986.
53
The f i s c a l y ear 1959 placed th e problem o f th e
growth o f fe d e ra l debt sq u are ly b e fo re the n a tio n . Com
b a tin g a re c e s s io n w hile conducting a cold war preparedness
program r e s u lte d in an $8.4 b i l l i o n in c re a se in th e fe d e ra l
d eb t. The e n ti r e $13 b i l l i o n 1959 f i s c a l d e f i c i t was not
r e f le c te d m erely because T reasury cash b alan ces were
d r a s t i c a l l y reduced to absorb as much o f th e d e f i c i t as
24
p o s s ib le . Ever sin c e th is tim e th e d eb t t o t a l has been
creep in g unexorably upward. On February 28, 1962 i t
reached $296 b i l l i o n , ^ and an a n tic ip a te d $308 b i l l i o n
26
debt is expected in 1962.
This review o f postw ar d ebt emphasizes th e obvious.
The debt is a c tu a lly in c re a sin g r a th e r than d e c re a sin g .
In the p a s t th irty -tw o y ears th e re have been only fiv e
y ea rs in which debt has been d ecreased . The t o t a l debt
d ec rease in t h i r t y y ears has amounted to $23.4 b i l l i o n , of
which $20.3 b i l l i o n m erely re p re s e n ts the r e tu r n o f th e
24
Annual Report o f the S e c re ta ry o f th e T re a s u ry ,
1959, p. 27.
25
Survey o f C urrent B u sin e ss, February 1962,
p. S-18.
26
Los Angeles Tim es. March 14, 1962.
54
unused proceeds o f the V ictory Loan o f World War I I .
In the post-W orld War I I period s t a r t i n g w ith f i s c a l
1947, d e f i c i t s have exceeded su rp lu ses by $21.1 b i l l i o n ,
o r an average o f $1.4 b i l l i o n p er y ea r. "Never once during
t h i s time have we balanced the budget over a b u sin ess
27
c y c le ." The n e c e s s ity and d e s i r a b i l i t y o f p e rp e tu a tin g
the h i s t o r i c p a tte r n o f debt containm ent and debt re d u ctio n
is open to q u estio n . The pros and cons o f th is q u estio n
must be analyzed in r e la tio n to v ario u s p o s s ib le economic
co n d itio n s such as in f l a t i o n or d e f l a t i o n , p ro sp e rity or
d e p re ssio n , wartime or peacetim e, o r any com bination o f
the above. Before th is can be done, i t is p re fe ra b le th a t
the attem pts a t debt re d u c tio n and containm ent be d iscussed
and evaluated as w ell as the im portance o f such fa c to rs as
the r e la ti v e burden o f th e d e b t, debt ownership d i s t r i b u
tio n , and m atu rity and i n t e r e s t r a te p a tte rn s .
I I . ATTEMPTS TO PREVENT THE ACCUM ULATION
OF FEDERAL DEBT
In th e eyes of such e a rly fin a n c ia l ex p erts as
Alexander Ham ilton, the accum ulation of debt was extrem ely
27
U .S ., Senator W allace F. B en n ett, C ongressional
Record, 87th Cong., 1 st Sess. (March 20, 1961), p. 3997.
55
hazardous. He thought p ro v isio n s fo r repayment o f the
debt should be made an in v io la b le p a r t o f th e c o n tra c t
w ith c r e d ito r s . This would p rev en t the fe d e ra l d eb t from
becoming permanent. For t h i s reaso n th e ad o p tio n o f a
28
sin k in g fund was proposed.
Modern-day f in a n c ia l e x p e r t s , e q u a lly concerned w ith
th e accum ulation o f d e b t, have foresaken th e sin k in g fund
approach. Today th e emphasis i s upon a government-
a u th o riz e d debt c e il in g . An a n a ly s is o f both approaches
is n ec essary fo r a b e t t e r u n d erstan d in g o f th e debt manage
ment problem.
The Sinking Fund Approach
to Debt R eduction
Many arguments have been advanced in favor o f th e
e stab lish m en t o f a sin k in g fund. A fte r th e C iv il War, the
S e c re ta ry o f th e T reasury under L incoln and Johnson s ta te d
th a t "only a fix ed p o lic y fo r re d u c tio n o f the p u b lic debt
29
w ill be lik e ly to p re v en t i t s in c re a s e ." Thus, th e
Samuel McKee, Alexander H am ilto n's Papers on
P ublic C r e d it, Commerce, and Finance (New York: L ib e ra l
A rts P r e s s , 1957), p. 154.
^Childs , op. cit. , p. 46.
56
p ro v isio n o f a sin k in g fund was regarded as in d isp e n sa b le
by many. In a d d itio n to th e sin k in g fund, a l l su rp lu se s
rem aining a t th e end o f th e f i s c a l y ea r were to be a p p lie d
to debt re d u c tio n . In t h i s manner su rp lu s p u b lic revenues
were re tu rn e d to th e channels o f tra d e . The a p p lic a tio n
o f unplanned T reasury s u rp lu se s to th e fe d e ra l debt is the
sim p le st method o f debt re d u c tio n . Sole r e lia n c e upon
t h i s method is not recommended. I t has been in e f f e c tiv e
in the p a s t. Over th e years th e unplanned d e f i c i t s tend
to exceed the unplanned s u rp lu se s.
Those who favor a form al sin k in g fund emphasize the
need o f c o n s ta n tly rem inding Congress o f i t s r e s p o n s i
b i l i t y . Congress must provide e i t h e r the tax revenues or
th e c o n tro l over ex p en d itu re which w ill accom plish debt
re d u c tio n . The form al sin k in g fund a lso appeals to the
popular d e s ir e fo r debt re d u c tio n . Frequent g i f t s a re
re c e iv e d by th e government w ith th e p ro v iso th a t th e money
be a p p lie d a g a in s t the p u b lic d e b t.
I t i s i n t e r e s t i n g to n o tic e the c r e a tio n in
England o f th e N atio n al Fund s t a r t e d by an
anonymous g i f t o f < £ 500,000 to accum ulate
to g e th e r w ith any o th e r g i f t s which m ight sub
seq u en tly be made fo r th e ev en tu al redem ption o f
the N atio n al Debt. To make t h i s g i f t le g a lly
v a lid th e law a g a in s t p e r p e tu itie s and long
57
accum ulations was amended in 1927. On March 31,
1934, th e Fund stood w ith accum ulations a t
£ 2,118 ,000.30
Such sin k in g funds must avoid th e fa lla c y th a t the
i n t e r e s t saved by r e t i r i n g fe d e ra l debt au to m a tic a lly
compounds, thus a ssu rin g fu rth e r debt re d u c tio n . This is
tru e only i f the i n t e r e s t which no longer must be paid out
is used in a p roductive manner. Under th ese circum stances
i n t e r e s t w ill be compounded according to i t s p ro d u c tiv ity .
When debt is r e t i r e d by the government, and no p ro v isio n
is made fo r the p ro d u ctiv e use o f the i n t e r e s t saved, no
compounding is p o s s ib le . Only th e need to tax in the
fu tu re in o rd e r to pay debt se rv ic e is avoided.
A co n stan t a p p ro p ria tio n sin k in g fund has g e n e ra lly
been favored by the United S ta te s Congress. This re q u ire s
th a t each year a s p e c ifie d sum be provided and ap p lied
30
Hugh D alton, P rin c ip le s of Finance (London:
Routledge and Kegan P au l, L td ., 1954), p. 195.
In the United S ta te s , Congress passed a law in
1961 sp e c ify in g th a t any bequests to c u t th e n a tio n a l debt
go in to a s p e c ia l T reasury fund in ste a d o f being lumped
w ith g en eral revenues as b e fo re . Only $4,044.68 has been
receiv ed fo r th e fund so f a r . Pending, however, is a g i f t
o f $2,034,000 l e f t to the government in the w ill of
Mrs. W ill Clayton of Texas, l a t e w ife o f a former S ta te
Department o f f i c i a l (see Wall S tre e t J o u r n a l, February 14,
1962, p. 1.
58
Coward d e b t r e d u c tio n . Such a c o n s ta n t a p p r o p r ia tio n may
be p ro v id e d to c o v e r a d e b t s in k in g fund and th e i n t e r e s t
on th e d e b t com bined. Under th e s e c irc u m sta n c e s , as th e
d e b t i s re d u c e d , what i s saved in i n t e r e s t i s added to th e
repaym ent o f th e p r i n c i p a l o f th e d e b t.
T e c h n ic a lly , th e s in k in g fund was s u c c e s s f u l in
e lim in a tin g th e e n t i r e f e d e r a l d e b t by 1836. In th e p o s t-
C i v il War p e rio d th e m onetary system was t i e d to th e
f e d e r a l d e b t. F e d e ra l bonds se rv e d as b ac k in g f o r b ankn ote
c i r c u l a t i o n . S in k in g fund e x p e n d itu re s p ro v id e d f o r in th e
S in k in g Fund Act o f 1862 c r e a te d d i f f i c u l t i e s by t h r e a t e n
in g to s h r in k th e b ac k in g f o r th e money su p p ly . The
i n s t a b i l i t y o f th e money su p p ly was th e m ain f a c t o r b eh in d
th e p assag e o f th e F e d e ra l R eserv e Act o f 1913.
The 1862 S in k in g Fund A ct was r e p e a le d in 1919 and
a c u m u la tiv e s in k in g fund was e s t a b l is h e d . T h is fund
amounted to an an n u al sum e q u a l to 2% p e r c e n t o f L ib e r ty
Bonds and n o te s o u ts ta n d in g on J u ly 1 , 1920. A d e b t
management problem o f th e p o st-W o rld War I p e rio d was to
p ro v id e enough s e c u r i t i e s f o r th e s in k in g fund a p p r o p r i
a tio n s w hich were d e sig n e d to r e t i r e th e d e b t in tw en ty -
f i v e y e a r s . The o r i g i n a l Act o f 1919 was amended to p e rm it
th e p u rc h a se o f re fu n d in g s e c u r i t i e s . The re v en u es o f th e
59
31
sin k in g fund were to be r a is e d through ta x a tio n .
The p ro v isio n s o f th e Sinking Fund Act o f 1919, i f
ap p lied as in te n d e d , meant th a t ta x a tio n could n o t be
reduced as much as d e s ire d in re c e s sio n a ry p e rio d s .
F urtherm ore, th e government e x p e n d itu re s on d eb t re d u c tio n
could r e s u l t in a re d u c tio n o r c a n c e lla tio n o f o th e r more
d e s ir a b le government e x p e n d itu re s. S t i l l , th e fe e lin g
pervaded throughout th e d ep ressio n th a t a sin k in g fund was
f in a n c ia lly w ise. As th e p u b lic works programs expanded,
the sin k in g fund a p p ro p ria tio n s were lik e w ise expanded by
Congress to p ro v id e fo r th e re tire m e n t o f th e new d e f i c i t s .
During World War I I , the sin k in g fund p ro v isio n
which p erm itted a p p ro p ria te d funds m erely to accrue was
u t i l i z e d . This p r a c tic e was a ls o continued in th e p o s t-
World War I I y e a rs. To d a te , June 30, 1960, th e unexpended
32
funds in the sin k in g fund amount to $12.5 b i l l i o n . Under
p re se n t s t a t u t e s , only n o tes and bonds a re e l i g i b l e fo r
d ir e c t purchase by the T reasury fo r th e sin k in g fund.
■^C hilds, op. c i t . , p. 132.
32
Annual Report of the Secretary of the Treasury,
1960, p. 576.
60
The m ajor c r iti c is m o f th e sin k in g fund approach to
debt re d u c tio n i s th a t i t s e f fe c tiv e n e s s depends upon
having budget s u rp lu s e s . The sin k in g fund p ro v isio n during
p erio d s o f budget d e f i c i t i s tantam ount to borrow ing more
money in o rd e r to r e t i r e th e e x is tin g d eb t. For example*
th e in c lu s io n o f sin k in g fund a p p ro p ria tio n s as expendi
tu re s in 1931 was re s p o n s ib le fo r tw o -th ird s o f th e 1931
33
d e f i c i t . This p o in t has been emphasized by th e S ecre
t a r i e s o f the T reasury under both m ajor p o l i t i c a l p a r ti e s .
According to S e c re ta ry o f th e T reasury S nyder,
serv in g under P re sid e n t Truman,
. . . th e sin k in g fund is e s s e n t i a l l y a m echanical
d ev ice to pro vide fo r a b a s ic framework fo r o rd e rly
debt re tire m e n t. I t s e f fe c tiv e n e s s depends in th e
f i n a l a n a ly s is on w hether th e fe d e ra l government
is o p e ra tin g a t a su rp lu s o f budget revenues or
e x p e n d itu re s .34
L ikew ise, S e c re ta ry o f th e T reasury Anderson,
serv in g under P re s id e n t Eisenhow er, sa id :
Sinking fund p lan s a re lau d ab le in purpose
but undue a tt e n t i o n to them tends to obscure the
h a rd , b a s ic f a c t th a t m eaningful d eb t re tire m e n t
^ C h ild s , op. c i t . , p. 190.
34
Annual Report of the Secretary of the Treasury,
1951, p. 247.
61
can be e ffe c te d only by means o f an o v e r a ll
su rp lu s o f budget r e c e ip ts over e x p e n d itu re s .^5
R e a liz in g th e shortcom ings o f a c o n sta n t a p p ro p ri
a tio n sin k in g fund, a graduated s c a le sin k in g fund has been
co n sid ered . During p r o s p e r ity , p ro g re s s iv e ly h e a v ie r
u n re le a se d debt re tire m e n t b alan ces accru in g in a sin k in g
fund would check in f la tio n a r y ten d en c ie s i f the funds were
provided by a budget s u rp lu s . The r e le a s e o f t h i s accrued
sum fo r debt re tire m e n t in tim es o f re c e s s io n , to g e th e r
w ith a suspension o f ta x a tio n fo r d eb t re tire m e n t purposes ,
could h elp h a ste n recovery by in c re a s in g th e funds a v a i l
ab le to th e p r iv a te economy.
The p o l i t i c a l d i s t a s t e fo r re d u c tio n s in p u b lic
spending an d /o r the in c re a sin g o f ta x a tio n , e s p e c ia lly in
a r e p r e s e n ta tiv e democracy, n e c e s s ita te s some r e s t r i c t i v e
devices to c o n ta in debt expansion. As a r e s u l t o f the
r e l a t i v e in e ff e c tiv e n e s s in re c e n t tim es o f th e sin k in g
fund approach, c o n sid e ra b le i n t e r e s t has focused upon a
r e l a t i v e l y new r e s t r i c t i v e fo rc e . The advantages and
d isad v an tag es o f a C o n g ressio n ally imposed debt c e ilin g
Annual Report of the Secretary of the Treasury,
1959, p. 272.
62
approach to debt containm ent has aroused c o n sid e ra b le
c o n tro v e rsy .
The Debt C e ilin g Approach to Debt Containment
T oday's fe d e ra l d eb t r e s t r i c t i o n s apply to th re e
types o f d e b t. These a re (1) the c u rre n t redem ption v alu e
o f saving bonds, (2) th e face amount o f o th e r o u tsta n d in g
d eb t issu ed under the a u th o r ity o f th e Second L ib e rty Bond
Act as amended, and (3) th e face amount o f a l l guaranteed
o b lig a tio n s h eld o u ts id e o f th e T reasury. Any tim e th a t
th e government s e l l s s e c u r i ti e s not included under the
Second L ib e rty Bond Act th e d eb t c e ilin g does n ot apply.
As o f June 30, 1960, th e t o t a l o u tsta n d in g p u b lic debt and
guaranteed o b lig a tio n s h eld o u ts id e o f the T reasury
amounted to $286.5 b i l l i o n , o f which only $0.4 b i l l i o n was
36
not s u b je c t to d eb t c e ilin g lim ita tio n s .
H is to ric development o f th e d ebt c e i l i n g . The debt
c e ilin g had i t s o r ig in in the endeavor to combine the
le g a l a u th o r ity fo r new iss u e s o f fe d e ra l government
s e c u r i t i e s . P r io r to t h i s tim e , each s e c u rity had to be
36
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
I9 6 0 , pp. 512-515.
63
s p e c if ic a l ly au th o rize d by Congress.
On September 24, 1917, th e Second L ib e rty Bond Act
was passed. S ection One o f th e Act a u th o riz e d th e T reasury
to is s u e $7.5 b i l l i o n d o lla r s in bonds, and S ectio n Five
o f th e Act provided a re v o lv in g a u th o riz a tio n fo r a t o t a l
o f $4 b i l l i o n o f T reasury C e r ti f i c a t e s o u tsta n d in g . With
th e growth o f d e f i c i t spending, Congress m erely amended
th e o r ig in a l Act as th e exigency fo r f u r th e r funds made
i t s e l f f e l t . This p r a c tic e has continued to th e p re se n t
tim e.
In th e course o f the World War I y ears , the bond
c e ilin g was ra is e d f i r s t to $12 b i l l i o n and then to $20
b i l l i o n . The T reasury C e r t i f i c a t e lim it was r a is e d f i r s t
to $8 b i l l i o n and then to $10 b i l l i o n . A lso, a new
S e c tio n , S ection E ig h teen , was added to provide fo r a
re v o lv in g a u th o rity fo r a t o t a l o f $7 b i l l i o n o u tstan d in g
in T reasury Notes. The Note lim ita tio n was ra is e d to
$7.5 b i l l i o n in 1921.
No f u r th e r debt c e ilin g amendments were passed u n t i l
1929, when the use o f T reasury B ills re q u ire d th a t S ection
Five be amended to in clu d e th e se s e c u r i ti e s as w ell as
T reasury C e r t i f i c a t e s . Another t e s t o f the debt c e ilin g
64
occurred d u rin g Che g re a t d e p re ssio n . In 1931, S ectio n One
was amended to provide fo r an in c re a s e in th e bond t o t a l
from $20 b i l l i o n to $28 b i l l i o n . In 1934, S ectio n E ighteen
was amended to r a i s e th e a u th o riz a tio n o f T reasury Notes
from $7.5 b i l l i o n to $10 b i l l i o n .
The f i r s t evidence th a t Congress would a d ju s t the
c e ilin g downward occurred in 1935. S ectio n One was amended
reducing th e bond is s u in g a u th o r ity from $28 b i l l i o n to
$25 b i l l i o n . At th e same tim e , S ectio n Twenty-one
c o n so lid a te d the p ro v isio n s fo r B i l l s , C e r t i f i c a t e s , and
Notes w ith o u t changing th e t o t a l o f $20 b i l l i o n .
For th e f i r s t tim e , in 1938, a t r u l y c o n so lid a te d
debt c e ilin g emerged. S ectio n Twenty-one was again
am ended--this time to in c lu d e S ectio n One. There was no
change in th e t o t a l combined lim it o f $45 b i l l i o n . From
t h i s d a te forw ard th e re would be no lim ita tio n as to th e
p a r t i c u l a r m a tu rity segments o f th e d e b t - - j u s t as to th e
combined t o t a l o f a l l m a tu r itie s o u tsta n d in g .
As p a r t o f th e p reparedness program fo r World War
I I , th e d ebt c e ilin g was r a is e d to $49 b i l l i o n in 1940 to
allow fo r $4 b i l l i o n o f N atio n al Defense S e rie s Bonds.
37
Again in February o f 1941, i t was r a is e d to $65 b i l l i o n .
I t was a t t h i s p o in t th a t P re s id e n t R oosevelt advocated the
38
removal o f th e d ebt l im it. C ongress, although w illin g
to r a is e th e debt l i m it to prov id e the n ecessary funds to
conduct th e war e f f o r t , was u n w illin g to abandon the debt
c e ilin g . In 1942 th e c e ilin g was r a is e d to $125 b i l l i o n ;
in 1943 to $210 b i l l i o n ; in 1944 to $260 b i l l i o n ; and
f i n a l l y , on A p ril 3 , 1945 to th e high p o in t o f $300
b i l l i o n . O b lig atio n s o f fe d e ra l agencies f u lly guaranteed
by th e U nited S ta te s h eld o u ts id e o f th e T reasury were
39
included in th e lim ita tio n a t th i s tim e.
At th e end o f World War 11, Congress again demon
s tr a te d i t s d e s ir e to use th e d eb t c e ilin g as a c o n tr o llin g
dev ice. A fte r c o n s u lta tio n w ith th e T re asu ry , S ection
Twenty-one was amended in 1946 to reduce th e c e ilin g on
th e debt o f $275 b i l l i o n w ith th e p roviso th a t o b lig a tio n s
redeem able p r io r to m a tu rity a t the o p tio n o f th e h o ld er
be computed on th e b a s is o f t h e i r c u rre n t redem ption value
37I b i d .
C h ild s, op. c i t . , p. 280.
39
Annual Report of the Secretary of the Treasury,
1946, p. 66.
66
r a th e r than t h e i r face v a lu e . S e c re ta ry o f th e T reasury
V inson, under q u e stio n in g by S enator Byrd, s ta te d t h a t th e
40
above arrangem ent would be ag reeab le to th e T reasury .
From 1946 to 1953 th e d ebt c e ilin g caused compar
a t i v e ly few problem s. However, in 1953, P re s id e n t E isen
hower asked Congress to in c re a se the d eb t l im it from $275
b i l l i o n to $290 b i l l i o n . A fte r f u l l d e l ib e r a tio n , th e
Finance Committee o f th e Senate re fu se d (11 to 4) to re p o rt
th e $290 b i l l i o n d ebt b i l l which had alre ad y been passed
/ 1
by th e House o f R e p re se n ta tiv e s. The r e s u l t s o f th i s
a c tio n w ill be ev alu ated when th e d isad v an tag es o f th e
d eb t c e ilin g a re d isc u sse d . In 1954, Congress was again
faced w ith an a d m in is tra tio n Bequest fo r a d eb t c e ilin g
in c re a s e . This tim e a tem porary in c re a se was begrudgingly
bestow ed.
In th e ensuing y ea rs th e debt c e ilin g was to become
a m ajor is s u e . Temporary c e ilin g s o r permanent c e ilin g s
were to be s h if te d each y e a r. Congress doggedly clung to
the concept th a t the d eb t c e ilin g should n o t be in cre ased
4QI b i d . , p. 296.
4^U.S. , Senator Harry Flood Byrd, Congressional
Record. 83rd Cong., 2d Sess. (August 13, 1954), p. 14376.
67
w itho ut c a r e f u l d e lib e r a tio n . The debt c e ilin g was
p urposely k ep t c lo s e to th e a c tu a l a n tic ip a te d d eb t t o t a l .
With th e la rg e d e f i c i t r e s u l t in g from f i s c a l o p era
tio n s in 1959, i t became ap p aren t th a t th e u se o f tem porary
c e ilin g in c re a se s was a poor su b te rfu g e . Much o f th e debt
above th e permanent lim it could n o t reaso n ab ly be expected
to be re p a id w ith in th e f i s c a l y e a r. C ongress, th e r e f o r e ,
adopted th e co u rse o f a c tio n o f a d ju s tin g th e permanent
debt c e ilin g upward slow ly to $283 b i l l i o n in 1959 and
$285 b i l l i o n in 1960. At th e same tim e th e tem porary
c e ilin g was a ls o a d ju s te d e i t h e r upward o r downward.
The combined permanent and tem porary d ebt c e ilin g
equaled $281 b i l l i o n fo r f i s c a l 1954 and 1955. In 1956
the combined c e ilin g was reduced to $278 b i l l i o n , and in
1957 to $275 b i l l i o n . F is c a l 1958, 1959, and 1960 n e c e s
s i t a t e d f u r th e r in c re a se s o f $280 b i l l i o n , $288 b i l l i o n ,
and $295 b i l l i o n , r e s p e c t i v e l y . ^ In 1961 th e combined
c e ilin g was reduced to $293 b i l l i o n , only to rebound
v ig o ro u sly to th e p re se n t $300 b i l l i o n c e il in g fo r f i s c a l
1962. Even th e $300 b i l l i o n c e ilin g w ill pro v id e l i t t l e
42
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
1960, pp. 512-515.
68
leeway fo r unexpected ex p e n d itu re s. The Kennedy
a d m in is tra tio n wished to avoid th e $300 b i l l i o n c e i l i n g ,
which is co n sid ered p o l i t i c a l l y conspicuous , but was
unable to do so. I t has asked Congress to r a is e th e debt
c e ilin g to $308 b i l l i o n . 43
E valuation o f th e d eb t c e i l i n g . Many arguments
have been used to condemn d eb t c e ilin g s . The follow ing
a re th e m ajor arguments: F i r s t , those opposed to th e debt
c e ilin g emphasize th a t a t i g h t debt c e ilin g r e s u l t s in a
lack o f leeway to accommodate seaso n al d iffe re n c e s between
r e c e ip ts and e x p e n d itu re s. I t was th e attem p t to provide
fo r th e se seaso n al d i s p a r i t i e s th a t led to th e adoption o f
temporary c e ilin g in c re a s e s . A lso, th e tim ing o f c o rp o ra
tio n income tax payments has been a lte r e d to provide fo r
four in sta lm e n ts so as to reduce some o f th e seasonal
v a r i a t i o n s . ^
Seasonal d iffe re n c e s in ex p en d itu re o u tla y and tax
r e c e ip ts r e s u l t in a la rg e temporary government d e b t. The
^ Wall S tre e t J o u r n a l, January 11, 1962, p. 3,
44
Warren L. Sm ith, Debt Management in th e United
S ta te s , U.S. C ongress, 86 th C ong., 2d Sess. , J o in t Commit
te e P r in t (Washington: Government P rin tin g O ffic e , 1960),
p. 45.
69
temporary government debt is in creased by the p ra c tic e of
the Treasury o f m aintaining as low a cash balance as
fe a s ib le . In f i s c a l 1958, average weekly government
expenditures to ta le d approxim ately $1.5 b i l l i o n . The
Treasury cash balance has been th a t low on se v e ra l
45
o c c a sio n s.
Faced w ith a ti g h t debt c e i l i n g , the Treasury has
no room to borrow fo r the purpose o f accum ulating a la rg e r
cash su rp lu s. A la rg e cash su rp lu s has some d e f in ite
advantages. I t allow s the Treasury f l e x i b i l i t y in tim ing.
This perm its the Treasury to avoid perio d s when th e market
is u n f a v o r a b le .^ The d e s ire fo r a la r g e r cash balance
was the prim ary cause o f the in c re a se o f debt in 1960.
Although re c e ip ts exceeded exp en ditures by $1.2 b i l l i o n in
1960, the t o t a l debt in creased by $1.6 b i l l i o n because of
an approxim ate $2.7 b i l l i o n in c re a se in the T re a su ry 's
cash balance.
When faced w ith a r e s t r i c t i v e debt c e ilin g and a
shortage o f cash , the Treasury must r e s o r t to expediency
45
Annual Report o f the S ecretary of the T re a su ry ,
1958. p. 245.
46
Nation s B u sin ess, June 1958, p. 83.
70
m easures. In 1953 and 1958 th e T reasury tu rn ed some o f
i t s gold in to new money under th e p re ssu re o f th e debt
47
c e il in g . The economic e f f e c ts o f t h i s a c tio n were the
same as i f the T reasury had borrowed funds d i r e c tl y from
the F ed eral Reserve System. However, d i r e c t borrowing
would have e n ta ile d the n e c e s s ity to r a i s e th e debt c e i l
in g , whereas the gold t r a n s f e r procedure d id n o t.
The T reasury may borrow up to $5 b i l l i o n d i r e c t l y
from th e F ederal R eserve System. This lin e o f c r e d i t has
been used only s p a rin g ly . I t has not been used a t a l l fo r
the purpose of in tro d u c in g g r e a te r f l e x i b i l i t y in to debt
^ 48
management.
As an inducement fo r th e T reasury to keep la rg e r
cash b alan ces when th e d eb t c e ilin g p erm its , commercial
banks could be c a lle d upon to pay i n t e r e s t on T reasury
d e p o s its . This would compensate th e T reasury fo r f o r e
going th e saving o f i n t e r e s t to be o b tain ed by r e t i r i n g
M arshall A. Robinson, The N atio n al Debt C e ilin g
(Washington: The Brookings I n s t i t u t i o n , 1959), p. 50.
48
U .S ., S en ate, Committee on F in an ce, H earings .
I n v e s tig a tio n o f th e F in a n c ia l C ondition o f the U nited
S ta te s , 85th C ong., 1 st S ess. , Ju ly -A u g u st, 1957 ,
pp. 894-895.
71
A second d isad v an tag e o f a t i g h t d eb t l im it is th a t
i t leaves l i t t l e room in which th e T reasury can maneuver
in i t s refu n d in g . For example:
The S e c re ta ry o f the T reasury announced on
November 9, 1953 th a t th e T reasury had purchased
on th a t day from th e F ed eral R eserve System and
r e t i r e d h b i l l i o n o f T reasury n o te s . . . . This
was done so th a t th e issu an ce o f 2.2 b i l l i o n o f
new T reasury Bonds would n o t r e s u l t in in c re a sin g
th e d eb t to a fig u re above th e s ta tu to r y lim it.
Payment was made in e f f e c t by use o f gold which
was p a r t o f the T reasury g e n e ra l f u n d . 50
Unless th e re i s room under th e debt c e i l i n g , the
T reasury cannot s e l l s e c u r i t i e s even though i t fe e ls th a t
c o n d itio n s a re id e a l. Thus, o v erlap p in g s e c u r i ti e s and
tap iss u e s a re negated. O verlapping s e c u r i t i e s means th a t
new s e c u r i t i e s a re issu ed a few days b e fo re th e old s e c u r
i t i e s e x p ire . For example, on May 11, 1959 th e T reasury
issu ed $2 b i l l i o n T reasury B ills to provide most o f the
funds n ecessary to pay o f f $2.7 b i l l i o n T reasury B ills
m aturing May 15. For th e in te rv e n in g four days th e re was
an in c re a s e in d eb t o f $2 b i l l i o n . This was p o s s ib le only
49
Sm ith, op. c i t . , p. 115.
"^Annual Report of the Secretary of the Treasury,
1954, p. 26.
72
because th ere was room under the temporary c e i l i n g . ^ An
advantage o f such e a r l i e r financing is th a t the Treasury
o ften can " tr y out" a r a te . With la rg e r cash balances the
Treasury would be w illin g to p ric e more c lo se ly . I f a
g re a te r refunding a t t r i t i o n r e s u lte d , i t would occasion no
d i f f i c u l t y .
A tap issue is one which is a v a ila b le fo r purchase
a t the d is c re tio n o f the in v e sto r over an extended period
o f time. The d i f f i c u l t y is th a t in v e sto rs may buy enough
s e c u r itie s to p e n e tra te the debt c e ilin g . Even on re g u la r
new s e c u rity i s s u e s , a tig h t c e ilin g may r e s u l t in reduced
allotm ents so as to avoid p ie rc in g the debt c e ilin g .
T h ird , the debt c e ilin g has re s u lte d in the
emergence o f su bterfu ges. I t has fo ste re d government
agency "back door" spending. This is discussed fu lly in
the following chapter.
Fourth, i t has been emphasized th a t more head room
under the c e ilin g is d e s ira b le in the event o f a sudden
Annual Report of the S ecretary of the T reasury,
1959, p. 255.
73
52
emergency when Congress might not be in sessio n . Worse
y e t , a tig h t debt c e ilin g may r e s t r i c t defense expenditures
and cause cutbacks in the v i t a l re se arc h programs. The
debt c e ilin g provides no c r i t e r i a as to what expenditures
are to be cu t. Waste can continue while e s s e n tia ls may
fe e l the pinch o f the debt c e ilin g .
F i f t h , a r e s t r i c t i v e debt c e ilin g a r b i t r a r i l y
ap p lie d , re lu c ta n tly changed, and not linked to the
economy's needs can impede the a p p lic a tio n by the govern
ment o f a sound f i s c a l p o licy . Even the delays in g e ttin g
the c e ilin g changed can in h ib it au to m atic, f le x ib le
c o u n te rc y c lic a l measures. S ellin g bonds to b u ild id le
Treasury cash balances as an a n ti- in f la tio n a r y device can
be done only i f th ere is room under the debt c e ilin g .
Likewise, expenditure programs designed to fig h t recessio n
may be held up due to lack of funds caused by c e ilin g
r e s t r i c t i o n s on borrowing.
S ix th , the debt c e ilin g d iv e rts a tte n tio n from the
need for good budget and debt management p o licy . These
52
U .S ., House, Committee on Ways and Means,
Hearings , Public Debt C eiling and I n te r e s t Rate C eilin g on
Bonds. 86th Cong., 1st S e s s ., June 10-12, 1959, p. 164.
74
have profound e f fe c ts on the American economy. The debt
c e ilin g con cen trates a tte n tio n on the s iz e o f the debt.
D espite the seemingly overwhelming weight of
argument emphasizing the disadvantages of a debt c e ilin g ,
the idea has many i n f l u e n t i a l su p p o rters. The c h ie f sup
p o rte r o f a s t r i c t , w ell-guarded, fe d e ra l debt c e ilin g is
the chairman o f the Senate Finance Committee, Senator
Harry Flood Byrd o f V irg in ia . "The s ta tu to ry lim it has
been described as the hallm ark o f f i s c a l i n t e g r i t y and the
53
l a s t hope fo r c o n tro llin g fe d e ra l spending."
Although more space under the debt c e ilin g would be
a p p re c ia te d , the S e c re ta rie s o f the Treasury of both
p o l i t i c a l p a r tie s have favored the debt c e ilin g p rin c ip le .
According to S ecretary of the Treasury Humphrey, serving
under a Democratic a d m in is tra tio n , the debt c e ilin g
. . . is a wholesome thing to have . . . i t is lik e
breaking through a sound b a r r i e r , th e re is an
explosion when you go through i t and th ere ought
to be one. I t has the weight of public sentim ent
and I think i t is a d e te r re n t to spending over
and above th a t amount, so I am in favor o f i t . 54
53
Robinson, op. c i t . , p. 1.
54
U .S ., Senate, Committee on Finance, H earings.
In v e stig a tio n of the F inancial Condition o f the United
S ta te s , 85th Cong., 1st S e s s ., July-A ugust, 1957, p. 258.
75
S ecretary Anderson, serving under a Republican
ad m in istratio n as l a t e as 1959, sta te d :
I b e lie v e a s p e c if ic d o lla r c e ilin g on the public
debt serves a u se fu l purpose and can be e f f e c tiv e in
focusing a tte n tio n in a unique way on the p a rt the
executive departm ents, the Congress , and the public
play in reso lv in g th e problems o f sound government
fin a n c e .55
B rie fly s t a t e d , the argument for a debt c e ilin g is
as follows: The debt c e ilin g discourages a continuous
expansion of the debt a t a time when a d d itio n a l debt is
considered harmful. By c a llin g a tte n tio n to the in crease
in the d e b t , the c e ilin g r e s u l t s in a review of the debt
problem by Congress. This forces Congress to examine i t s
spending and taxing programs. Such examination assures
the public th a t debt increases w ill not occur w ithout
Congressional d e lib e ra tio n .
There is nothing in the long h is to ry o f public
finance which in d ic a te s th a t any government and
e s p e c ia lly a democratic government can be
depended upon to apply the brakes to c r e d it
expansion when the proper moment has a rriv e d .
Annual Report of th e S ecretary of the Treasury,
1959. p. 255.
"^Harold G. Moulton, The Philosophy o f the Public
Debt (Washington: The Brookings I n s t i t u t i o n , 1943),
p. 8 0.
76
Since Congress has not been able to find any other
p r a c tic a l device to co n tro l the b u d g et, a Congressional
review of the debt lim it provides the oppo rtunity fo r
57
Congress to review the e n tir e budgetary procedure.
I t is apparent th a t the case fo r a debt c e ilin g is
simple yet powerful. Admitting a l l o f the d isadvan tages,
proponents o f the debt c e ilin g s t i l l favor the p rin c ip le .
They do not oppose ad ju stin g the debt c e ilin g so as to make
Treasury op eratio n s e a s ie r. However, they fe e l th a t the
second chance given Congress to re ap p raise i t s expenditure
policy compensates fo r any inconveniences due to the
ex isten ce o f a debt c e ilin g .
I I I . SU M M A RY
The growth of the debt h i s t o r i c a l l y has re s u lte d
from the d ec isio n o f the budgetary a u th o r itie s to spend on
a higher plane than tax re c e ip ts warranted. In times o f
war, such a d ec isio n is unavoidable. In times o f depres
s io n , such a d ecisio n is d e s ira b le . In times of
U .S ., House, Ways and Means Committee, Hearings ,
Increase the Public Debt L im it, 85th Cong. , 2d Sess. ,
July 30, 1958, pp. 40-41.
77
p ro sp e rity , such a decision is re g re tta b le . Unlike
previous postwar periods , the presen t f is c a l a u th o ritie s
lack the fo rtitu d e e ith e r to lower the lev el of expenditure
or r a is e the lev el of tax atio n enough so th a t the budget is
balanced in prosperous times , and a t the same time provide
for debt reduction.
The sinking fund and the debt c e ilin g both have
been in e ffe c tiv e in h a ltin g the debt growth. The sinking
fund has been reduced to a mere bookkeeping procedure.
Funds are accumulated, but without a budget surplus the
expenditure of these funds would merely mean th a t old debt
is being repaid by issu ing new debt. The debt c e ilin g has
had some meaning. I t has re su lte d in the c o s tly evasion
of the s p i r i t o f the law by obeying the l e t t e r of the law.
The foregoing an aly sis of the debt has not attempted
to deal with two basic questions. F i r s t , to what extent
should new d e f i c i t s be perm itted and under what circum
stances? Second, what should be done about ex istin g debt?
Chapters VIII and IX are concerned with the various aspects
of these problems.
This chapter has d e a lt with the size of the debt as
defined by the Treasury. In order to appraise fu lly the
t o t a l o b lig a tio n s of the fe d e ra l government, i t is
necessary to analyze the contingent fe d e ra l l i a b i l i t i e s .
Once the s iz e of the f u l l fe d e ra l o b lig a tio n is grasped,
an inquiry in to the r e l a t i v e burden of debt becomes more
m eaningful.
CHAPTER III
THE RELATIVE BURDEN OF THE FEDERAL DEBT
In properly a s c e rta in in g the economic e ffe c ts o f
fe d e ra l debt management, various re le v a n t fa c to rs must be
considered. What is the magnitude of the fe d e ra l debt
including oth er contingent fe d e ra l l i a b i l i t i e s ? What is
the re c ip ro c a l a c tio n between d ir e c t and in d ir e c t fe d e ra l
o b lig a tio n s? What is the re la tio n s h ip of the fe d eral debt
to p riv a te debt? How do changes in n a tio n a l income,
n a tio n a l w ealth , p o p u latio n , and purchasing power o f money
modify the burden of the fe d e ra l debt? Who bears the
burden of the debt?
I. CONTINGENT FEDERAL LIABILITIES
In the previous chapter the fe d e ra l debt had been
purposely defined as the " t o t a l outstanding fe d eral debt
and guaranteed o b lig a tio n s held o u tsid e of the T reasury."
Such a d e f in itio n perm itted an an a ly sis of the growth of
79
80
the major segment of the fe d e ra l debt. However, i t must
be recognized th a t th is is not the t o t a l ex tent of govern
mental l i a b i l i t y . Nor is i t the lim it of fe d e ra l borrowing
capacity. This became c le a rly evident when debt c e ilin g
lim ita tio n s led to the u t i l i z a t i o n of government agency
borrowing power.
Commercial type programs presided over by government
corporations and agencies are le g a lly financed by several
procedures. F i r s t , they may be s e l f - s u f f i c i e n t i f th e ir
re c e ip ts are as g re at or g re a te r than t h e ir expenditures.
Second, i f they are in need of a d d itio n a l c a p ita l funds
they may issu e c a p ita l sto ck , they may s e l l bonds to the
p u b lic , or they may borrow d i r e c tl y from the Treasury.
Unless the debt c e ilin g causes d i f f i c u l t i e s , government
agencies o rd in a rily borrow t h e i r funds d ir e c tl y from the
Treasury. F in a lly , they may ask Congress fo r a d d itio n a l
a p p ro p ria tio n s .
The a b i l i t y o f government agencies to ob tain d ir e c t
loans from the public or the T reasury, and thus avoid
coming before Congress annually for ap p ro p riatio n s , has
been dubbed "back door spending." "More than 2 dozen
fe d eral agencies have already spent more than 100 b i l l i o n
81
of the taxpayers' money. For f i s c a l 1958 fe d eral agencies
had as much as 70 b i l l i o n of unexpended balances in old
a p p ro p ria tio n s," ^ and for f i s c a l 1961, $19.2 b i l l i o n
2
borrowing a u th o rity s t i l l remained unused.
Government agencies must c le a r w ith the Treasury
as to the form s, denom inations, m a tu ritie s , ra te s of
i n t e r e s t , term s, and co nditions of the o b lig a tio n s they
wish to issu e. The issu in g tim e, manner, and p ric e must
also be approved by the S ecretary of the Treasury. The
few agencies which are exempt from th is requirem ent must
consult with the S ecretary of the Treasury before issuing
o b lig a tio n s to the public. However, only Congress can
3
lim it the amount of debt these agencies can c re a te . The
v a rie ty of a c t i v i t i e s of these government agencies has
l i t e r a l l y transformed the government in to a v a st holding
company or investment t r u s t .
U .S ., Senator Harry Flood Byrd, Congressional
Record, 85th Cong., 1st Sess. (April 4 , 1957), p. 5074.
2
U .S ., T reasury, Annual Report of the S ecretary of
the Treasury. 1960 (Washington: Government P rin tin g
O ffic e , 1960), p. 694.
3
31 U.S.C. 868.
82
Independent government agency financing o rig in ated
in the establishm ent of the R econstruction Finance
Corporation. In January 1932 th is agency was given
au th o rity to borrow up to $1.5 b i l l i o n by issuing i t s own
o b lig atio n s which would be fu lly guaranteed by the United
S tates. In 1932 alone, under P resident Hoover, the funds
supplied by the government to the Reconstruction Finance
Corporation amounted to approximately 40 per cent of the
increase in the public debt.^
The Reconstruction Finance Corporation formula was
applied to other agencies throughout the depression.
C redit was made av a ilab le through such agencies as the
Home Owner's Loan C orporation, the Federal Farm Mortgage
C orporation, and the Federal Ship Mortgage Insurance Fund.
Some of the New Deal programs also created government
agencies with borrowing powers. For example, the
Commodity C redit C orporation, in 1933, was authorized to
issue up to $4.75 b i l li o n of o b lig atio n s which were guar
anteed by the government.
C. F. C hilds, Concerning United S tates Government
S ecu rities (Chicago: C. F. Childs and Company, 1947),
p. 196.
83
The reasoning behind the a u th o riz a tio n to govern
ment agencies to issue o b lig a tio n s was lo g ic a l. I t was
assumed th a t the loans given by these agencies would be
paid back. When th is occurred, the government's o b lig a
tio n s would be r e ti r e d . I t was even a n tic ip a te d th a t a
surplus might develop. Provision was made to use th is
surplus to r e t i r e a p o rtio n of the fe d e ra l debt. In
p r a c tic e , however, i t is questionable whether some of the
lo a n s , such as the farm p ric e support loans , w ill ever be
paid back.^
Since the increase in fed eral debt evoked alarm ,
the ad m in istratio n throughout the 1930's used agency
financing extensively. By th is procedure, debt fig u res
were not a ffe c te d because the ordinary fe d e ra l budget or
statem ent does not in d ic a te the in d ire c t o b lig a tio n s . With
the advent of the preparedness program of 1941, government
agencies stopped issuing s e c u r itie s to the public and
r e lie d so le ly on the Treasury fo r financing t h e i r a c ti v
i t i e s . Throughout the war, the Treasury increased i t s
holdings of government agency s e c u r itie s . At the end of
5
Wall Street Journal„ April 26, 1961, p. 1.
84
World War I I the guaranteed d e b t, in so fa r as i t was held
by the general p u b lic , had ceased to e x is t. The Treasury
continued i t s po licy of providing the funds needed by
government co rp o ratio n s. This meant th a t the Treasury
borrowed money from the p u b l i c , which i t then le n t to the
government agencies.
P residen t Truman recommended th a t the ag encies,
since they purported to be s e lf - s u s ta in in g , reimburse the
Treasury fo r the co st o f the funds borrowed to accommodate
t h e i r needs. The i n te r e s t r a te on such lo an s, unless fixed
by s t a t u t e , is determined by the Treasury from month to
month. I t is based on the co st which the Treasury would
have to pay for borrowed money in the c u rre n t market as
re fle c te d by p re v a ilin g market y ie ld s on government o b lig a
tio n s w ith corresponding m a tu ritie s . As o f June 30, 1960,
a t o t a l of $25.6 b i l l i o n is owed to the Treasury by govern
ment corporations on which the Treasury received $.5
b i l l i o n in i n t e r e s t .
Three agencies can s t i l l s e l l guaranteed s e c u r itie s
to the p u b lic. These are the Commodity C redit C orporation,
Annual Report of the Secretary of the Treasury,
1960, pp. 699, 706.
the Federal Housing A dm inistration, and the Maritime
A dm inistration.^ This independent borrowing power was not
used u n t i l the debt c e ilin g exerted increasing pressure on
Treasury financing in the 1950's. In 1953 a request for a
debt c e ilin g r a is e was pigeonholed by the Senate Finance
Committee. The Treasury then requested the Commodity
C redit Corporation to borrow the $1.1 b i l l i o n i t needed
from the p riv a te s e c to r o f the economy. Since th is was
not borrowed under a u th o riz a tio n of the Second L iberty
Bond Act as amended, the debt lim it s ta tu te was not a p p li
cable to these o b lig a tio n s . The c e r t i f i c a t e s issued by
the Commodity C redit Corporation bore a higher r a te of
in t e r e s t than the Treasury would have had to pay a t th a t
time on s im ila r s e c u r i ti e s . The a d d itio n a l i n t e r e s t cost
was estim ated to be nearly $10 m illio n . Two years l a t e r
the c e r t i f i c a t e s were paid o ff w ith the proceeds of a
Treasury loan to the Commodity C redit C orporation. The
b elated Treasury loan was made p o ssib le by an increase in
Annual Report of the Secretary of the Treasury,
1951, p. 216.
86
g
the debt ceiling.
In 1957 the ad m in istratio n made no serio u s e f f o r t
to get the time lim it on the temporary debt c e ilin g
extended. S ecretary Anderson s ta te d th a t i t might very
w ell be necessary to r e s o r t to some c o stly expedients.
The r e s u l t was another expensive excursion in to government
9
agency financing o u tsid e the Treasury. This time the
Federal N ational Mortgage A ssociation was asked to s e l l
s e c u r itie s in the p riv a te market and turn the proceeds
over to the Treasury in te ch n ica l payment of some old
d e b t . ^ The s e c u r itie s of the Federal National Mortgage
A ssociation are not guaranteed e ith e r as to i n t e r e s t or
p rin c ip a l by the government. However, the s e c u r itie s
market accepts them as almost the equivalent of d ir e c t
government o b lig a tio n s . In ad d itio n to the Federal
g
U .S ., House, Committee on Banking and Currency,
Hearings , Increase Borrowing Power of Commodity C redit
Corporation to $10 B i l l i o n , 83d Cong., 2d S e s s ., July 15,
1954, pp. 15-16.
9
U.S. , Senate, Committee on Finance, Hearings , Debt
C eiling In c r e a s e . 85th Cong., 2d S e s s ., January 27, 28;
February 4, 7, 1958, p. 13.
10
Wall Street Journal, January 2, 1962, p. 3.
87
National Mortgage A sso ciatio n , o th er government-sponsored
corporations issue nonguaranteed o b lig a tio n s to the pu b lic.
C urrently these corp oration s are the Bank for C o o p erativ es,
the Federal Interm ediate C redit Banks, the Federal Land
Banks, and the Federal Home Loan Banks. The t o t a l o u t
standing o b lig a tio n s fo r a l l fiv e agencies amounted to
$8.4 b i l l i o n as of June 30, 1 9 6 0 .^
In 1960 the Treasury inaugurated a new procedure
whereby under pressure of the debt c e ilin g the Treasury,
in e f f e c t , redeemed government bonds using Federal N ational
Mortgage A ssociation mortgages in stead of cash. The pro
p rie ty of such evasion ta c t i c s was questioned by
C ongress.
I t is apparent th a t the guaranteed and nonguaranteed
o b lig a tio n s of government agencies and corpo rations both
re p resen t an important element o f government fin a n c ia l
o p eratio n s. The fe d e ra l government h as, in f a c t , become
the c o u n try 's p rin c ip a l banker. T otal a ss e ts of the
Annual Report of the S ecretary o f the T re asu ry ,
1960, p. 47.
U.S. , House, Committee on Ways and Means, Hear
ings , Public Debt C eiling and I n te r e s t Rate C eilin g on
Bonds, 86th Cong., 1st S e s s ., June 10-12, 1959, p. 146.
88
numerous c r e d it agencies amounted to over $19 b i l l i o n in
13
1953. In our mixed economy the government has continued
to assume functions neglected by or u n su ita b le for p riv a te
e n te rp ris e . Although such actio n s may be n ecessary, i t is
s t i l l e s s e n tia l for the continuance of a fre e e n te rp ris e
mixed economy th a t the extent o f government a c t i v i t i e s be
comprehended. According to R epresentative Cannon of
Missouri:
Congress has been o b lig a tin g the Nation a t such
a rap id r a te and on such a rid ic u lo u s plan th a t no
one down a t the Treasury or anywhere e lse can t e l l
us how much we are o b lig ated fo r. There is no way
fo r anybody to know. W e have been shoveling money
out the back door a t such a r a te th e re is no way
to estim ate i t . . . . Could i t be th a t we do not
want to know--that we do not want the people to
find o u t ? 14
The most recen t estim ate of the t o t a l fed eral
contingent l i a b i l i t i e s was approximately $450 b i l l i o n . ^
This fig u re includes a l l sums for which the United S tates
1 3
Anatol Murad, P riv a te C redit and Public Debt
(Washington, D.C.: Public A ffa irs P re ss, 1954), p. 57.
■^U.S. , R epresentative Clarence Cannon, Congres
sio n al Record, 87th Cong., 1st Sess. (April 26, 1961),
p. 6298.
15
U .S ., House, Hearings , Public Debt C eiling and
I n te r e s t Rate C eiling on Bonds , 86th Cong. , 1st Sess. ,
June 10-12, 1959, p. 151.
government is d ir e c tly resp o n sib le upon the fu lfillm e n t of
s p e c ific co nd itio n s. Such o b lig a tio n s as s o c ia l s e c u rity ,
unemployment in su rance, and n a tio n a l l i f e insurance tr u s t
funds would be included under th is category. The con
tin g en t l i a b i l i t y fig u re also includes a l l sums fo r which
the United S tates government is in d ir e c tly re sp o n sib le ,
such as Federal Housing A uthority and Veterans Adm inistra
tio n mortgages. I t must be remembered, however, th a t a l l
of these p o te n tia l claims are conditioned upon something
more than the simple passage of time. The f u l l t o t a l must
th e re fo re be used with care. However, the contingent
l i a b i l i t y fig u re does serve to emphasize em phatically the
extent to which the government p a r tic ip a te s in the n a tio n 's
economy. I t lends added sig n ific a n c e to the impact of
government debt. This is e s p e c ia lly tru e as new methods
are developed which enable the Treasury to s h i f t a t w ill
between the contingent fe d eral debt sec to r and the d ir e c t
fed eral debt se c to r. S h iftin g of debt from the fed eral
sec to r to the p riv a te se c to r has also evolved. T herefore,
i t is e s s e n tia l th a t the c o r re la tio n between fe d eral and
p riv a te debt be understood.
90
I I . PRIVATE A N D FEDERAL DEBT CORRELATION
P riv ate debt is herein defined as the fixed value
o b lig atio n s of the economy o th e r than fed eral debt. I t is
so defined to include s t a te and lo cal debt s p e c if ic a lly in
the p riv a te se c to r. This is d e s ira b le since s t a t e and
lo cal debt actio n s more n early approximate p riv a te corpo
r a te financing than fe d e ra l government financing. Also
included in p riv a te debt are long- and sh o rt-term debts of
corp oration s and households , such as bonds, m ortgages, and
instalm ent c r e d it.
Actions taken in the public debt se c to r can a f f e c t
the p riv a te debt se c to r. In a d d itio n , economic changes
can a f f e c t both se c to rs. For example, the market for a l l
fixed d o lla r o b lig a tio n s was a ffected adversely by the
recent preference of in v esto rs for common stocks as an
in f l a t i o n hedge. On the o th er hand, the high corporate
*
income tax s tru c tu re has been conducive to bond financing
r a th e r than equity financing.
What h i s t o r i c a l comparisons can be made between the
siz e of the fe d e ra l debt and the magnitude o f a l l o th er
types of debt? P riv ate debt tends to increase in
91
p ro sp e rity and decrease in depression. Federal debt v a rie s
in v e r s e ly , th a t i s , i t tends to decrease in p ro sp e rity and
increase in depression. Wars, however, cause the g re a te s t
d is to r tio n in the r a ti o o f fe d e ra l to p riv a te debt. In
1916 the fe d eral debt comprised le s s than 2 per cent of
the t o t a l p riv a te and fed eral debt. As a r e s u l t of World
War X in 1919, th is percentage had increased to s lig h tly
more than 20 per cen t. Between 1919 and 1929, while the
fe d eral debt was g rad u ally d ecreasin g , household, b u sin ess,
and s t a t e and lo cal government debt grew. By the end of
1929 the fe d e ra l debt accounted fo r only 8 per cent of the
t o t a l d e b t . ^
During the depression th ere was a notable lack of
e f fe c tiv e demand fo r p riv a te c a p ita l investment funds.
The r e s u l t was a resurgence of fe d eral debt r e l a t i v e to
p riv a te debt. On the eve of World War I I , in 1939,
fed eral debt stood a t 23 per cent of the t o t a l debt.
Again, the war completely d is to r te d the e x istin g
re la tio n s h ip between fed eral and p riv a te debt. The
Treasury was dealing with a captive market since there was
Committee fo r Economic Development, Managing the
Federal Debt (New York: The Committee, 1954), pp. 14-15.
92
l i t t l e com petition fo r c a p ita l funds. By the time World
War I I had ended, the fe d e ra l debt exceeded the p riv a te
debt fo r the f i r s t time in the n a tio n 's h is to ry . On
February 28, 1946, a t i t s postwar peak of $280 b i l l i o n ,
the fe d e ra l debt c o n s titu te d 60 per cent o f the t o t a l
d e b t . ^ The Treasury thus became the dominant fa c to r in
the money and c a p ita l markets of the n atio n .
During the post-World War I I p e rio d , p riv a te d e f i c i t
fin an cin g , which had been r e s t r i c t e d during the war, began
to expand s ig n if ic a n tly . Consumer, i n d u s t r i a l , r e a l
e s t a t e , c o rp o ra te , and s t a t e and lo c a l government loans
increased twice the amount th a t the fe d e ra l debt decreased
18
from February 1946 through June 1949. Nearly a l l
in v e sto r groups began reducing t h e i r government debt
holdings s te a d ily and re in v e stin g these funds in p riv a te
s e c u r i ti e s . However, as la te as 1950 the fe d eral debt
s t i l l rep resen ted more than one h a lf of the t o t a l debt
Annual Report of the S ecretary of the T re a su ry ,
1950, p. 162.
18
Annual Report of the Secretary of the Treasury,
1949, p. 89.
19
of the United States.
In the 1950's, sev e ral circum stances combined to
reduce ra p id ly the percentage o f fe d e ra l debt to t o t a l
debt. F i r s t and forem ost, the r e l a ti v e a ttra c tiv e n e s s of
n early a l l types o f s e c u r itie s as compared w ith government
s e c u r itie s increased w ith the growing confidence o f the
American in v e sto r th a t the government would avoid severe
20
recessio n s and depressions. This occurred a t a time
when new investment o p p o rtu n itie s were becoming more and
more abundant.
Second, a f t e r the T reasury-Federal Reserve Accord
of March 4 , 1951, government s e c u r i ti e s were no longer
supported a t par. This re s u lte d in a decrease in p ric e
which was commensurate to a decrease in m a rk e ta b ility .
Understandably, th is caused a d e c lin e in the r e la tiv e
p o p u larity of government s e c u r itie s as compared to p riv a te
debt o b lig a tio n s . Yields on government s e c u r itie s have
19
Annual Report of the S ecretary o f the T re asu ry ,
1950, p. 32.
20
Address before the American Finance A ssociation
and the American Economic A ssociation a t Washington, D .C .,
December 29, 1959, by S ecretary of the Treasury Anderson,
c ite d in Annual Report of the S e cretary of the Treasury,
1960, p. 287.
94
r is e n r e l a t i v e to those on p riv a te debt during the l a s t
decade. At the same tim e, the s iz e of the p u b licly held
fe d e ra l debt has been d ec lin in g r e l a t i v e to the amount of
p riv a te debt outstanding. This tends to s u b s ta n tia te the
view th a t government s e c u r itie s have become le s s a t t r a c t i v e
21
to in v e sto rs.
Attempts to make fe d e ra l s e c u r itie s more competi
t iv e have had re v e rb e ra tin g e f fe c ts on the p riv a te economy.
This is e s p e c ia lly tru e in those f ie ld s th a t are clo se sub
s t i t u t e s fo r government debt. Savings bonds compete with
savings accounts. Long-term mortgages and co rporation
bonds compete with long-term government bonds. Debt
management decision s a ffe c tin g the amount, m a tu rity , and
terms of fe d eral s e c u r i ti e s have an immediate impact on
r e la te d areas o f the p riv a te economy.
In the 1950's the trend of the fe d eral debt to grow
a t the expense of the p riv a te debt was reversed. Venture
c a p ita l became more p l e n t i f u l , thereby promoting the
growth p o te n tia l o f the economy. This was in keeping with
21
Warren L. Sm ith, Debt Management in the United
S tates , U.S. Congress, 86 th Cong. , 2d Sess. , Jo in t Economic
Committee, Study Paper No. 19 (Washington: Government
P rin tin g O ffic e , January 28, 1960), p. 7.
95
the Treasury o b jectiv e a t th is tim e, i . e . , to enhance the
flow of funds into p riv a te investment even though th is
increased the d i f f i c u l t i e s of debt management. By 1952
the fe d e ra l debt had been reduced to 36 per cent of t o t a l
22
d e b t , and by 1958 th is r a t i o had fa lle n to 28 per c e n t ,
23
even though the fe d eral debt was in creasin g .
P art of the increase in the p riv a te debt s e c to r was
a tt r i b u t a b l e to the government program to guarantee or
insure p riv a te debt. This was done by using o b lig a tio n s
such as Federal Housing A uthority and Veterans Adm inistra
tio n mortgages. These s e c u r itie s are equivalent to
contingent government o b lig a tio n s and are evaluated as
such in the market place. This c la ss of p riv a te debt
s e c u r itie s o ffe rs higher long-term i n t e r e s t ra te s than
fed eral o b lig a tio n s . In a d d itio n , borrowers ex h ib it a
pronounced tendency to pay these mortgages o ff in f u l l
s u b s ta n tia lly before m atu rity. Furtherm ore, the market
support a c t i v i t i e s of the Federal N ational Mortgage
A ssociation have helped to develop an in cre asin g ly a c tiv e
Committee for Economic Development, Managing the
Federal D ebt, loc. c i t .
23
Smith, op. cit., p. 29.
96
secondary market in government-supported m ortgages, thus
g re a tly in creasin g t h e i r liq u id ity . These s e c u r itie s have
moved out of what was la rg e ly a bank market and are now
considered to be a t t r a c ti v e investments by business corpo-
24
ra tio n s and o th ers.
I t is a p p a re n t, th en, th a t the fe d e ra l debt and
p riv a te debt sec to rs are not completely separated. S h if t
ing from one s e c to r to the o th er can and does occur.
Such s h if tin g must be considered in evalu ating fed eral
debt op eratio n s. Actions in one se c to r can enhance or
d e te r the performance of the o th er se c to r. Another
example of government aid to p riv a te debt growth occurred
in World War I I . The government guaranteed c r e d it
extended to p o te n tia l producers of war su p plies who were
unable to obtain the necessary financing without such
g u a r a n tie s .
Ju s t as the fe d e ra l government sometimes en ters the
area which o rd in a rily is the p rero g ativ e of p riv a te d e b t ,
on other occasions the p riv a te economy assumes some of the
fed eral debt. This occurred when banks, instead of the
24
Robert V. Roosa, Federal Reserve Operations in
the Money and Government S e c u ritie s Market (New York:
Federal Reserve Bank o f New York, 1956), p. 24.
97
T reasury, were c a lle d upon to finance $1.1 b i l l i o n of
Commodity C redit C orporation's crop loans in 1954. I t
occurred again in 1957 when c o n tra c to rs of m ilita ry
p ro je c ts were forced to borrow from banks due to the slow
down of government payments of b i l l s for work in progress.
This slowdown and accumulation of b i l l s was caused by a
25
tig h t debt c e ilin g .
The t o t a l debt f ig u re , th en , provides a guide to
the fin a n c ia l development and c r e d it base of the economy.
However, the major emphasis of debt management remains
upon the d ir e c t fed eral debt. To determine the burden of
th is d ir e c t d e b t, i t is e s s e n tia l to know i t s re la tio n s h ip
to the n a tio n a l income, n a tio n a l w ealth, and population
and purchasing power changes.
I I I . ECONOM IC GROW TH EFFECTS O N THE
BURDEN OF THE DEBT
The fe d e ra l debt is a fixed d o lla r o b lig a tio n . To
appraise the meaning of th is sum, i t is e s s e n tia l th a t
the conditions under which the d o lla r debt e x is ts be
25
Wall Street Journal, January 2, 1962, p. 3.
98
considered. The most dynamic element is the measure of
the earning power o f the economy, i . e . , the n atio n al
income. P opulation, tangible w ealth, and re a l purchasing
power of the nation are also p e rtin e n t fa c to rs. The
re la tio n s h ip of the fed eral debt to a l l of these fa cto rs
can serve a dual purpose of guiding and warning the debt
managers.
The C orrelation Between Federal Debt and
National Income
The size and the ra te of growth of n atio n al income
are s ig n ific a n t in a sc e rta in in g the burden of the fed eral
debt. I f earning power is high, a large debt in absolute
figures may be r e la tiv e ly unimportant. The r a tio between
the debt and n atio n al income in d icates the e f f o r t which
the nation may be c a lle d upon to make to serv ice and
r e t i r e the debt. Any increase of n a tio n a l debt a t a ra te
which is less than the growth of n atio n al income, in
e f f e c t , r e s u lts in a decrease in the r e la tiv e debt burden.
Under these conditions , supporters of d e f i c i t
financing ra tio n a liz e th a t a growing debt need not be
feared. Debt growth may stim ulate the r i s e of income.
The increased income may provide the source from which the
99
26
increased debt is financed. Such reasoning assumes th a t
d e f i c i t spending r e s u l ts in a m u ltip lie r e f f e c t. Due to
the m u ltip lie r e f f e c t , n a tio n a l income grows f a s te r than
debt. However, such reasoning makes no allowance for the
p o ssib le adverse e f fe c ts o f government d e f i c i t spending.
For example, p riv a te investment might decrease as a r e s u l t
of increasing government indebtedness.
The g r e a te s t emphasis is placed on the e f f e c t of an
ascending n a tio n a l income, i . e . , growing up to the debt.
Obviously, n a tio n a l income can d ec lin e a lso . I t should be
remembered th a t "a sharp decrease in n a tio n a l income in
one year could increase the burden of the debt much more
than we can hope to decrease i t through many years of debt
27
re d u c tio n ." As n a tio n a l income grows la r g e r , i t becomes
in c re a sin g ly d i f f i c u l t to make larg e percentage gains in
the growth of n a tio n a l income. Temporary fa c to rs may also
r e s u l t in an u n su stain ab le r a te of n a tio n a l income growth.
An example would be the stim ulated n a tio n a l income growth
Seymour H arris , N ational Debt and New Economics
(New York: McGraw-Hill Book Company, I n c ., 1947), p. 5.
27
Annual Report of the Secretary of the Treasury,
1946 , p. 2.
100
which followed the end o f World War I I .
Many s ig n if ic a n t s h i f t s have taken place in the
n a tio n a l incom e-federal debt r a t i o . As a new n atio n in
1799, the fed eral debt comprised 11 per cent of the
estim ated n a tio n a l income. This percentage flu c tu a te d
modestly u n t i l the C iv il War. As a r e s u l t of th a t con
f la g r a tio n , the fe d e ra l debt rose to nearly 50 per cent of
28
the n a tio n a l income. In the in terim between the C iv il
War and World War I , the debt percentage to n atio n a l
income dropped to 7 per cent in 1900. However, a f t e r
World War I , the fe d eral debt represented n early one
q u a rte r of the n a tio n a l earning power. In the prosperous
1920's, th is re la tio n s h ip was reduced. At the end of
f is c a l 1929, the fe d e ra l debt equaled only 16 per cent of
29
n atio n a l income.
As a r e s u l t of the d ep ressio n , the debt rose to
almost 50 per cent of the n a tio n a l income by 1939. World
War II provided a tremendous stim ulus to both debt growth
Committee on Public Debt P o licy , Our N ational
Debt (New York: H arcourt, Brace and Company, I n c ., 1949),
p. 12.
Marshall A. Robinson, The N ational Debt C eiling
(Washington: The Brookings I n s t i t u t i o n , 1959), p. 92.
101
and n a tio n a l income growth. However, d e f i c i t financing
expanded more ra p id ly than n a tio n a l income. Consequently,
the debt before the end o f the war surpassed the n a tio n a l
income in magnitude. F in a lly , a t the end of war in 1946,
the fe d e ra l debt was more than one and one h a lf times
n a tio n a l income.
Although the t o t a l fe d e ra l debt had increased
16.2 times from 1929 to 1946, the index of debt
to n a tio n a l income shows an increase of only 7.72
tim e s.^0
The trend was reversed a f t e r World War I I . Although
fe d e ra l debt cre p t forward, the n a tio n a l income expanded
more ra p id ly than debt. Except for the th ree recessio n
years of 1949, 1954, and 1958, the r a ti o of debt to
n a tio n a l income has decreased each year. The d ec lin e has
been la rg e ly due to the r i s e in n a tio n a l income ra th e r
than to the decrease of fe d e ra l debt. However, i t should
be noted th a t n early h a lf of the growth of n a tio n a l income
between 1947 and 1958 is accounted for by a r i s e in
31
p r i c e s .
Nien Min Sun, "An Economic Analysis of the
Burdens of the Public Debt" (unpublished PhD. d i s s e r t a
tio n , U n iversity o f Southern C a lifo rn ia , Los Angeles,
1950) , p. 126.
31
Smith, op. cit.. pp. 27-29.
102
The c r i t i c a l le v e ls of the n a tio n a l incom e-federal
debt r a t i o are unknown. Foreign d e b t-n a tio n a l income
r a tio s have been t r a d i t i o n a l l y higher than those of the
United S ta te s. The debt of Great B rita in during the
n in eteen th century reached two times the n a tio n a l income.
Some American economists such as Alvin Hansen suggest th a t
32
th is is also a safe lim it fo r the United S ta te s.
Caution should be exercised as to assumptions on
the safe lim its of the fe d e ra l debt. The many fa c to rs
th a t compose the n a tio n a l income, as w ell as the t o t a l
fig u re s , must be considered. Such things as the burden of
annual i n t e r e s t c h a rg e s, p e n sio n s, s o c ia l s e c u rity o u t l a y s ,
m ilita r y co sts , and o th e r expenditures of the nation
a f fe c t the safe r a t i o lim it. The higher these t o t a l s , the
lower the safe r a ti o of fe d e ra l debt to income; and of
co u rse, the lower these c o s ts , the g re a te r can be the
33
r a ti o of debt to income.
Alvin Hansen, F isc a l Policy and Business Cycles
(New York: W . W . Norton and Company, 1941), p. 136.
33
Elton Raymond Shaw, The N ational Debt and Our
Future (Washington, D.C.: Shaw Publishing Company, 1946),
p. 103.
103
The C o rrelation Between Federal Debt
and Population and National Wealth
The e ffe c t of size o f population on debt burden is
much less conclusive than n a tio n a l income. Mere growth of
the number of people may a c tu a lly heighten the burden of
the debt ra th e r than lower i t . For example, assume th a t
population had doubled with n atio n a l income unchanged.
This would be the same as c u ttin g in h a lf the average
income in the natio n . As the average income approaches
the subsistence level i t becomes in creasingly d i f f i c u l t to
tax in order to provide debt serv ice or repayment.
Per c a p ita debt comparisons are valuable w ithin a
sin g le nation over a sh ort period of time. They may also
provide meaningful comparisons between nations of equal
economic development in the short run. Although the
absolute amount of the debt of the United S tates is higher
than Great B rita in and F rance, the per c a p ita debt is much
lower. At the end of World War I I , while United S tates
per c a p ita debt equaled $1,908; Great B r ita in 's equaled
$2,993; and F rance's equaled $4,610.
Within a country, as the composition of the popula
tio n changes, the per c a p ita d e b t's meaning also changes.
104
With the modem trend to lim it the working force by
excluding those considered too young, or too o ld , the debt
per productive worker is enlarged. Because of fa c to rs such
as th is , i t is exceedingly d i f f i c u l t to make meaningful
comparisons over long periods of time.
The h ig h lig h ts of per c a p ita debt movements reviewed
b r i e f l y are as follows: An i n i t i a l per c a p ita debt o f $19
in 1790 rose to $78 a f t e r the C iv il War, $243 a f t e r World
War I , $309 in 1939 a t the s t a r t of World War I I , ^ and
$1,908 in 1946 a t the end of World War I I . Today the per
c a p ita debt approximates $1,600.
Care must be taken in s e ttin g any express lim it on
the per c a p ita debt th a t a n a tio n 's economy can s u s ta in .
Today's per c a p ita debt is much g re a te r than th a t deemed
c r i t i c a l by the authors of the Twentieth Century Fund's
1937 re p o rt t i t l e d , The N ational Debt and Government
35
C red it. I t should also be remembered th a t the present
34
Roy A. Foulke, N ational T h rift and the Public Debt
(New York: Dun and B ra d s tre e t, I n c ., 1944), p. 60.
Charles Cortez A bbott, Management of the Federal
Debt (New York: McGraw-Hill Book Company, I n c ., 1946),
p. v i i .
105
per c a p ita fed eral debt of $1,625 is considerably below the
1959 per c a p ita p riv a te debt o f $2,700."^
The fe d e ra l d e b t's re la tio n s h ip to n a tio n a l wealth
must also be applied w ith caution. Such statem ents as
"our debt is equivalent to the assessed value of a l l the
land, a l l the b u ild in g s , a l l the mines, a l l the machinery,
a l l the liv e sto c k --e v e ry th in g of tan g ib le value in the
37
U.S." are not conducive to a ra tio n a l economic judgment
of the debt management problem. As s p e c if ic a lly d efin ed ,
government c r e d i t , u n lik e p riv a te c r e d i t , does not r e s t
upon any form of mortgage s e c u rity a v a ila b le fo r loan
repayment. R ather, the earning power and the w illin g n ess
to levy taxes to repay and serv ice debt are the bases of
government c r e d it. This is re fle c te d in our fe d eral tax
system. The bulk of fe d e ra l re c e ip ts is received from
income taxes ra th e r than from property taxes.
F urtherm ore, an in te rn a l debt is n e u tra l in i t s
e ffe c ts on n a tio n a l wealth. Debt repayment might c o n s ti
tu te a r e d is tr ib u tio n of wealth but no in crease in w ealth.
Robinson, op. c i t . , p. 93 (fo o tn o te).
37
U.S., Senator Harry Flood Byrd, Congressional
Record, 84th Cong., 1st Sess. (May 4, 1955), p. 5693.
F i n a l l y , the very value a t which w ealth is computed is a
d e riv a tiv e o f the income produced by the a s s e ts and the
38
r a te o f i n t e r e s t a t which th is income is c a p ita liz e d .
T herefore, income, not w ealth, is the major measure of
debt cap acity .
The E ffect of I n f la tio n upon the
Burden of the Debt
Care must be taken to d i f f e r e n t i a t e between r e a l
growth and in fla te d growth of n a tio n a l income. Both can
reduce the d o lla r debt burden, but in fla te d growth is the
equ ivalent of re p u d ia tio n . Debt and n a tio n a l income are
compiled in d o lla rs of equal value in the same time period.
However, in f la tio n between time periods increases n a tio n a l
income without changing d o lla r debt t o t a l s . For th is
reason i n f la tio n is most o ften judged to r e s u l t in a
decrease in the burden of the debt.
Whether th is method of decreasing the debt burden is
acceptable is highly debatable. Informed opinion v a rie s
considerably. To some, "economic s t a b i l i t y should be a
p re d ic ta b le outcome of the ru le s of the system, ru le s which
107
are c o n s titu te d once and fo r a l l , and which are in a r e a l
39
s e n s e , r e l a t i v e l y absolute a b so lu te s." For o th e rs , the
damage has already been done: "D eflatio n to cure i n f la tio n
is lik e running over a man w ith an autom obile, then to make
,,40
amends, backing up over him again. Such thinking
emphasizes the macroeconomic viewpoint ra th e r than the
in d iv id u al balance sh eet. F in a lly , the viewpoint is
advanced th a t the democratic process has p re v aile d .
The American people have got p re c is e ly what they
asked fo r. Anytime th a t they decide th a t they
have had enough in f l a t i o n and are w illin g to
give up something to stop i t they can do so.41-
I n f la tio n may cause m a l-d is trib u tio n o f resources
which impedes the optimum functioning of the economic
system. To the extent th a t th is o ccu rs, the burden o f the
debt is increased ra th e r than decreased. With the d e s tru c
tio n of confidence among bondholders , the decrease o f the
burden of the e x is tin g debt is o f f s e t by the increased
cost of issu in g new debt. For example, a f t e r 1816 the
39
James M . Buchanan, Public P rin c ip le s of the
Public Debt (Homewood, I l l i n o i s : Richard D. Irw in, Inc. ,
1958), p. 195.
40
Our N ational D ebt. p. 142.
41
Robinson, op. cit., p. 99.
108
Treasury had to increase i t s debt by $5 m illio n to borrow
42
$1 m illio n in sp ecie. The modern-day equivalent to th is
loss of confidence is the c a p ita l flow from a country,
which r e s u l ts in an unfavorable balance of trad e and a
gold d rain .
I t should be remembered th a t the a c tu a l issuance of
debt instrum ents is a n t i - i n f l a ti o n a r y i f the funds are
impounded in the Treasury. I f the funds are used to r e t i r e
the debt held by the Federal Reserve Banks , a m u ltip le
c o n tra c tio n would r e s u l t . Only when the public debt
fo s te rs an in crease in spending in the economy does i t
have in fla tio n a r y p o t e n t i a l , and then u su a lly under condi
tio n s of f u l l employment or n ea rly f u l l employment. Given
a lim ited supply of goods, some o f the p ressure o f demand
can be reduced by issuin g debt to the p u b lic. This was
p a rt of the r a tio n a le behind the savings bonds campaigns
of World War I I . I f th ere is genuine oversaving on the
p a rt of the general p u b lic , debt cannot cause i n f la t i o n .
The danger of a debt is i t s in fla tio n a r y p o te n tia l.
I t is the l i q u id i ty fa c to r inherent in debt instrum ents
Our National Debt, p. 12.
109
th a t can convert a th re a t of in f l a t i o n in to a serious
i n f l a t i o n . This is a l l the more lik e ly to occur when
public confidence in s e c u r itie s as a s to re of value is
s h a tte r e d .
Meaningful debt comparisons over a period of years
re q u ire th a t the r e a l weight of the fin a n c ia l burden of
the debt be determined. This is accomplished by removing
the in f la tio n a r y fa c to r from in te ry e a r comparisons.
N ational income is thus ad ju sted to changes in purchasing
power. The major purpose of debt r a ti o s to o th er re le v a n t
economic fa c to rs is to provide a b e t te r understanding of
the burden of the debt.
IV. THE PHILOSOPHY OF THE FEDERAL DEBT
One of the most im portant determ inants of the
course o f debt management is the philosophy held toward
the fe d eral debt. This philosophy can range the g a u n tle t
from u ltra c o n s e rv a tiv e through u l t r a l i b e r a l . Most
economists adopt a moderate viewpoint.
Arguments ag ain st D e fic it Financing
The opponents of d e f i c i t financing are g e n e ra lly ,
r a th e r than t o t a l l y , unreceptive to the idea of public
110
borrowing. Emphasis is placed on the m u ltip lic a tio n of
taxes th a t r e s u lts from using d e f i c i t financing. Under
ordinary circu m stan ces, government spending is regarded as
a fa c to r which discourages p riv a te spending and investm ent.
T h e re fo re , i t is f e l t th a t d e f i c i t s should be kept a t a
minimum. Budget balancing is considered v irtu o u s.
D e fic it financing is u su a lly sanctioned only in
wartime. Under such conditions the tax burden would almost
be c o n fisc ato ry . When d e f i c i t spending is condoned, an
in te rn a l debt is favored r a th e r than an ex te rn a l debt. I t
is f e l t th a t an in te rn a l debt causes fewer burdens fo r the
economy. F in a lly , i t is emphasized th a t d e f i c i t spending
u su ally r e s u l t s in an accumulation of debt. When the
accumulation of debt becomes g r e a t, i t is seldom completely
and f a i r l y paid o f f . ^
Arguments for D e fic it Financing
The advocates of d e f i c i t spending are o f the opinion
th a t i t supplements ra th e r than supplants p riv a te spending.
The value of d e f i c i t financing depends on the type of
a s s e t re s u ltin g from the debt. Economists have
Adam Smith and David Hume would p ersonify th is
type of o p position to d e f i c i t financing. See Charles
J. B ullock, Selected Readings in Public Finance (Boston:
Ginn and Company, 1906), pp. 503-509.
Ill
d i f f e r e n t i a te d between th ree types of debts according to
the type of expenditure th a t they finance. An a c tiv e debt
r e s u lts in an incom e-creating a s s e t; fo r example, a
power-producing dam. Such an a s s e t pays o ff the d e b t, the
i n t e r e s t on the d e b t, and provides a source of fu tu re
income. The b e n e fits to be derived from in cu rrin g a c tiv e
debt have re c e n tly been emphasized. However, the idea is
o f ancient o rig in . "D ietzel and Hamilton both emphasized
the wisdom of income-producing public l o a n s . " ^
A passive debt r e s u l t s in the c re a tio n of an a s s e t
of a nonincome-producing v a r ie ty . Examples are l i b r a r i e s ,
schoo ls, ro a d s, and so fo rth . To compensate for such
passive d e b t, the improved a s s e t value of the property is
emphasized as well as the improvement in s o c ia l u t i l i t y
which is not measurable in d o lla rs and ce n ts.
Even a dead-weight debt produces a s s e ts . The
a ss e ts acquired by the government merely happen to be of
a d i f f e r e n t order than those acquired by p riv a te business
in the process of in v estin g . S ocial s t a b i l i t y , n a tio n a l
g lo ry , honor, power, and so fo rth may be noble and worthy
Buchanan, op. cit. , p. 19.
112
o b je c tiv e s , but from a c a p i t a l i s t i c viewpoint t h e i r
45
balance sheet value must be zero.
Recent advocates of government d e f i c i t spending
suggest th a t such expenditures are capable o f ra is in g the
46
le v el o f n a tio n a l income. This reasoning is based on
th ree assumptions:
1. The c re a tio n of the public debt does not
involve any tr a n s f e r of primary r e a l burden to
fu tu re g en eratio n s.
2. The analogy between in d iv id u a l or p riv a te
debt and pub lic debt is fa lla c io u s in a l l
e s s e n tia l re sp e c ts.
3. There is a sharp and im portant d is tin c tio n
between an in te rn a l and ex te rn a l d e b t.47
P rofessor Buchanan d isagrees w ith a l l th re e assum ptions,
presen tin g thoroughly both pro and con arguments in his
book, Public P rin c ip le s of the Public D ebt.
B rie fly reviewed, those who are frie n d ly to d e f i c i t
financing see i t as a means of improving the money supply
45
Murad, op. c i t . , p. 176.
46
Alvin Hansen, Monetary Theory and F isc a l Policy
(New York: McGraw-Hill Book Company, 1949), p. 195;
Abba P. L e m e r , ’’Functional Finance and the Federal D ebt,”
S ocial R esearch, X, No. 1 (February 1943), 50.
Buchanan, op. cit., p. 4.
113
and v e lo c ity of money. Opponents consider d e f i c i t fin a n
cing as a step toward currency d e te rio ra tio n .
The proponents of d e f i c i t spending fe e l th a t i t is
productive in th a t i t is e ffic ie n c y -c re a tin g , u t i l i t y -
c re a tin g , and incom e-creating. Opponents worry about the
e ffe c t of d e f i c i t spending upon the economic in centives of
the p riv a te economy.
Advocates favor d e f i c i t financing as a method of
tapping unused funds and thereby promoting trad e.
Opponents emphasize th a t d e f i c i t financing in v ite s i r r e
sponsible budgets and encourages a nation to liv e beyond
i t s means by mortgaging i t s future.
Advocates s tr e s s the d iffe re n c e between p riv a te
debt and fed eral debt. The fa ct th a t the government can
con trol the in te r e s t r a t e , can refund, and can even
repudiate the debt is emphasized. Those who are again st
d e f i c i t financing claim a strong analogy between federal
and p riv a te d eb t, e sp e c ia lly in tech n ical s i m il a r it i e s .
Both advocates and opponents agree th a t an in te rn a l
debt is less burdensome than an ex tern al debt. Advocates
claim no burden e x ists o u tside of tra n s f e r charges for an
in te rn a l debt. "Every cent expended becomes income for
114
members of our own so ciety . Costs and incomes are j u s t
48
opposite sides of the same sh ie ld ." Opponents emphasize
the questionable p ro d u c tiv ity of government d e f i c i t spend
ing and i t s e f fe c t on p riv a te investment in ad dition to
the tra n s fe r f r i c t i o n burdens. Also, even though we may
owe the debt to ourselves in a macroeconomic sense, th is
does not solve the microeconomic problems of taxing to pay
d eb th o ld ers.
The g re a te s t contention cen ters around the question
of whether or not the burden of the debt is sh ifte d to
fu tu re generations. The advocates of d e f i c i t financing
contend th a t present so ciety gives up re a l resources.
T herefore, there is no s h i f t of burden--only a tra n s f e r
payment between fu tu re c re d ito rs and futu re debtors. This
approach emphasizes the community balance sh eet. Opponents
of d e f i c i t financing argue th a t present resources being
expended do not rep resen t a s a c r if ic e . Bond purchases are
made w illin g ly . For th is reason the resources which these
funds could have purchased are excess resources. The
present bond buyer must value these excess resources lower
Alvin Hansen, A fter the War--Full Employment
(Washington: Government P rin tin g O ffice, 1942), p. 5.
115
than p o ssib le future purchases of resources. On the o th er
hand, the future taxpayer is making a compulsory s a c r if ic e
o f resources. Therefore, the tr a d itio n a l argument contends
th a t the burden on fu tu re generations depends upon the
b e n e fit the fu ture taxpayer derives from the debt
expenditure compared to his cost through taxes fo r the
expenditure. Thus, the opponents of d e f i c i t financing
emphasize the individ ual balance sheet. The community
burden could be ascertain ed in the same way through the
p rin c ip le of marginal so c ia l u t i l i t y . The p rin c ip le of
marginal so c ia l u t i l i t y would compare the cost in taxes to
the fu tu re generation as a whole, with the b e n e fits derived
from the expenditure by the fu tu re generation as a whole.
Advocates of d e f i c i t financing see few problems in
a g re a te r expansion o f public debt. The contention th a t
repayment of the debt is not necessary is also put forward.
T h e o re tic a lly , th is is possible:
Congress could le g a lly authorize the issuance
of paper money without lim it i f i t chose to do
so. The same r e s u lt as the unlim ited issuance
o f paper money may be achieved by governmental
borrowing from Federal Reserve Banks using
116
government bonds and o th er instrum ents of debt
as c o l l a t e r a l . 49
The opposition view, however, emphasizes th a t there is a
lim it to public c r e d it. Borrowing becomes a h ab it which
leads to abuse of public c r e d it and fin a lly r e s u lts in the
d e stru c tio n of the n a tio n 's c r e d it. The public faced by
unlim ited debt expansion and a p o ssible repudiation of
debt have, in the p a s t ,
. . . f i r s t refused to buy long term s e c u r i t i e s ,
and then begun to convert the bonds and currency
they already possessed into goods and e q u itie s
in order to p ro te c t themselves ag ain st fu rth e r
increases of p r i c e s .50
The ideas expounded by the advocates of d e f i c i t
financing are r e a lly not new.
A conception of public debts s tr ik in g ly sim
i l a r to those held by the new philosophy was
widely prevalent in the 18th century and before
and was considered an e s s e n tia l p a rt o f the
whole m e rc a n tilis t d o c tr in e .51
49
Clark Lee A llen, James M . Buchanan, and Marshall
R. Colberg, P r i c e s , Income, and Public Policy (New York:
McGraw-Hill Book Company, I n c ., 1959), p. 238.
50
Twentieth Century Fund, In c . , The National Debt
and Government C redit (New York: Twentieth Century Fund,
I n c . , 1937) , p. 27.
51
Buchanan, Public P rin c ip le s of Public D ebt,
p. 17.
117
What is new is the fa c t th a t th is philosophy can,
fo r the f i r s t tim e , be c a rrie d out in an environment
created by an e f f i c i e n t c e n tr a l banking system and an
economy operatin g on a broad c r e d it base. I t is th is
environment which perm its a c tio n on a sc a le not contem
p lated p reviously.
V. SU M M A R Y
The d ir e c t fe d eral debt is composed o f the t o t a l
fe d e ra l o b lig a tio n s and guaranteed s e c u r itie s held o u tsid e
of the Treasury. Although th is is the major segment with
which debt management is concerned, contingent l i a b i l i t i e s
g re a tly expand the influence o f the government in the
fin a n c ia l se c to r of the economy. S h iftin g between d ir e c t
and contingent fe d e ra l l i a b i l i t i e s occurs a t the govern
m ent's d is c r e tio n and has been used in re cen t times to
sid estep d e lib e ra te ly the Congressional debt c e ilin g .
These contingent l i a b i l i t i e s compete fo r funds in the
market place w ith d ire c t fe d e ra l o b lig a tio n s . They make
the task o f debt management more d i f f i c u l t .
The p riv a te debt s e c to r tends to be the m irror
image of the fe d e ra l debt s e c to r. S h iftin g takes place
118
between the two s e c to rs. Debt management must ex ercise
care not to impinge upon the fin a n c ia l scene to the
detrim ent o f p riv a te debt and economic growth.
Growth of n a tio n a l Income is a tru e aid in reducing
the burden of the debt. Growth of population or n a tio n a l
w ealth may or may not cause the burden of debt to dim inish.
The decrease o f debt burden due to i n f la tio n must be b a l
anced a g a in st any adverse e f f e c ts upon the economy as a
r e s u l t o f in f la tio n .
The impact of the burden of the debt is in d isp u te .
Opponents of d e f i c i t financing m aintain th a t i t is upon
the fu tu re g en eratio n s. Advocates of d e f i c i t financing
m aintain th a t the burden of the debt f a l l s upon the
p resent g en eratio n and t h a t , a t m o st, only a tr a n s f e r
burden e x is ts when the debt is held in te r n a lly .
Since the fe d e ra l debt is held i n te r n a ll y , i t
becomes e s s e n tia l th a t proper debt management be p a r ti c u
l a r ly concerned w ith the d i s t r ib u tio n o f the ownership of
the debt. The d is t r i b u ti o n o f debt ownership can aggra
vate or a l l e v i a t e the burden o f the debt by i t s e f fe c ts
upon the s iz e o f the n a tio n a l income. The d ecisions as to
who w ill own the debt are r e f le c te d in the m aturity
p a tte rn and in t e r e s t r a te p a tte rn of the fe d e ra l debt.
Both o f these p a tte rn s c re a te a d d itio n a l burdens, p a r tic u
la r l y in the microeconomic s e c t o r , as the economy seeks a
balance between p riv a te and public forces in the market
place. F in a lly , the techniques o f the debt manager can
in crease o r decrease the burden o f the d e b t, as debt
management po licy is used to implement f i s c a l and monetary
po licy .
CHAPTER IV
FACTORS AFFECTING THE DISTRIBUTION OF THE DEBT
Nearly a l l of the debt o f the federal government is
in te rn a lly held. However, the fa c t th a t "we owe the debt
to o urselv es1 1 provides l i t t l e solace. Since the "we" and
"ourselves" are not one and the same person, the debt which
autom atically seems to cancel i t s e l f out in the macro-
economic sense creates a m ultitude of problems.
The d is tr ib u tio n of debt ownership is determined a t
the time of the issuance, refunding, and retirem ent of the
debt. The Treasury a ffe c ts ownership o f the debt by i t s
decisions on the terms and types of debt se c u rity to be
issued. The Federal Reserve Board of Governors a ffe c ts
d is tr ib u tio n of the debt by governing the amount of surplus
funds th a t w ill be av a ilab le fo r government se c u rity
^Alvin Hansen, "Toward F ull Use of Our Resources,"
F ortu ne, XXVI, No. 5 (November 1942), 170.
120
121
Investment and the types of s e c u r itie s purchased and sold
in open market o p eratio n s. The Congress and the P resid ent
a f f e c t debt ownership by the p rovisions fo r tax atio n and
government ex p e n d itu re, and the p o l i t i c a l atmosphere
created . F in a lly , the p riv a te s e c to r of the economy
a f f e c ts fe d e ra l debt d i s t r i b u tio n by the n atu re of the
a lte r n a tiv e investment o p p o rtu n itie s th a t are made a v a i l
a b le , by i t s propen sity to save, and by i t s liq u id ity
preference.
An e n tir e m u ltitude o f debt management problems are
dependent upon d ecisio ns such as: Who is to possess the
debt? For what reason? Where are the funds coming from?
Why are they used in th is manner?
Debt managers have r e it e r a t e d two major o b jectiv es
r e la tin g to debt ownership. F i r s t , the debt manager seeks
to achieve a widespread d i s t r i b u ti o n of debt ownership.
Second , the p a tte rn of debt ownership is to be s ta b iliz e d
by encouraging the re te n tio n of s e c u r itie s already
purchased.
I. THE OBJECTIVES OF DEBT OWNERSHIP DISTRIBUTION
The debt manager d e s ire s the p a r tic ip a tio n of a l l
kinds of in v e sto rs. A legion of debt owners holding a
122
wide range of m a tu ritie s u su ally r e s u lts in inexpensive
financing and g re a te r s t a b i l i t y . Undue concentration of
the debt in any secto r is lik e ly to prove both expensive
2
and un stable.
F ittin g the In vesto rs' Needs
Broad ownership of the debt places an ad d itio n al
re s p o n s ib ility upon the debt manager. Every major section
of the economy can be affected by his ac tio n s. Recogni
tio n of th is re s p o n s ib ility ch aracterized World War I I
financing. The Treasury made a determined e f f o r t to avoid
the erro rs of World War I. S e c u ritie s were purposely
designed to f i t the needs of the d if f e r e n t classe s of
in v esto rs. This ta ilo r in g of the debt a t time of issuance
required continuous revamping as economic conditions
changed during periods of refunding and retirem en t of debt.
In World War I I , the id eal was to e s ta b lis h a
basket of s e c u ritie s from which each investor could se le c t
2
U.S., Treasury, Annual Report of the Secretary of
the Treasury, 1960 (Washington: Government Printing
Office, 1960), p. 316.
123
3
whatever most f i t t e d h is n eed s. Such com partm entalization
of debt was deemed d e s ira b le . The Treasury hoped to p re
vent a d is o rd e rly liq u id a tio n of s e c u r itie s through the
market. The aim was to avoid a r e p e titio n of the p o st-
World War I market debacle. I t was expected th a t the
v a r ie ty o f s e c u r itie s i n i t i a l l y employed to make fe d e ra l
o b lig a tio n s more a t t r a c t i v e would also serve to prevent
th e i r in ju d ic io u s r e s a le a t a l a t e r date. I f debt once
purchased was to be re ta in e d , then the T reasury, in i t s
debt management operations , would have to consider the
needs and wishes of i t s p ast and p o te n tia l customers.
A minimum amount o f fe d e ra l s e c u r itie s is a t
present a n e c e ssity to the economy. F in an cial and non-
fin a n c ia l i n s t it u t i o n s both have grown accustomed to the
ex isten ce o f government o b lig a tio n s in t h e i r p o r tf o lio s .
Such o b lig a tio n s provide investment o p p o rtu n itie s for
s h o r t - , in te rm e d ia te -, and long-term pools of funds. The
p riv a te economy would have to try to develop a s u f f i c ie n t
supply of s im ila r s e c u r itie s in t h e i r absence.
Henry C. Murphy, N ational Debt in War and T ra n si
tio n (New York: McGraw-Hill Book Company, Inc. , 1950),
p. 104.
124
To th is s ta b le base is added the marginal holdings
of s e c u r i ti e s . The m arginal amount of fe d e ra l debt held
by each c la ss of in v esto r is a function of debt management
d ec isio n s. F isc al a u th o rity , when form ulating debt manage
ment p o lic ie s , must consider w ith g re a t care whether a
p a r tic u la r course of ac tio n w ill widen or narrow these
m arginal holdings. At times the m arginal holdings are
knowingly and purposely overextended. For example, the
in v esto r during World War I I who overbought s e c u r itie s now
found th a t the force of i n e r t i a was conducive to holding
bonds r a th e r than cash. I f , as a r e s u l t , more s e c u r itie s
were permanently a llo c a te d , then the o v e rse llin g by the
Treasury was j u s t i f i e d . This assumes th a t the bonds th a t
were re so ld caused no economic i l l e f fe c ts .
Changes in the p a tte rn of debt ownership can produce
important economic consequences of them selves, independ
en tly of whether the debt i t s e l f is in creasin g or d ecreas
ing. The p a tte rn of fed eral debt ownership may be compared
to an in fla te d balloon--com press i t a t one point and i t
expands a t another.^
Charles Cortez Abbott, The Federal Debt (New York:
The Twentieth Century Fund, 1953) , p . 120.
Forced Savings
Should the p a tte rn o f ownership of s e c u r itie s become
too u n s ta b le , i t is w ith in the power o f the government to
use compulsion. With minor exceptions, such as corporate
excess p r o f i t refund bonds, the debt managers have chosen
to u t i l i z e the fre e market process. This was one of the
more d i f f i c u l t d ecisio ns p e rta in in g to World War I I
financing.
Arguments in favor o f some form of forced savings
emphasized th a t compulsion was not co n trary to democratic
p rin c ip le s . T axation, s e le c tiv e s e rv ic e , and m ilita ry
procurement were a l l accepted during the war. The only
d iffe re n c e between ta x a tio n and forced saving is th a t the
l a t t e r lig h te n s the blow by the promise of a postwar
refund: " I f i t is consonant with democratic p rin c ip le s to
h i t the taxpayer w ith b rass knuckles i t ought to be even
more so to h i t him with padded gloves."'* Forced savings
was advocated to supplement, not su p p lan t, rigorous wartime
ta x a tio n . The proponents of forced savings claimed th a t
i t could serve a double purpose. F i r s t , i t would decrease
Murphy, op. cit., p. 283.
126
e f f e c tiv e ly wartime spending, thus f a c i l i t a t i n g the exer
c is e of d ir e c t c o n tro ls. Second, forced savings would aid
the c o n tro l of postwar c y c lic a l p o licy . In fla tio n a ry
tendencies would be more amenable to co n tro l since the
d ecision to liq u if y the debt would be a government preroga
tiv e . Depression th re a ts could be combated due to the
ready source of expendable funds whose d is tr ib u tio n was
already designated.
The most fa m ilia r forms of compulsory lending make
use o f the tax mechanism and take the form of refundable
income and excess p r o f it s taxes. John Maynard Keynes and
h is follow ers championed the idea of d eferred savings in
Great B rita in a t the beginning o f World War I I . His plans
for financing World War I I were not adopted. B rita in did
provide fo r a refund o f the new wartime taxes on the lowest
incomes and a repayment of a lim ited p a rt of the taxes on
higher incomes.
Another type of forced saving was recommended by
Hugh D alton, B ritis h Chancellor of the Exchequer. Big
in v e s to rs , such as wealthy in d iv id u a ls and i n s t i t u t i o n s ,
would le g a lly be required to hold a prescribed p a rt of
127
t h e i r funds in public s e c u r i ti e s .^ This suggestion, th en ,
would c re a te for the in d iv id u al a fund s im ila r to the
secondary reserv e plan suggested fo r the banking system.
Canada and the United S tates both experimented with
the forced savings idea. Canada used compulsory loans in
the form of a refundable p o rtio n of the in d iv id u al income
tax. The United S tates tim id ly imposed the 5 per cent
" v ic to ry 1 * tax on in d iv id u a l incomes in 1942 , p a r t of which
was to be returned a f t e r the war. Also, a 10 per cent
c r e d it a g a in st the United S tates excess p r o f i t s tax was to
be refunded.^
The forced savings plan was ruled out as a major
segment of United S tates war financing. I t was f e l t th a t
a forced savings plan would in h ib it an in crease in ordinary
tax es. I t could se rio u sly a f f e c t voluntary sa le s programs
to s e l l s e c u r itie s . F in a lly , i t would in crease the
government-financing problems in the t r a n s i t io n period
following the war. In 1942 a l l suggestions fo r forced
^Hugh D alton, P rin c ip le s of Public Finance (London:
Routledge and Kegan Paul, L td ., 1954), p. 204.
7
A lfred G. B uehler, Public Finance (3d ed.; New
York: McGraw-Hill Book Company, I n c ., 1948), p. 652.
8
Annual Report of the S ecretary o f the T re asu ry .
128
savings were abandoned fo r th e rem ainder o f th e war. The
d e c is io n to r e ly upon th e "v o lu n ta ry way" and to support
the bond m arket a t p ar w ith a fix e d i n t e r e s t r a t e s tr u c tu r e
was made c o n c u rre n tly w ith th e d e c is io n t h a t some bonds be
made i n e l i g ib l e fo r bank ow nership. I t was hoped th a t
r e s t r i c t i n g bank ownership would serv e as an i n f l a t i o n
check.
Bank R e s tric te d Bonds
Bank r e s t r i c t e d bonds were decided upon a f t e r a long
p erio d o f d is c u s s io n . One school o f thought b e lie v e d th a t
the s e c u r i ti e s o ffe re d to commercial banks should be v a rie d
by an o c c a sio n a l change o f pace. Some medium- o r long-term
issu e s w ith coupons as high as 2-1/4 per c e n t, o r p o s sib ly
2-1/2 p er cent should be in clu d ed . The o th e r school
b e lie v e d th a t th e re should be an a b so lu te lim ita tio n o f
ten years on the m a tu rity and 2 p er ce n t on th e coupon
r a te a v a ila b le fo r commercial bank s u b s c rip tio n . The
l a t t e r school o f thought p re v a ile d . I t was backed by th e
re p o r t o f th e Economic P o lic y Commission o f th e American
B anker's A s so c ia tio n , the T re a su ry , and th e F ederal
129
9
Reserve System.
The m ajor e f f e c t o f t h i s d e c is io n was th a t i t made
banks i n e l i g ib l e to purchase long-term bonds. This
r e s t r i c t i o n was c a r r ie d forw ard in to the postw ar p e rio d .
L im ita tio n s were placed on th e a b i l i t y o f commercial banks
to su b sc rib e to long-term bonds. The T reasury a ls o d i s
crim in ated a g a in s t commercial banks in th e allo tm e n t o f
long-term s e c u r i ti e s th a t were bank e l i g i b l e . One j u s t i f i
c a tio n o f th e se a c tio n s supposedly lay in the d e s ir e to
p ro te c t th e l i q u id i t y o f th e commercial banks.
The Government would c e r ta in ly be doing th e
banks no favor i f i t p e rm itte d them to load them
se lv e s w ith long-term is s u e s . A lso , th e low r a te s
were j u s t i f i e d on th e b a s is th a t th e se funds were
th e r e s u l t o f d e p o sit c r e a tio n and th e re fo re
re p re se n te d an i n d ir e c t subsidy to th e b an k s.10
The arguments fo r and a g a in s t a bank subsidy a re p re se n ted
l a t e r in t h i s c h a p te r.
As a r e s u l t o f t h i s d e c is io n , more than h a l f o f the
t o t a l in c re a s e in the p u b lic debt th a t occurred in the
y ears 1940-1946 re p re se n te d s e c u r i ti e s th a t were r e s t r i c t e d
Murphy, op. c i t . , p. 116.
^ A d d re ss b efo re the Investm ent Banking A sso c ia tio n
a t W ashington, D .C ., O ctober 19, 1942, by U n d ersecretary of
th e T reasury B e ll, c ite d in Annual Report o f th e S e c re ta ry
o f th e T re asu ry , 1943, p. 390.
130
as to bank ownership fo r a p erio d o f y e a rs. These bank
r e s t r i c t e d m arketable bonds were an e n t i r e l y new type of
debt in stru m e n t, and by 1946 embodied o n e - f i f t h o f th e
t o t a l debt.*'*'
At the beginning o f World War I I , long-term bond
issu e s were issu ed in r e g is te r e d form to in s u re th a t they
were not purchased by banks. However, i t was found th a t
such p o lic in g was n o t n e c e ssa ry . There were th re e excep
tio n s to th e r e s t r i c t i o n on bank ow nership. F i r s t , during
th e F o u rth , F i f t h , and S ix th V icto ry Loan D riv e s,
commercial banks were p e rm itte d purchases fo r th e lim ite d
investm ent o f t h e i r sav ings d e p o s its . Second, tem porary
a c q u is itio n s by commercial banks o f r e s t r i c t e d is s u e s due
to f o r f e i t u r e o f c o l l a t e r a l were allow ed. T h ird , commer
c i a l banks were encouraged to hold a lim ite d amount o f
bank r e s t r i c t e d T reasury bonds fo r tra d in g purposes. In
t h i s way banks could re n d er b e t t e r s e rv ic e to in d iv id u a ls
and c o rp o ra tio n s w ishing to tra d e in bank r e s t r i c t e d
12
bonds. This a c tio n provided a lim ite d amount of
*~*~Annual Report of the Secretary of the Treasury,
1946, p. 294.
^ Ibid. , p. 43.
131
u n d e rw ritin g o f T reasury iss u e s by the banking system .
R e s tr ic tio n s upon commercial banks' purchases of
long-term government bonds had s a c r if ic e d an e f f e c tiv e
source o f u n d e rw ritin g s e rv ic e th a t the banks could have
provided to th e T reasury. This s a c r i f i c e was u n j u s t if ie d
sin c e th e re was nothing to p re v en t th e banks from buying
e l i g i b l e s e c u r i t i e s in th e secondary m arket when T reasury
a llo tm e n ts were in ad eq u ate. A lso, th e passage o f tim e
g ra d u a lly moved more and more o f th e d eb t in to th e bank-
e l i g i b l e categ o ry .
The f a c t th a t m arket s a le s were ra p id ly t r a n s f e r r in g
e l i g i b l e bonds from nonbank in v e s to rs to banks was apparent
to both th e T reasury and th e F ed eral Reserve System. The
h is to r y o f th e war loans c o n s is ts la r g e ly in th e d isc u ss io n
o r adoption o f su c c e ssiv e ex p ed ien ts to block t h i s .
R e tre a ts from th e se ex p ed ien ts occu rred when they t h r e a t
ened to be so su c c e ss fu l as to slow down th e s a le s to the
nonbank s e c to r . About 12 per c e n t o f th e i n i t i a l nonbank
s u b s c rip tio n s were financed by loans which were u s u a lly
re p a id q u ick ly a f t e r th e d riv e s by bank purchases o f th e
1 ^
s e c u r i t i e s o r ig in a lly fin an ced . This backflow gave r i s e
^"^Murphy , op. cit. , pp. 188-190.
132
to the re p re h e n s ib le p r a c tic e o f wartim e " f r e e r id in g ."
Free R iding
The peacetim e p r a c tic e o f fix in g th e terms o f new
government o ffe rin g s so as to in s u re t h e i r success in the
m arket g e n e ra lly r e s u lte d in such s e c u r i ti e s being so ld a t
a premium as soon as tra d in g began. As a r e s u l t o f t h i s ,
sp e c u la to rs adopted th e p r a c tic e o f su b s c rib in g fo r s e c u r
i t i e s w ith the in te n tio n o f s e ll i n g them in the open
m arket as soon as a c tiv e tra d in g s ta r t e d . This a c tio n came
to be termed " f r e e r id in g ." B efore th e w ar, such sp e c u la
tio n was lim ite d . Everyone, in c lu d in g th e commercial
b a n k s, had an o p p o rtu n ity to su b sc rib e w itho ut lim it a t
th e o ffe rin g p ric e . T h e re fo re , th e p r o f i t from such
s p e c u la tio n was sm all and u n c e rta in . However, th e wartime
p r a c tic e o f d is c rim in a tin g a g a in s t banks in th e a llo tm e n t
o f b a n k - e lig ib le s e c u r i ti e s , w hile awarding f u l l a llo tm e n ts
to in d iv id u a ls , r e s u lte d in a ready r e s a le m arket fo r th e
fre e r i d e r .
The m oderate p r o f i t s enjoyed by fre e r id e r s du ring
th e e a rly war loans re s u lte d in g r e a te r s p e c u la tiv e
p re ssu re s in the l a t e r war lo an s. The T reasury endeavored
to disco u rag e s p e c u la tio n by new re g u la tio n s . D ealers
133
were req u ested not to purchase s e c u r i ti e s b e fo re they were
a v a ila b le fo r d e liv e ry . The s u b s c rip tio n blank was a lte r e d
to in clu d e a pledge not to s e l l s e c u r i ti e s b e fo re th e sub
s c r ip tio n books c lo se d . S u b scrib ers were asked to agree
to accep t delayed d e liv e ry in r e g is te r e d bonds. The
T reasury rese rv ed th e r i g h t to r e j e c t or modify s u b s c rip
tio n a p p lic a tio n s from suspected fre e r i d e r s . Commercial
banks were re q u ested to d e c lin e to make loans to fin an ce
s p e c u la tiv e s u b s c rip tio n s . F in a lly , T reasury p o s t-d riv e
o ffe rin g s to banks were suggested to reduce the source of
fre e r i d e r p r o f i t s . A ll o f th ese a c tu a l o r contem plated
m easures were o f no a v a il.
The V ictory Loan was follow ed by a wave o f sp e c u la
tio n which se n t premiums on the bank r e s t r i c t e d s e c u r i ti e s
o ffe re d in the loan up to $4.44 p er $100 two months a f t e r
the beginning o f tra d in g . I t is d o u b tfu l i f an o th er loan
could have been concluded a f t e r the V icto ry Loan w ith o u t a
d r a s t i c re v is io n o f techniques to c u r t a i l fre e r i d i n g . ^
Free r i d i n g , which had been frowned upon as
u n p a tr io tic during the w ar, flo u ris h e d in th e postw ar
p erio d . Of the t h i r t y - f i v e refu n d in g o p e ra tio n s which
14Ibid. , p. 183.
134
took p la c e during the p erio d o f 1953-1957, only fo u r d id
n o t r e s u l t in premium p ric e s when tra d in g o p e n e d . T h e
clim ax came in 1958 when re p u ta b le f in a n c ia l and n o n fin an -
c i a l c o rp o ra tio n s not only extended q u e stio n a b le lo a n s ,
b u t jo in e d in th e re v e lry th em selv es. ^
The abuse o f s p e c u la tiv e c r e d i t r e s u lte d in a study
o f th e government s e c u r i ti e s m arket by th e T reasury and
th e F ed eral R eserve. Many d i s in te r e s t e d o b se rv e rs f e l t
th a t th e sponsors o f the study o f th e government s e c u r i ti e s
m ark et, th e T re a su ry , and the F ed eral R eserve System
them selves could not avoid a sh are o f th e b la m e .^
The co n clu sio n o f the study was th a t the ex ten sio n
o f c r e d i t w ithout adequate m argin fo r th e purpose o f
c a rry in g s p e c u la tiv e p o s itio n s in government s e c u r i tie s
was a c o n trib u tin g f a c to r to th e d is r u p tiv e f lu c tu a tio n s
in government s e c u r i t i e s p ric e s during th e l a t e sp rin g and
U .S ., S en ate, Committee on F in an ce, H e a rin g s.
In v e s tig a tio n o f th e F in a n c ia l C ondition in th e U nited
S ta te s , 85th C ong., 1 s t S e s s ., Ju ly -A u g u st, 1957, Appendix
B, pp. 691-692.
16
U .S ., House, Committee on Ways and Means,
H e a rin g s» P ublic Debt C e ilin g and I n t e r e s t Rate C e ilin g on
Bonds, 86th C ong., 1 st S e s s ., June 1959, p. 248.
17
New York Times, March 15, 1959, p. 1-F.
135
18
summer o f 1958. The need fo r a c tio n to assu re sound
c r e d it standards in government s e c u r itie s d ealin g s was
dem onstrated, but to d a te has not been acted upon. The
apparent conclusion to be drawn is th a t the use o f bank
r e s t r i c t e d s e c u r itie s o r nonbank p re fe rre d allo tm en t p ro
cedures have proved in e f f e c tu a l, outmoded, and conducive
to uncommendable a c tio n s on th e p a r t o f the fin a n c ia l
community and the g e n e ra l p u b lic .
I I . THE SOURCES OF FUNDS FOR DEBT OW NERSHIP
In C hapter I I i t was p o inted out th a t 46 per cent
o f the needed funds in World War I I were ra is e d by ta x a tio n
19
as c o n tra ste d to 28 per cent in World War I . Even w ith
the v a s tly improved ta x - r a is in g e f f o r t o f World War I I ,
th e re s t i l l remained 54 per ce n t o f t o t a l exp en ditures fo r
the f i s c a l p eriod 1940-1946 to be ra is e d . This sum
re p re se n te d 211 b i l l i o n d o lla r s .
How could such a sum be c o lle c te d ? O bviously, the
e x is tin g in a c tiv e cash balances were inadequate. The
18
Annual Report of the Secretary of the Treasury,
I960, p. 304.
19
Supra, p. 45.
136
growth o f n a tio n a l income g en erated by government spending
would be an a d d itio n a l source o f funds as c u rre n t savings
in c re a se d . Assuming th a t th o se who re c e iv e d th e d e f i c i t
funds sp en t by the government saved a l l o f i t , th e a d d i
tio n a l sum could be financed in th i s manner. For example,
i f a "fo rced sav in g s" p lan o f s u f f i c i e n t m agnitude to
absorb th e e q u iv a le n t o f 54 p er cen t o f th e governm ent's
ex p en d itu re had been in au g u rated along w ith th e e x is tin g
tax system , t h i s would have been s u f f i c i e n t to finance
World War I I .
V oluntary fin a n c in g did n o t achieve th i s le v e l o f
sav in g s. That p o rtio n o f war ex p en d itu re n o t paid fo r by
ta x a tio n o r v o lu n ta ry saving was financed by c r e a tin g new
d e p o s its through th e banking system .
I t is o b v io u s, th e n , th a t th e ow nership o f the
fe d e ra l debt may be c a te g o riz e d in to two main b o d ie s --
bank and nonbank h o ld e rs . Nonbank in v e s to r s ' funds came
la rg e ly from p revio us cash b alan ces and savings accum ulated
from c u rre n t income p lu s any p o s s ib le s h i f t i n g from o th e r
e x is tin g in v estm en ts. The funds fo r government s e c u r ity
investm ent by banks came la rg e ly from new d e p o s it c r e a tio n s
which supplemented e x is tin g investm ent c a p it a l funds. Of
137
the funds expended by the government in World War I I ,
46 p er cent were provided by ta x a tio n , w hile nonbank
in v e sto rs su pplied alm ost 34 per cent and the banking
20
s e c to r su p p lied alm ost 21 per cen t o f the rem ainder.
In a d d itio n to o r ig in a l purchases d i r e c tl y from the
T reasu ry , commercial banks were in d ir e c tly re sp o n sib le fo r
a co n sid erab le volume o f o th e r bond s a le s . This was
dem onstrated by the prevalence o f the p r a c tic e o f fre e
rid in g . The end r e s u l t o f m arket purchases o f bonds by
the banking s e c to r was th a t by th e end o f the w ar, the
p o rtio n o f the fe d e ra l government debt held by the banking
s e c to r had expanded to 42 per c e n t. This occurred d e s p ite
a determ ined e f f o r t on the p a r t o f the Treasury to reduce
bond s a le s to the commercial and F ederal Reserve Banks.
D espite the tremendous in c re a se in s e c u r itie s o u t
stand in g fo r the f i s c a l p eriod 1940-1946, the percentage
d is tr i b u tio n between bank and nonbank in v e sto rs remained
alm ost th e same throughout the s ix -y e a r p erio d . However,
c o n sid erab le percentage change occurred in the d is tr ib u tio n
o f ownership o f th e fe d e ra l debt due to postwar debt
?n
Murphy, op. cit., p. 25 7.
138
management d e c is io n s . These tre n d s a re d is c e r n ib le in
Table I I , which shows th e d i s t r i b u ti o n among th e m ajor
c la s s e s o f in v e s to rs .
From Table I I i t is c le a r th a t the commercial banks
have experienced a stead y d ecrease in t h e i r ho lding of
fe d e ra l debt sin c e th e end o f World War I I . They r e l i n
quished t h e i r p o s itio n as th e la r g e s t c la s s o f in v e s to r in
fe d e ra l debt to in d iv id u a ls . W ithin th e nonbank in v e s to r 's
categ o ry a d ecrease occurred in the fe d e ra l o b lig a tio n s
held by in su ran ce companies and m utual savings banks.
Both groups cut t h e i r d o lla r hold in g s approxim ately in h a lf
a f t e r the war. Government T ru st Funds moved in the
o p p o site d ir e c tio n . Although th e percen tag e o f debt held
by Government T ru st Funds a c tu a lly decreased during the
w ar, in the postw ar p erio d th e se h o ld in gs showed a most
pronounced percen tag e in c re a s e , alm ost doubling in s iz e .
However, i t was th e s t a t e and lo c a l government hold in g s of
fe d e ra l debt and m iscellaneous in v e s to rs which e x h ib ite d
the g r e a te s t percen tag e in c re a s e . These s e c to rs a c tu a lly
doubled and t r i p l e d t h e i r p ercen tag e sh ares o f th e fe d e ra l
d eb t. F ederal Reserve banks, in d iv id u a ls , and c o rp o ra tio n s
dem onstrated a tendency toward s t a b i l i t y a f t e r t h e i r
TABLE II
DISTRIBUTION OF THE OW NERSHIP OF THE FEDERAL DEBT
A M O N G THE M AJOR CLASSES OF INVESTORS
June 30 , 1941 February 28, 1946 June 30, 1960
Category Amount* Percentage Amount* Percentage Amount* Percentage
Banks
Commercial $19.7 36 $93.8 34 $55.6 19
Federal Reserve 2.2 4 22.9 8 26.5 9
Total $21.9 40 $116.7 42 $82.1 28
P riv a te Nonbank In v esto r
Individual $11.2 20 $64.0 23 $68.2 24
Insurance companies 7.1 13 24.4 9 11.8 4
Mutual savings banks 3.4 6 11.1 4 6.6 2
C orporations 2.0 4 19.9 7 21.7 8
S tate and lo c a l g o v ts. .6 1 6.7 2 18.1 6
M iscellaneous in v esto rs .7 _1 8.9 _3 22.5 _9
Total $25.0 45 $135.1 48 $149.0 53
Govt. T rust Funds $8.5 15 $28.0 10 $55.3 19
T otal debt $55.3 100 $279.8 100 $286.5 100
Note: D iscrepancies are due to rounding.
*C alculated in b illio n s of d o lla rs .
139
140
wartime accum ulation o f fe d e ra l d eb t. The a c tio n s o f each
c la s s o f in v e s to r w ill be examined in more d e t a i l in the
follow ing ch a p te r.
The Bank Subsidy C ontroversy
The i n i t i a l d e c isio n to allow the commercial banks
to perform the bulk o f the n ecessary d e p o sit c re a tio n had
been a ttack e d from th e very in au g u ratio n o f war fin an cin g .
This d e c isio n was tantam ount to the adoption o f a subsidy
program fo r commercial banks. Bank purchases o f s e c u r itie s
from d e p o sit c re a tio n are not an o rd in ary "market" t r a n s
a c tio n of the exchange o f e q u iv a le n ts. The government
could have issued i t s c r e d it instrum ents in the form of
currency o r fe d e ra l re se rv e bank d e p o s its .
Since c re a tin g demand d e p o sits e n t a il s no s a c r if i c e
on the p a r t o f the commercial bank, th e debt se rv ic e charge
could have been placed as low as was deemed d e s ira b le .
D espite th is obvious f a c t , e a rly war fin an cin g a t the 2 per
cent r a te went badly. The F ederal Reserve System had to
employ moral suasio n in the l a s t few hours o f the 1942
o ffe rin g to in su re th e success o f the is su e . Under
s e c re ta ry o f the Treasury B ell pointed out the obvious.
In an address to the Investm ent Banking A sso ciatio n he
141
denied d is c rim in a tio n a g a in s t b a n k s, n o tin g th a t "a la rg e
p a r t o f th e s e c u r iti e s which w il l be bought by banks w ill
be financed by in c re a s e s in d e p o s its fo r the banking
21
system as a w hole." By th e end o f th e w ar, alm ost one
h a lf o f th e commercial banks' t o t a l earn in g s came from
22
t h e i r h o ldings o f U nited S ta te s government o b lig a tio n s .
The f i n a l d i s t r i b u t i o n o f th e bank subsidy is a
m a tte r o f s p e c u la tio n . There a re th re e p r in c ip a l r e c i p
ie n ts . Time d e p o s ito rs gain to th e e x te n t th a t government
i n t e r e s t h elp s pay fo r i n t e r e s t on sav in g s. Demand
d e p o s ito rs g ain to th e e x te n t th a t they re c e iv e banking
s e rv ic e in excess o f s e rv ic e c o s ts to them. F in a lly ,
sto ck h o ld ers g ain to th e e x te n t th a t government i n t e r e s t
h elp s pay cash d iv id en d s. Who g ain s th e most? According
to one s tu d y , th re e q u a rte rs o f th e i n t e r e s t paid by th e
U nited S ta te s government on fe d e ra l s e c u r i t i e s h eld by
commercial banks went in to the pockets o f the sto ck h o ld ers
Annual Report o f the S e c re ta ry o f the T re a s u ry ,
1943, p. 390.
22
Donald C. M ille r , Taxes , th e P u b lic D eb t, and
T ra n sfe rs o f Income (Urbana: U n iv e rsity o f I l l i n o i s
P re s s , 1950), p. 107.
142
o f th e banks in 1 9 4 5 .^
I n d ir e c t s u b s id iz a tio n o f banks has continued in
th e postw ar p e rio d . I t is th e r e s u l t o f the F ederal
Reserve System 's p o lic y o f reducing re se rv e requirem ents to
f ig h t re c e s s io n and s e ll i n g s e c u r i ti e s in th e open m arket
to f ig h t i n f l a t i o n . Since 1951 re se rv e requirem ents have
been reduced s e v e ra l tim e s, p r in c ip a lly in fig h tin g th e
re c e s s io n s o f 1953-1954 and 1957-1958. The banks used a
g re a t d e a l o f th is newly c re a te d excess re s e rv e to purchase
government s e c u r i t i e s r a th e r than to extend b u sin e ss loans
which would h elp f ig h t th e re c e s s io n . In f i s c a l 1955 th e
F ed eral Reserve p o r tf o lio o f government s e c u r i t i e s was
reduced by $1.4 b i l l i o n , la rg e ly due to th e re d u c tio n o f
24
member bank re se rv e requirem ents in th e summer o f 1954.
In 1959 Chairman M artin t e s t i f i e d th a t th e F ed eral Reserve
System made a v a ila b le enough money in 1958 fo r th e banks
to extend c r e d i t amounting to about 10.5 b i l l i o n d o l l a r s .
23
Nien Min Sun, "An Economic A nalysis o f th e Burdens
o f th e P u b lic Debt" (unpublished Ph.D. d i s s e r t a t i o n , The
U n iv e rsity o f Southern C a lif o r n ia , Los A ngeles, 1950),
p. 158; F ed eral Reserve B u lle tin (Washington: Government
P rin tin g O ffic e , November 1945), pp. 1353, 1388.
24
Annual R eport o f th e S e c re ta ry o f th e T re a s u ry ,
1955, p. 33.
143
Congressman Patman pointed out:
. . . th e banks made investm ents in U nited S ta te s
government bonds to th e tune o f 10.4 b i l l i o n a t
t h i s tim e which they re c e iv e d a b s o lu te ly fre e by
reaso n o f th e f r e e re se rv e s given to them by th e
F ed eral Reserve System .25
The funds made a v a ila b le by red u cin g re s e rv e requirem ents
remained in v e ste d in government s e c u r i ti e s during th e
re c e s s io n p e rio d , but were liq u id a te d to provide th e funds
demanded by th e m arket d uring th e ensuing t i g h t money
p e rio d . Such an occu rren ce r e s u lte d in a m u ltip le burden
on th e economy. F i r s t , a d d itio n a l i n t e r e s t payments went
to th e commercial b a n k s, which could have been re ta in e d by
th e government. Second, F ed eral Reserve m onetary p o lic y
was in e f f e c tiv e in th e re c e ss io n a ry p erio d and negated in
the follow ing in f la tio n a r y p e rio d .
Since 1951 th e F ed eral Reserve System has v i r t u a l l y
abandoned th e m an ip u latio n o f re se rv e requirem ents as an
a n t i - i n f l a t i o n a r y m easure. In s te a d , i t has emphasized open
m arket o p e ra tio n s . The F ed eral R e se rv e 's in s is te n c e upon
fu tu re p u r s u it o f t h i s p o lic y has occasioned some p a r ti c u
l a r l y b i t t e r C ongressional comment. A proposed amendment
25
U .S ., House, Committee on Ways and Means, H ear
ings , P u b lic Debt C e ilin g and I n t e r e s t Rate C e ilin g on
Bonds, 86th C ong., 1 s t S e s s ., June 1959, p. 228.
144
to the Federal Reserve Act, stated:
. . . th e system to th e g r e a te s t e x te n t p o s s ib le
should b rin g about needed fu tu re m onetary expansion
by purchasing U nited S ta te s s e c u r i t i e s o f vary in g
m a tu r itie s r a th e r than by low ering bank re se rv e
req uirem ents and th a t th e system should prom ptly
and f u l l y ex p lo re methods whereby use o f th e
power to r a i s e re se rv e requ irem ents may become a
more u sa b le and e f f e c tiv e a n t i - i n f l a t i o n a r y to o l.^ 6
Although Congress did not pass th e amendment, C ongressional
debate d id serv e to emphasize th e bank subsidy im p lic a tio n s
o f F ed eral Reserve monetary p o lic y .
I n t e r e s t r e c e ip ts a re n o t th e only fe d e ra l aid to
the banking system . The huge supply o f id e n tic a l o r n e a rly
id e n tic a l s e c u r i t i e s in each m a tu rity b ra c k e t enables
commercial banks to work out p r o f i t a b l e tax swaps in gov
ernment is s u e s . Under 1958 tax law s, commercial banks may
pay c a p i t a l gain s tax on n e t c a p it a l g ain s during a tax
y ear. But i f they in c u r a n e t c a p i t a l lo ss on s e c u rity
tra n s a c tio n s d uring th e year the lo ss may be ap p lied
a g a in s t c u rre n t income. The d iffe re n c e between th e 52 per
cen t income tax and th e 25 per c e n t c a p it a l g ain s tax
makes i t p r o f i t a b le to co n v ert book lo s s e s in to r e a liz e d
lo s se s th a t can be used to reduce c u rre n t income. This is
26Ibid. , p. 253.
145
done by s e l l i n g th e s e c u r i t i e s and th en buying them back
a g a in . When p r ic e s a re h ig h , th e banks s e l l th e s e c u r
i t i e s , paying a c a p i t a l g a in s ta x on th e p r o f i t , and buy
s im ila r s e c u r i t i e s a t th e same tim e. In t h i s way a new
book v a lu e is e s ta b lis h e d a g a in s t which lo s s e s may be tak en
in th e f u t u r e . 22
I f a sub sid y to th e banking system i s j u s t i f i e d and
d e s i r a b le , i t should be openly d e sig n a te d as such. P ro
v id in g a su b sid y in th e form o f i n t e r e s t payments on bonds
is c o n fu sin g , d e v io u s, and s u b je c t to abuse. I t runs
c o n tra ry to th e accep ted American concept th a t our i n s t i t u
tio n s should su p p o rt th e government r a t h e r th an v ic e v e rs a .
T o ta l A s s e ts --F e d e ra l S e c u r itie s
H oldings R atio
In a p p ra is in g th e amount o f d eb t h eld by each c la s s
o f in v e s to r , i t i s v a lu a b le to know what p e rc e n ta g e o f th e
i n v e s t o r 's t o t a l a s s e ts th e s e d eb t h o ld in g s r e p r e s e n t.
However, c a re should be taken in ap p ly in g th e average
f ig u r e s o f th e e n t i r e c la s s o f in v e s to rs to in d iv id u a l
27
T ilf o r d C. G ain es, "T echniques o f T reasu ry Debt
Management" (u npublished Ph.D. d i s s e r t a t i o n , Columbia
U n iv e r s ity , 1960), p. 328.
146
i n v e s to r s . As an i l l u s t r a t i o n , in 1946, when governm ent
s e c u r i t i e s amounted to n e a r ly one h a l f o f a l l l i f e i n s u r
ance a s s e t s , some com panies had on ly 15 p e r c e n t o f t o t a l
a s s e ts in t h i s form , w h ile th e r a t i o o f o th e r companies
28
reach ed as h ig h as 67 p e r c e n t.
D uring World War I I th e la r g e grow th o f f e d e r a l d e b t
had a tw ofold e f f e c t on th e v a rio u s segm ents o f th e
economy. F i r s t , i t in c re a s e d th e t o t a l l i q u id a s s e t s o f
a l l s e c to r s . Second, i t e n la rg e d th e p o r tio n o f liq u id
a s s e t s t h a t were h e ld in f e d e r a l o b l i g a t io n s . Government
s e c u r i t i e s became th e dom inant form o f in v estm en t f o r th e
e n t i r e economy.
The p e rc e n ta g e o f t o t a l a s s e t s in v e s te d in f e d e r a l
s e c u r i t i e s e x h ib its v a ry in g tr e n d s . For some i n v e s t o r s ,
such as th e com m ercial banks , th e p e rc e n ta g e o f t o t a l
a s s e ts p la c e d in governm ent o b li g a t io n s f lu c tu a te d w id ely .
The p o r tio n o f e a rn in g a s s e t s in v e s te d in f e d e r a l s e c u r
i t i e s by com m ercial banks in c re a s e d from 38 p e r c e n t in
1939 to 65 p e r c e n t in 1946. In th e postw ar y e a rs t h i s
r a t i o d e c re a se d to 45 p e r c e n t by 1952 and f u r t h e r to
28
Ibid. , p. 338.
147
29
36 per c e n t a t the end o f f i s c a l 1956.
Insurance companies e x h ib it a s im ila r tendency fo r
th e p ercen tag e o f a s s e ts in v e ste d in U nited S ta te s s e c u r i
t i e s to f lu c tu a te . The p ro p o rtio n o f t o t a l a s s e ts to
fe d e ra l debt h eld by in su ran ce companies ro se d uring World
War I to 11% p er c e n t. T h e re a fte r i t decreased during th e
p ro s p e rity o f th e 1 9 2 0 's. By 1930 government s e c u r i ti e s
comprised le s s than 2 p er cen t o f t o t a l in su ran ce companies'
a s s e t s . On th e eve o f U nited S ta te s ' e n try in to World
War I I , th e percen tag e o f fe d e ra l s e c u r i t i e s to t o t a l
a s s e ts had r is e n to 20 p e r c e n t. This in c re a se continued
to m an ifest i t s e l f throughout th e war. At th e end o f
World War I I , th e r a t i o o f a s s e ts to fe d e ra l d eb t reached
a high o f 46 p er c e n t. From t h i s p o in t i t decreased
30
s te a d ily . Today i t is le s s than 5% p er c e n t.
Some in v e s to rs tend to m ain tain the same p ercen tag e
o f a s s e ts in fe d e ra l d eb t. For example, Savings and Loan
A sso ciatio n s have in cre ased t h e i r government h o ld in g s from
Annual Report o f th e S e c re ta ry o f the T re a s u ry ,
1957, p. 25.
30
L ife Insurance F act Book (New York: I n s t i t u t e
o f L ife In su ra n c e , 1961), p. 71.
y ear to y e a r approxim ately in s te p w ith th e growth o f
t o t a l a s s e ts and sh are c a p it a l . The r a t i o o f government
o b lig a tio n s to t o t a l a s s e ts has h eld in th e range o f 7 per
Reserve C re d it
Reserve c r e d i t may be d efin e d as th e funds fu rn ish e d
to commercial banks when th e F ed eral Reserve Banks ac q u ire
c e r ta in a s s e t s , p rim a rily government s e c u r i t i e s . T o tal
F ederal R eserve Bank h o lding s o f U nited S ta te s government
s e c u r i ti e s amounted to le s s than $2 b i l l i o n b e fo re the
d ep ressio n o f th e 1 9 3 0 's. During 1933 th e F ed eral Reserve
System in cre ased i t s p o r tf o lio by $.5 b i l l i o n and i t
remained alm ost c o n sta n t a t t h i s le v e l u n t i l 1941. With
the ou tb reak o f w ar, re s e rv e c r e d i t expanded ra p id ly . The
F ed eral Reserve System purchased la rg e amounts o f govern
ment s e c u r i t i e s fo r the double purpose o f su p p o rtin g the
government bond m arket and o f supplying banks w ith a d d i
tio n a l re s e rv e s . By th e end o f th e V icto ry Loan o f
December 31, 1945, re se rv e c r e d i t had reached a peak o f
alm ost $25 b i l l i o n .
Annual Report of the Secretary of the Treasury»
1959, p. 241.
149
In th e e a rly postw ar p erio d th e T reasury debt
re d u c tio n program was aimed p rim a rily a t r e t i r i n g th e debt
h eld by th e F ed eral Reserve Banks. P r io r to th e outbreak
o f th e Korean War, th e t o t a l o f re se rv e c r e d i t had dropped
to $17.5 b i l l i o n - - a drop o f n e a rly one th ir d from th e war
tim e high o f $25 b i l l i o n . During th e l a s t h a lf o f 1950,
re se rv e c r e d it expanded ra p id ly . By th e tim e o f th e
T reasu ry -F ed eral Reserve Accord in March 1951, re se rv e
32
c r e d it had rebounded to $23 b i l l i o n . I t has not f l u c
tu a te d s i g n i f i c a n t l y from t h i s le v e l sin c e the Accord.
However, s i g n i f i c a n t changes in th e com position o f re se rv e
c r e d i t have o ccu rred . The m ixture o f s e c u r i ti e s h eld by
th e F ed eral Reserve System is a fu n c tio n o f the d e s ire s o f
the o th e r in v e s to r c la s s e s . U n til December 1947, when the
su pport p ric e s fo r T reasury s e c u r i t i e s were lowered on
C hristm as Eve, v i r t u a l l y a l l o f th e re se rv e c r e d i t hold ings
o f government s e c u r i ti e s had a m a tu rity o f le s s than one
y ea r. This was to be expected sin c e th e li q u id i t y o f the
2% p er c e n t bonds was assured by government sup port o f
m arket p r ic e s . In v e sto rs h eld th e h ig h e r paying long-term
32
Annual Report of the Secretary of the Treasury,
1951, p. 251.
150
a s s e ts and so ld th e lower y ie ld in g sh o rt-te rm s e c u r iti e s
to th e F ed eral Reserve as long as th e l i q u id i t y o f th e two
s e c u r i ti e s appeared to a l l in te n ts and purposes to be
equal.
As soon as confidence in th e fu tu re l i q u i d i t y a t o r
above p ar o f long-term s e c u r i ti e s was shaken, in v e s to rs
q u ick ly re v ersed t h e i r p o s itio n s . W ithin one y e a r a f t e r
su pp ort p ric e s were low ered, o b lig a tio n s due o r c a lla b le
beyond one y ear expanded from 5 p er cen t o f th e F ed eral
Reserve System 's p o r tf o lio to 50 p er c e n t. S e c u r itie s in
th e te n - to tw enty-year b ra c k e t were n e a rly one th ir d o f
th e t o t a l . There was no expansion in t o t a l hold in g s a t
th i s tim e because long-term s e c u r i t i e s purchases were
33
o f f s e t by sh o rt-te rm s e c u r i t i e s s a le s .
I I I . M ETHODS OF CATEGORIZING DEBT OWNERSHIP
Various in te r p r e ta tio n s can be drawn from the
p a tte r n o f ownership o f th e d e b t. These in te r p r e ta tio n s
depend upon th e c r i t e r i a used fo r grouping d i f f e r e n t
c la s s e s o f in v e s to rs .
Annual Report of the Secretary of the Treasury,
1949, p. 325.
151
Ownership Is sometimes se p a ra te d in to th e two
c a te g o rie s o f government ow nership and nongovernment
ownership o f fe d e ra l d e b t. Such a s e p a ra tio n serv es to
emphasize th e d iffe re n c e in management problem s. However,
the c o n te n tio n th a t th e d eb t owned by th e government m erely
e n t a i l s bookkeeping adjustm ents is a dangerous o v er
s im p lif ic a tio n .
Government h eld d ebt must be managed w ith c a re
because d eb t owned by th e F ed eral R eserv e, government
agencies , and T reasury t r u s t funds i s fre q u e n tly s h if te d
over to th e nongovernment s e c to r . Two i l l u s t r a t i o n s o f
such s h i f t i n g w ill dem onstrate th e p o in t:
F i r s t , in 1946, when th e long -term government
s e c u r ity m arket was s u b s ta n tia lly above par and th re a te n in g
to r i s e f u r t h e r , the T reasury in cre ased th e m arket supply
o f long-term bonds by s e l l i n g from i t s t r u s t fund h o ld in g s.
Second, the F ed eral Reserve adopted the p o lic y o f low ering
re se rv e req u irem en ts in the postw ar era when i t d e s ire d
monetary e a s e , in s te a d o f u t i l i z i n g open m arket o p e ra tio n s
to purchase bonds. This r e s u lte d in an in c re a s e in th e
h o ld in g s o f th e nongovernment s e c to r a t the expense o f
the government s e c to r .
152
The e x iste n c e o f a la rg e and growing fe d e ra l d eb t in
th e hands o f the government r a is e s as many problems fo r the
debt manager as i t so lv e s. For example, debt once placed
w ith nongovernment in v e s to rs ceases to be th e prim ary
concern o f th e debt manager. I f funds a re needed b efo re
the repayment p e r io d , th e nongovernment in v e s to r must make
the b e s t arrangem ents he can in th e m arket p la c e . However,
when government agencies and t r u s t funds a re in need o f
funds, i t becomes the r e s p o n s i b i l ity o f the debt manager
to m onetize t h e i r fe d e ra l s e c u r ity h o ld in g s.
F in a lly , th e funds used by government investm ent
funds to purchase fe d e ra l s e c u r i t i e s r e p r e s e n t, on the
w hole, o b lig a tio n s o f th e government to p riv a te in d iv id
u a ls . This can be c le a r ly ex em plified by Old Age Survivor
Insurance funds and Unemployment Insurance funds. Both
the nongovernment bondholder and the "in su red " American
have a claim on the ta x a b le c a p a c ity o f the U nited S ta te s .
In r e a l i t y , what th e government accom plishes by buying i t s
own d ebt i s m erely to re p la c e one s e t o f c r e d ito r s w ith
an o th er.
F u rth erm o re, th e debt manager has only p a r t i a l
c o n tro l over the f lu c tu a tio n s in th e amount o f fe d e ra l
153
s e c u r i t i e s held by government agencies and t r u s t funds.
W ithdrawals from funds In resp o n se to expanded cash needs
can I n t e r f e r e w ith d eb t management o p e ra tio n s . A dditions
to funds can a ls o c la s h w ith d eb t re d u c tio n o p e ra tio n s .
This i s p a r t i c u l a r ly tru e i f a sh o rtag e o f s e c u r i t i e s
develops. Such a sh o rtag e re c e n tly re s u lte d in an unem
ployment tax h o lid a y o f s ix months d u ra tio n in West
Germany. This was necessary because th e government o f
West Germany feared th a t continued c o n trib u tio n s would
sw ell th e Unemployment Insurance Fund to unmanageable
34
p ro p o rtio n s .
A second method o f c a te g o riz in g in v e s to r c la s s e s is
to d iv id e them according to bank in v e s to rs , p r iv a te non
bank in v e s to r s , and p u b lic nonbank in v e s to rs . Such a
s e p a ra tio n serv e s to emphasize th e d iffe re n c e in th e
p o s s ib le sources o f investm ent funds. The im portance o f
the d e p o sit c re a tio n fa c u lty o f both commercial and F ederal
Reserve Banks s e ts them a p a rt from th o se in v e s to rs who must
purchase fe d e ra l debt from p re v io u sly accum ulated funds
o r c u rre n t sav in g s.
~^Wall Street Journal, June 22, 1961, p. 19.
154
The s e p a ra tio n o f government nonbank in v e s to rs from
p r iv a te nonbank in v e s to rs has m e rit. Areas in which the
government must compete w ith th e demand fo r p riv a te in v e s t
ment funds in the open m arket p la c e a re d is tin g u is h e d from
are a s in which th e government has some a d m in is tra tiv e
o p tio n as a p u rch aser a t the same time th a t i t is the major
su p p lie r o f funds. This method o f c a te g o riz in g debt owner
sh ip w ill be a p p lie d in th e follow ing c h a p te r.
IV. SU M M A R Y
The a c tu a l d i s t r i b u t i o n o f th e fe d e ra l debt is
determ ined by a v a r ie ty o f f a c to r s . The World War I I
d e c isio n was to t a i l o r the debt to f i t th e needs o f the
in v e s to rs . By doing so , i t was hoped th a t some o f the
m istakes o f World War I d eb t issu an ce would be avoided.
In avoiding some p i t f a l l s , th e d eb t managers made o th e r
m ista k e s, the e f f e c ts o f which have p e r s is te d to the
p re se n t tim e. The g r e a te s t e r r o r was th e c r e a tio n o f an
oversupply o f h ig h ly liq u id a s s e ts . Such l i q u i d i t y could
have been reduced by "fo rced sa v in g s." In s te a d , the
adoption o f th e "v o lu n tary " method o f fin an c in g re s u lte d
in th e use o f war loan d riv e s . Such d riv e s were designed
155
to g a m e r the n ecessary funds from nonbank in v e s to rs ;
th e r e f o r e , bank s u b s c rip tio n s were r e s t r i c t e d . However,
th e r e s t r i c t i o n upon bank s u b s c rip tio n s ra is e d i t s own
problem s. The excess re se rv e s o f th e banks s p i l le d over
in to the m arket p lace in search o f s u ita b le investm ent.
The end r e s u l t was an in c re a s e in fre e r id in g p r a c tic e s .
This p r a c tic e continued to plague th e c a p it a l m arkets in
th e postw ar p e rio d .
The wartim e d e c isio n to fin an ce by means o f com
m erc ia l bank d e p o sit expansion had a tw ofold r e s u l t . The
banking system was given a v i r t u a l subsidy. This subsidy
has been continued by the F ed eral Reserve p o lic y o f low er
ing re se rv e requirem ents to c r e a te money ease r a th e r than
e f f e c tin g money ease by open m arket o p e ra tio n s . The second
r e s u l t o f commercial bank d e p o sit c r e a tio n was an in c re a s e
in th e volume o f liq u id a s s e ts in th e economy. The bulk
o f th e se liq u id a s s e ts soon came to be h eld in the form of
government s e c u r i t i e s . The w idespread d i s t r i b u t i o n o f
th e se s e c u r i ti e s among the in v e s to r c la s s e s o f th e n a tio n
made the in f la tio n a r y p o te n tia l o f th e d ebt le s s amenable
to c o n tro l. To judge the e f f e c t o f the d i s t r i b u ti o n o f
the d e b t , i t w ill be n ecessary to c a te g o riz e d eb t ownership
and examine each in v e s to r c la s s s e p a ra te ly .
CHAPTER V
CLASSES OF DEBT OWNERSHIP
The T reasury o f the U nited S ta te s has adopted the
p o lic y , fo r a n a ly tic a l p u rp o ses, o f se p a ra tin g th o se
h o ld e rs o f fe d e ra l debt who can c r e a te d e p o s its from th o se
who cannot. In accum ulating debt i t has been th e c o n sta n t
o b je c tiv e o f th ose in charge o f debt management to s e l l
s e c u r i t i e s to banks only i f they could n o t be placed w ith
nonbank in v e s to rs . A lso, in th e postw ar p e rio d s o f debt
re d u c tio n , th e debt managers have given f i r s t p re fe re n c e
to the re tire m e n t o f bank h eld debt whenever p o s s ib le .
I . BANK INVESTORS
Both commercial banks and F ed eral Reserve Banks
have th e a b i l i t y to c r e a te demand d e p o s its . The degree o f
d e p o s it c re a tio n th a t commercial banks can e f f e c t is
decided by the p o lic ie s adopted by th e F ed eral Reserve
Board o f Governors. N early one h a lf o f th e ex p en d itu re
156
157
d uring World War XI was a r e s u l t o f d e p o sit c r e a tio n . How
was th is accom plished? What was i t s e f f e c t upon the
economy?
Wartime F a c to rs ^
Many f a c to r s combine to a f f e c t the s iz e and type o f
commercial bank government s e c u r ity h o ld in g s. Prim ary
c o n s id e ra tio n is given by th e commercial banking system to
ach iev in g a s a fe l i q u i d i t y le v e l. Before th e d e p re ssio n
o f th e 1 9 3 0 's, commercial bank h o ld in g s o f fe d e ra l
s e c u r i t i e s averaged only 10 per c e n t o f t o t a l a s s e ts .
Commercial bank purchases were p r in c ip a lly fo r investm ent
purposes and th e re fo re were c o n c e n tra te d in in te rm e d ia te -
and long-term s e c u r i t i e s . As l a t e as 1939 th e average
m a tu rity o f government s e c u r i t i e s h eld by the commercial
banks was n in e y e a rs . As th e p o rtio n o f a s s e ts h eld in
governments grew, commercial banks became more in te r e s te d
in l i q u i d i t y . By 1953 the average m a tu rity o f fe d e ra l
d eb t held by commercial banks was reduced to th re e y e a rs .^
U.S., Treasury, Annual Report of the Secretary of
the Treasury, 1953 (Washington: Government Printing
Office, 1953) , p. 265.
158
Commercial bank liq u id ity is a c tu a lly a fu n ctio n of
government re g u la tio n . To f a c i l i t a t e the fin an cin g of
both world w a rs, se v e ra l e f f e c tiv e measures were taken by
the government to a ssu re liq u id i ty in the c a p ita l funds
m arket. In 1917 the S e c re ta ry o f th e Treasury was s p e c if
i c a l l y au th o rized to re d e p o s it w ith s e le c te d d ep o sito ry
banks amounts o f money equal to th e i r own and th e i r
custom ers' s u b sc rip tio n s to L ib e rty Bonds and Treasury
2
C e r t i f i c a te s . These d e p o sits were subsequently withdrawn
by the Treasury in in stalm e n ts as needed to meet government
ex p en d itu res. This procedure prevented the m a ld is trib u tio n
o f funds which would otherw ise have occurred due to the
scope o f T reasury r e c e ip ts and ex p en d itu res.
The system o f government d e p o s ito rie s was r e
e s ta b lis h e d in World War I I . Such funds were not su b je c t
to re se rv e requirem ents o r F ederal D epository Insurance
C orporation assessm ents u n t i l s ix months a f t e r c e ssa tio n
o f h o s tilitie s ." ^
Annual Report o f th e S ecretary o f the T re a su ry ,
1917, p. 26.
3
C. F. Childs, Concerning United States Government
Securities (Chicago: C. F. Childs and Company, 1947),
p. 302.
159
In a d d itio n to d e p o sito ry a c c o u n ts , commercial
banks were encouraged to su b sc rib e fo r fe d e ra l s e c u r i ti e s
by low ering re se rv e req u irem en ts. A lso , a p r e f e r e n ti a l
d isc o u n t r a te on government iss u e s o f \ o f 1 per ce n t a
y ea r was e s ta b lis h e d w ith p ro v isio n s fo r rep u rch ase a t th e
same r a te . F in a lly , th e fe d e ra l s e c u r ity m arkets were
supported a t p ar by th e F ederal R eserve. These a c tio n s
were tantam ount to m onetizing th e fe d e ra l d e b t. They made
i t p o s s ib le fo r banks to keep f u lly in v e ste d in fe d e ra l
debt w ith o u t fe a rin g th a t t h e i r re se rv e s were i n s u f f i c i e n t
fo r a l l c o n tin g e n c ie s. Since no l i q u i d i t y was s a c r i f i c e d ,
the r a t e o f i n t e r e s t was im m aterial: " I t could as e a s ily
have been a 1-per c e n t war as a 2 -p er c e n t w ar."^ Wartime
fin a n c in g through th e use o f fe d e ra l s e c u r i ti e s and bank
c re a te d d e p o s its was as e f f e c tiv e as p r in tin g c u rre n c y ,
b u t much le s s obvious to th e g e n e ra l p u b lic . Whether
commercial banks o r the F ed eral Reserve Banks should have
been accorded th e bulk o f the n ecessary d e p o s it- c r e a tio n
p r iv ile g e was q u estioned b e fo re and a f t e r th e war.
4
Paul A. Samuelson, "The E ffe c t o f I n t e r e s t Rate
In c re a se s on th e Banking System ," American Economic
Review, X X X V (March 1945), 26.
160
As the war p ro g re sse d , th e nonbank s e c to r developed
as a m arket fo r government s e c u r i ti e s and r e lia n c e upon
commercial banks and F ed eral R eserve Banks d ecreased . For
example, th e $25 b i l l i o n In c re a se In s e c u r i t i e s purchased
by th e commercial banks In 1944 was about th e same as
during 1943 and 1942, but i t was 24 p er c e n t o f th e t o t a l
funds r a is e d by th e fe d e ra l government in 1944 compared
w ith 37 per c e n t in 1942.
Of the $25 b i l l i o n in c re a s e in commercial bank
h o ld in g s o f fe d e ra l s e c u r i ti e s in 1944, n e a rly $18 b i l l i o n
was acq u ired i n d ir e c tly in th e open m arket.^ The te c h
niques o f o v e r s e llin g th e nonbank s e c to r , w hile r e s t r i c t i n g
s a le s from th e T reasury to th e bank s e c to r , had forced
commercial banks to purchase s e c u r i t i e s through the m arket
p la c e .
Post-W orld War IX Developments
Im m ediately a f t e r World War I I , th e excess funds
ra is e d by th e V icto ry Loan Drive fo r tu n a te ly were not
needed. Reconversion had proceeded s w if tly and r e l a t i v e l y
sm oothly. These funds were a p p lie d to reduce th e amount
5Childs, op. cit. . p. 314.
161
o f fe d e ra l d ebt held by commercial b a n k s. By December
1947 commercial bank h o ld in g s had been reduced from $94
b i l l i o n to $61 b i l l i o n . By red ucing th e p o rtio n o f th e
debt h eld by th e commercial banks in t h i s manner, th e
T reasury m issed an o p p o rtu n ity to o b ta in th e maximum
d e f la tio n a r y e f f e c t which would have occurred had th e se
funds m erely been impounded. The use o f debt o b lig a tio n s
m erely to remove excess funds from th e economy w ith o u t th e
subsequent d is p e r s a l o f such funds by the government is a
phase o f m onetary p o lic y which has n o t been co n scio u sly
a p p lie d in th e p a s t.
From 1948 to 1953 , commercial bank h o ld in g s
flu c tu a te d w ith in a range o f $54.5 b i l l i o n to $60.5
b i l l i o n . The m agnitude o f f lu c tu a tio n was $6 b i l l i o n , or
ro u g h ly , 10 p er c e n t o f th e maximum amount.^ Commercial
bank ownership o f government s e c u r i t i e s in cre ased by $10.8
b i l l i o n between June 1951 and December 1954. Five b i l l i o n
d o lla r s o f th i s in c re a s e occu rred in th e a d m in is tra tio n o f
S e c re ta ry o f th e T reasury Snyder, and $5.8 b i l l i o n
^C harles C ortez A b b o tt, The F ed eral Debt (New York:
The T w entieth Century Fund, 1953), p. 130.
162
occurred under S e c re ta ry Humphrey. ^
Between 1953 and 1960 commercial banks system
a t i c a l l y in c re a se d t h e i r hold in g s o f government s e c u r i t i e s
during p erio d s o f re c e s s io n and low i n t e r e s t r a t e s . This
occurred from June 1953 to December 1954, and a lso in
September 1957 and June 1958. These in c re a se s were made
p o s s ib le by F ed eral Reserve a c tio n s which lowered re s e rv e
req u irem en ts. During p erio d s o f t i g h t money and r i s i n g
i n t e r e s t r a te s , commercial banks have liq u id a te d government
s e c u r ity h o lding s in o rd e r to s h i f t in to lo a n s. Such
Q
a c tio n s occurred between December 1954 and September 1957.
The p a tte r n o f fe d e ra l s e c u r i ti e s h o ld in g s in commercial
banks p o r t f o l i o s , th e r e f o r e , would be the d i r e c t o p p o site
o f th a t p a tte r n which m onetary p o lic y would d e s ir e .
F a ilu re o f commercial banks to change th is p a tte r n
v o l u n ta r il y , or o f th e government to c o n tro l t h i s p a tte r n
f o r c ib ly , has made the ta s k o f conducting m onetary p o lic y
^ T ilfo rd C. G aines, "Techniques o f T reasury Debt
Management" (unpublished Ph.D. d i s s e r t a t i o n , Columbia
U n iv e rs ity , 1960), p. 198.
8
Warren L . S m ith, Debt Management in th e U nited
S ta te s , U.S. C ongress, 86th C ong., 2d S ess. , J o in t
Economic Committee, Study Paper No. 19 (Washington:
Government P rin tin g O ffic e , January 28, 1960), pp. 104-105.
163
more d i f f i c u l t fo r th e F ed eral R eserve.
The F ed eral Reserve System 's monetary p o lic y a c tio n s
can expand th e supply o f money s u f f i c i e n t l y so t h a t govern
ment s a le s o f fe d e ra l s e c u r i t i e s to banks in tim e o f
re c e s s io n do n o t mean th a t th e re a re le s s funds a v a ila b le
fo r p r iv a te c r e d i t needs. However, th e a v a i l a b i l i t y o f
bonds as investm ents means th a t th e m agnitude o f the
e f f o r t to encourage p r iv a te investm ent must n e c e s s a r ily be
g r e a te r . For example, w hile th e government was s tru g g lin g
to emerge from th e g re a t d e p re ssio n o f the 1 9 3 0 's ,
commercial banks bought h a l f o f the a d d itio n a l s e c u r i ti e s
issu ed in th e y ea rs 1930-1935. Commercial banks were thus
ab le to m ain tain what they co n sid ered c o n se rv a tiv e and
9
s a fe in v e stm e n ts, thus d e te r r in g from the e f f o r t s o f the
government to s tim u la te p r iv a te investm ent. In o rd e r fo r
th e p riv a te economy to g ain th e f u l l e f f e c t o f lowered
re se rv e requirem ents in tim es o f re c e s s io n , commercial
banks should be discouraged from purchasing government
s e c u r i t i e s w ith the in c re a se d funds. This could be done
by low ering i n t e r e s t r a te s and y ie ld s to th e p o in t th a t
9
W illiam W ith ers, The P u b lic Debt (New York: The
John Day Company, 1945), p. 37.
164
they were u n a ttr a c tiv e to p r iv a te in v e s to rs . Such
s e c u r i ti e s could be purchased by the F ed eral Reserve Banks
a t such tim es. These a c tio n s would have th e b e n e f ic ia l
e f f e c t o f in c re a s in g th e supply o f funds a t th e same time
th a t th e re was a n o ta b le lack o f e f f e c tiv e loan demand.
The r e s u l t would be th e low ering o f i n t e r e s t r a te s and th e
easin g o f loan p r a c tic e s as th e in c re a se d funds competed
fo r th e lim ite d investm ent demand. The decreased r a te o f
i n t e r e s t and th e more l i b e r a l loan p r a c tic e s would serv e
to promote g r e a te r investm ent.
I I . N O N BA N K INVESTORS
The debt management o b je c tiv e o f seeking funds to
th e g r e a te s t e x te n t p o s s ib le from nonbank in v e s to rs is
based on th e d e s ir e to reduce th e in f la tio n a r y p o te n tia l
o f T reasury fin a n c in g . However, th e d eb t manager has few
guides in accom plishing t h i s o b je c tiv e . There is no
g e n e ra l agreement in economic th eo ry as to th e r e l a t i v e
im portance o f th e fa c to rs governing th e flow o f c a p it a l
funds to th e c a p it a l m arket. There is very l i t t l e evidence
on why in v e s to rs make th e choices they do among competing
o u tle ts fo r c a p ita l funds.
S everal major fa c to rs did c o n trib u te to th e purchase
o f s e c u r itie s by the nonbank s e c to r o f th e economy. F i r s t
and forem ost, th e p a t r i o t i c urge stim u la te d by an ag g res
siv e s a le s o rg a n iz a tio n combined to make government
s e c u r itie s th e b e s t a d v e rtise d and most w idely-held in v e s t
ment medium o f a l l tim e. Second, th e s c a r c ity o f o th e r
s u ita b le s e c u r itie s caused funds to be tr a n s f e r r e d in to
government s e c u r itie s u n t i l p riv a te investm ent demand again
presen ted i t s e l f . T h ird , the in tro d u c tio n o f new forms of
s e c u r itie s formed a "b asket" from which a l l in v e sto rs could
pick s u ita b le investm ents. As a r e s u l t o f th ese f a c t o r s ,
throughout th e d ep ressio n period and th e preparedness
p e rio d , nonbank in v e sto rs absorbed over h a lf o f the
in c re a se in fe d e ra l d eb t.
With the g re a t expansion o f debt during the e ig h t
World War I I loan d riv e s , only th e f i r s t two d riv e s
re q u ire d any s ig n if ic a n t bank su p p o rt. The Treasury p ro
gram fo r a l l subsequent war loan d riv e s was to r e ly h e a v ily
upon nonbanking i n s t i t u t i o n s . At the high p o in t o f the
Annual Report of the Secretary of the Treasury,
1951. p. 291.
166
fe d e ra l debt on February 28, 1946, t o t a l nonbank holdings
had in creased from $25 b i l l i o n to $135 b i l l i o n . S p e c ific
segments o f the nonbank in v e s to rs category dem onstrated
s p e c ia l c h a r a c t e r is t i c s . T h erefo re , g r e a te r understanding
can be a tta in e d by analyzing each o f th e nonbank in v e s to r
c la s s e s s e p a ra te ly .
In d iv id u a l In v e sto rs
What fa c to rs l i e behind th e magnitude o f th e in d i
v id u a l in v e s to rs ' ownership o f debt? The most powerful
impetus to s a le s o f government s e c u r itie s to in d iv id u a l
in v e s to rs was th e com bination o f in creased income and a
goods sh o rtag e th a t was experienced in w artim e. A lso, the
p ro p e n sity to save was re in fo rc e d sin c e spending h a b its
change slow ly d e s p ite the ra p id in c re a se in income.
Once saved and in v ested in government s e c u r i t i e s ,
th e se funds were le s s lik e ly to be spent than i f they had
been held in th e form o f currency or bank d e p o s its . This
help s to account fo r th e s t a b i l i t y o f in d iv id u a l in v e s to rs '
holdings o f fe d e ra l s e c u r i t i e s . In a d d itio n , the la rg e
investm ent o f in d iv id u a ls in nonm arketable redeemable
s e c u r i t i e s , in e f f e c t , makes th ese holdings eq u iv alen t to
a secondary cash re se rv e . This is e s p e c ia lly tru e sin ce
167
th e re i s no danger o f d e f a u lt o r f lu c tu a tio n o f d o lla r
v alu e on th e se s e c u r i t i e s .
T r a d itio n a lly , th e T reasury has endeavored to
encourage th e p a r ti c i p a ti o n o f in d iv id u a l in v e s to rs in th e
government s e c u r ity f i e l d . As e a rly as 1877, S e c re ta ry o f
th e T reasury Sherman, in an e f f o r t to dem ocratize th e d e b t,
provided fo r sm all denom inational bonds. In a d d itio n ,
$10 c o n v e rtib le c e r t i f i c a t e s were o ffe re d to th e people o f
the U nited S t a t e s . ^
The wide d i s t r i b u ti o n o f sm all denom inational bonds
was deemed to be b e n e f ic ia l to th e n a t i o n 's economy. I t
r e s u lte d in g ain in g p o p u lar i n t e r e s t in th e n a t io n 's c re d it.
Many sm all h o ld e rs were le s s lik e ly to d is tu r b th e m arket
p la c e by t h e i r in d iv id u a l a c tio n s . I n f la tio n a r y ten d en c ie s
were dim inished sin c e in d iv id u a ls decreased t h e i r spending
in o rd e r to purchase fe d e ra l d e b t. In tim es o f lim ite d
goods, th e m ajor purpose o f u sin g fe d e ra l s e c u r i ti e s is to
absorb in f la tio n a r y purchasing power u n t i l such time as
goods again become p l e n t i f u l . F in a lly , savings bonds
R obert T. P a tte r s o n , F ed eral Debt-Management
P o l i c i e s , 1865-1879 (Durham, N. C.: Duke U n iv e rsity
P re s s , 1954), p. 109.
168
tended to encourage th e h a b it o f t h r i f t among the populace.
In fin a n c in g World War I , i t was b e lie v e d th a t th e
h a b it o f t h r i f t could be a c c e le ra te d i f th e in d iv id u a l
in v e s to r borrowed from the banking system in o rd e r to
purchase s e c u r i t i e s . Once in d e b t, i t was f e l t th a t th e
s e c u r ity h o ld e r would have an a d d itio n a l in c e n tiv e to save.
U n fo rtu n a te ly , th e a n tic ip a te d sav in g s d id not m a te r ia liz e .
The "borrow and buy" L ib e rty bond cam paigners had ex e rted
tremendous p re ssu re upon many p a t r i o t i c Americans to
overextend them selves. These in v e s to rs were th e ones who
s u ffe re d lo s s e s as th e post-W orld War I re c e s s io n forced
more and more in d iv id u a ls to s e l l out in th e m arket p lace
a t below p a r p r i c e s . At d isc o u n t p ric e s , th e d eb t moved
from in d iv id u a l h o ld e rs to more experienced i n s t i t u t i o n a l
in v e s to r s , n o ta b ly commercial banks. By 1920 about 18
m illio n o r i g i n a l h o ld e rs o f L ib e rty bonds were estim ated
to have so ld out to 4 m illio n investm ent b u yers. The
T re asu ry , by i t s appeals to p a tr io tis m and a p p lic a tio n o f
s o c ia l p re s s u r e , had s u c c e s s fu lly so ld i t s bonds a t p ric e s
1 2
which were probably h ig h er than t h e i r investm ent v a lu e s .
12
Committee on P u b lic Debt P o lic y , Our N atio n al
Debt (New York: H a rc o u rt, Brace and Company, I n c ., 1949),
pp. 19-20.
169
R e s is tin g p re ssu re s th a t i t supp ort th e L ib e rty bond
m arket a f t e r World War I , th e T reasury o ffe re d only th i s
so lace :
The h o ld ers o f l i b e r t y bonds who save and hold
t h e i r bonds as investm ents w i l l n o t in the o p in
ion o f the T reasury r e g r e t i t nor w ill they s u f f e r
by reason o f th e p re se n t d e p re c ia tio n in m arket
p r i c e s .13
The in e q u itie s a r is in g from th e post-W orld War I
bond m arket debacle r e s u lte d in th e r e je c tio n o f the
"borrow and buy" techniq ue in fin a n c in g World War I I . The
redeem able savings bond was s p e c if ic a l ly designed to avoid
th e problems experienced by L ib e rty bond h o ld e rs . I t was
f e l t th a t a n o n -n e g o tiab le s e c u r ity w ith a guaranteed
redem ption v alu e would n o t be s u b je c t to panicky liq u id a
tio n . Such liq u id a tio n m ight occur among sm all h o ld ers o f
m arketable s e c u r i ti e s in th e event o f a d e c lin e in t h e i r
m arket v a lu e . N on-negotiable s e c u r i t i e s , on th e o th e r
hand, would probably n o t be disposed o f u n t i l th e h o ld er
f e l t an a c tu a l need fo r th e use o f th e funds. By th e end
o f World War I I , in d iv id u a l h old in g s o f fe d e ra l s e c u r itie s
had in creased s ix f o ld . They accounted fo r 25 per cen t o f
^Childs, op. cit. . pp. 136-138.
170
th e t o t a l o f a l l fe d e ra l borrow ing from June 30, 1939 to
June 30, 1946.14
The a n tic ip a te d ra p id redem ption o f redeem able
s e c u r i ti e s by in d iv id u a l in v e s to rs d id not m a te r ia liz e in
the immediate post-W orld War I I p e rio d . Redemption
experience w ith S e rie s E bonds w as, in f a c t , more fa v o ra b le
than th e postw ar tu rn o v er in o th e r forms o f s a v i n g s . ^ The
o v e r - a ll in c re a s e o f savings bonds h o ld in g s which d id occur
in th e postw ar years was th e o p p o site o f what had been
expected. Monthly redem ptions as a p ercen tag e o f th e
amount o u tsta n d in g o f a l l s e r ie s o f savings bonds d e c lin e d
in 1948. The r a t i o o f 0.69 p er c e n t, which was th e low est
in th re e y e a r s , was reached in November 1947 and a g a in in
February 1 9 4 8 .^
The e x iste n c e o f a la rg e volume o f redeem able
o b lig a tio n s poses a t h r e a t o f i n f l a t i o n a t a l l tim es. The
Korean c r i s i s was an e x c e lle n t example o f how a d d itio n a l
14
Annual R eport o f th e S e c re ta ry o f th e T re a s u ry ,
1946, p. 60.
15
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
1950, p. 162.
16
Annual Report of the Secretary of the Treasury,
1948. p. 25.
171
consumer power can r e s u l t from debt liq u id a tio n . I t is an
u n fo rtu n a te consequence o f World War I I fin a n c in g th a t th e
m o n etizatio n o f so la rg e a segment o f th e debt is a t th e
d is c r e tio n o f th e d eb t owners r a th e r than th e fe d e ra l
government and is governed by th e in d iv id u a l in v e s to r s '
psychology. However, as long as new s a le s o f nonm arketable
is s u e s equaled o r exceeded red em p tio n s, cash demands from
t h i s d ir e c tio n would be n i l . The savings bond is e sse n
t i a l l y a long-term s e c u r ity d e s p ite i t s redeem able f e a tu re .
The average d o lla r in v e ste d in savings bonds s ta y s w ith th e
T reasury approxim ately 7% y e a r s , and approxim ately 14
b i l l i o n , o r over one th ir d o f a l l S e rie s E bonds o u ts ta n d
ing a re in the ex ten sio n p e r i o d . ^
In d iv id u a l in v e s to rs began sw itching out o f govern
ments o r from nonm arketables to m arketables a f t e r the
Accord. This was a r e f l e c t i o n o f th e more a t t r a c t i v e
i n t e r e s t r a te s o ffe re d by p r iv a te s e c u r i ti e s and m arketable
governm ents, such as th e 5 p er ce n t n o te o f May 1964, and
th e on e-y ear b i l l au ctio n ed in January 1960 a t a y ie ld o f
^ Annual Report of the Secretary of the Treasury,
1955, p. 28.
5.067 p er cent.'*'®
F in a lly , in a tta in in g a maximum d i s t r i b u ti o n o f d eb t
to in d iv id u a l in v e s to r s , th e q u e stio n a r is e s : What a re th e
economic e f f e c ts o f such debt holdings? Debt may cause a
r e d is t r i b u t i o n o f w ealth . The degree to which r e d i s t r i b u
tio n o f w ealth occurs depends upon th e r e la tio n s h ip o f two
m ajor f a c to r s . This r e la tio n s h ip i s th e p ro p o rtio n a l
d i s t r i b u t i o n o f d eb t as compared to th e p ro p o rtio n a l d i s
t r i b u t io n o f taxes used to make payments on th e debt and
i t s s e rv ic e ch arges.
In modem c a p ita lis m most people who d e riv e income
w ithout working do so by the ownership o f c r e d i t i n s t r u
ments r a th e r than the d i r e c t ownership o f the m a te ria ls
19
and in stru m en ts o f p ro d u c tiv e in d u s try . Who a re th e se
people? There is no unanim ity o f o p in io n . Judgments run
20
th e g a u n tle t from th e "upper income groups" to the high
1 8
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
1960. p. 41.
19
Anato1 Murad, P riv a te C re d it and P u b lic Debt
(W ashington, D.C.: P u b lic A ff a irs P re s s , 1954), p. 83.
20
Seymour H a rris , N atio n al Debt and th e New
Economics (New York: McGraw-Hill Book Company, In c. ,
1947) , pp. 10-11; E lton Raymond Shaw, The N atio n al Debt
and Our F uture (W ashington, D.C.: Shaw P u b lish in g
Company, 1946), p. 90.
173
m iddle c l a s s , i . e . , $25,000 to $50,000 n e t income per
21
y e a r , to th e sm all to medium c la s s sav ers and
22
in v e s to r s . The growing sh are o f d eb t owned by th e
Government T ru st Funds , which in r e a l i t y re p re s e n ts th e
e n t i r e American la b o rin g f o r c e , p a s t and p r e s e n t, must
a ls o be co n sid ered in judging th e in d iv id u a l ownership o f
d e b t.
R egardless o f th e group h o ld in g th e fe d e ra l d e b t,
th e e f f e c t may be to d ec rease work in c e n t iv e s , thus low er
ing r e a l o u tp u t and e s ta b lis h in g a r e n t i e r c la s s . The
makeup o f th e modern-day r e n t i e r c l a s s , however, may be
r a d ic a lly d i f f e r e n t from th e group to whom th e term has
been a p p lie d h i s t o r i c a l l y . The p u b lic and p r iv a te pen
sio n e rs may be th e tw e n tie th ce n tu ry r e n t i e r c la s s .
Since th e g r e a t m a jo rity o f in d iv id u a l h o ld in g s o f
fe d e ra l s e c u r i t i e s a re in th e form o f savings b o n d s, i t is
n ecessary th a t th e v a rio u s fa c e ts o f th a t program be
a n a ly z e d .
21
Nien Min Sun, "An Economic A nalysis o f th e
Burdens o f th e P u b lic Debt" (unpublished Ph.D. d i s s e r t a
t i o n , The U n iv e rsity o f Southern C a lif o r n ia , Los A ngeles,
1950), pp. 143-144.
22
Annual Report of the Secretary of the Treasury,
1955 . p. 271.
174
Development o f the savings bond program . The
savings bond program was form ally in au g u rated in 1935. I t
re p la ced the p o s ta l savings bond which had been a v a ila b le
sin c e 1911. The 2.5 p er c e n t p o s ta l savings bonds were
redeem able one y ear from d a te o f is s u e . They were r e g i s
te re d bonds and p aid tax-exem pt i n t e r e s t by means o f
sem i-annual coupon. Denominations ranged from $20 to $500.
In a d d itio n to p o s ta l savings b o n d s, a war stamp and
c e r t i f i c a t e program was i n i t i a t e d in World War I . The war
saving stam p, which c o st $ 4 .1 2 , in cre ased in v alu e a t the
r a t e o f one ce n t a month and had a m a tu rity v alu e o f $5.00.
The war savings c e r t i f i c a t e s o f World War I matured in
fiv e y ears , b u t could be redeemed a f t e r two months upon
23
ten days w ritte n n o tic e .
From 1935 to 1941, fo u r s e r ie s o f savings bonds
were is s u e d , i . e . , S e rie s A, B, C, and D. Each s e r ie s was
dated the f i r s t day o f the month in which sold and m atured
te n y ears from such d a te . The P ublic Debt Act o f 1941
a p p lie d to th e newly inau g u rated S e rie s E, F, and G bonds.
I t provided th a t th e i n t e r e s t on such bonds be s u b je c t to
^Childs, op. cit. . p. 424.
175
fe d e ra l income ta x e s. The investm ent y ie ld approximated
2.9 per cent compounded sem i-annually.
S eries E savings bonds. Since 1941 th e savings
bond has developed in to th e forem ost " ta p 1 1 s e c u rity issued
by the government. The T reasury has found th a t buyers of
savings b onds, g e n e ra lly sp e a k in g , f a l l in to two d i s t i n c t
groups. F i r s t , sm all savers who a re in te r e s te d m ainly in
bonds o f le s s than $100 denom ination. Second, purchasers
w ith co n sid erab le investm ent experience and w ith su b sta n
t i a l amounts o f funds to in v e st who a re p rim a rily
in te r e s te d in the la rg e r denom ination bonds.
The im portance o f the savings bond program is borne
out by the fa c t th a t during th e fiv e y ears from June 30,
1941 to June 30, 1946, th e n e t in c re a se in the amount of
S eries E bonds alone financed 8 per cen t o f the govern
m ent's e x p e n d itu re , 15 per cent o f the governm ent's
d e f i c i t for th a t p e rio d , and absorbed 4.5 per cent of
25
t o t a l perso n al income a f t e r ta x e s. During the f i s c a l
24
Henry C. Murphy, N ational Debt in War and T ra n si
tio n (New York: McGraw-Hill Book Company, I n c ., 1950),
p. 35.
25
Ibid. , p. 194.
176
years 1942-1946, sm all denom inations, i . e . , $10 and $25
S eries E bonds c o n s titu te d about one th ir d o f the t o t a l
s a le s . A fte r the w ar, s a le s o f sm all denom inational bonds
d e c lin e d . By 1948 they c o n s titu te d only one s ix th o f t o t a l
s a le s . The s a le s o f la rg e denom inations o f S eries F and G
26
bonds showed the re v e rse tren d .
The savings bond program appears to have become a
permanent p a r t o f our f in a n c ia l system . At th e c lo se o f
the 1960 f i s c a l y e a r, S eries E and H bonds o u tstan d in g
amounted to more than $42.5 b i l l i o n , a $12 b i l l i o n in c re a se
sin ce the calen d ar y ea r 1946. Savings bonds also in creased
in terms o f th e percentage o f t o t a l debt o u tsta n d in g --15
per cen t a t the c lo se o f 1960, as compared w ith 12 p er cent
27
in December 1946.
L i t t l e d isc u ssio n o f th e a d v is a b ility o f such a
permanent program o f d e f i c i t financing has taken place
d e s p ite the fa c t th a t the savings bond program is a more
c o s tly form o f o b ta in in g funds than the s a le o f m arketable
s e c u r i ti e s . The government c o s t, which is s l i g h tl y over
Sun, op. c i t . , p. 145.
27
Annual Report of the Secretary of the Treasury.
1960, p. 159.
177
one d o lla r fo r every $1,000 o f S e rie s E and H bonds s o ld ,
re p re s e n ts only a sm all p o rtio n o f t o t a l s a le s c o s t.
C ountless hours o f p e rso n a l tim e have been taken from busy
liv e s to o rg a n iz e and d i r e c t saving s bonds s a le s .
Thousands o f banks and o th e r f in a n c ia l i n s t i t u t i o n s s e l l
bonds fre e o f charge and redeem savings bonds a t an average
28
r a te o f 12.5 c e n ts p er bond. A ll a d v e rtis in g tim e and
space c o s ts o f th e program , amounting an n u ally to more
than $50 m illio n , a re borne by p r iv a te in d u s try . The
prom otional c o s ts o f p a y ro ll sav in g s campaigns in v a rio u s
b u sin e sse s and i n d u s t r i e s , as w ell as th e o p e ra tio n a l c o s ts
o f th e p la n s , a re borne by th e businessm en o f th e n a tio n
29
as a p u b lic s e rv ic e .
D esp ite a l l o f t h i s e f f o r t , savings bonds have been
lo sin g ground. Even in wartim e th e p ro p o rtio n o f $25
b o n d s, fo r exam ple, redeemed a f t e r one y ea r ro se from
4 p er cent in 1941 to 46 per c e n t in 1 9 4 5 .^ In peacetim e
y ears t h i s tren d co n tin u ed . Redemptions o f savings bonds
O Q
I b i d . , p. 123.
29
I b i d . , p. 158.
30
Murphy, op. cit.. p. 204.
178
exceeded s a le s In each month o f 1959 and I960, w ith the
31
monthly cash d ra in a t tim es topping $150 m illio n .
At no time has any attem pt been made to use the
savings bond program as a f i s c a l p o lic y to o l to fig h t
d e f la tio n as w ell as i n f l a t i o n . Emphasis was c o r re c tly
placed upon th e v alu e of such devices as the p a y ro ll
savings plan as a d e te r r e n t to wartime in f la tio n a r y
p re ssu re . The s a le o f savings bonds can be used as a
double-edged sword a g a in s t peacetim e in f l a t i o n . Not only
is purchasing power taken d i r e c tl y out o f the hands o f
consum ers, bu t the funds thus ob tain ed a re a v a ila b le fo r
the re tire m e n t o f bank held d e b t, thereby reducing the
32
money supply to th a t e x te n t. What would be even more
e f f e c tiv e would be a p o lic y to r e ta in such savings bonds
s a le s funds as id le T reasury b alan ces.
Viewed from th e sta n d p o in t o f peacetim e c o u n te r
c y c lic a l debt management, the perform ance has been le s s
fa v o rab le. The program which proved so s u c c e ssfu l in
combating i n f l a t i o n served to d i l u te th e e ffe c tiv e n e s s o f
31
Wall S tre e t J o u r n a l, September 7, 1961, p. 4.
32
Annual Report of the Secretary of the Treasury,
1949, p. 18.
179
an a n ti- d e f la tio n a r y p o lic y . There i s no way in which th e
government can fo rc e th e redem ption o f savings bonds should
i t d e s ir e to do so. The d e f la tio n a r y use o f the savings
bond program has been given l i t t l e emphasis by f i s c a l
p o lic y makers. The only m ajor argument p re se n ted i s th a t
in th e event o f a severe re c e s s io n th e saving bond re se rv e s
in th e hands o f th e p u b lic would a c t as a cushion which
could h elp s u s ta in the economic l i f e o f th e co u n try .
The p a y ro ll savings p la n , in p a r t i c u l a r , does not
respond to c o u n te rc y c lic a l m an ip u latio n . Automatic devices
fo r th e re g u la r investm ent o f saving s have an a t t r a c t i o n
which s u s ta in s t h e i r usage through v ary in g economic
c o n d itio n s . The wartime peak o f 25 m illio n persons under
th e p lan was reduced d r a s t i c a l l y im m ediately a f t e r th e war
33
and has sin c e le v e le d o f f a t 8 m illio n p a r ti c ip a n t s .
The main defense fo r c o n tin u in g the savings bond
program during tim es o f re c e s s io n when i t works a g a in s t
f i s c a l and monetary p o lic y is th a t th e h a b it o f t h r i f t is
Annual Report of the Secretary of the Treasury,
1960. p. 159.
34
not adaptable to the vagaries of policy actions.
L i t e r a l l y m illio n s o f Americans have accum ulated t h e i r
f i r s t savings through p a y ro ll ded u ctio n s , and having once
acq u ired th e h a b it o f t h r i f t they become custom ers o f o th e r
35
types o f i n s t i t u t i o n s which o f f e r a more v a rie d program.
The T reasury departm ent has taken p a r t i c u l a r c a re to
encourage p e rso n a l savings in any form --not j u s t to
encourage th e s a le o f savings bonds. The in c re a s e o f
savings d e p o s its d uring th e y e a rs December 31, 1952 to
December 31, 1958 showed commercial bank saving s up 52 p er
c e n t , m utual bank savings up 50 per c e n t , sav in gs and loan
sh are s up 150 per c e n t , and S e rie s E and H savings bonds
up 21 p er c e n t. With fe d e ra l in su ran ce o f bank d e p o s its
and savings and loan sh ares , the r i s k d i f f e r e n t i a l between
p riv a te savings and government bonds has v i r t u a l l y
d is a p p e a re d . ^
34
Annu a l Repo r t o f th e S e c re ta ry o f th e T re a su ry ,
1958. p. 264.
35
Committee fo r Economic Development, Managing th e
F ed eral Debt (New York: The Committee, 1954), p. 30.
36
Annual Report o f the S e c re ta ry o f th e T re a s u ry ,
1959. p. 241.
181
Due to the increasing competition of other
i n s t i t u t i o n s , th e savings bond program has taken a sm a lle r
p ercen tag e o f th e savings m arket. Although savings bonds
have never been promoted a t th e expense o f o th e r types o f
savings , th e T reasury does wish to m ain tain a re aso n ab le
37
share o f th e n a t i o n 's savings in S e rie s E and H bonds.
To make savings bonds more c o m p e titiv e , Congress
has p erm itted a r i s e in th e i n t e r e s t r a t e from 2.9 per
cen t to 3.25 p er c e n t, and again to 3.75 p er c e n t. The
3.75 p er ce n t r a t e was co nsidered com parable w ith average
p r iv a te i n s t i t u t i o n savings r a t e s . This r a te was g u aran
teed fo r the f u l l term o f th e bond, whereas p riv a te r a te s
were s u b je c t to downward r e v is io n a t th e o p tio n o f th e
38
savings i n s t i t u t i o n . I t rem ains to be seen whether
th e se i n t e r e s t changes w ill in c re a se th e a ttr a c tiv e n e s s o f
savings bonds. Small in v e s to r s ' h o ld in g s o f S e rie s E
bonds seem to be r e l a t i v e l y in s e n s itiv e to i n t e r e s t r a te
changes. T h eir b eh av io r was marked by s t a b i l i t y even under
37
U .S ., House, Committee on Ways and Means,
Hearings , P u b lic Debt C e ilin g and I n t e r e s t Rate C e ilin g on
Bonds, 86th Cong., 1 st Sess. , June 10-12, 1959, p. 148.
38
Annual Report of the Secretary of the Treasury,
I960, p. 301.
182
th e e x tra o rd in a ry c o n d itio n s a r is in g o ut o f th e Korean War.
T h eir purchases and redem ptions have a ls o been r e l a t i v e l y
unresponsive to postw ar b u sin ess c y c le s . Custom and
convenience p lay a la rg e p a r t in th e se investm ent
39
d e c is io n s .
An a d d itio n a l advantage o f S e rie s E bonds is th a t
they postpone payment o f any income tax on the i n t e r e s t
a c c ru a ls u n t i l th e bonds a re redeemed o r m a tu re , whichever
occurs f i r s t . With th e ex ten sio n o f m a tu rity th a t has
been g ra n te d , many h o ld ers can postpone redem ptions u n t i l
a time o f l i f e when they may be in a lower tax b ra c k e t, o r
40
not s u b je c t to any ta x . This appears b u t a s l i g h t
inducement when the purchasing power which has been lo s t
over th i s time period is co n sid ered .
S e rie s F , G, H, J , and K savings bonds. S e rie s F
savings bonds were designed fo r club s and o th e r o rg a n iz a
tio n s w ith sm all sums to in v e s t, sin c e S e rie s E bonds a re
issu ed only to n a tu ra l p erso n s. S e rie s G bonds were
39
George Hanc, ’’United S ta te s Savings Bonds and
F ederal Debt Management" (unpublished Ph.D. d i s s e r t a t i o n ,
Columbia U n iv e rs ity , 1958), p. 123.
40
Annual Report of the Secretary of the Treasury,
I960, p. 158.
183
designed p rim a rily fo r th e la rg e i n s t i t u t i o n a l and w ealthy
in v e s to r. Net s a le s o f S e rie s F and G bonds during the
p eriod from June 30, 1941 to June 30, 1946 were eq u iv alen t
to 4 p er cen t o f a l l government e x p e n d itu re , 7 per cent o f
th e government d e f i c i t fo r th a t p e rio d , and absorbed 2.2
per cen t o f t o t a l p erso n al income a f t e r t a x e s . ^ S eries H
has an i n t e r e s t r a te s im ila r to S e rie s E, but is an income
s e c u r ity r a th e r than an i n t e r e s t a c c ru a l s e c u rity . The
H bond was designed to appeal to in v e s to rs who o rd in a r ily
/ o
purchased m arketable s e c u r i ti e s . S eries J and K bonds
re p la ced F and G bonds in 1952. However, la rg e in v e s to rs
s h if te d in and out o f th ese s e c u r itie s as postwar i n t e r e s t
r a te s flu c tu a te d . This c re a te d such debt management
problems th a t S eries J and K bonds were d isco n tin u ed in
43
195 7.
Insurance Companies
The amount o f fe d e ra l debt held by l i f e insurance
companies is in flu en ced by the volume o f t h e i r reso u rces
^M urphy, op. c i t . , p. 196.
^ Wall S tre e t J o u r n a l, August 28, 1961, p. 20.
4 34
Annual Report of the Secretary of the Treasury,
1957. p. 279.
184
and the degree o f Investm ent d i v e r s i f i c a t i o n d e s ire d .
Insurance companies appear to use t h e i r government s e c u rity
p o r tf o lio s to b alance excesses o r d e f ic ie n c ie s in the
supply o f h ig h er y ie ld in g p riv a te s e c u r i t i e s . During th e
w ar, in su ran ce companies p laced a l l o f t h e i r in creased
a s s e ts in government s e c u r i t i e s . P a trio tis m and in d u stry
p re ssu re even re s u lte d in o v e rs u b s c rip tio n to bond d riv e s .
However, excess purchases were eq u alized by m arket s a le s
o f o th e r government s e c u r i t i e s from l i f e in su ran ce
com panies' p o r t f o li o s . In o rd e r to provide fo r a smooth
flow o f r e c e ip ts in to government s e c u r i t i e s , in su ran ce
companies borrowed from th e commercial banks to buy
s e c u r i t i e s du ring war lo an s. They then p aid o f f t h e i r
loans as in su ran ce premiums were re c e iv e d . In t h i s way
they were a b le to o b ta in th e 2.5 p er cen t i n t e r e s t r a t e as
t h e i r funds became a v a ila b le , in s te a d o f accum ulating
funds in s h o rt-te rm lower y ie ld in g s e c u r i ti e s between
lo a n s .
A fte r World War I I , the in su ran ce companies sw itched
ra p id ly to p r iv a te s e c u r i t i e s . This sw itch was prompted
by a d e s ir e fo r d i v e r s i f i c a t i o n , and by th e need fo r h ig h er
y ie ld s . The d o lla r amount o f government s e c u r i ti e s held
185
by l i f e in su ran ce companies d ecreased q u ic k ly . I f th e
p ercen tag e o f a s s e ts is used as a m easure, then the
d e c lin e o f fe d e ra l d ebt ho ld in g s is even more d ram atic.
F ed eral Reserve statem en ts aroused th e f e a r th a t
th e p o lic y o f government m arket su p port m ight be abandoned.
This a c c e le ra te d th e liq u id a tio n o f long-term government
h o ld in g s. The most ra p id s e l l in g by l i f e in su ran ce
companies o ccurred between th e end o f 1947 and A p ril 1954.
The lack o f new fe d e ra l long-term is s u e s a t a t t r a c t i v e
r a te s o f i n t e r e s t a lso c o n trib u te d to th e d e c lin e o f
in su ran ce company h o ld in g s. The sh o rta g e o f such issu e s
was a r e s u l t o f th e post-W orld War I I debt management
p o lic ie s o f em phasizing s h o rt-te rm s e c u r i ti e s and a low
i n t e r e s t r a t e s tr u c tu r e which was n o t co m p etitiv e w ith
long-term p r iv a te o b lig a tio n s .
During th e e a rly post-W orld War I I y e a r s , holding s
o f f i r e , c a s u a lty , and m arine in su ran ce companies behaved
in marked c o n tr a s t to l i f e in su ran ce companies. Between
February 1946 and December 1954 government h o ldings o f
th ese companies n e a rly doubled. This p e r s is t e n t and
r e l a t i v e l y la rg e in c re a se was occasioned by two f a c to r s .
F i r s t , th e a s s e ts o f th e se companies expanded g r e a tly .
186
Second, fo r s a f e t y 's sake I t was n ecessary to m ain tain a
la rg e p o te n tia l claim fund. For th e se re a s o n s , f i r e ,
c a s u a lty , and m arine in su ran ce com panies' hold in g s are
c o n c en trated in is s u e s w ith m a tu r itie s o f le s s than ten
44
y e a rs. A fte r December 1944, however, th e government
h o ldings o f th e se companies d ecreased .
Mutual Savings Banks
Although Mutual Savings Banks a re a f fe c te d by
fundam entally th e same fa c to rs as o th e r in v e s to r c la s s e s ,
t h e i r p a tte r n o f fe d e ra l debt hold ings is s u b s ta n tia lly
d i f f e r e n t . Throughout th e war th e se i n s t i t u t i o n s a c tu a lly
in v ested in fe d e ra l s e c u r i t i e s more than t h e i r whole
in c re a s e o f earning a s s e ts . This means th a t as prewar
investm ents were liq u id a te d , th e funds were placed in the
government s e c u rity s e c to r r a th e r than being re in v e s te d in
the p r iv a te s e c u r ity s e c to r .
B efore World War I I , Mutual Savings Banks had 30
per ce n t o f t h e i r earn in g a s s e ts in v e ste d in U nited S ta te s
s e c u r i t i e s . On February 28, 1946 t h e i r fe d e ra l debt
Annual Report of the Secretary of the Treasury ,
1960, p. 42.
187
hold in g s re p re se n te d 67 p e r cen t o f t h e i r a s s e ts and had
an average m a tu rity o f 14 y ea rs d e s p ite a secondary
re se rv e o f $.5 b i l l i o n o f s h o rt-te rm s e c u r i t i e s . A fte r
th e w ar, Mutual Savings Banks e x h ib ite d no p a r t i c u l a r
in c lin a tio n to in c re a se o r d ec rease t h e i r d o lla r h o lding s
o f government s e c u r i t i e s . U n til 1950 they m aintained 50
p er ce n t more o f t h e i r funds in v e ste d in fe d e ra l s e c u r i ti e s
than in a l l o th e r types o f loans and s e c u r i ti e s com bined.^
In th e decade o f th e 1 9 5 0 's, th e Mutual Savings
Banks jo in e d the s h i f t away from fe d e ra l debt h old in g s ,
and by 1959 the r a t i o o f government s e c u r i ti e s to a s s e ts
had dropped to 19 p er c e n t.
C orporations
C orporations tend to u t i l i z e t h e i r government
s e c u r i ti e s holdings alm ost e x c lu s iv e ly as a secondary cash
re s e rv e . The average m a tu rity o f th e c o rp o ra te government
s e c u r itie s p o r tf o lio was 12 months in 1 9 6 0 .^ Pegged
m arkets during the war encouraged c o rp o ra tio n s to p lace
45
Annual R eport o f the S e c re ta ry o f the T re a s u ry ,
1949, p. 325.
46
Annual Report of the Secretary of the Treasury,
I960, p. 43.
188
a l l types o f funds in to fe d e ra l d eb t. The o p p o rtu n ity to
convert cash in to r is k l e s s incom e-earning a s s e ts p resen ted
an unprecedented o p p o rtu n ity fo r added p r o f i t s .
Most co rp o rate investm ent in government s e c u r itie s
was m erely o f a temporary n a tu re . U n d istrib u ted co rp o rate
p r o f it s during World War I I provided la rg e liq u id b alan ces.
These funds would be needed a f t e r the war to expand
shrunken in v e n to r ie s , finance accounts r e c e iv a b le , and
ca rry in to e f f e c t postponed r e p a ir and expansion programs.
In a d d itio n , co rp o ra tio n s experienced a tremendous turno ver
o f government s e c u r itie s as a r e s u l t o f in d u stry p re ssu res
ex erted during war bond d riv e s . C orporate goals in war
loans were s e t g re a tly in excess of new co rp o ra te funds
a v a ila b le fo r investm ent. O v ersu b scrip tio n s of m arketable
is s u e s , th e r e f o r e , in the l a s t a n a ly s is , were made p o ssib le
by the extension o f bank loans to co rp o ratio n s , which were
then rep aid by the s a le of government s e c u r i ti e s in the
market p la c e . The money thus ra is e d perm itted the Treasury
to conduct fewer war loan d r i v e s . More freq u en t d riv e s
would have re s u lte d in the r a is in g o f a la rg e r p ro p o rtio n
o f a l l funds from bona fid e nonbank in v e s to rs .
When the war ended, co rp o ratio n s s h if te d immediately
out o f government s e c u r i ti e s . T heir holdings decreased
189
more than any o th e r c la s s o f in v e s to r in th e immediate
postw ar y e a rs. C orporations were f u r th e r aided in recon
v e rsio n by th e Tax Adjustment Act o f 1945 , which provided
fo r th e redem ption o f th e n o n -n e g o tiab le and non-
tr a n s f e r a b le excess p r o f i t s tax refund bonds. These bonds
provided the c o rp o ra tio n s w ith a 10 p er c e n t c r e d i t on th e
excess p r o f i t s taxes o f each y e a r ending a f t e r December 31,
47
1941.
But even th e la rg e liq u id re se rv e s m aintained by
c o rp o ra tio n s proved i n s u f f i c i e n t to meet reco n v ersio n
needs. The demand fo r o u ts id e fin an c in g re s u lte d in a
flood o f new c o rp o ra te o b lig a tio n s which were in d i r e c t
co m p etitio n fo r investm ent funds w ith fe d e ra l s e c u r i ti e s .
As o th e r in v e s to rs moved out o f government s e c u r i ti e s , th e
debt managers in r e a l i t y became th e m ajor s u p p lie rs o f
c a p ita l funds to th e p riv a te economy.
By 1948 c o rp o ra tio n s had liq u id a te d a l l government
s e c u r i ti e s except tho se h eld by funds which were co n sid ered
liq u id re s e rv e s . As t h e i r supply o f sh o rt-te rm liq u id
funds grew, t h e i r h o ld in g s o f fe d e ra l debt began to
47
Annual Report of the Secretary of the Treasury,
1946, p. 52.
190
in c re a s e a g a i n . C o r p o r a t i o n tr e a s u r e r s had learn ed w ell
the wartime lesso n o f g arn erin g e x tra p r o f i t s through th e
u t i l i z a t i o n o f government s e c u r i ti e s fo r temporary cash
accum ulations. As y ie ld s on government s e c u r i ti e s
in c re a s e d , every e f f o r t was made to expand th e se cash
accum ulations by c lo s e r su p e rv isio n o f c o rp o ra te cash
budget p o lic y .
S ta te and Local Governments
S ta te and lo c a l governm ents' use o f fe d e ra l d ebt is
s im ila r to th a t o f c o rp o ra tio n s . During w artim e, when
ex p en d itu re o u tla y s were r e s t r i c t e d , tax r e c e ip t accumula
tio n s were placed in fe d e ra l s e c u r i t i e s . A lso, in th e
postw ar y ears tem porary c o n s tru c tio n funds were placed in
fe d e ra l s e c u r i t i e s . Thus, some r e tu r n could be d eriv ed
from the time o f th e r e c e ip t o f th e se funds to the time o f
t h e i r disbursem ent. This accounts fo r th e bulk o f th e
in c re a se in s t a t e and lo c a l government h o ldings o f fe d e ra l
deb t.
About one th ir d o f th e fe d e ra l s e c u r ity hold in g s
o f s t a t e and lo c a l governm ental u n its i s in employee
Annual Report of the Secretary of the Treasury,
1950, p. 29.
191
49
re tire m e n t funds. These pension funds a re o fte n
r e s t r i c t e d in t h e i r investm ents to U nited S ta te s government
s e c u r i ti e s and th e s e c u r i ti e s o f o th e r s t a t e and lo c a l
governments. However, in p erio d s o f c r e d i t r e s t r a i n t ,
pension funds have been used in c re a s in g ly to a id s t a t e and
lo c a l government bond o f f e r in g s . As a r e s u l t , th e
percentag e o f th ese funds in v ested in fe d e ra l s e c u r i ti e s
has f a ll e n from 54 p er cen t to 35 p er ce n t in the years
1953 to 1959.50
M iscellaneous In v e sto rs
This c a tc h - a l l categ o ry in clu d es such h o ld ers o f
government s e c u r i ti e s as savings and loan a s s o c ia tio n s
and fo re ig n acco u n ts. Savings and loan a s s o c ia tio n s use
government s e c u r i t i e s to s a t i s f y the requirem ent th a t t h e i r
l i q u id i t y re se rv e funds may be in cash o r U nited S ta te s
s e c u r i t i e s . Savings and loan investm ents a re r e s t r i c t e d
to the mortgage f i e l d . In the postw ar b u ild in g boom they
liq u id a te d government s e c u r ity h o ldings r a p id ly . In th e
Annual R eport o f th e S e c re ta ry o f th e T re a su ry .
1955, p. 32.
50
Annual Report of the Secretary of the Treasury,
1956. p. 33.
192
1 9 5 0 's, however, savings and loan a s s o c ia tio n s in cre ased
t h e i r h o ldings o f fe d e ra l d eb t as they b u i l t up t h e i r
51
secondary re se rv e s a g a in s t la rg e sh are b a la n c e s.
Foreign accounts o fte n hold s p e c ia l n o n in te r e s t-
b ea rin g n o te s. These were p re se n te d to th e I n te r n a tio n a l
Bank o f R eco n stru ctio n and Development, and a ls o to the
I n te r n a tio n a l Monetary Fund as p a r t payment fo r United
S ta te s s u b s c rip tio n s to th e se o rg a n iz a tio n s . O ther fo re ig n
investm ents in U nited S ta te s government s e c u r i ti e s have
been in c re a sin g as a r e s u l t o f re c e n t U nited S ta te s b alan ce
o f payments d i f f i c u l t i e s . These investm ents a re m ainly o f
a s h o rt-te rm n a tu re and s u b je c t to g r e a t f lu c tu a tio n in
response to rumors o f d e v a lu a tio n o f th e d o l l a r in terms
o f g o ld , war j i t t e r s , and so fo r th .
In an attem pt to encourage fo re ig n tr e a s u r ie s and
c e n tr a l banks to r e t a i n t h e i r h o ld in g s o f d o l la r a s s e ts ,
in s te a d o f c o n v e rtin g them to g o ld , P re sid e n t Kennedy
d ire c te d S e c re ta ry o f the T reasury D illo n to is s u e s p e c ia l
h ig h er in te r e s t- b e a r in g s e c u r i ti e s to fo re ig n governments.-^
^ Annual Report of the Secretary of the Treasury ,
1956, p. 33.
S2
Wall Street Journal» February 9, 1961, p. 3.
193
I I I . GOVERNM ENT TRUST FUNDS
The emergence o f Government T ru st Funds as a m ajor
fe d e ra l d eb t owner is o f re c e n t o r ig in . The Congress has
e s ta b lis h e d some f i f t y Government T ru st Funds. Five m ajor
funds accounted fo r alm ost 90 p er ce n t o f th e t o t a l a s s e ts .
These fiv e m ajor funds a re th e F ed eral Old-Age S urvivors
In su ran ce T ru st Fund, th e Unemployment Insu rance T ru st
Fund, th e N atio n al S erv ice L ife Insurance Fund fo r
V e te ra n s, the F ed eral D is a b ility Insurance T ru st Fund, and
th e R ailro ad R etirem ent Account.
The funds a re composed o f c o lle c tio n s made by th e
government in which th e in d iv id u a ls r e t a i n a d i r e c t
i n t e r e s t . They a re in r e a l i t y a form o f "fo rced savings"
and a re tr e a te d as such by th e American people. The
investm ent of th ese funds is r e s t r i c t e d by law to m arket
a b le and s p e c ia l iss u e s o f U nited S ta te s government
s e c u r i t i e s .
Whether th e se funds a re in v e ste d in m arketable
government s e c u r i ti e s o r in s p e c ia l is su e s depends upon
the r a t e o f accum ulation , th e y ie ld of m a rk e ta b le s , and
the d e s ir e o f th e fund managers fo r m ark etab les. The
194
e x is tin g p ro v isio n s o f the law p lace f u l l r e s p o n s ib ility
on th e S e cretary o f th e T reasury fo r th e investm ent o f
many o f th e se funds. Those few funds which a re not handled
by the T reasury d i r e c t l y must c o n su lt w ith th e S e c re ta ry
53
on t h e i r investm ent p r a c tic e s .
The T reasury is lim ite d by Congress as to the r a te
o f i n t e r e s t to be paid on Government T ru st Funds. I f
m arket r a te s a re below the re q u ire d y i e l d , then i t is
n ecessary fo r th e T reasury to iss u e s p e c ia l s e c u r i ti e s
c a rry in g r a te s o f i n t e r e s t in lin e w ith the fu n d 's income
req u irem en ts. Over 80 per cen t o f the s e c u r i ti e s h eld by
the investm ent funds are in th e form o f s p e c ia l issu e s
h eld only by th e se accounts. ^ This income from i n t e r e s t
is n ecessary i f the t r u s t s a re to c a rry out s p e c ifie d
purposes and programs in accordance w ith t r u s t agreem ents
- - - 55
or s t a t u t e s .
W ithout the e x is te n c e o f the fe d e ra l debt i t is
d o u b tfu l w hether enough s u ita b le investm ents a t the
Annual R eport o f the S e c re ta ry o f th e T re a s u ry ,
1960, p. 22.
54
I b i d . , p . 44.
55Ibid. , p. 21.
195
approved r a te o f in t e r e s t could be found to accommodate
the growing accum ulations o f the t r u s t funds. F ederal
d e b t, th e r e f o r e , serves to channel th ese funds back in to
th e economy. The debt holdings o f the Government T ru st
Funds in d ic a te th e amount of t h e i r accum ulation which is
being used fo r g en eral government purposes.
Although th e fe d e ra l debt in creased $6.7 b i l l i o n
from February 28, 1946 to June 30, 1960 the holding s o f
Government Investm ent Funds in creased by $27.3 b i l l i o n in
the same p e rio d , to a t o t a l o f $55.6 b i l l i o n . Investm ent
funds, th e r e f o r e , have become one o f the major s u p p lie rs
of funds to the s e c u r i ti e s m arket. This has occurred
because investm ent funds as a whole have experienced a
su rp lu s o f re c e ip ts over ex p en d itu res. A n e t su rp lu s has
occurred c o n s is te n tly in every y ear from 1941 through
1958. These su rp lu ses have ranged as high as $4 b i l li o n
an n u ally . However, the Treasury cannot continue to expect
th is degree of aid in the fu tu re . T ru st funds experienced
a d e f i c i t o f $1,5 b i l l i o n in 1959 and a d e f i c i t o f almost
$.75 b i l l i o n in I9 6 0 .56
56Ibid., p. 450.
196
In o rd e r to m onetize th e government s e c u r i t i e s h eld
by investm ent funds , the government would have to r e s o r t
e it h e r to ta x a tio n o r money c r e a tio n . Money c r e a tio n in
th e form o f p rin te d currency o r demand d e p o s its may be in
r e a l i t y m erely a form o f hidden ta x a tio n o f money during
p erio d s o f f u l l employment o r p erio d s approaching f u l l
employment. At such tim es the purchasing power o f e x is tin g
money sto ck s is reduced by the in c re a se o f th e supply o f
money w ith o u t a co n cu rren t in c re a se in the supply o f goods.
T h e re fo re , ta x a tio n of one form o r an o th er u s u a lly su p p lie s
th e funds needed by h o ld ers o f fe d e ra l s e c u r i ti e s , whether
those h o ld e rs be Government T ru st Funds o r o th e rs . P lacin g
debt s e c u r i ti e s in the p o r tf o lio s o f Government T ru st Funds
does not in any way reduce the n e c e s s ity to tax in o rd e r
to e lim in a te th e o b lig a tio n o f e x is tin g fe d e ra l s e c u r i t i e s .
Opposing view points a re p resen ted by H arley L. Lutz and
Lewis H. Kiramel.^^
The argument is sometimes put fo rth th a t th e govern
ment may have a co n tin g en t l i a b i l i t y fo r th e w e lfa re o f
"^H arley L. L u tz, " S e c u rity to Burn o r a B lessin g in
D isg u ise ," The N atio n al Review. IV, No. 3 (Ju ly 13, 1957),
57-58, 63; Lewis H. Kimrael, " I s th e F ed eral Old-Age and
S urvivors Insu rance T ru st Fund V alid?" N atio n al Tax -
J o u rn a l, V II, No. 4 (December 1954), 327-341.
197
i t s c i t i z e n s , w hether or not th e l i a b i l i t y is "acknowl-
58
edged'1 by th e e x iste n c e o f th e se funds. The crux o f th e
problem h ere is one o f degree o f o b lig a tio n . C iv iliz e d
n a tio n s do assume l i a b i l i t y fo r t h e i r c i t i z e n s ' w e lfa re .
"Forced saving" may seem to r e lie v e the government o f th is
l i a b i l i t y . However, th e l i a b i l i t y which form erly had been
assumed now becomes fo rm alized . P rev io u sly the government
was c a lle d upon r e lu c ta n tly by needy c i t i z e n s to f u l f i l l
i t s o b lig a tio n . "Forced saving" r e s u l t s in not only the
e x p e c ta tio n o f such government a i d , b u t the le g a l demand
fo r government a id in accordance w ith s ta tu to r y c o n tra c t.
Old-age a s s is ta n c e never p re se n ted th e i l l u s i o n o f w ealth
to any p o s s ib le fu tu re r e c i p ie n ts . S o cial S e c u rity
Insurance does e x a c tly th a t.
An a d d itio n a l co m p licatio n a r is e s in th a t Government
T ru st Funds a n tic ip a te th a t i n t e r e s t payments w i ll r e p r e
se n t a r e a l in c re a s e in the v alu e o f t h e i r accum ulations.
This can occur only i f such funds a re put to p ro d u c tiv e
u se. In v e stin g in fe d e ra l d ebt in no way a ssu re s th is
r e s u l t . I n t e r e s t payments could m erely re p re s e n t i n f l a t i o n
■^Abbott, op. cit.. p. 331.
198
if "the resultant increase in expenditure caused by the .
growth of Government debt is not o f f s e t by an expansion of
5 9
r e a l o u tp u t." This type of i n f l a t i o n o f a s s e ts n u l l i f i e s
th e r e a l meaning o f t r u s t funds' p ro v isio n s fo r insurance.
IV. SU M M A R Y
*
The debt m anager's prim ary o b je c tiv e is to achieve
a w ide, s ta b le d i s t r i b u ti o n o f the ownership o f United
S ta te s government s e c u r i ti e s . To accom plish th is he has
developed a "basket" o f s e c u r itie s o ffe rin g a v a r ie ty of
debt forms a t varying terms and c o n d itio n s. The success
o f h is endeavor can be measured by h is a b i l i t y to a t t r a c t
reso u rces which a re a v a ila b le fo r debt ownership.
The s t a t e o f the economy determ ines both the supply
o f e x is tin g funds and th e com petition fo r th ese funds.
Given th ese c o n s id e ra tio n s , the degree o f com partm ental-
iz a tio n o f the debt due to debt ownership c o n sid e ra tio n s
w ill determ ine the p a tte r n of the m a tu ritie s , the range of
i n t e r e s t r a t e s , and o th e r terms contained in fe d e ra l debt
h o ld in g s .
59
A urelius Morgner, The N ational Debt and Economic
S ta b ility " (unpublished Ph.D. d i s s e r t a t i o n , U n iv ersity o f
M innesota, 1956), p. 100.
199
C om partm entalization allow s th e government to serv e
b e t t e r the d iv e rg e n t needs o f th e v a rio u s c la s s e s o f
in v e s to rs and the g en eral economy under v ary in g economic
c o n d itio n s. In tim es o f i n f l a t i o n a determ ined e f f o r t is
made to avoid supplying d ebt in stru m en ts to F ed eral Reserve
o r commercial bank in v e s to rs . In tim es o f re c e s s io n th e
F ederal Reserve should be encouraged to a c t as the
r e c ip ie n t o f government s e c u r i t i e s .
P riv a te nonbank in v e s to r s ' fe d e ra l d eb t holdings
a re a ffe c te d by the demand fo r c a p it a l funds in th e non
government s e c to r o f th e economy. A s c a r c ity o f such
demand w ill r e s u l t in la r g e r United S ta te s government
s e c u r i ti e s h o ld in g s, and v ic e v e rsa . No u n iv e rs a l p a tte r n
o f response by the d if f e r e n t c la s s e s o f in v e s to rs was
e v id en t. The g r e a te s t s t a b i l i t y o f t o t a l holdings and
in te r n a l com position was dem onstrated by c la s s e s w ith the
l e a s t investm ent s k i l l , such as in d iv id u a ls . The more
sagacious in v e s to rs e x h ib ite d e i t h e r a marked i n s t a b i l i t y
in t o t a l holdings o r c o n sid e ra b le f lu c tu a tio n in the types
o f h o ld in g s. Of p a r t i c u l a r i n t e r e s t is the growth o f
investm ent usage o f tem porary accum ulations o f funds by
c o rp o ra tio n s , and s t a t e and lo c a l governments. This
provides an expanded m arket fo r sh o rt-te rm debt s e c u r i t i e s .
200
The in c re a se in the holdings o f Government T ru st
Funds re q u ire s a r e - a p p r a is a l o f the economic meaning and
impact o f the d ebt. Far from so lv in g the debt problem
because "we owe i t to o u rselv e s" i t fu r th e r com plicates i t .
As widespread ownership through Government T rust Funds is
a tta in e d , the e f f e c t is to in c re a se the p ro p e n sity to
consume and reduce the p ro p e n sity to save of the fund
p a r tic ip a n ts . The re c e ip t o f such funds is co n tin g en t
upon requirem ents o th e r than p erso n al ownership. There
fo re , the w ealth i l l u s i o n , in the sense o f a v a ila b le
a s s e t s , does not r e s u l t from fund accum ulation to the same
e x te n t as occurs from the accum ulation o f bonds.
The old s ty le r e n t i e r c la s s recognized the p o s sib le
inroads th a t ta x a tio n could make on t h e i r accum ulations
and discounted th e i r w ealth p o s itio n s acco rd in g ly .
Today's p u b lic and p riv a te p ensioner c la s s of in v e s to r,
who to g e th e r own the major p o rtio n o f the fe d e ra l d e b t,
apply no such d isco u n t. T heir f a il u r e to d isco u n t t h e ir
accumulated w ealth can r e s u l t in decreased p ro d u c tiv ity and
a lowered r e a l n a tio n a l income, thus reducing the only
tru e source of debt repayment.
201
O btaining th e d e s ir a b le p a tte r n o f ownership o f th e
debt is th e prim ary debt management o b je c tiv e . This
determ ines th e m a tu rity p a tte r n o f U nited S ta te s s e c u r i ti e s
th a t w ill be e s ta b lis h e d .
CHAPTER VI
MATURITY PATTERN OF THE FEDERAL DEBT
The m a tu rity p a tte r n o f the fe d e ra l debt has g re a t
s ig n ific a n c e due to th e many and v a rie d r e s u l t s which i t
produces. One example would be th e in flu e n c e o f the
m a tu rity p a tte r n upon th e a b i l i t y o f th e n a tio n to respond
to changing economic c o n d itio n s . For in s ta n c e , an excess
o f h ig h ly liq u id sh o rt-te rm debt could n eg ate the govern
m en t's t i g h t money p o lic y in tim es o f in f l a t i o n .
A d i v e r s i f i e d m a tu rity p a tte r n p erm its w idespread
ownership o f fe d e ra l d eb t by th e v a rio u s s e c to rs o f th e
f in a n c ia l m arket. Thus, a means i s provided by which funds
can be tr a n s f e r r e d between s e c to r s o f th e economy as
needed. The tim ing and s iz e o f the debt m anager's problems
a re determ ined by th e debt m a tu rity p a tte r n . Besides
co n sid e rin g the p o s s ib le consequences o f th e e x is tin g
m a tu rity p a tte r n a t any p a r ti c u l a r p o in t o f tim e, th e
process o f accom plishing changes in the m a tu rity p a tte r n
202
203
a lso has i t s economic e f f e c ts . These changes occur in the
most v o l a t i l e p o rtio n o f the d e b t , a n d , in th e sh o rt r u n ,
th e most i n f l u e n t i a l .
I . CRITERIA OF A DESIRABLE M ATURITY PATTERN
The debt m anager's m ajor o b je c tiv e in e s ta b lis h in g
a m atu rity p a tte rn is to secure the m a tu rity p a tte rn
balan ce which is b e s t s u ite d to the needs o f th e n a tio n .
This was th e most p re ssin g debt management problem during
the f i s c a l y ear 1960.^ The Treasury has attem pted to
m ain tain an adequate volume o f m arketable o b lig a tio n s in
each m a tu rity s e c to r.
S everal proposals fo r achiev ing a balanced m atu rity
p a tte r n have been made by stu d en ts o f debt management.
The estab lish m en t of a "bench mark" p a tte rn o f debt o f f e r -
ings has been suggested. This p re se n ta tio n en v isio n s a
"normal y ear" model s e t o f o ffe rin g s which could then be
^U.S. , T reasu ry , Annual Report of the S ecretary of
th e T re a su ry , 1960 (Washington: Government P rin tin g
O ffic e , 1960), p. 6.
2
J. M . C u lb ertso n , "A P o s itiv e Debt Management
Program," Review o f Economics and S t a t i s t i c s . XLI (May
1959), 89.
204
flu c tu a te d as d e s ire d in p erio d s o f i n f l a t i o n and r e c e s
sio n . A b a sic p a tte r n o f m a tu rity o ffe rin g s may serv e as
a d e s ir a b le debt management g u id e. However, the r e a l
problem rem ains o f when to a l t e r th e b a s ic p a tte r n and to
what degree.
A s im ila r p ro p o sal en v isio n s a " s ta b le m a tu rity
p a tte rn " which would be adhered to w itho ut reg ard to f i s c a l
3
e f f e c t . This propo sal would r o u tin iz e T reasury fin a n c in g .
As a r e s u l t , u n c e rta in ty as to m a tu rity o ffe rin g s would
d isa p p e a r. In th is way i t is hoped th a t th e economic
e f f e c ts o f debt management would be n e u tr a liz e d . I t is
q u e stio n a b le whether th e o f fe rin g and repayment p o lic y o f
a $286.5 b i l l i o n debt could have a n e u tr a l economic
in flu e n c e even w ith sta n d a rd iz e d fin an c in g p ro c e d u re s.
Moreover, f l e x i b i l i t y o f th e m a tu rity p a tte r n allow s th e
T reasury freedom to meet any contingency. F l e x i b i l i t y ,
th e r e f o r e , may be d e s ir a b le . The r e a l essence o f the
problem can be summed up as follow s: How can th e T reasury
m ain tain a f le x ib le debt m a tu rity p a tte r n w ith o u t c o n tr ib
u tin g to th e i n s t a b i l i t y o f the economy?
3
T ilfo rd C. G aines, "The Techniques o f T reasury Debt
Management" (unpublished Ph.D. d i s s e r t a t i o n , Cambridge
U n iv e rs ity , 1960), p. 539.
The d eterm in atio n o f th e c h a ra c te r o f th e m atu rity
p a tte rn depends upon se v e ra l f a c t o r s . The p a s t and
p re se n t Treasury p o lic y o f o ffe rin g s e c u r i ti e s fo r cash or
refu n d in g , plus the T reasury p o licy o f repaying debt
decides the m atu rity p a tte rn o f the e n tir e d eb t. The
F ederal Reserve Open Market Committee a f f e c ts the m atu rity
p a tte rn o f th a t p o rtio n o f th e debt h eld by p riv a te
in v e s to rs . However, in th e f i n a l a n a ly s is th e o r ig in a l
p u rc h a s e r's holding p erio d w ill depend p rim a rily upon h is
own fu tu re needs and convenience. Only to a very minor
e x te n t does the holding p erio d depend upon the nominal
m a tu rity o f the s e c u rity purchased. World War I provided
an e x c e lle n t example o f the problems r e s u ltin g from the
in d isc rim in a te issuance o f long-term s e c u r iti e s to a l l
c la s s e s of in v e s to rs . The u n s ta b le d is t r i b u ti o n o f fe d e ra l
o b lig a tio n s caused severe flu c tu a tio n s in the p ric e s of
A
long-term s e c u r itie s in the post-W orld War I p erio d .
Unlike the p r iv a te d e b to r , who is r e la ti v e l y
u n affected by the s a le o f h is s e c u r itie s b efo re m a tu rity ,
the Treasury is v i t a l l y concerned w ith the s t a t e o f the
^Annual Report of the Secretary of the Treasury,
1945, p. 412.
206
s e c u r ity m arket. The m agnitude o f the fe d e ra l d eb t and
the fre q u en t T reasury t r i p s to th e m arket p lace make i t
exceedingly d i f f i c u l t fo r th e government j u s t to s i t back
and l e t th e m arket run i t s co u rse. To p ro te c t i t s own
c r e d i t , th e government, u n lik e th e p r iv a te in v e s to r , may
be forced to redeem in th e m arket p la c e some o f i t s own
d eb t. This is the very same debt which i t a t one time had
considered to be firm ly placed w ith p r iv a te in v e s to rs .
The e x iste n c e o f a firm T reasury debt m a tu rity
p a tte r n p o lic y implemented by o ffe rin g s and repayments
made w ith due regard to m arket c o n d itio n s is an assum ption
unsupported by f a c t. No w e ll-d e fin e d sequence o f p o lic y
o b je c tiv e s has been d e lin e a te d by debt management
a u t h o r i t ie s . Those o b je c tiv e s which are acknowledged,
such as len gthening th e average m a tu rity o f the debt and
m inim izing th e debt s e rv ic e c o s t, tend to be incom patible.
T h erefo re , sin c e World War I I , debt o p e ra tio n d e c isio n s
have most fre q u e n tly been made on th e b a s is o f e x is tin g
market c o n d itio n s . This is tantam ount to an acknowledgment
th a t the m a tu rity p a tte r n is governed by the a c c id e n ta l
in te rp la y o f fo rc es and th e d r i f t o f tim e. Such a p o licy
is the very o p p o site o f th e id e a l s i t u a tio n in which
207
d e c isio n s a re based d i r e c tl y on c o n s id e ra tio n o f th e type
o f b alance in the m a tu rity schedule th a t is most
d e sira b le .'*
In d isc u ssin g the m a tu rity p a t t e r n , th e d eb t w ill
be d iv id ed in to th e follow in g c a te g o rie s : f u lly m arketable
d e b t , m arketable but bank r e s t r i c t e d d e b t , nonm arketable
bu t c o n v e rtib le d e b t, and nonm arketable debt com prised o f
s p e c ia l s e c u r i t i e s .
I I . M ARKETABLE FEDERAL DEBT
M arketable debt is d efin e d as o b lig a tio n s o f t r a n s
fe ra b le q u a lity which make no d i s t in c t i o n between the
p re se n t h o ld e r and the o r ig in a l p r o p r ie to r o f th e loan.
The issu an ce o f m arketable d eb t is advantageous fo r both
th e government and the s e c u r ity h o ld e r. The amount o f
demand s e c u r i ti e s which th e government would o th erw ise have
to iss u e is reduced. The e x is te n c e o f m arketable s e c u r
i t i e s in a l l m a tu rity are a s g iv es th e F ed eral Reserve a
c e r ta in amount o f f l e x i b i l i t y in expanding o r c o n tra c tin g
the c r e d it b ase. The in v e s to r i s s t i l l ab le to borrow on
5
C harles C ortez A bb ott, The F ed eral Debt (New York:
The Tw entieth Century Fund, 1953), p. 185.
208
o r s e l l h is s e c u r ity a t w i l l . In a d d itio n , bo th d eb to r
and c r e d ito r a re assu red o f paying o r re c e iv in g a s p e c ifie d
r a t e o f i n t e r e s t over a given p erio d o f tim e.
M arketable F ed eral Debt O peration
S u ccessfu l management o f a la rg e fe d e ra l d eb t is
dependent upon a c le a r knowledge o f th e o b je c tiv e s to be
achieved. Knowledge o f th e p re v a ilin g th e o rie s and p ra c
t i c e s w i l l aid in ach iev in g th e s e o b je c tiv e s .
O b jectiv es o f m ark etable fe d e ra l debt management.
Since World War I I , th e debt managers have reduced the
m arketable p o rtio n o f th e d eb t w ith p a r t i c u l a r emphasis
upon th e m arketable debt h eld by the banking s e c to r o f th e
economy.** Up to th e time o f th e T re asu ry -F ed e ral Reserve
A ccord, th e m arketable s e c to r dropped from 70 p er c e n t o f
th e t o t a l debt in 1946 to 54 p er c e n t in 1951 (see
T able I I I ) . The t o t a l d eb t had decreased only $14.6
b i l l i o n , w hile th e m arketable s e c to r had d ecreased $51.8
b i l l i o n . The d iffe re n c e was la rg e ly the r e s u l t o f th e
* * Annual R eport o f th e S e c re ta ry o f th e T re a s u ry .
1948, p. 363; Gaines , o p . c i t . . p. 198; A bbott, op. c i t . .
p. 132.
TABLE III
M A RK ETA BLE PORTION OF THE FEDERAL DEBT, 1946-1960
June 30, 1946 June 30, 1951 June 30, 1960
M aturity B illio n s Percentage B illio n s Percentage B illio n s Percentage
W ithin 1 year $62.0 23 $43.9 17 $70.5 25
1 to 5 years 24.8 9 46.5 18 72.8 25
5 years and over 102.9 38 47.5 19 40.7 14
T otal m arket
able debt $189.7 70 $137.9 54 $184.0 64
T otal nonmar-
k e ta b le debt 80.2 30 127.4 46 102.5 36
T otal debt
$269.9 100 $255.3 100 $286.5 100
Source: U .S ., T reasury, Annual Report o f the S ecretary o f the T reasu ry , fo r the
years 1946, 1951, 1960 (Washington: Government P rin tin g O ffic e . 1946,
1951, 1960).
209
210
in c re a se o f holdings by Government T ru st Funds. A lso » the
exchange o f long-term m arketable bonds in to nonm arketable
b u t c o n v e rtib le bonds such as Investm ent S eries B Bonds o f
1975-1980 a ffe c te d th e t o t a l s . The reappearance of
d e f i c i t s re v ersed the tre n d . In the p erio d from June 1958
to December 1959, fo r example, the m arketable debt
in creased by more than $20 b i l l i o n .^ The reduced
accum ulations o f the Government T ru st Funds a t th is time
a lso c o n trib u te d to the r i s e in m arketable d eb t. By 1960
m arketable debt again c o n s titu te d 64 p er cen t o f the t o t a l
d e b t.
A second o b je c tiv e o f debt management is to reduce
the amount o f sh o rt-te rm d eb t. Debt which m atures w ith in
one y ear is d efined as s h o rt-te rm d eb t. The unused funds
o f th e V ictory Loan and the budget su rp lu ses re ceiv ed by
the Treasury in 1947 and 1948 were ap p lied to the s h o r t
term s e c to r. By th e tim e o f the Accord, debt due to mature
w ith in one y ear had been reduced from 23 per cent o f the
t o t a l fe d e ra l debt in 1946 to 17 per cent in 1951. As a
r e s u l t o f the in c re a se in m arketable d e b t, th e sh o rt-te rm
Annual Report of the Secretary of the Treasury,
I960. p. 286.
211
debt s e c to r today i s a h ig h e r percentage o f t o t a l debt
than i t was a t th e end o f World War I I . As o f June 30,
1960, debt w ith a m a tu rity o f le s s than one y ear r e p r e
sen ted one q u a rte r o f th e t o t a l fe d e ra l d eb t and 38 p er
cen t o f a l l m arketable d eb t.
A th ir d o b je c tiv e o f th e debt manager is to lengthen
th e average m a tu rity o f th e d e b t. The measure most
commonly used to i n t e r p r e t changes in th e le n g th o f debt
m a tu r itie s i s th e concept o f "average m a tu rity ." The
average is a rriv e d a t by m u ltip ly in g each m arketable
s e c u r ity by th e number o f months i t s t i l l has to run.
This c a lc u la tio n uses th e f i r s t c a lla b le d a te on c a lla b le
bonds. The t o t a l s a re then added up and d iv id ed by th e
amount o f m arketable d eb t o u tsta n d in g to give a fig u re on
g
average le n g th o f m a tu rity . U nless th e average m a tu rity
o f the debt is le n g th e n e d , th e government w ill a r r iv e a t a
p o in t u ltim a te ly in which th e l i q u id i t y o f the government
s e c u r i ti e s in th e economy embody a high in f la tio n a r y
p o te n t i a l . In a d d itio n , due to th e sh o rte n in g o f m a tu rity
o f the d e b t , T reasury management o p e ra tio n s w ill occur
g
Annual Report of the Secretary of the Treasury,
1957, p. 275.
212
9
more fre q u e n tly and in la rg e r amounts.
However, th e average m atu rity o f th e fe d e ra l debt
has not been lengthened except fo r b r i e f sp oradic i n t e r
v a ls . Since the end o f the war th e re has been a steady
seepage of long-term s e c u r i t i e s , i . e . , bonds over fiv e
years o l d , in to the in term ed iate s e c u rity c l a s s . This
occurs a u to m atically w ith the passage o f tim e. The seepage
is evidenced by th e u n re m ittin g a t t r i t i o n o f the s iz e o f
the fiv e years and o ld e r s e c to r o f the fe d e ra l d eb t. This
s e c to r has decreased from 38 per cen t o f t o t a l debt in 1946
to 19 per cent in 1951, and f i n a l l y , to 14 per ce n t today.
The flow from the long-term s e c to r combined w ith
the determ ined attem pt a f t e r 1951 to extend the interm e
d ia te s e c to r is r e f le c te d in th e percentage growth o f the
one- to fiv e -y e a r m a tu rity s e c to r. This s e c to r in creased
s te a d ily from 9 per cent in 1946 to 18 per cent in 1951.
Today th is s e c to r com prises 25 per cent o f th e t o t a l
fe d e ra l d ebt.
9
Address b efo re th e American Finance A sso ciatio n
and the American Economic A sso ciatio n a t W ashington, D .C .,
December 29, 1959, by S ecretary o f th e Treasury Anderson,
c ite d in Annual Report o f the S ecretary o f the T re a su ry .
I9 6 0 , p. 287.
2X3
At th e beginning o f th e European war in 1939, the
average m a tu rity o f th e t o t a l fe d e ra l d eb t was 7 y ears
2 months. By th e end o f World War I I , i t had f a ll e n to
6 y ears 3 months. The d ec rease in th e se war y ea rs was
m erely a m a tte r o f T reasury p o lic y which did n o t f u lly
e x p lo it th e e x is tin g lon g-term s e c u r ity demand. With a
supported bond m a rk e t, demand was h e a v ily w eighted in favor
of lo ng-term bonds. The p re fe re n c e o f p r iv a te in v e s to rs
fo r long-term s e c u r i t i e s was evidenced in th e accum ulation
o f s h o rt-te rm s e c u r i ti e s by th e F ed eral R eserve. Due to
i t s m arket su pport o p e ra tio n s , th e F ed eral Reserve h eld as
much as 50 p e r c e n t o f a l l o u tsta n d in g sh o rt-te rm s e c u r
i t i e s a t th e end o f World War I I .
From 1946 to 1952 th e average m a tu rity decreased
an o th er 40 p er c e n t to 3 y ea rs 10 months. This was due
la rg e ly to the passage o f tim e. "One is reminded o f the
q u o ta tio n from A lice in W onderland, where th e Red Queen
s a id , 'You have to run very f a s t to stan d s t i l l . T h i s
i s p a r t i c u l a r ly tru e o f th e d eb t m a tu rity p a tte r n .
Thus , th e d eb t sh o rte n in g b efo re th e Accord was not
due to any d e lib e r a te p o lic y . On th e c o n tra ry , i t was the
1QIbid. , p. 274.
214
r e s u l t o f a lack o f p rev en tiv e p o lic y . The Treasury
fin an cin g p o licy was predominated by the c o n tin u a l issu ance
o f sh o rt-te rm o b lig a tio n s . Market c o n d itio n s which would
have perm itted su c c e ssfu l long-term o ffe rin g s were not
e x p lo ite d . Long-term in v e s to rs were given l i t t l e opportu
n ity to m aintain the m atu rity p a tte r n o f t h e i r p o r tf o lio s
o f government s e c u r i ti e s . During th is p e rio d , the number
o f iss u e s o u tstan d in g in th e f iv e - to te n -y e a r b ra c k e t was
cu t alm ost in two. The d o lla r amount o f debt w ith a
m atu rity or c a l l d ate in excess o f ten years f e l l s h a rp ly ,
and th e debt w ith a m atu rity or c a l l in excess o f twenty
years d is a p p e a r e d .^ Some long-term in v e sto rs were even
forced to buy long-term s e c u r i ti e s in the market p lace to
12
o f f s e t the autom atic sh o rten in g o f t h e i r p o r tf o lio s .
With th e change o f a d m in istra tio n s in 1953, the new
government proclaim ed i t s e l f stro n g ly in favor o f len g th en
ing the average m atu rity o f the d eb t. An e x c e lle n t s t a r t
was made in 1953 and s u b s ta n tia l debt lengthening occurred
in 1954. Refundings were c h a ra c te riz e d by m u ltip le
^ A b b o tt, op. c i t . . p. 116.
12
Annual Report of the Secretary of the Treasury,
1950. p. 161.
215
o ffe rin g s which included a more a t t r a c t i v e l y p rice d long
term is s u e . For the f i r s t time sin c e 1946, th ir ty - y e a r
bonds were used. In n in e o f the eleven major fin an cin g s
o f 1953-1954, some debt lengthening was accom plished by
s e llin g in te rm e d ia te -te rm s e c u r i tie s as w ell as long-term
13
s e c u r i ti e s . As a r e s u l t o f th ese e f f o r t s , th e average
m a tu rity in creased to 4 years 7 months by December 1955.
However, in 1956 th e Treasury found few opportune tim es to
p rev en t th e d ecrease o f th e average m a tu rity o f th e fe d e ra l
d eb t. By December 1956 the average m a tu rity had slip p e d
back to 3 years 9 m onths--which was one month s h o rte r than
four years e a r l i e r . ^ A fte r th e incumbent a d m in is tra tio n
was re tu rn e d to power, the p o lic y o f lengthening the
average m a tu rity o f th e debt was re a ffirm e d . This time
the e f f o r t was more s u c c e s s fu l. Today the average m atu rity
of the fe d e ra l debt stands a t 4 y ears 7 months.
M arketable debt management theory and p r a c t i c e .
In accom plishing th e l a t e s t ex ten sio n o f average debt
13
Annual Report o f th e S ecretary o f th e T re a su ry ,
1955, p. 270.
14
Annual Report of the Secretary of the Treasury,
1957, p. 276.
216
m a tu r ity , the Treasury has operated c o n tra ry to the
d ic ta te s o f debt management th eo ry . The twofold response
to the b u sin ess cy cle envisioned by debt management
t h e o r is t would serve to re in fo rc e monetary p o licy in the
follow ing manner. F i r s t , long-term s e c u r itie s would be
issued in tim es o f in f l a t i o n . Such s e c u r itie s a c t as
s t a b i l i z e r s by reducing th e liq u id ity p o te n tia l o f the
debt and th e number of times th e T reasury would have to
come to the market p lace fo r fin an c in g . Reducing the
number o f Treasury v i s i t s to the market place meant th a t
th e re would be le s s need fo r F ederal Reserve market
su p p o rt, which might be c o n tra ry to e x is tin g monetary
p o lic y . Second, sh o rt-te rm s e c u r itie s would be issued in
tim es of re c e ssio n to in c re a se the l i q u id ity o f the
fin a n c ia l s e c to r of the economy. This would also leave
the maximum amount o f long-term funds a v a ila b le fo r
re v iv in g p riv a te e n te r p ris e .
The r ig id a p p lic a tio n of the c o u n te rc y c lic a l
approach would mean a la rg e b u ild -u p of sh o rt-te rm
s e c u r itie s in re c e ssio n . These would have to be refin an ced
in to long-term s e c u r itie s during p ro s p e rity . In p r a c tic e ,
the Treasury has been su c c e ssfu l in lengthening th e debt
217
only in re c e s sio n a ry p erio d s and in e a rly reco very p erio d s
during the l a s t s ix y e a rs . Examples were th e p e rio d s o f
e a rly recovery o f 1954 through th e f i r s t q u a r te r o f 1955,
and a lso th e re c e ss io n which began in 1957 and culm inated
in 1958.
In endeavoring to s e l l long-term s e c u r i ti e s in
in f la tio n a r y p erio d s , th e T reasury found th a t m arket
e x p e c ta tio n s and co m p etitio n from a c c e le ra te d p r iv a te
investm ent demand r e s u lte d in h ig h e r i n t e r e s t r a te s than
i t was le g a lly a b le to pay. A lso, th e p re ssu re s fo r cash
a t tim es forced th e T reasury in to th e s h o rt-te rm m arket
re g a rd le s s o f th e d ic t a t e s o f c o u n te rc y c lic a l monetary
p o lic y . This occurred because th e demand fo r s e c u r i ti e s
was much b roader and more c o n s is te n t in th e s h o rt-te rm
m arket and re p re se n te d a s ta b le source o f funds.
Unable to s e l l long-term s e c u r i ti e s a t th e le g a l
i n t e r e s t r a t e during i n f l a t i o n , th e T reasury had to re v e rs e
th e t r a d i t i o n a l approach in o rd e r to p rev en t th e sh o rte n in g
o f th e average m a tu rity o f th e d e b t. The T reasury began
to s e l l long-term s e c u r i ti e s in re c e s s io n . There were
com pensating advantages o f such a r e v e r s a l o f p o lic y . The
e x iste n c e o f long-term s e c u r i ti e s helped the monetary
218
a u th o r it i e s c o n tro l th e follow ing in f la tio n a r y p e rio d .
The d eb t management goal o f an accum ulation o f sh o rt-te rm
s e c u r i t i e s had the tendency to in c re a se th e in f la tio n a r y
p o te n tia l in th e next prosperous p e rio d .
F i n a l l y , the theo ry o f debt management suggested
th e id ea t h a t a com plete b u sin e ss cy c le r e s u l t s in a r e tu r n
to an e q u ilib riu m p o s itio n . However, in a dynamic growing
economy, th e cy c le i s lik e ly to be c h a ra c te riz e d by s h o r te r
re c e s s io n p erio d s and longer boom p e rio d s. In o rd e r to
p rev en t the slow accum ulation o f long-term d e b t, given
such a b u sin ess c y c le , th e debt manager would be forced to
s e l l s h o rt-te rm s e c u r i ti e s in p erio d s o th e r than re c e s s io n .
In an aly zin g the m arketable d e b t, i t is convenient
to d iv id e the t o t a l in to fo u r s e c to r s . S h o rt-term debt
in clu d es th e fe d e ra l o b lig a tio n s m aturing o r c a lla b le
w ith in one y e a r , such as T reasury B ills and T reasury
C e r t i f i c a t e s . In te rm e d ia te -te rm d eb t in clu d es m ainly
T reasury Notes and some in te rm e d ia te bonds. Long-term
debt d e a ls w ith fix ed m a tu rity and c a lla b le bonds and
government term a n n u itie s . In d e te rm in a te -term debt d ea ls
w ith such o b lig a tio n s as conso ls and government p e rp e tu a l
a n n u i t ie s .
219
Short-Term Marketable Federal Debt
S h o rt-term debt i s a d i s t i n c t body o f debt m aturing
o r c a lla b le w ith in one y e a r. I t is re g u la rly and r o u tin e ly
r o lle d over and n o t refunded in any way. The m ajor p o rtio n
o f s h o rt-te rm d eb t is v i r t u a l l y impounded in th e p recau
tio n a ry re se rv e s o f c o rp o ra tio n s , commercial banks , fo re ig n
c o n tro l banks, and s im ila r o rg a n iz a tio n s . The m arginal
p o rtio n a v a ila b le fo r t r a d i t i o n a l needs o f th e money m arket
has d e c r e a s e d .^ The m ajor components a re T reasury B ills
and T reasury C e r t i f i c a t e s .
The re c e n t use o f unpaid b i l l s and w arran ts issu ed
in excess o f funds should r i g h t f u l l y be co n sid ered in t h i s
categ o ry b u t a re d e le te d from government t o t a l s . Such
d ev ices a re g e n e ra lly looked upon as sig n s o f c r e d i t
weakness and t h e i r use c o n s titu te s one o f th e c o s t l i e s t
methods o f borrow ing and one o f th e most d i f f i c u l t to
c o n t r o l . ^ During World War I I , B r ita in a ls o used T reasury
^ R o b e r t W . Roosa, F ed eral R eserve O perations in
th e Money and Government S e c u r itie s Market (New York:
F ederal Reserve Bank o f New York, 1956), p. 21.
16
A lfred G. B u eh ler, P u b lic Finance ( th ir d e d itio n ;
New York: McGraw-Hill Book Company, I n c . , 1940), p. 640.
220
d e p o sito ry r e c e ip ts in th is s e c to r. These were compulsory
sh o rt-te rm loans from th e banks to th e T reasury. They
were not popular w ith the banks and have been rep laced
sin c e the end o f the war by Treasury B i l l s . ^
The use o f sh o rt-te rm debt in World War I I financing
was c o n tra ry to h i s t o r i c a l p r a c tic e . N e v e rth eless, i t was
adopted by the United S ta te s and o th e r major b e llig e r e n ts .
T r a d it io n a l l y , s h o rt-te rm debt is used to accommodate the
government fo r those p erio d s when th e r e c e ip ts to cover
the debt are known to be forthcom ing. Tax savings notes
which were used b efo re the adoption o f th e w ithholding tax
system a re a good example o f th i s type o f sh o rt-te rm d eb t.
O rd in a rily , i f the debt is to be of a prolonged n a tu re ,
then th e debt instrum ent a lso should be o f a long-term
n a tu re .
Two reasons were advanced by the Treasury to j u s t i f y
sh o rt-te rm World War I I fin an c in g . F i r s t , the Treasury
t r i e d to avoid the m istakes o f World War I , when co rp o ra
tio n s , banks , and in d iv id u a ls were overloaded w ith
long-term bonds. These long-term bonds were liq u id a te d in
*^Hugh D alton, P rin c ip le s o f Finance (London:
Routledge and Kegan P au l, L td ., 1954), p. 195.
221
th e m arket fo r as low as se v e n ty -e ig h t c e n ts on the
d o l l a r d uring th e post-W orld War I p e rio d . I t was a n t i c i
pated th a t i f i n t e r e s t r a te s went up a f t e r World War I I ,
th e government r a th e r than th e p riv a te in v e s to r should
r i g h t l y b e a r th e burden. Second, th e p o lic y o f f i t t i n g the
s e c u r ity to the needs o f the in v e s to r made i t d e s ira b le
th a t a la rg e p o rtio n o f the fe d e ra l debt should c o n s is t o f
s h o rt-te rm s e c u r i t i e s . This would perm it an u n tro u b led
18
s h i f t o f funds du ring re co n v ersio n .
A s h o rt-te rm d ebt has s e v e ra l peacetim e advantages.
I t reduces th e s t r a i n on th e money market by p ro v id in g a
c lo s e s u b s t i tu te fo r money which can be s h if te d from one
s e c tio n o f the country to a n o th e r. A s h o rt-te rm debt
allow s accum ulations o f ta x re s e rv e s and tem porary funds
to occur w ith out money m arket s t r a i n . During t i g h t money
p e r io d s , r o ll i n g over sh o rt-te rm debt r e s u l t s in le s s
in te r f e r e n c e w ith F ederal Reserve monetary p o lic y than
long-term refu n d in g d o e s.
The e x iste n c e o f a la rg e volume o f s e c u r i ti e s
m aturing each y ea r allow s th e T reasury to be s e le c tiv e as
Annual Report of the Secretary of the Treasury.
1945. pp. 411-412.
222
to th e s e c to r in which debt repayment w ill tak e p la c e .
For exam ple, th e la rg e re d u c tio n o f th e debt h eld by the
commercial banking system in the e a rly post-W orld War I I
y ea rs o f 1946 and 1947 was accom plished w itho ut d is tu rb in g
the money m arket. A lso , because o f t h e i r hig h l i q u id i t y
f a c t o r , th e r a t e o f i n t e r e s t on sh o rt-te rm s e c u r i ti e s is
u s u a lly low er. The government g ain s in reduced debt
s e rv ic in g charges and th e in v e s to r g ain s income w hile
m ain tain in g l iq u i d i t y . The in v e s to r can use h is s h o r t
term s e c u r i ti e s as a secondary r e s e r v e , thus in c re a sin g
h is a b i l i t y to r e a d ju s t h is cash p o s itio n . F in a lly , i t is
im portant to th e T reasury th a t th e s h o rt-te rm s e c u r ity
m arket be m aintained so th a t minor em ergencies may be
handled. Emergency funds could be r a is e d in th e s h o rt-te rm
m arket r a th e r than by u sin g the T re a s u ry 's a u th o rity to
borrow d i r e c t l y from th e F ed eral Reserve System.
A sh o rt-te rm debt may a ls o be d isadvantag eo us. I t
has r e s u lte d in p r a c t ic a l dom ination o f th e sh o rt-te rm
m arket by th e government. P riv a te forms o f sh o rt-te rm
debt in stru m en ts have become r e l a t i v e l y unim p o rtan t. I t
w i l l be d i f f i c u l t fo r th e p r iv a te s e c to r to re p la c e the
government as a s u p p lie r o f such s h o rt-te rm funds. This
223
could r e s u l t in a sh o rtag e o f incom e-earning sh o rt-te rm
s e c u r i ti e s should th e government repay o r fund th e d e b t.
The g re a t volume o f sh o rt-te rm debt and th e n e c e s
s i t y o f r o l l i n g i t over s e v e ra l tim es a y ear allow the
T reasury le s s f l e x i b i l i t y o f d eb t o p e ra tio n . In o rd e r to
avoid a heavy cash a t t r i t i o n , the T reasury must judge
c o r r e c tly th e m arket r a t e o f i n t e r e s t . In tim es o f money
m arket s t r e s s th e s h o rt-te rm r a t e o f i n t e r e s t becomes
*
burdensome, sometimes r i s i n g above th e long-term r a te .
T h e re fo re , a la rg e s h o rt-te rm d ebt may em barrass a govern
m ent, s u b je c tin g i t too much and too co n tin u o u sly to th e
19
c a p ric e o f th e p r iv a te le n d e rs.
F in a lly , and most im p o rta n t, a s h o rt-te rm d eb t is
h ig h ly liq u id and th e re fo re h ig h ly v o l a t i l e in in f la tio n a r y
p e rio d s. The u s e fu ln e ss to in v e s to rs o r to th e country o f
a volume o f s h o rt-te rm debt o f p re se n t-d a y magnitude has
not been dem onstrated o r ever even been argued by the
T reasury a u th o r it i e s in any e x p l i c i t fa sh io n . C e rta in ly
some o f th e problems experienced by th e T reasury follow ing
th e outbreak o f fig h tin g in Korea were im m ediately t r a c e
a b le to th e e x is te n c e o f such a la rg e volume o f sh o rt-te rm
19
Dalton, op. cit. , p. 200.
224
20
government debt.
T reasury B i l l s . T reasury B ills a re d efin ed as
n o n in te r e s t b e a re r o b lig a tio n s a g a in s t th e government.
Denominations range from one thousand d o lla r s to one
m illio n d o lla r s . They a re issu e d on a d isc o u n t b a s is and
a re payable on m a tu rity a t p a r. S ales a re made fo r cash
under se a le d b id a u c tio n p ro ced u res.
T reasury B ills were f i r s t a u th o riz e d fo r use in th e
U nited S ta te s in 1929. T reasury C e r t i f ic a te s were being
disco u n ted a t th a t tim e by d e p o sito ry banks. S e c re ta ry o f
th e T reasury Andrew Mellon b e lie v e d th a t a new form o f
s e c u r ity p a tte rn e d a f t e r th e T reasury B i l l used by th e
21
B r itis h would be p re fe ra b le under th e circu m stan ces.
At th e p re se n t tim e th e T reasury has th i r t e e n
re g u la r iss u e s o f three-m onth B i l l s , and t h i r te e n issu e s
o f six-m onth B i l l s . These two s e ts form a p a tte r n in
which one iss u e m atures and is re p la c e d by a B i ll o ffe rin g
each week. In a d d itio n , th e re a re now four iss u e s o f
20
A b bott, op. c i t . , p. 45.
21
Annual Report of the Secretary of the Treasury,
1929, pp. 40-42.
225
one-year B i ll s m aturing once each q u a r te r in Jan u a ry ,
A p r il, J u ly , and O ctober. The t o t a l amount o f th e se
r e g u la r ly r o lle d over T reasury B i ll s was $33.5 b i l l i o n a t
the end o f Ju ly 1 9 5 9 .^
The T re a s u ry , in o rd e r to speed i t s fin a n c in g
o p e r a tio n s , began s e l l in g T reasury B ills in "packages" in
1961. Each s in g le b a tc h co n tain ed e ig h te e n sh o rt-te rm
B i ll s w ith m a tu r itie s vary in g from two months to fiv e
months. The p re se n t r e g u la r r o llo v e r o f T reasury B ills
23
amounts to $2 b i l l i o n weekly. This r o llo v e r is accom
p lish e d by exchanging m aturing is s u e s fo r new B i l l s . Cash
adjustm ents a re made fo r th e d iffe re n c e between th e par
v alu e o f th e m aturing B i ll and th e is s u e p ric e o f the new
B i l l . Since th e r o llo v e r procedure is u t i l i z e d by the
F ederal R eserve, T reasury B i ll refu n d in g re p re s e n ts one o f
th e few occasions o f d i r e c t d e a lin g between the T reasury
and th e c e n tr a l bank n o t s u b je c t to C ongressional
24
lim ita tio n .
22
Annual R eport o f the S e c re ta ry o f th e T re a s u ry ,
1960, p. 29.
23
Wall S tr e e t J o u r n a l, June 5 , 1961, p. 1; Ju ly 6,
1961, p. 2.
2
Annual Report of the Secretary of the Treasury,
1947, p. 33.
226
The o r ig in a l purpose o f th e T reasury B ill when i t
was in au g u rated in 1929 was to provide a s e c u r ity to meet
seaso n al gaps between r e c e ip ts and e x p e n d itu re s. Due to
th e ro u tin e issu an ce o f T reasury B i l l s , they a re no longer
s u ita b le fo r th is purpose. Seasonal fin an c in g i s accom
p lis h e d by means o f Tax A n tic ip a tio n C e r t i f i c a t e s a t the
p re se n t tim e. These Tax A n tic ip a tio n C e r t i f i c a t e s have
acq u ired th e f l e x i b i l i t y th a t T reasury B ills have l o s t .
As long as th e government supported th e bond m arket
a t p a r, th e commercial and c e n tr a l banking system s held
90 per ce n t o f th e o u tsta n d in g volume o f T reasury B i ll s .
When th e T reasu ry -F ed eral Reserve Accord removed the
bond m arket su p p o rts , the p riv a te s e c to r became the m ajor
h o ld e r o f T reasury B i l l s . The T reasury survey o f debt
ownership in 1956 showed th a t combined commercial and
c e n tr a l bank hold in g s had dwindled to 15 p er ce n t o f the
25
o u tsta n d in g T reasury B i l l s . A fte r th e Accord, the
F ed eral Reserve embarked upon i t s p o lic y o f u sin g T reasury
B ills only in i t s open m arket o p e ra tio n s . This " b i l l s
only" p o lic y was te c h n ic a lly abandoned in 1961, although
Roosa, op. cit. , p. 21.
227
T reasury B ills a re s t i l l used to e x p e d ite open m arket
26
o p e ra tio n s w ith only minor ex c e p tio n s. This p o lic y
r e s u lte d in much d is c u s s io n w ith in th e F ed eral Reserve
System i t s e l f . Chairman W illiam M artin favored the p o lic y
and A llen S p ro u l, P re sid e n t o f th e F ed eral Reserve Bank o f
27
New York, opposed i t . The F ed eral Reserve p r e f e r s to
r e s t r i c t i t s e l f to u sin g T reasury B ills to e f f e c t m onetary
p o lic y changes because they a re " th e c lo s e s t e q u iv a le n t to
28
money." In su p p o rt o f th e " b i l l s only" p o lic y , i t is
suggested th a t i n t e r e s t r a te s through a r b itr a g e move in
more o r le s s th e same d ir e c tio n re g a rd le s s o f th e m a tu rity
s e c to r in which the F ed eral Reserve open m arket o p e ra tio n s
occur. The co n clu sio n th a t i n t e r e s t r a te s a d ju s t as w ell
when only one d eb t m a tu rity s e c to r i s su b je c te d to F ed eral
Reserve p re ssu re has not been proved. Assuming th a t
i n t e r e s t r a t e e f f e c ts a re tra n s m itte d e a s ily between
F ed eral Reserve B u l l e t i n , February 1961, p. 165;
March 1961, p. 276.
27
Board o f Governors o f th e F ed eral R eserve System,
Annual R e p o rt, 1953 (Washington: Government P rin tin g
O ff ic e , 1953), p. 89.
28
Monthly L e tte r o f B usiness and Economic Condi
tio n s , by Chairman W illiam M artin , F i r s t N atio n al C ity
Bank, New York, December 1958, p. 136.
228
m a tu rity s e c to rs weakens r a th e r than su p p o rts th e argument
fo r co n fin in g o p e ra tio n s to T reasury B ills on ly . I f the
same e f f e c ts could be garnered by d e a lin g in any o r a l l
s e c to r s , due to a r b itr a g e , i t becomes more d i f f i c u l t to
j u s t i f y d e a lin g in only one s e c to r .
T reasury C e r t i f i c a t e s . A T reasury C e r t i f i c a t e is
d efin e d as a b e a re r o b lig a tio n is s u a b le a t no le s s than
p a r , a t such r a te s o f i n t e r e s t as the S e c re ta ry o f the
T reasury may p re s c rib e and payable a t p erio d s not to
extend one y ear from d a te o f is s u e . T reasury C e r t i f ic a te s
have been issu ed fo r as s h o rt a p erio d as one and o n e -h a lf
months. The average m a tu rity is about fiv e months.
During World War I , c e r t i f i c a t e s o f indebtedness were used
e x c lu s iv e ly on a bond a n tic ip a tio n o r tax a n tic ip a tio n
b a s is . The f l e x i b i l i t y they provided th e d ebt manager fo r
i n t r a f i s c a l y ear adjustm ents r e s u lte d in t h e i r continued
use through the post-W orld War I p e rio d . Between 1934 and
1942, C e r ti f i c a t e s were re p la ced by T reasury B i ll s .
S h o rt-term r a te s o f i n t e r e s t were so low th a t any s ta te d
i n t e r e s t r a t e would have appeared lu d ic ro u s . The T reasury
B i l l , a d isco u n ted debt in stru m e n t, th e r e f o r e , was used
229
29
ex c lu siv e ly during t h i s p erio d .
In fin an cin g World War I I , c e r t i f i c a t e s o f in d e b t
edness were re in tro d u c ed . Commercial banks were p erm itted
to su b scrib e fo r as many Treasury C e r tif ic a te s as was
necessary to fu rn ish a d d itio n a l funds to the government.
S u b scrip tio n s fo r Treasury C e r tif ic a te s re q u ire d no excess
re se rv e s. Payment o f such s e c u r iti e s was e ffe c te d by
c re d itin g the Government War Loan Accounts a t the com
m ercial banks. As th ese funds were spent by th e government
they would alm ost com pletely reap p ear as p riv a te bank
d e p o s its , thereby fu rn ish in g th e bank funds re q u ired to
pay fo r the Treasury C e r t i f i c a t e s u b s c rip tio n s .
A fter World War I I , commercial banks continued to
use th is com bination o f Treasury C e r tif ic a te s and govern
ment d ep o sito ry accounts. In p eriods o f monetary ea se,
banks would su b scrib e fo r and r e ta in T reasury C e r tif ic a te s
as a source o f income. In times o f c r e d i t s trin g e n c y , th e
commercial banks would su b scrib e fo r Treasury C e r tif ic a te s
but then s e l l them. These s a le s could even occur a t a
29
C. F. C h ild s, Concerning United S ta te s Government
S e c u ritie s (Chicago: C. F. C hilds and Company, 1947),
pp. 428-429.
230
d isco u n t sin c e the funds thus procured would provide a
temporary in c re a se in the commercial banks' re se rv e s . This
was due to the fa c t th a t the government had not y e t spent
the funds c re d ite d to i t s d ep o sito ry account. Conse
q u e n tly , when commercial banks a re under severe re se rv e
requirem ent p r e s s u r e , o th e r in v e sto rs tend to w ithhold
t h e i r s u b s c rip tio n s during th e T reasury cash o ffe rin g of
C e r ti f i c a t e s . These o th e r in v e sto rs plan to buy the se c u r
i t i e s a t a d isco u n t as th e banks unload them on the m arket.
The ex ten t to which th is occurs is i l l u s t r a t e d by the
T re a su ry 's cash s a le of $2.4 b i l l i o n C e r tif ic a te s in March
1957, o f which commercial banks were awarded a l l but $0.1
b i l l i o n . W ithin th re e months commercial bank holdings o f
30
th is issu e had been reduced by $1.7 b i l l i o n .
T reasury C e r tif ic a te s combined w ith Treasury B ills
c o n s titu te th e e n tir e "w ith in one year" s e c to r o f the
fe d e ra l debt w ith minor ex cep tio n s. Today th is s e c to r
accounts fo r 25 per cent o f the t o t a l debt and 38 per cent
of the m arketable d eb t. N eith er form o f debt instrum ent
involves " re a l" borrowing i f the funds are supplied e ith e r
30
Gaines, op. cit. , pp. 407-408.
231
from tem p o rarily id le accum ulations o r from d e p o sit
c r e a tio n by th e banking system . This p o rtio n o f th e debt
was th e n e a re s t form to money when issu ed o r i g i n a l l y . As
h eld by s h o rt-te rm in v e s to rs to d ay , the s h o rt-te rm debt
s t i l l re p re s e n ts a money e q u iv a le n t. L i t t l e m easurable
lo s s o f l i q u id i t y tak es p la c e as a r e s u l t o f investm ent in
th i s type o f s e c u r i t i e s .
Money may be issu ed a t zero c o s t. T herefore
th a t p o rtio n o f th e n a tio n a l debt which does
re p re s e n t "money" in i t s re le v a n c e to human behavior
can be re p la c e d w ith a c tu a l money, c u rre n c y , w ithout
p riv a te people being forced to s a c r i f i c e r e a l goods
and s e r v ic e s . The sh are o f t o t a l debt which r e p r e
se n ts "genuine" o r "pure" d eb t can b e s t be determ ined
by c a p ita li z i n g th e i n t e r e s t payments stream a t a
r a te in d ic a tin g th e pure r a te o f y ie ld on m arginal
investm ents in th e p r iv a te s e c to r . This would make
t o t a l debt measurement appear as follow s: N atio n al
Debt as o f June 30, 1957 m a tu rity v alu e $272 b i l l i o n ,
p re se n t m arket v alu e $25 7 b i l l i o n , th e re fo re "pure"
debt equals $185 b i l l i o n and "m onetized" debt equals
$72 b i l l i o n . 31
I t is extrem ely in t e r e s t i n g to find th a t Buchanan's
method o f determ in ing "m onetized" debt in 195 7 c o in c id e s
e x a c tly to th e $71.95 b i l l i o n d ebt which c o n s titu te d the
32
"w ith in one y ear" s e c to r o f the fe d e ra l debt in 1957.
31
James M. Buchanan, P u b lic P rin c ip le s o f P u b lic
Debt (Homewood. I l l i n o i s : R ichard D. Irw in . I n c .. 1958).
ppT- 205-206.
32
Annual Report of the Secretary of the Treasury,
1960. p. 487.
232
The c o n te n tio n th a t th e "w ith in one y ear" debt
s e c to r is in r e a l i t y m onetized today is supported by the
in c re a s e o f v e lo c ity o f a v a ila b le currency and demand
d e p o s its . Such v e lo c ity in c re a s e is exem plified by two
c u rre n t p r a c tic e s which have developed in resp onse to the
stim u lu s o f tu rn in g cash in to an earn in g a s s e t.
The lu re o f s h o rt-te rm d eb t earn in g s has r e s u lte d in
th e r e v iv a l of th e u se o f bank d r a f t s to su p p lan t checks by
such m ajor c o rp o ra tio n s as American Telephone and T elegraph
Company, Sw ift and Company, G eneral E le c tr ic Company,
G reat A tla n tic and P a c ific Tea Company, G ulf O il C orpora
t i o n , S in c la ir R efining Company, and Kroger and Company.
In h an d lin g i t s p a y r o lls , fo r in s ta n c e , American Telephone
and T elegraph can pay an employee by d r a f t on F rid ay . The
employee cashes the d r a f t a t h is lo c a l bank, which sends
i t on to American Telephone and T e le g ra p h 's New York Bank.
I t may be Wednesday o r Thursday b e fo re the d r a f t a r r iv e s .
The bank then sends i t to th e company's accounting d e p a r t
m ent, which has u n t i l 3 p.m. th a t day to in s p e c t and
approve i t . Not u n t i l then does American Telephone and
T elegraph d e p o sit funds in i t s bank to pay the d r a f t . A
company w ith a $3 m illio n F riday p a y r o ll can , by u sin g
d r a f t s , earn more than $1,000 i n t e r e s t in a week by p la c in g
233
th e funds in sh o rt-te rm government s e c u r i ti e s in s te a d o f
33
th e bank.
The second example o f th e in cre ased v e lo c ity o f
money rev o lv es around th e development o f "rep u rch asin g
agreem ents" by government bond d e a le rs . A rep u rch ase
agreement perm its a d e a le r to s e l l s h o rt-te rm s e c u r i ti e s
to a medium s iz e commercial bank o r la rg e c o rp o ra tio n w ith
th e express p ro v isio n th a t th e d e a le r w ill buy th e same
s e c u r iti e s back a t a s p e c if ie d p r ic e . Such an agreement
perm its commercial banks and c o rp o ra tio n s to in v e s t funds
p r o f ita b ly th a t would o th erw ise have been id l e fo r a day
o r two. Since rep u rch ase agreem ents use sh o rt-te rm
government s e c u r i ti e s , they e n t a i l n e ith e r c r e d i t nor
money r i s k . The d e a le r provides the s e rv ic e o f o rg a n iz in g
e f f e c tiv e ly a m arket which can be made as liq u id in terms
o f m a tu rity as the cash requirem ents o f th e in v e s to r
d i c t a t e . For th i s s e rv ic e he re c e iv e s a p o rtio n o f the
i n t e r e s t payment due from the s h o rt-te rm government
s e c u r ity , and the v a rio u s s u p p lie rs o f th e funds re c e iv e
34
th e b alan ce.
33
Wall S tre e t J o u r n a l» August 29, 1961, p. 1.
o /
Gaines, op. cit. . p. 484.
Assuming th a t such a c tio n s as th e use o f d r a f ts and
repurchase agreements are the r e s u l t o f a sh o rtag e o f r e a l
money forms as r e f le c te d by the wide flu c tu a tio n s o f v ery -
sh o rt-te rm i n t e r e s t r a t e s , a proposal to m onetize th e
91-day b i l l s e c to r o f th e debt could be co n sid ered. Unlike
the m o netization o f the e n tir e fe d e ra l d e b t, such an a c tio n
would not be in f la tio n a r y . The F ederal Reserve acknowl
edges 91-day b i l l s as the c lo s e s t eq u iv alen t to cash.
There is no reason why in f la tio n a r y exp en diture should
occur i f th is p o rtio n o f th e debt were rep laced by F ederal
Reserve notes or bank demand d e p o s its . The end r e s u l t of
such an in c re a se in the supply o f money under such co n d i
tio n s would be the re tu r n to a normal v e lo c ity o f money.
I t would h a l t th e d is ru p tin g in flu e n c e o f the use o f
d r a f t s , which a t p re se n t is causing commercial banks con
s id e ra b le c o n ste rn a tio n . This re tu r n to normal v e lo c ity
o f money would occur g ra d u ally as the o p p o rtu n ity to tu rn
cash balances in to an incom e-earning a s s e t disappeared
w ith th e re d u ctio n o f the la r g e , w ell-o rg an ized government
91-day b i l l m arket.
In a d d itio n , the F ederal Reserve could be made the
only le g a l r e c ip ie n t of a l l forms o f debt w ith le s s than
235
91 days to m a tu rity d a te . Such a requirem ent would tend to
stre n g th e n monetary p o lic y . I t would g ive the F ederal
Reserve e f f e c tiv e c o n tro l o f the process which perm its th e
liq u id a tio n o f v e ry -sh o rt-te rm a s s e ts . In v e sto rs would
then have to a d ju s t t h e i r p o r tf o lio s w ith due regard fo r
t h i s c o n d itio n . In th is manner, the economy would
e f f e c tiv e ly d is tin g u is h between money forms and tr u ly
in v e s ta b le funds o f even a r e l a t i v e l y sh o rt-te rm n a tu re .
By o ffe rin g the in v e s to r a h ig h er i n t e r e s t r a t e on
in te rm e d ia te -te rm issu e s in i t s m u ltip le refunding o p era
tio n s , the Treasury today is taking a p relim in ary step
toward encouraging th e in v e s to r to d is tin g u is h between
tr u ly in v e sta b le funds and money. Since 86 per ce n t o f
to d a y 's $286.5 b i l l i o n debt m atures in le s s than fiv e
y e a rs , o r is redeem able a t the h o ld e r 's o p tio n , i t becomes
a m atter o f v i t a l n e c e s s ity th a t tru e investm ent funds be
so d esig n ated and th a t money s u b s titu te s be su b jected to
the same c o n tro ls as money i t s e l f .
Interm ediate-T erm M arketable F ederal Debt
Those s e c u r iti e s having a m a tu rity o f not more than
fiv e years o r le s s than one y ear are c l a s s i f i e d as
in te rm e d ia te -te rm m arketable d ebt. This s e c to r c o n s is ts
236
la rg e ly o f T reasury Notes which have an o r ig in a l m a tu rity
o f from one to fiv e y e a r s , a r e l a t i v e l y few issu e s o f
bonds o r i g i n a l l y issu ed w ith m a tu r itie s o f under fiv e
y e a r s , and an accum ulation o f bonds whose m a tu rity has
been sh o rten ed through th e passage o f tim e to under fiv e
y e a rs . T reasury Notes a re b e a re r o b lig a tio n s paying a
s p e c if ie d r a t e o f i n t e r e s t by means o f sem i-annual coupons.
35
They c o n s t i tu te 10 p er ce n t o f to d a y 's d e b t. The
T reasury Note system , sin c e i t b rin g s the day o f payment
c lo s e r to the day o f e x p e n d itu re , has been commended as an
e f f e c tiv e guard a g a in s t w aste and extravagance. This
reaso n in g assumes th a t th e T reasury Note w i ll be paid from
ta x a tio n when due and n o t m erely be refunded tim e and
ag a in . T reasury Notes do not t r u l y c o n s titu te a funded
d ebt when compared to lo n g er-te rm is su e s , bu t a re more
c lo s e ly a lig n e d w ith tru e investm ent funds than w ith money
form s.
A s h i f t in T reasury p o lic y from sh o rt-te rm to
in te rm e d ia te -te rm debt could be accom plished by issu in g
T reasury Notes in ste a d o f C e r t i f ic a te s and B i l l s . Such an
35
M arshall A. Robinson, The N atio n al Debt C e ilin g
(Washington: The Brookings I n s t i t u t i o n , 1959), p. 10.
237
issu in g p o lic y should h elp to detach those funds which are
tr u ly in v e sta b le from those which a re m erely a v a ila b le fo r
very sh o rt p erio d s o f tim e. A lso, using in term ed iate-te rm
debt to e f f e c t the lengthening o f th e average m atu rity of
the fe d e ra l debt would be b e n e f ic ia l. S h iftin g in to
in term ed iate-te rm debt would have a le s s r e s t r i c t i v e e f f e c t
upon p r iv a te investm ent than a much sm aller amount of
36
s h if tin g to long-term bonds.
In the endeavor to c o o rd in a te debt management w ith
c y c lic a l monetary p o lic y , the in term ed iate-te rm debt
appears most amenable to providing b e n e f ic ia l r e s u l t s . The
debt lengthening d e s ire d in tim es o f i n f la ti o n could be
accom plished w ith le s s d i f f i c u l t y in the in term ed iate-te rm
s e c to r than in the long-term s e c to r. The com petition
between the government and the p riv a te s e c to r fo r funds in
*
the "one to fiv e year" m a tu rity range is not as keen as i t
is in the long-term s e c to r. F urtherm ore, th e in te rm e d ia te -
term debt would not be as firm ly placed. In the event o f
an extended re c e s s io n , th e in term ed iate debt could be
allowed to seep in to th e sh o rt-te rm category and re p a id ,
Committee fo r Economic Development, Managing the
F ederal Debt (New York: The Committee, 1954), p. 29.
238
thus in c re a s in g the money supply. This would tak e p la c e
a t a time when such a debt management p o lic y would be
welcomed by f i s c a l p o lic y m akers. The s t a b il iz in g
in flu e n c e o f in te rm e d ia te -te rm debt is fu rth e re d by th e
f a c t th a t commercial banks p re fe r s e c u r i ti e s in th e "one
to fiv e y ear" s e c to r due to t h e i r h ig h e r re tu r n .
Long-Term M arketable F ed eral Debt
Long-term m arketable fe d e ra l d eb t is composed o f
in te re s t-p a y in g b e a re r o b lig a tio n s w ith a m a tu rity o f over
fiv e y e a rs. There is no s p e c if ie d o u te r lim it on th e
m a tu r itie s fo r which bonds may be i s s u e d , b u t cu sto m arily
they do not exceed f o r ty y e a rs.
The United S ta te s has issu ed some bonds th a t had no
s p e c if ic m a tu rity d a te and were m erely payable a t the
p le a su re o f the U nited S ta te s government. These p e r p e t
u i t i e s were issu ed in te r m itte n tly during th e 1870's and
3 7
1880's and were much in demand. P riv a te c o rp o ra te use
o f p e r p e tu itie s has a lso occurred in th e U nited S ta te s .
Examples would in clu d e the o b lig a tio n s o f th e West Shore
R a ilro a d , payable in 2361; and th e Elm ira and W illiam sport
37
Robinson, op. cit., p. 10.
239
R ailro ad payable in 2862--one thousand y ears a f t e r th e
38
d a te o f is s u e . P e r p e tu itie s have a lso been used f r e
q u en tly in Europe, e s p e c ia lly to c o n so lid a te war d e b ts.
Such p e r p e tu itie s a re continued from one g e n e ra tio n to th e
n ex t. E: l.es would in clu d e such iss u e s as th e B r itis h
co nsols and th e French r e n t i e r s .
The economic reaso n in g behind a p e rp e tu ity is th a t
the bondholder lends n othing when he a c q u ire s th e bond; he
has m erely bought th e r i g h t to a s tip u la te d income fo r an
in d e f in ite p erio d o f tim e. At tim es government p e rp e tu
i t i e s even tak e the form o f a n n u itie s which a re issu ed fo r
th e l i f e o f the h o ld e r. Given a s u f f i c i e n t l y high r a t e o f
i n t e r e s t , such a n n u itie s m ight be made a t t r a c t i v e enough
39
to e v e n tu a lly r e t i r e th e d eb t held by in d iv id u a ls .
The id e a l form o f s e c u r ity , from the debt m anager's
p o in t o f view , would be a c a lla b le p e r p e tu ity . E xclusive
use o f p e r p e tu itie s as debt in stru m en ts has been
40
advocated. The in c lu s io n o f the c a lla b le fe a tu re in
38
Anatol Murad, P riv a te C re d it and P u b lic Debt
(W ashington, D.C.: P u b lic A ffa irs P re s s , 1954), p. 108.
39
B u eh ler, o p . c i t . . p. 643.
^ H e n ry Simmons, "Our Debt P o lic y ," Jo u rn a l o f
P o l i t i c a l Economy, L II (December 1944), 356.
240
p e r p e tu itie s would be d e s ir a b le . Examples o f th e u se o f
such p e r p e tu itie s would in clu d e th e 2 p er c e n t c o n so lid a te d
bonds which combined th e remnants o f prev io u s C iv il War
bonds. These s e c u r i ti e s were c a ll a b le p e r p e t u it i e s . They
had no d e f i n i t e m a tu rity d a te , b u t were redeem able a t the
p le a s u re o f th e government a f t e r t h i r t y y ears from d a te o f
41
is s u e . A nother example would be th e is s u e in 1881 o f
3.5 p e r c e n t bonds c a lla b le a t any tim e a t th e o p tio n o f
42
th e government.
D esp ite th e obvious advantages o f the c a lla b le
fe a tu re to th e governm ent, th e T reasury has issu ed no
c a lla b le bonds s in c e May 1953, and no c a ll a b l e n o tes sin c e
43
September 1957. This is a l l the more s u rp ris in g in view
o f th e p re v a ilin g high r a te s o f i n t e r e s t . The a d d itio n a l
i n t e r e s t c o s t to th e T reasury o f m arketing a c a lla b le
is s u e might be more than compensated fo r by refunding in
any fu tu re low i n t e r e s t r a te p e rio d . A study in 1958
^ C h i l d s , op. c i t . . p. 361.
42
G aines, op. c i t . . p. 26.
43
Warren L. Sm ith, Debt Management in th e U nited
S ta te s , U.S. C ongress, 86 th C ong., 2d S e s s ., J o in t Economic
Committee, Study Paper No. 19 (Washington: Government
P rin tin g O ff ic e , January 28, 1960), fo o tn o te p. 47.
241
covering the preceding th irty -tw o y ears in d ic a te d th a t the
a d d itio n a l in t e r e s t c o sts to borrow ers on bonds su b je c t to
immediate o r e a rly c a ll s was r e l a t i v e l y sm all in comparison
AA
w ith c o sts on bonds which were not c a lla b le .
Indeed, the Treasury seems to be adopting j u s t the
o p p o site course o f a c tio n , i . e . , p lacin g th e o p tio n to
c a l l in the hands o f the in v e sto r in ste a d o f the govern
ment. An example o f th i s type o f s e c u rity would be the
3 -1 /4 p er cent Investm ent S eries B bonds o f 1975-1980.
These bonds allow the in v e sto r to convert to Treasury
Notes a t h is own d is c r e tio n . Such issu e s tend to negate
the forem ost advantage o f lengthening the d eb t.
During periods o f government m arket s u p p o rt, such
as from 1942 to 1951, long-term fin an cin g is r e la ti v e l y
m eaningless. Treasury bonds to a l l e x te n ts and purposes
become liq u id in stru m en ts. The d iffe re n c e in i n t e r e s t
r a te s between equally liq u id s e c u r itie s re s u lte d in p riv a te
in v e sto rs co n c en tratin g t h e i r holdings in long-term bonds.
As l a t e as September 1947 i t was necessary fo r th e F ederal
R eserve, the T reasury, and even the Government T ru st Funds
^ Annual Report of the Secretary of the Treasury,
1960, p. 295.
242
to s e l l t h e i r own long-term holdings to supply th e market
demand fo r bonds. However, th e f a ilu r e o f the F ederal
Reserve to support the bond market f u lly in the l a s t months
o f 1947 c re a te d in v e s to r apprehension as to the fu tu re
li q u id i t y o f long-term government s e c u r iti e s . The f in a l
r e s u l t o f the fe a rs th a t bond supports would not continue
was an ever-grow ing supply of bonds on the m arket, which
culm inated in the T reasury-F ed eral Reserve Accord o f
March 195l . 45
Aside from the World War IX issu e s , th e re were no
m arketable Treasury bonds o ffe re d u n t i l 1952. At th is
tim e, a 2-3/8 per cent bond w ith a m atu rity o f fiv e to
seven years was m arketed. Since the change in adm inis
t r a t i o n in 1953, $34 b i l l i o n fiv e to ten year bonds , $2
b i l l i o n ten to twenty y ear bonds, and $6.5 b i l l i o n o f
46
over twenty years bonds have been issu ed . The lo n g est
term category included the 3-1/4 per cent tw en ty -fiv e to
t h i r t y year bonds and the 3-1/2 per cent t h i r t y y ear bonds
Annual Report o f th e Secr e t a r y o f the T reasu ry ,
1951, p. 260.
46
U .S ., House, Testimony by S ecretary o f the
T reasury A nderson, Hearings , P ublic Debt C eilin g and
I n t e r e s t Rate C eilin g on Bonds , 86th C ong., 1 st S e s s .,
June 1959, p. 123.
243
issu ed in 1953, p lus th e 3 p er c e n t fo rty y ea r bonds
issu ed in 1955. The l a t t e r was th e lo n g est term T reasury
47
iss u e sin c e 1911.
The T reasury has fre q u e n tly r e i t e r a t e d the s e l f -
imposed c o n d itio n th a t i t s long-term fin an cin g must not
i n t e r f e r e w ith th e needs fo r funds by s t a t e and lo c a l
governments and p riv a te e n te r p r is e . The S e c re ta ry o f th e
T reasury s ta te d th a t the fo rty y ea r bond was chosen to
appeal to such long-term in v e s to rs as pension funds and
insurance companies in an a re a beyond th e prim ary demand
fo r mortgage funds. R egardless o f i n t e n t , th e se long-term
iss u e s d id r e s u l t in a d ec rease in th e volume o f funds
48
a v a ila b le fo r m ortgages. The d ir e c t r e la tio n s h ip between
th e long-term government bond m arket and the mortgage
m arket i s fu r th e r evidenced by th e in c re a se in government
guaranteed F ederal Housing A u th o rity and V eterans A u th o rity
m ortgages. The t o t a l o f th e se guaranteed m ortgages
expanded from le s s than $5 b i l l i o n in 1945 to over $50
47 ?
Annual Report o f th e S e c re ta ry o f the T re a s u ry ,
1955, p. 24.
48
Rudolph Smutny, Government S e c u r itie s and the
Money Market (New York: L ife O ffic e rs Investm ent S e rv ic e ,
1955), p. 37.
244
49
b i l l i o n in 1958. With n e a rly e q u iv a le n t government
s e c u r iti e s vying fo r long-term fu n d s , i t is n ot s u rp ris in g
th a t the T reasury has had d i f f i c u l t y in achieving i t s
o b je c tiv e o f len gthen in g th e d eb t.
The long-term m arket was fu r th e r narrowed when
commercial banks re v e rse d t h e i r p o s itio n a f t e r th e ti g h t
money p erio d o f 1955-1957. Before 1955 commercial banks
had c o n tin u a lly s tr iv e n to lengthen th e long-term s e c to r
o f t h e i r government s e c u r ity p o r tf o li o s . D espite th is
e f f o r t , commercial banks' h o ld in g s had an average m a tu rity
o f s l i g h t l y over th re e y ears in 1950, la rg e ly as a r e s u l t
o f government r e s t r i c t i o n s upon t h e i r purchases o f long
term i s s u e s . ^ A fte r 1957, however, th e T reasury surveys
found l i t t l e encouragement to is s u e bonds designed fo r
51
commercial bank a b so rp tio n .
The m ajor hope fo r s u b s ta n tia l improvement o f the
long-term bond problem l i e s in th e e f f o r t to help
t r a d i t i o n a l long-term in v e s to rs m ain tain t h e i r p o r tf o lio
49
Sm ith, op. c i t . , p. 65.
50
Annual Report o f th e S e c re ta ry o f the T re a s u ry ,
1950, p. 30.
51
Annual Report of the Secretary of the Treasury,
1957, p. 25.
p o s itio n s . Such i n s t i t u t i o n s as p u b lic and p riv a te
pension funds and in su ran ce companies a re being asked by
th e T reasury to p a r ti c i p a t e in a new technique o f advanced
re fu n d in g . Advanced refu n d in g is designed to encourage
long-term s e c u r i t i e s h o ld e rs to re p la c e t h e i r p re se n t
long-term h o ld in g s w ith lo n g er-term is s u e s . This would
be done w hile th e long-term s e c to r o f t h e i r p o r tf o lio s
was s t i l l i n t a c t and had not undergone a t t r i t i o n . To
encourage such re fu n d in g , s p e c ia l tax p ro v isio n s have
been passed by Congress. The process seems to be su c c e ss
fu l thus f a r and w ider a p p lic a tio n is being urged as both
52
d e s ir a b le and n e c e ssa ry . In Canada, 40 per cen t o f
th e n a tio n 's $15 b i l l i o n debt was refunded in advance.
S e c u r itie s having m a tu r itie s from s ix months to e ig h t
y ears y e t to run were exchanged fo r s e c u r i t i e s w ith
53
m a tu r itie s rang ing from th re e y ea rs to tw e n ty -fiv e y e a rs .
52
U .S ., R e p re se n ta tiv e John R. P i l l i o n , Congres
s io n a l R ecord. 87th C ong., 1 st Sess. (March 28, 1961),
pp. 4725-4726.
Annual Report of the Secretary of the Treasury
1959, p. 259.
246
Another c u rre n t attem p t to r e t a i n long -term bond
h o ld ers in government s e c u r i t i e s i s th e T reasury p o lic y o f
o ffe rin g sm all amounts o f long-term o b lig a tio n s on a
re g u la r b a s is . I t i s hoped th a t making lo ng-term s e c u r
i t i e s a v a ila b le to in v e s to rs as t h e i r funds accum ulate
w ill encourage p u rch ases. I f a reaso n ab le amount o f
long-term s e c u r i ti e s can be m arketed in most y e a r s , th e
T reasury w ill re c e iv e th e b e n e f it o f an average le v e l o f
r a te s over tim e. This w i l l avoid th e bunching o f long-term
54
fin an cin g during p e rio d s o f high r a t e s .
The d i f f i c u l t i e s o f such an approach a re not
insurm ountable. To avoid an unw ieldly number o f is s u e s o r
the reopening o f e x is tin g is s u e s , such s e c u r i t i e s could be
purchased on th e in sta lm e n t p lan provided p roper safeg u ard s
were m ain tain ed . C e rta in ly th i s s e c to r o f th e d eb t has
been th e most n e g le c te d and devoid o f im ag in ativ e handling
in the post-W orld War I I p e rio d .
I I I . NONM ARKETABLE DEBT
U nited S ta te s Savings Bonds com prise th e m ajor
p o rtio n o f th e nonm arketable fe d e ra l d eb t. Although
•^Annual Report of the Secretary of the Treasury,
1960, p. 296.
247
redeemable upon the demand of the investor, these funds
have dem onstrated a high degree o f s t a b i l i t y . These funds
r e f l e c t consumption changes to a g r e a te r e x te n t than o th e r
f e d e r a l o b lig a tio n s . This was p a r t i c u l a r l y e v id e n t d u rin g
th e months follo w ing th e Korean War. A f u l l d is c u s s io n o f
th e v a rio u s fa c e ts o f th e savings bond program , in c lu d in g
th e e f f e c ts upon th e m a tu rity p a t t e r n , a lre a d y have been
55
d e a lt w ith in d e t a i l .
The o th e r m ajor categ o ry o f nonm arketable d eb t i s
the s p e c ia l iss u e s h eld by Government T ru st Funds. The
im pact o f th e s e s e c u r i t i e s upon monetary p o lic y w ill depend
upon th e r e la tio n s h ip o f Government T ru st Fund r e c e ip ts and
e x p e n d itu re s. The continuan ce o f heavy accum ulations o f
funds as has occu rred in th e p a s t cannot be expected.
F uture a c t i v i t i e s o f Government T ru st Funds w ill probably
have a n e t n e u tr a l e f f e c t as ex p en d itu res more n e a rly
• * . , _ 56
approxim ate r e c e ip ts .
The nonm arketable but c o n v e rtib le debt was
in au g u rated by th e T re asu ry -F ed e ral Reserve Accord o f 1951.
S u p ra. pp. 174-186.
~*^S u p ra. pp. 193-198.
248
I t has v i r t u a l l y disappeared due to the e x e rc is e o f the
r i g h t to co nvert the 3-1 /4 per cen t bonds in to T reasury
N o tes.
IV. SU M M A R Y
The problem o f a tta in in g and m ain tain in g a d e s ir a b le
m a tu rity p a tte r n o f th e fe d e ra l debt has plagued debt
managers sin c e the end o f World War I I . D r if t and
expediency, which c h a ra c te riz e d th e p re -T re a su ry -F e d e ra l
Reserve Accord p e r io d , were re p la c e d by a determ ined
e f f o r t to accom plish c e r ta in d eb t management m a tu rity
o b je c tiv e s . However, th e reco rd o f th e post-A ccord p erio d
re v e a ls few c o n c re te r e s u l t s d e s p ite good in te n tio n s .
One o f the re v e la tio n s o f re c e n t debt management
a c t i v i t i e s is the f a c t th a t th e re is no "good time" to
s e l l long-term bonds. Debt management th e o rie s o f s e l l i n g
long-term bonds d uring in f la tio n a r y p erio d s have not proved
p r a c t ic a l. As a r e s u l t , th e sh o rt-te rm debt s e c to r has
continued to grow. I t now resem bles the permanent debt
s e c to r due to th e f a c t th a t i s i s v i r t u a l l y being r o lle d
over a u to m a tic a lly . The e x iste n c e o f a m arket fo r $33
b i l l i o n in h ig h ly l i q u id , v e ry -s h o rt-te rm s e c u r i ti e s has
r e s u lte d in th e in cre ased v e lo c ity o f money. By in c re a sin g
249
v e lo c ity th e p riv a te economy has been ab le to co n v ert
e x is tin g money forms in to an incom e-earning a s s e t. That
p o rtio n o f the sh o rt-te rm s e c to r o f th e debt which is
financed by in c re a s in g th e v e lo c ity o f money could be
m onetized w ithout any in f la tio n a r y im pact. R e s tr ic tin g
th e purchase o f v e ry -s h o rt-te rm debt to th e F ed eral Reserve
System would p rev en t the p riv a te s e c to r o f th e economy from
m onetizing such s e c u r i ti e s a t w i l l . This s e c to r o f th e
d ebt would then be under th e c o n tro l o f th e same a u th o r
i t i e s as a l l o th e r forms o f money. Such com plete c o n tro l
o f a l l money forms is n ec essary i f m onetary p o lic y is to
be e f f e c tiv e .
The in te rm e d ia te -te rm s e c to r o f th e debt provides
the most prom ising area fo r debt len g th en in g . F inancing
in th i s s e c to r appears to re in f o rc e r a th e r than n eg ate
monetary and f i s c a l p o lic y a c tio n s . A lso , in te rm e d ia te -
term fin an c in g does e f f e c tiv e ly d i f f e r e n t i a t e between
investm ent funds and money.
The long-term s e c to r has been s u b je c t to u n re le n tin g
a t t r i t i o n . The passage o f tim e re q u ire s a c o n s ta n t e f f o r t
to m ain tain t h i s s e c to r . Recent ad option o f advanced
refu n d in g techniques and re g u la riz e d long-term o ffe rin g s
250
should Improve c o n d itio n s in t h i s s e c to r . The com petition
fo r long-term funds by o th e r s e c u r i t i e s , such as m o rtg ag es,
has made th e ta sk o f th e d eb t manager exceedingly d i f f i c u l t
in t h i s a re a .
I t i s d i f f i c u l t to u n d erstan d th e re lu c ta n c e o f th e
T reasury to make f u l l use o f th e c a lla b le fe a tu re in i t s
fin a n c in g . Such a c tio n would be o f c o n sid e ra b le advantage
to th e d eb t manager and, accord ing to e x is tin g s tu d ie s ,
e n t a i l l i t t l e c o s t. F in a lly , th e use o f p e r p e tu itie s
in clu d in g th e c a lla b le fe a tu re o r l i f e a n n u itie s has not
been experim ented w ith , although th e re i s much to recommend
e it h e r form o f s e c u r ity . H i s t o r i c a l ly , both forms have
been used s u c c e s s fu lly both in the U nited S ta te s and
ab ro ad .
CHAPTER VII
THE INTEREST RATE A N D THE FEDERAL DEBT
The T reasury d e c is io n as to th e m a tu r itie s o f new
and refu n d in g is s u e s is a ffe c te d by the r a te s o f i n t e r e s t
which w ill have to be p a id . There is c o n s id e ra b le con
tro v e rs y as to what determ ines th e i n t e r e s t r a te on the
fe d e ra l d eb t.
I . DETERMINANTS OF INTEREST RATES
The elem entary d is c u s s io n o f i n t e r e s t r a te s on
c a p ita l funds emphasizes four m ajor th e o r ie s . The a b s t i
nence th eo ry s tr e s s e s th e tendency to p r e f e r th e p re se n t
to the fu tu re . The r a te of i n t e r e s t , th e n , is e q u iv a le n t
to the s a c r i f i c e o f w a itin g . The p ro d u c tiv ity o f c a p it a l
th eory s tr e s s e s th e s u p e r io r ity o f the roundabout method
o f p ro d u ctio n . The i n t e r e s t r a t e re p re s e n ts a p a r t o f th e
ensuing in c re a s e in th e sto ck o f goods. The l i q u i d i t y
p re fe re n c e th eo ry o f i n t e r e s t s tr e s s e s th a t an a d d itio n a l
251
252
sum, namely th e I n t e r e s t r a t e , is n e c e ssa ry to persuade
h o ld e rs o f funds to d e c re a se t h e i r l i q u i d i t y . F i n a l ly ,
th e modem com posite th eo ry s t r e s s e s t h a t th e d e te rm in a n ts
o f i n t e r e s t a re (1) th e q u a n tity o f money, (2) th e i n v e s t
ment demand s c h e d u le , (3) th e sav in g s f u n c tio n , and (4) th e
l i q u i d i t y p re fe re n c e sch ed u le. "P ut in o ld e r term in o lo g y ,
th e fo u r d e te rm in a n ts o f th e r a t e o f i n t e r e s t a re (1) th e
q u a n tity o f money, (2) p r o d u c tiv ity , (3) t h r i f t , and
(4) th e d e s ir e fo r cash ."* - In a l l o f th e s e th e o r ie s o f
i n t e r e s t a m arket p la c e f o r c a p i t a l funds governed by th e
fo rc e s o f supply and demand i s assumed to e x i s t .
The C om petitive Market P lace and
R ates o f I n t e r e s t
The prem ise o f T reasu ry d eb t management o r d in a r ily
has been t h a t th e T reasury should compete fo r th e funds i t
needs w ith o u t p re fe re n c e in a f r e e money and c a p i t a l
m arket. This was most firm ly s ta te d by S e c re ta ry o f th e
T reasury Anderson:
The T reasu ry does n o t e s t a b l i s h th e r a t e a t
which i t can s e l l i t s s e c u r i t i e s . The T reasury
s e l l s in a c o m p e titiv e m arket a t th e low est
A lvin H. Hansen, Monetary Theory and F is c a l P o lic y
(New York: McGraw-Hill Book Company, I n c . , 1949), p. 71.
253
p o s s ib le p r i c e s . The m arket i s e s ta b lis h e d by
demand f o r and supply o f funds r e f l e c t i n g th e
a c tio n s o f le n d e rs and borrow ers o f every c h a r
a c t e r o v er th e n a t i o n . 2
A lthough th e government has th e power o f c o e rc io n ,
th e T re asu ry has adopted a p o lic y o f n o n in te rfe re n c e .
T his p o lic y was based on th e b e l i e f t h a t a h e a lth y and
growing economy could b e s t be promoted i f f r e e m arket
mechanisms perform ed th e e s s e n t i a l fu n c tio n o f p ro v id in g a
m eeting p la c e where fo rc e s o f su p p ly and demand could
o p e ra te to ac h ie v e th e b e s t u t i l i z a t i o n o f r e s o u r c e s . A
f u r t h e r b e n e f i t o f such a p o lic y was th e f a c t th a t i t
fre e d th e F e d e ra l R eserve System to e x e rc is e i t s m onetary
p o lic y more e f f e c t i v e l y . As a r e s u l t o f a more e f f i c i e n t
m onetary p o lic y , i n f l a t i o n a r y p re s s u re s would be more
amenable to c o n tr o l.
S ince th e p u rch ase o f governm ent s e c u r i t i e s i s
v o lu n ta r y , th e T re a su ry , in o rd e r to a t t r a c t custom ers in
a f r e e m a rk e t, would sim ply r a i s e th e r a t e o f i n t e r e s t
o f f e r e d in is s u in g f e d e r a l s e c u r i t i e s . As th e i n t e r e s t
r a t e on government s e c u r i t i e s ro s e r e l a t i v e to o th e r r a t e s ,
U .S ., House, Committee on Ways and Means, H e a rin g s,
P u b lic Debt C e ilin g and I n t e r e s t R ate C e ilin g on B onds.
86th Cong. , 1 s t S ess. , June 1959, p. 128.
254
th e needed funds would be re ch an n ^ le d v o l u n t a r i l y from
o th e r In v estm en ts in to governm ent s e c u r i t i e s . The a c tu a l
p a t t e r n o f r a t e s would be d eterm in ed by th e su p p ly o f funds
and th e m a tu rity demands o f th e in v e s to r s r e a c tin g to th e
need f o r funds and th e c h o ic e o f m a tu r ity p a t t e r n by
p r i v a t e and governm ent b o rro w ers.
Types o f c o m p e titiv e s e c u r i t i e s . In th e f r e e
m arket p la c e f e d e r a l s e c u r i t i e s have th e d i s t i n c t i o n o f
b ein g th e o n ly " r i s k l e s s " is s u e s . The r a t e d i f f e r e n t i a l
betw een f e d e r a l d e b t and c o r p o ra te d e b t w i l l depend upon
th e im portance a tta c h e d to th e v a r i a t i o n in r i s k . As
e a r ly as 1925 an in c re a s in g sp rea d developed betw een th e
y ie ld on f e d e r a l bonds and th e y i e ld on n o n fe d e ra l bonds
as re p re s e n te d by an index o f s i x t y h ig h g rad e bonds w ith
long m a t u r i t i e s . In th e 1930's t h i s sp re a d widened to as
much as one f u l l p o in t. T his o c c u rre d in s p i t e o f th e
heavy is s u e o f T reasu ry bonds and th e ste a d y s h o r t supply
o f c o r p o ra te bonds. By March 1935 r a t e s o f i n t e r e s t were
low er th an th ey had been a t any tim e in th e p re v io u s f i f t y
y e a r s . A pproxim ately one t h i r d o f th e n a tio n a l d e b t had
m arket v a lu e s producing v i r t u a l l y no y i e l d when c a lc u la te d
255
3
to the next callable or redemption date.
I t was not u n t i l a f t e r World War I I th a t c o rp o ra te
and s t a t e and lo c a l government s e c u r i t i e s became se rio u s
co m p etito rs fo r th e c a p it a l funds p re v io u sly in v ested in
fe d e ra l s e c u r i t i e s . As th e postw ar e ra developed in to an
in f la tio n a r y p erio d r a th e r than a s ta g n a tio n and d e f la
tio n a ry p e rio d , th e r i s k d i f f e r e n t i a l was reduced. This
weakened th e co m p etitiv e p o s itio n o f th e T reasury in th e
c a p it a l funds m arket. In a d d itio n , th e eq u ity s e c u r ity
m arket a ttr a c te d many who o r d in a r ily would hold fix ed
o b lig a tio n s . These in v e s to rs were seeking an i n f l a t i o n
hedge. F in a lly , the growth in government agency s e c u r iti e s
o u tsta n d in g and th e development o f an a c tiv e m arket fo r
th e se h ig h e r y ie ld in g government s e c u r i t i e s made fe d e ra l
deb t management even more d i f f i c u l t . The volume o f o u t
stan d in g T reasury s e c u r i ti e s d e c lin e d somewhat a t th e same
tim e th a t v i r t u a l l y a l l o th e r kinds o f d eb ts were r e g i s t e r
ing huge in c re a s e s . The e x p e c ta tio n would be th a t the
in cre ased r e l a t i v e s c a r c ity o f T reasury s e c u r i ti e s might
3
C. F. C h ild s , Concerning U nited S ta te s Government
S e c u r itie s (Chicago: C. F. C hilds and Company, 1947),
p. 221.
256
have produced some d e c lin e in t h e i r y ie ld s r e l a t i v e to th e
y ie ld s o f o th e r kinds o f d e b ts. I f a n y th in g , th e re v e rs e
seems to have been th e c a se. A ll o f th i s in d ic a te s t h a t
th e re has been a d e c lin e in th e a ttr a c tiv e n e s s to in v e s to rs
4
o f fe d e ra l debt r e l a t i v e to o th e r kinds o f d eb t.
Psychology o f th e i n v e s t o r . The e x p e c ta tio n a l
th eo ry o f the i n t e r e s t r a t e s tr u c tu r e emphasizes th a t the
a n tic ip a tio n o f changing r a te s has an independent e f f e c t
on th e supply o f and the demand fo r credit.** The change
o f i n t e r e s t r a te s has become in c re a s in g ly ra p id a t th e
tu rn in g p o in ts o f b u sin ess a c t i v i t y due to in v e s to r
e x p e c ta tio n a l psychology. Most o f th e d e c lin e in m arket
i n t e r e s t r a te s on government s e c u r i t i e s follow ing confirm a
tio n in th e l a t e f a l l o f 1957 th a t economic re c e s s io n had
s e t in was e ffe c te d w ith in le s s than fo u r months.
L
Warren L. Sm ith, Debt Management in th e U nited
S ta te s , U.S. C ongress, 86th C ong., 2d S e s s ., J o in t
Economic Committee, Study Paper No. 19 (Washington:
Government P rin tin g O ffic e , January 28, 1960), p. 68.
^ J. R. H icks, Value and C a p ita l (second e d itio n ;
Oxford: The Clarendon P re s s , 1946), C hapter 11; R ichard
Abel M usgrave, The Theory o f P ub lic Finance (New York:
McGraw-Hill Book Company, I n c . , 1959), p. 544.
^U.S. , Treasury, Annual Report of the Secretary of
the Treasury, 1959 (Washington: Government Printing
Office, 1959), p. 293.
257
In changing from re c e s s io n to re c o v e ry , th e a n t i c i
p a tio n is th a t g r e a te r o p p o rtu n itie s fo r investm ent w ill
r e s u l t in h ig h e r i n t e r e s t r a t e s . As recovery g ain s
momentum and in f la tio n a r y ten d en c ie s ap p e ar, th e ex p e cta
tio n is th a t a r e s t r i c t i v e F ed eral R eserve m onetary p o lic y
which in clu d es h ig h e r i n t e r e s t r a te s w ill be in au g u ra te d .
T h e re fo re , th e re is a r e a l m otive fo r s e c u r ity h o ld e rs to
s e l l in e a rly recovery p e rio d s in o rd e r to make more
advantageous u se o f in v e s ta b le funds a f t e r i n t e r e s t r a te s
r i s e . Added to th e se a c tio n s on th e p a r t o f th e in v e s to r s ,
borrow ers who a n tic ip a te fu tu re c a p it a l needs become
anxious to iss u e new s e c u r i ti e s w h ile r a te s a re s t i l l low.
Both o f th e se fa c to rs r e s u l t in an in c re a se d supply o f
s e c u r i t i e s e a rly in the recov ery p erio d which would q u ite
probably be met by a d ec rease in ag g reg ate demand fo r
s e c u r i t i e s . The decreased demand co n tin u es as in v e s to rs
d e s e r t th e m arket aw aitin g th e time when s e c u r ity p ric e s
have reached rock bottom .^ The r e s u l t o f th e in c re a se d
supply and th e decreased demand is a sh arp e r i n t e r e s t r a t e
r i s e than would norm ally occu r. For many y ears the
^Seymour E. H a r r is , The N atio n al Debt and th e New
Economics (New York: McGraw-Hill Book Company, I n c .,
1947) , p. 19.
258
T reasury under S e c re ta ry Snyder opposed a r i s e in i n t e r e s t
r a te s p a r t i a l l y because the ty p ic a l i n v e s to r 's r e a c tio n to
h ig h er r a te s might be to w ait and see r a th e r than to run
g
and in v e s t. I t was f e l t th a t once a n tic ip a tio n s o f
changes in one d ir e c tio n had been e s ta b lis h e d i t might be
very d i f f i c u l t to re v e rs e such a n tic ip a tio n s and to o f f s e t
unwanted r e s u l t s .
In p erio d s o f change from p ro s p e r ity to r e c e s s io n ,
th e r a te o f i n t e r e s t change would be eq u a lly ra p id b u t in
th e o p p o site d ir e c tio n . Only a t tim es when r a te s a re not
expected to ch an g e, o r when an in c re a se o r d ecrease seems
approxim ately e q u a l, w ill th e r a t e o f i n t e r e s t p a tte r n
s t a b i l i z e . At such tim es i t w ill s t a b i l i z e a t a p o in t
where long- and s h o rt-te rm r a te s a re approxim ately eq u al.
A d m in istra tiv e P o lic y and
th e Rate o f I n t e r e s t
The e x iste n c e o f a quick-changing m arket in flu en ced
by th e a t t i t u d e s o f in d iv id u a ls working in response to
u n y ield in g economic laws does not p re se n t a very s u ita b le
environm ent fo r th e debt o p e ra tio n s n e c e s s a r ily connected
g
Annual Report of the Secretary of the Treasury,
1959. p. 308.
259
w ith a fe d e ra l debt o f the p re se n t s iz e . I t would be naive
to th in k th a t a borrower as la rg e as th e T reasury can a c t
as an equal com petitor in a fre e m arket p la c e . There is a
pronounced tendency fo r both the T reasury and th e F ederal
Reserve to overemphasize the fre e m arket d eterm in atio n o f
i n t e r e s t ra te s and to underemphasize th e e f f e c ts o f t h e i r
own a c tio n s upon the i n t e r e s t r a te s tr u c tu r e .
As a r e s u l t o f th e f a ilu r e o f th e Treasury o r the
F ederal Reserve to e x e rc ise th e c o n tro l which the s iz e o f
t h e i r o p eratio n s made n e c e ssa ry , the government s e c u rity
m arket has been marred by sp e c u la tiv e ex cesses. In v e s to rs ,
p a r tic u la r ly commercial banks, by d e f a u lt became th e market
le a d e rs as they attem pted to a n tic ip a te T reasu ry-F ederal
Reserve a c tio n s . Market p ric e s ro se the most and by the
la r g e s t percentage amounts when the commercial banks bought
in la rg e q u a n titie s , and f e l l when commercial banks sold
in la rg e q u a n titie s . F in a lly , when th e commercial banks
bought and sold they acted in unison. T heir c o lle c tiv e
9
a c tio n s re in fo rc e d r a th e r than o f f s e t each o th e r. In
9
Robert H. P ark s, " P o rtfo lio O perations o f Com
m ercial Banks in the United S ta te s T reasury S e c u ritie s
Markets" (unpublished Ph.D. d i s s e r t a t i o n , U n iv ersity o f
P en n sy lv an ia), in D is s e rta tio n A b stra c ts , XVIII, No. 6
(1958), 2020.
260
1958, f i f t y banks made $300 m illio n o f which twenty o f th e
la r g e s t banks in t h i s "crap shooting" s p e c u la tiv e a c t i v i t y
made $220 m illio n . Twenty banks averaged $11 m illio n each
in 1958 sp e c u la tin g on government s e c u r i ti e s in what is
co n sid ered a fre e co m p etitiv e m a r k e t .^ Furtherm ore,
such s p e c u la tiv e a c t i v i t y r e s u lte d in a sh arp ly r i s i n g
i n t e r e s t r a te in th e f i r s t bloom o f recov ery. Such a
prem ature r i s e o f i n t e r e s t serv es to s t i f l e th e ensuing
boom. In b e la te d re c o g n itio n o f th e f a lla c y o f a fre e
m arket fo r government s e c u r i t i e s , th e T reasury and the
F ederal Reserve undertook a j o i n t study o f th e way in
which th e government s e c u r i t i e s m arket o p e r a t e s . ^
The development o f government c o n tro l ov er th e r a te
o f i n t e r e s t on i t s s e c u r i t i e s is a r e s u l t o f wartim e
expediency. The C iv il War had w itn essed extreme p ric e
f lu c tu a tio n s o f as high as 20 p er c e n t in one y e a r on
government s e c u r i t i e s . In World War I , the T reasury again
t r i e d to respond to th e p re ssu re s o f th e m arket. F in a lly ,
U .S ., House, Testimony by Congressman Patman,
Hearings » P u b lic Debt C e ilin g and I n t e r e s t R ate C e ilin g on
Bonds, 86th C ong., 1 st S e s s ., June 1959, p. 231.
^ Annual Report of the Secretary of the Treasury,
1959. p. 286.
261
in the T hird L ib e rty Loan, w ith previous L ib e rty Bonds
being quoted a t le s s than p ar in th e f in a n c ia l m a rk e t,
S e c re ta ry o f th e T reasury McAdoo balked a t a f u r th e r
in c re a se in th e c o s t o f government borrow ing. He s t a b i
liz e d th e i n t e r e s t r a te s on new is s u e s o f government bonds.
He based h is a c tio n on th e assum ption th a t changes in
i n t e r e s t r a te s in wartim e could n o t b alan ce th e supply and
demand fo r s a v in g s . Such changes m erely compounded th e
d i f f i c u l t i e s o f wartim e fin a n c in g . Follow ing th e o u tb reak
o f World War I I , long-term T reasury bonds d e c lin e d an
average o f about 2.5 p o in ts . This tim e, however, th e
b e l i e f t h a t th e T reasury would support the m arket stopped
1 2
em otional s e l l i n g .
T reasury techniques and th e r a t e o f i n t e r e s t . The
T re a su ry , as th e re p r e s e n ta tiv e o f a p o l i t i c a l e n t i t y , is
a b le to determ ine w ith F ed eral Reserve su p p o rt th e r a t e o f
i n t e r e s t i t is w illin g to pay. However, i t cannot decide
w hether o r not i t w ill borrow. This choice w ill be made
by th o se in charge o f f i s c a l p o lic y . As th e m ajor d eb to r
o f th e n a tio n , th e T re a s u ry 's d e c is io n s on th e term s o f
^Childs, op. cit. . pp. 123, 282.
262
i t s o f fe rin g s in flu e n c e s th e term s which a l l o th e r borrow
e rs must pay.
In an e f f o r t to reduce i t s d eb t s e rv ic e charges ,
th e T reasury has com partm entalized th e d e b t. By o f fe rin g
s p e c ia l fe a tu re s o f v a lu e to in d iv id u a l groups o f
in v e s to r s , a lower average i n t e r e s t r a t e was achieved.
By borrow ing in many s e c to r s o f th e m ark et, th e m arginal
c o s t o f funds could be eq u a lize d in a l l s e c to r s . I t i s ,
th e r e f o r e , ap p aren t th a t le a d e rs h ip i s th e n a tu r a l r o le
fo r th e T reasury throughout th e investm ent m arket. How
e v e r, th e T reasu ry has o r d in a r ily d isd a in e d from assuming
t h i s r e s p o n s ib il i ty . In s te a d , i t p r e f e r s to r e le g a te
i t s e l f to th e p o s itio n o f a f re e m arket cam pfollow er.
The T reasury u ses th e q u o ta tio n s o f th e government
s e c u r i ti e s m arket as th e s t a r t i n g p o in t f o r p ric in g i t s
is s u e s . The d if f e r e n c e between th e e x is tin g m arket r a te
and th e r a te o f the new is s u e is u s u a lly o n e -e ig h th o f a
p o in t in e i t h e r d ir e c tio n . Thus, d isc u s s io n s p r io r to
fin an c in g a re not so much concerned w ith r a t e s o f i n t e r e s t
as w ith th e q u e stio n o f what kind o f s e c u r ity should be
so ld . The S e c re ta ry o f the T reasury makes h is d e c is io n
s u b je c t to approval by th e P re s id e n t on m a tu r itie s over
263
one y ear l i t e r a l l y in th e l a s t hour b e fo re th e p u b lic
13
announc emen t .
This p o r t r a i t o f th e T reasury s tu d io u s ly try in g to
guess th e m arket d e s ire s w h ile rem aining im p a rtia l has been
q u estio n ed . At tim es th e T reasury has been accused o f
s tr iv i n g to m ain tain low i n t e r e s t r a te s and in flu e n c in g
th e r a te s paid to p a r t i c u l a r in v e s to r c la s s e s . Such
o b je c tiv e s were a sc rib e d to S e c re ta ry S n y d e r .^ At o th e r
tim es th e T reasury has been accused o f d e lib e r a te ly
s tr i v i n g to r a i s e i n t e r e s t r a te s a r b i t r a r i l y when th e re
were no pent-up i n f l a ti o n a r y p re ss u re s e v id e n t. Such
o b je c tiv e s were a sc rib e d to S e c re ta ry Humphrey by S enator
D o u g la s .^ Senator D ouglas' views th a t th e i n t e r e s t r i s e
was unnecessary were r e lu c ta n tly s u b s ta n tia te d by Chairman
W illiam M artin o f th e F ed eral Reserve a t a C ongressional
h earing:
13
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
1937. p. 285.
14
C harles C ortez A bbott, The F ed eral Debt (New York:
The T w entieth Century Fund, 1953), p. 44.
^■*U.S. , S en ate, Subcommittee on Economic S t a b i l i z a
ti o n , H e a rin g s. U nited S ta te s Monetary P o lic y Recent
Thinking and E x p erie n ce, 84th C ong., 2d S ess. , 1956,
pp. 207, 210, 212.
264
Mr. Patman:
Mr. M artin:
Mr. Patman:
Mr. M artin:
Were you c o n su lte d about th e issu an ce
o f th e se 3-1 /4 p er c e n t bonds l a s t
A pril?
Yes s i r , 1 was.
Did you ag ree to i t ?
I agreed th a t i t was in l in e w ith
F ed eral Reserve P o lic y , y es.
Mr. Patman: A re n 't you so rry th a t you did?
Mr. M artin: No s i r .
Mr. Patman:
Mr. M artin:
Mr. Patman:
Mr. M artin:
Mr. Patman:
Mr. M artin:
W e ll, th e re has been a d iffe re n c e
w ith in one y e a r 's time in th e
high and low on th e se p a r t i c u l a r
bonds o f $11.30 on a hundred
d o lla r s and then w ith 3 -1 /4 per
ce n t i n t e r e s t fo r th a t y e a r, th a t
makes 14-3/4 p er ce n t in one y e a r
on th e r i s k l e s s government bond.
I r e g r e t th a t f lu c tu a tio n . I
wish i t had n o t happened.
D on't you th in k i t had something to
do w ith managing money t h a t caused
i t ?
I have a lre a d y t e s t i f i e d , Mr. Patman,
th a t we made a m is c a lc u la tio n in th e
sp rin g .
In o th e r w ords, you made a m istak e.
A ll r i g h t , a m ista k e—y e s. I do n o t
ap o lo g ize fo r a m is ta k e .16
H earings . P u b lic Debt C e ilin g and I n t e r e s t Rate
C e ilin g on Bonds , 86th C ong., 1 st S e s s ., June 10-12, 1959,
p. 237.
265
I t i s adm itted th a t th e T reasury has th e power fo r
a p erio d o f tim e to accom plish e i t h e r th e re d u c tio n o f th e
in c re a se o f i n t e r e s t r a te s so long as i t has th e su pport
o f th e F ed eral R eserve. An example o f r e s is ta n c e to th e
upward push o f i n t e r e s t r a te s occurred in 1948. The
T reasury so ld long -term bonds from th e h o ld in g s o f Govern
ment Investm ent Funds in o rd e r to check th e r i s e in long
term bond p r ic e s .
The T reasury is s u e o f 5 p e r c e n t, 4 y ear 10 month
Notes is an example o f a c tio n s conducive to i n t e r e s t r a t e
advances. These "magic fiv e s " caused c o n sid e ra b le
apprehension on th e p a r t o f o th e r savings i n s t i t u t i o n s
concerning th e impact o f fu tu re T reasury debt management
a c tio n s . Some o f th e funds re ceiv ed by th e T reasury had
been withdrawn from savings d e p o sits and saving and loan
s h a r e s . ^ This 5 p er ce n t r a t e , th e h ig h e s t p aid by the
T reasury in over t h i r t y y ea rs , receiv ed fro n t-p a g e a t t e n
tio n in many newspapers and was reviewed e x te n siv e ly over
ra d io and te le v is io n news broadcasts.^®
^ Annual Report o f th e S e c re ta ry o f th e T re a s u ry .
1960, p. 31.
18
Treasury Bulletin (Washington: Government
Printing Office, October 1959), p. A-l.
266
Federal Reserve actions and the rate of interest.
The wartim e d e c is io n by th e T reasury and th e F ed eral
Reserve to .s u p p o rt th e government bond m arket a t a fix ed
i n t e r e s t r a t e p a tte r n v i r t u a l l y stopped a l l m arket
g y ra tio n s . The w e ll-p u b lic iz e d r a t e s tr u c tu r e became a
v e r it a b l e wartime s t r a i t ja c k e t. Once th is was done, the
war could be financed a t a c o n sta n t i n t e r e s t r a t e r a th e r
than a c o n tin u a lly clim bing r a t e such as had c h a ra c te riz e d
a l l prev io u s major w ars. The T reasury was assu red o f a
m arket fo r i t s s e c u r i ti e s a t r a te s o f i n t e r e s t known in
advance. The in c e n tiv e fo r in v e s to rs to d e fe r purchases
was removed.
1. I n t e r e s t r a te s under F ederal R eserve m arket
sup port o p e ra tio n s . The low le v e l a t which r a te s were
pegged was, in la rg e p a r t , an h i s t o r i c a l a c c id e n t r e s u ltin g
from the g re a t d e p re ssio n . The p a tte r n th a t was fro z e n ,
in which s h o rt r a te s were lower than long r a te s , was an
unusual p a tte r n . Since 1900 i t had been more common fo r
long r a te s to be below s h o r t , than fo r the re v e rs e
1 9
s i t u a t io n to p r e v a il. The p a tte r n o f r a te s on m arketable
^ A b b o tt, op. c i t . . p. 73.
267
iss u e s agreed upon ranged from 3/8 p er c e n t on three-m onth
T reasury B ills to 2-1/2 p er ce n t on th e lo n g e st term
20
bonds. As th e m arket a d ju ste d to th e fix e d p a tte r n o f
i n t e r e s t r a t e s , th e in h e re n t c o n tra d ic to ry n a tu re o f th e
program became e v id e n t. The s te e p ly in c lin e d i n t e r e s t r a t e
s tr u c tu r e r e f l e c t s an e x p e c ta tio n th a t r a te s w i l l r i s e .
With r a t e s h eld i n f l e x i b l e by government s u p p o r ts , such
e x p e c ta tio n s could not be r e a liz e d . The r e s u l t was th e
w h olesale dumping o f s h o rt-te rm iss u e s upon th e F ed eral
Reserve by th e p r iv a te s e c to r o f th e economy and th e
scram ble fo r th e h ig h e r y ie ld in g bonds. The only r a t e
s tr u c t u r e th a t could be m aintained w ith o u t undue r e lia n c e
on re se rv e c r e d i t was one in which r a t e s on th e v ario u s
21
m a tu r itie s were approxim ately eq u al.
Government m arket support a c t i v i t i e s tended to tu rn
th e e n t ir e w a r-c re a te d d eb t in to a form o f in te r e s t- b e a r in g
near-money. During th e war such a s i t u a t io n may have been
u n av o id ab le. The m aintenance o f th e pegged r a t e s a f t e r
20
Annual Report o f th e S e c re ta ry o f th e T re a s u ry ,
1951, p. 256.
21
C harls £. W alker, "F ed e ral Reserve P o lic y and
th e Government S e c u rity Market" (unpublished Ph.D. d i s
s e r t a t i o n , U n iv e rsity o f P en n sy lv an ia, 1955), p. 99.
th e war was a tta c k e d as in f la tio n a r y . Chairman E ccles
t e s t i f i e d th a t m arket su p p o rt in h ib ite d F ed eral Reserve
22
m onetary p o lic y . I t should be n o te d , however, th a t i t
was th e nonm arketable s e c to r th a t was co n sid ered to have
th e g r e a te s t in f la tio n a r y p o te n tia l im m ediately upon
c e s s a tio n o f h o s t i l i t i e s . This in f la tio n a r y th r e a t f a ile d
to m a te r ia liz e as th e postw ar economy o p erated on a high
p ro d u ctiv e le v e l u n t i l th e end o f 1948. From th e end o f
1948 to m id-1950, m arket support a c t i v i t i e s were conducive
to th e e x is tin g a n ti- r e c e s s io n a r y m onetary p o lic y o f the
F ederal R eserve. With the outbreak o f th e Korean War, the
d e s ire to fre e monetary p o lic y from the burden o f m arket
su p p o rt r e s u lte d in th e f i n a l abandonment o f pegged p r ic e s .
The new o b je c tiv e sought was to in c re a s e s t a b i l i t y in
fe d e ra l d ebt ow nership. The s e l l e r s o f th e se s e c u r i ti e s
were to be p en alized in an e f f o r t to reduce bond
l i q u id a ti o n .
With the abandonment o f the i n t e r e s t r a t e p a t t e r n ,
debt management was now fre e to r a i s e i n t e r e s t r a te s in
22
U .S ., S en ate, Subcommittee on M onetary, C re d it,
and F is c a l P o lic ie s o f th e J o in t Committee on th e Economic
R e p o rt, H earin g s, M onetary, C r e d it, and F is c a l P o lic ie s ,
8 i s t C ong., 1 st S e s s ., September-December 1950, p. 223.
269
o rd e r to make i t s s e c u r i t i e s more a t t r a c t i v e . A s im ila r
a c tio n had been taken by the B r i t is h in 1947. B r itis h
co n so ls had experienced a d e c re a sin g i n t e r e s t r a t e t r e n d ,
dropping from a 5 p er cen t y ie ld in 1920 to 4 per cen t in
1932, 3 p er c e n t in 1935, 2.5 p er c e n t in 1943, 2 per ce n t
in 1946, and a low o f 1.87 per cen t in 1 9 4 7 .^ By 1949
the B r itis h tren d had re v ersed and th e y ie ld had r is e n to
4 p er c e n t , a t which p o in t th e government renewed m arket
su pp ort a c t i v i t i e s . The B r itis h use o f tem porary m arket
su p p o rts has not been s u c c e s s fu l. The average long-term
y ie ld on B r itis h consols in 1958 and 1959 has been as hig h
* * - 24
as 5.5 p er c e n t.
In th i s country th e changeover from fix ed to f l e x
ib le i n t e r e s t r a te s was in au gurated in th e sh o rt-te rm
s e c to r . The wartime posted B ill r a t e was dropped and th e
T reasury B ill i n t e r e s t r a t e was p erm itted to r i s e g ra d
u a lly . This was follow ed by a r i s e in the r a te s o f
T reasury C e r ti f i c a t e s from the p re v io u sly e s ta b lis h e d
Nien Min Sun, "An Economic A nalysis o f the
Burdens o f th e P ublic Debt" (unpublished Ph.D. d i s s e r t a
t i o n , The U n iv e rsity o f Southern C a lif o r n ia , 1950), p. 83.
f
Annual Report of the Secretary of the Treasury,
1959. p. 250.
270
wartime r a te s . In 1947 long-term bond p ric e s were p e r
m itted to drop to lower le v e ls although supported a t par.
F in a lly , in 1951 a l l formal m arket supports were dropped.
Peacetime re te n tio n o f s e c u rity market supports was
j u s t i f i e d on the b a s is th a t such supports c o n trib u te d to
the underlying s tre n g th o f th e c o u n try 's fin a n c ia l system.
Confidence in the c r e d it o f the United S ta te s would be
m aintained. S u b s ta n tia l c a p ita l lo sse s fo r many s e c u rity
h o ld ers would be avoided. The i n t e r e s t burden o f the debt
would be lowered. F in a lly , the fe a r e x iste d th a t i f d i s
ru p tiv e tra d in g a c t i v i t i e s occurred in the s e c u rity market
i t could produce chain re a c tio n s leading to com pletely
u n p re d ic ta b le r e s u lts which might be d i f f i c u l t to c o r re c t.
The m ajor opposing arguments were th a t such supports
hampered F ederal Reserve monetary a c tio n s and th a t they
tended to be in f la tio n a r y . The e f f e c ts o f i n f la tio n on
government c o sts would be more expensive than the a n t i c i
pated r i s e in the i n t e r e s t r a te . F in a lly , i t was
considered to be safe to experim ent on a sm all sc a le
sin ce any m istakes could be e a s ily r e c t i f ie d .
2. I n te r e s t ra te s a f t e r the T reasury-F ederal
Reserve Accord. Since the abandonment o f pegs, the
271
i n t e r e s t r a te has d r if te d upward w ith only b r i e f in te r r u p
tio n s . Much of the r i s e has been a ttr ib u te d to F ederal
Reserve monetary p o lic y . T ight money and high i n t e r e s t
ra te s were w idely heralded as th e cure fo r in f l a t i o n during
the period o f market su p p o rts. There was no tim id ity in
acknowledging th ese p o lic ie s . However, as in f l a t io n con
tinued d e s p ite the r is in g i n t e r e s t r a te s , both th e Treasury
and the F ederal Reserve rev ersed t h e i r p o s itio n s . The
a d m in istra tio n stro v e to c r e a te the im pression th a t the
r i s e in i n t e r e s t r a te s was la rg e ly the r e s u l t o f the fre e
play of market fo rces ra th e r than d e lib e r a te government
a n t i - in f la t io n a r y p o lic y .
To promote the o p eratio n o f a fre e m arket, the
F ederal Reserve has purposely n eg lected s e le c tiv e c o n tro ls
which serve to govern the a llo c a tio n o f c r e d it w ith in the
economy. S e le c tiv e c o n tro ls could re g u la te some o f the
demand fo r c r e d it d i r e c t l y , ra th e r than re ly in g upon
accom plishing the same th in g in d ir e c tly by decreasin g and
in c re a sin g g en eral i n t e r e s t r a te s .
Increased re lia n c e on s e le c tiv e c r e d it c o n tro ls
would tend to reduce the i n t e r e s t c o sts on the fe d e ra l
d eb t. For in s ta n c e , the government pays w idely v a c il la t i n g
r a te s on 91-day B i l l s , which a re a d m itte d ly th e c lo s e s t
th in g to money. Such r a te s ex p erien ce v io le n t f lu c tu a
t io n s . These f lu c tu a tio n s a re la r g e ly th e r e s u l t o f th e
m arket p l a c e 's a n tic ip a tio n o f th e u se o f F ed eral R eserve
q u a n tita tiv e c o n tr o ls . In th e p a s t seven y ea rs th e 91-day
b i l l r a t e has clim bed to 2-3/8 p er c e n t in 1953, dropped
to 5/8 p er ce n t in 1954, clim bed to 3 -5 /8 p er c e n t in 1957,
and dropped ag ain to 5/8 p e r ce n t in 1958, only to r i s e to
4 -5 /8 p e r c e n t in December 1959. Six months l a t e r i t was
25
back down to 2-3/8 p er c e n t. Such changes o f i n t e r e s t
r a te s on a money e q u iv a le n t a re u n j u s t i f i e d when the
m otives o f th e e x tre m e ly -sh o rt-te rm in v e s to r a re co n sid
ered . F oreign ac c o u n ts, s t a t e and lo c a l governm ents, and
c o rp o ra tio n s a re in te r e s te d p rim a rily in l i q u i d i t y . The
funds in v e ste d in 91-day B ills a ls o re p re s e n t a method o f
tu rn in g te m p o ra rily id le cash b alan ces in to incom e-earning
a s s e t s .
The m ajor in stru m en ts o f q u a n tita tiv e monetary con
t r o l , i . e . , re s e rv e re q u ire m e n ts, th e d isc o u n t r a t e , and
open m arket o p e ra tio n s can e f f e c t i v e l y c o n tro l th e i n t e r e s t
25Ibid. , p. 252.
273
r a te s fo r a p erio d o f tim e. I f reducing i n t e r e s t c o s t is
the prim ary o b je c tiv e o f debt management, t h i s could be
accom plished by r a is in g re s e rv e requirem ents and then
o f f s e t t i n g th i s a c tio n by purchasing d e b t. The F ed eral
Reserve has p e r s i s t e n t l y avoided th is approach in both
World Wars and the postw ar p erio d s although under c o n sid
e ra b le C o ngressional p re ss u re to i n i t i a t e j u s t such a c tio n .
L e g is la tiv e P o licy and the
Rate o f I n t e r e s t
I t is th e p re ro g a tiv e o f Congress to determ ine the
coinage and the value o f money. C ongress, by i t s a c tio n s ,
has a lso seen f i t to a f f e c t , bo th d i r e c t l y and i n d i r e c t l y ,
the p ric e paid fo r th e use o f money, i . e . , th e i n t e r e s t
r a t e .
D ire c t and i n d ir e c t i n t e r e s t p r e s s u r e s . The
i n d ir e c t C ongressional e f f e c ts on i n t e r e s t r a te s a re
u s u a lly the r e s u l t o f o th e r o b je c tiv e s . In our e a rly h i s
to r y , government bonds were used to secu re banknote
c ir c u la ti o n . The p r o f i t a b i l i t y o f such a c t i v i t y was
r e f le c te d in abnorm ally low i n t e r e s t r a te s on fe d e ra l
s e c u r i t i e s . During World War I the acceptance o f
274
government bonds a t p ar fo r c o l l a t e r a l purposes a t th e
same time th a t they were being so ld in the m arket below
p ar in cre ased t h e i r a ttr a c tiv e n e s s to la rg e c o rp o ra tio n s .
When th is p r iv ile g e was rev o k ed , th e government s e c u r i ti e s
experienced a subsequent p ric e d e c lin e . The post-W orld
War I p r iv ile g e o f ten d e rin g L ib e rty bonds a t par in pay
ment o f war d eb ts made fo re ig n c o u n trie s w illin g buyers
when bonds sold a t d is c o u n ts. Since World War I I , the
p ro v isio n th a t T reasury bonds can be tu rn ed in a t par on
the death o f th e owner to pay fe d e ra l e s ta t e tax es tends
to add m arket sup port as fe d e ra l s e c u r i ti e s drop below
26
p a r.
Congress has ex e rc ise d a d i r e c t in flu e n c e on i n t e r
e s t r a te s by means o f an i n t e r e s t r a te c e ilin g . P rio r to
1919 Congress had approved i n t e r e s t r a t e maximums as the
o ccasio n w arran ted . In 1919 Congress removed a l l l i m i t a
tio n s on s e c u r i ti e s w ith a m a tu rity o f fiv e years o r le s s .
However, th e i n t e r e s t r a t e on s e c u r i t i e s w ith a m a tu rity o f
over fiv e y ea rs was lim ite d to 4 -1 /4 p er c e n t. I t should
be remembered th a t the o r ig in a l 4 -1 /4 p e r ce n t r a t e was in
la rg e p a r t a tax-exem pt r a te . A ll T reasury bonds issu ed
26
Annual Report of the Secretary of the Treasury,
I960 , p. 302.
275
sin c e February 1941 have been f u lly ta x a b le , and a t income
27
tax r a te s which a re s u b s ta n tia lly h ig h e r than in 1918.
Before th e Accord fre ed i n t e r e s t r a t e s , th e Congres
s io n a l c e ilin g was m erely o f academic i n t e r e s t . A fte r the
Accord, i n t e r e s t r a te s s t a r t e d to r i s e . As m arket r a te s
o f i n t e r e s t impinged upon th e c e i l i n g , th e T re a s u ry 's
p re ro g a tiv e to choose w hatever m a tu rity le v e l i t d e s ire d
was r e s t r i c t e d . The r e s u l t was th a t th e T reasury r e li e d
alm ost e x c lu siv e ly on s e c u r i ti e s o f under fiv e y ea rs
m a tu rity .
Two p o s s ib le loopholes have appeared in th e i n t e r e s t
r a t e c e il i n g . In World War IX, th e T reasury was given th e
p re ro g a tiv e o f o ffe rin g s e c u r i ti e s a t a d isc o u n t. This
o p tio n s t i l l rem ains. I t i s p e rm issib le under p re se n t
s ta tu to r y a u th o rity fo r the T reasury to is s u e a bond w ith
a 4 -1 /4 p er c e n t coupon r a t e a t a p ric e below p ar in o rd e r
to y ie ld any r a t e o f i n t e r e s t to th e in v e s to r above 4 -1 /4
28
p er c e n t which may be re q u ire d by m arket c o n d itio n s .
The T reasury has not adopted th is method o f eluding
27
Annual Report of the Secretary of the Treasury,
1959, p. 250.
2 Q
Ibid. , p. 249.
276
C ongressional c o n tro l. Such r e s t r a i n t on th e p a r t o f the
Treasury d o u b tless was in s p ire d by the knowledge th a t
Congress could r e t a l i a t e by not only removing the loophole
b u t a lso by extending c o n tro ls .
The second loophole has developed w ith the advent
o f advance refunding. In r e la ti n g the i n t e r e s t c e ilin g to
advance re fu n d in g , i t is obvious th a t th e coupon r a te on
the new s e c u rity does n ot re p re se n t th e tru e i n t e r e s t c o st
to th e Treasury to o b ta in the debt ex ten sio n . The r e a l
i n t e r e s t c o s t would add to the coupon r a te the a d d itio n a l
i n t e r e s t paid by th e T reasu ry , due to advance refunding .
This a d d itio n a l i n t e r e s t c o st is th e d iffe re n c e between
the c o st o f se rv ic e on the balance o f time to m atu rity
under the old c o n tra c t as compared to th e new c o n tra c t.
The r e a l r a te o f i n t e r e s t might q u ite conceivably exceed
the le g a l lim ita tio n under such circum stances. Changes o f
th is type in the r e a l r a t e o f i n t e r e s t have t h e i r e f f e c t
upon market e x p e ctatio n s and lead toward h ig h er i n t e r e s t
29
r a t e s .
29
The Bureau o f N ational A f f a ir s , I n c . , Report to
the B usiness Executive (W ashington, D.C.: The Bureau,
May 25, 1961), p. 1.
277
I n t e r e s t r a t e c o n t r o l . The v i t a l f a c to r in a p p r a is
ing l e g i s l a t i v e in flu e n c e on i n t e r e s t r a t e s i s th e e x te n t
to which i n t e r e s t r a te s in our economy can be c o n tro lle d .
The view point o f W illiam M artin , Chairman o f th e Board o f
Governors o f th e F ed eral Reserve System is th a t th e F ed eral
Reserve cannot determ ine th e d i r e c ti o n o f i n t e r e s t r a te s
o r th e a c tu a l i n t e r e s t r a t e except in th e s h o rt run. The
F ed eral Reserve can lead o r follow a t v a rio u s tim e s , b u t
m arket fo rc e s a re b ig g e r than the F e d e ra l R eserve, th e
30
T re a su ry , o r even th e government.
Mr. M a rtin 's views a re in d i r e c t o p p o sitio n to th e
views expressed by Mr. E cc le s. In resp o n se to th e q u e stio n
posed by S enator Douglas:
Do you mean to say t h a t w ith your p re s e n t [1947]
open m arket committee and the o p e ra tio n o f th e
F ed eral Reserve as i t now s t a n d s , re g a rd le s s o f
what th e n a tio n a l income i s o r th e economic f a c t o r s ,
th a t you can g u aran tee to us th a t our i n t e r e s t r a t e
w il l remain a t around 2.06 p e r cen t?
Mr. E ccles r e p lie d :
W e c e r ta i n ly can. W e can g u aran tee th a t i n t e r
e s t r a t e s so f a r as th e p u b lic d eb t i s concerned
30
H e a rin g s . P u b lic Debt C e ilin g and I n t e r e s t Rate
C e ilin g on Bonds. pp. 186-187.
278
i s where th e open m arket committee o f th e F ed eral
Reserve d e s ire s to put i t . 31
The co n tro v ersy over th e e x iste n c e o f an e f f e c tiv e
fre e m arket has a ls o perm eated th e T reasury. S e c re ta ry
Anderson has assumed a p o s itio n s im ila r to Mr. M artin.
"In o rd e r to fin an c e t h i s d e b t , you w ill have to pay w hat
ever th e people w ith th e money demand in th e way o f
32
i n t e r e s t r a t e s . " S e c re ta ry Snyder su p p o rts th e views o f
form er Chairman Eccles:
I t has been argued th a t lon g-term r a t e s should
be allow ed to seek t h e i r n a tu r a l le v e l. What is
sometimes meant by th e n a tu r a l le v e l i s th e
d e te rm in a tio n s made by th e investm ent and money
m arkets. But t h i s u se o f th e term n a tu r a l adds
l i t t l e to th e d is c u s s io n , as th e d eterm in atio n s
made by the money m arket a re f o r th e most p a r t
m erely r e f le c tio n s o f th e u n d erly in g c r e d i t
p o lic ie s o f th e monetary a u t h o r i t i e s .33
The d eb ate over th e e x is te n c e o f a f r e e m arket has
p e r s is te d up to th e p re se n t tim e. In the mind o f P re s id e n t
Kennedy, " th e p a tte r n o f i n t e r e s t r a te s was a m a tte r
d i r e c tl y under the c o n tro l o f th e F ed eral Reserve Board and
31I b i d . . pp. 236-237.
32I b i d . , pp. 124-125.
33
Speech b e fo re th e Academy o f P o l i t i c a l S cien ce,
A p ril 1, 1948, c ite d in Annual R eport o f th e S e c re ta ry o f
th e T re a su ry , 1948. p. 369.
279
a d e s ira b le le v e l o f i n t e r e s t r a te s should be m ain tain ed ."
The envisioned d e s ira b le p a tte r n o f i n t e r e s t r a te s would
reduce long-term borrowing c o s ts as a stim u la n t to b u sin ess
and s u s ta in th e sh o rt-te rm i n t e r e s t r a t e le v e l in o rd e r to
curb th e flow o f investm ent funds o v erseas. However,
Mr. M artin s t i l l remains re s o lu te in h is p o s itio n . His
response to P re sid e n t Kennedy's statem en t was th a t " th e re
is a d iffe re n c e between what is c le a r and d e s ir a b le and
Q /
what may come ab o u t."
Mr. M a rtin 's th e s is o f a n e u tr a l c e n tr a l bank
re a c tin g to a fre e m arket i s n o t the view adopted by
B r i t a i n 's C hancellor o f th e Exchequer, Hugh D alton.
Mr. Dalton in s is te d on a 2.5 per ce n t r a te throughout h is
35
term o f o f f ic e .
The T reasury and F ederal Reserve in s is te n c e upon
follow ing th e d ic ta te s o f a fre e m arket d eterm in atio n o f
i n t e r e s t r a te s b rin g s to mind Keynes' i l l u s t r a t i v e example
o f a newspaper beauty c o n te s t. In th is case th e reasoning
3W i S tre e t J o u r n a l, June 5 , 1961, p. 3; February
9, 1961, p. 1.
35
Hugh D alton, P rin c ip le s o f Finance (London:
Routledge and Kegan P a u l, L td ., 1954), p. 237.
280
would be as follow s: The T reasury t r i e s to choose th e
i n t e r e s t r a t e p a tte r n which most c lo s e ly corresponds to
th e average p re fe re n c e o f the in v e s to r s . Each in v e s to r* s
p re fe re n c e i s in flu e n c e d by what he th in k s th e T reasury
w i l l do. T h e re fo re , th e T reasury i s r e a l l y tr y in g to
determ ine what th e in v e s to r ex p ects th e T reasury to do.
Such reaso n in g can be c a r r ie d to a fo u rth degree w ith th e
in v e s to r endeavoring to determ ine what th e T reasury th in k s
th e in v e s to r expects th e T reasury to do. And as Keynes
s ta te d i t , "There a re some 1 b e lie v e who p r a c tic e th e f i f t h
and h ig h e r d eg rees.
I I . EFFECTS OF INTEREST RATES
I n t e r e s t r a t e s a re im portant to th e f i s c a l p o lic y
m ak ers, monetary p o lic y m ak ers, and d eb t management p o lic y
m akers. This m u ltip le concern g iv es r i s e to c o n f li c t s in
adopting d e s ir a b le i n t e r e s t r a t e p a tte r n s . The m ajor
d is c u s s io n c e n te rs upon th e e f f e c t o f i n t e r e s t r a t e s on
th e growth and d i s t r i b u t i o n o f income, and th e e f f e c ts o f
i n t e r e s t r a t e changes on consumption and investm ent.
JOJohn Maynard Keynes, A General Theory of Employ
ment. Interest and Money (New York: Harcourt, Brace and
Company, 1935), p. 156.
281
I n t e r e s t R ate E ffe c ts on th e
D is tr ib u tio n o f Income
Opinions o f th e e f f e c t o f fe d e ra l d ebt i n t e r e s t
payments on th e s iz e and d i s t r i b u t i o n o f n a tio n a l income
a re v a rie d . Some presume th a t income r e d is t r i b u t i o n ta k e s
p la c e n o t only from th e poor to th e r i c h , b u t from th e
younger to th e o ld e r , and from th e a c tiv e to th e p a ssiv e
37
elem ents in th e economic l i f e o f th e community.
The opposing view i s p re se n te d in an e m p irical
stu d y . I n t e r e s t r e c e ip ts a re shown as flow ing to the
banking system , in su ran c e com panies, and c o rp o ra tio n s , b u t
a f u r th e r ta sk rem ains o f s h if t i n g th e se amounts to
in d iv id u a ls . To what e x te n t do v a rio u s in d iv id u a ls
b e n e fit? Does th e sto ck h o ld er o f th e c o rp o ra tio n , the
wage e a rn e r, o r th e p u rch aser o f th e c o r p o r a tio n 's product
b e n e f it from th e r e c e ip t o f i n t e r e s t payments? Do the
demand d e p o s ito rs o f commercial banks b e n e f it as w ell as
th e savings d e p o s ito rs and sto ck h o ld ers? Should the
b e n e fic ia ry o f th e in su ran ce p o lic y , the premium p a y e r, o r
37
D alto n , op. c i t . . p. 182; A rthur C. P ig o u , The
P o l i t i c a l Economy o f War (re v ise d e d itio n ; New York:
The Macmillan Company, 1941), p. 78.
282
th e sto ck h o ld er in th e company be viewed as th e r e c ip ie n t
o f insurance company i n t e r e s t re c e ip ts ? Acknowledging th e
p o s s i b i li t y o f e rro rs o f judgment in making assum ptions on
th e s h if tin g o f i n t e r e s t paym ents, the inciden ce o f ta x a
tio n and so f o r t h , th e author concludes th a t th e p u b lic
debt ap p a ren tly was not a very Im portant fa c to r in connec-
38
tio n w ith the r e d is tr ib u tio n o f income in 1945.
The T reasury estim ates the d i s t r i b u tio n o f i n t e r e s t
payment on th e fe d e ra l debt p u rely on th e b a s is of
in v e s to r c la s s e s , as shown in Table IV. The la r g e s t
percentage in c re a se o f i n t e r e s t r a t e r e c e ip ts went to the
F ederal R eserve. However, the o p e ra tio n s o f th e F ederal
Reserve can be regarded as b e n e fitin g the economy as a
whole. The c o st o f such o p e ra tio n s i f not paid through
i n t e r e s t re c e ip ts would be paid from tax r e c e ip ts . Aside
from o p e ra tin g expenses and a s ta tu to r y dividend o f 6 per
cent on member bank funds , 100 p er cen t o f a l l i n t e r e s t
payments receiv ed by th e F ederal Reserve are re tu rn e d to
th e T reasury in the form o f a tax a g a in s t F ederal Reserve
38
Donald C. M ille r , Taxes . th e P u blic D ebt. and
T ra n sfers o f Income (Urbana: U n iv e rsity o f I l l i n o i s
Press, 1950), p. 136.
283
TABLE IV
DISTRIBUTION OF INTEREST PAYM ENT
ACCORDING TO INVESTOR
ON THE FEDERAL
CLASSES
DEBT
I n t e r e s t R eceip ts in B illio n s
In v e sto r C lass 1946
Year
1958
In d iv id u a ls
Savings bonds $.7 $1.5
O ther s e c u r i t i e s .5 .4
Commercial banks 1.4 1.5
Mutual savings banks .2 .2
Insurance companies .5 .3
N o n fin an cial c o rp o ra tio n s .2 .6
S ta te and lo c a l governments .2 .4
M iscellaneous in v e s to rs .2 .4
F ed eral R eserve banks .1 .8
G o v 't, investm ent accounts . 7 1.5
T o tal $4.7 $7.6
Source: U.S., Treasury, Annual Report of the
Secretary of the Treasury, 1959 (Washington: Government
Printing Office, 1959), p. 266.
284
39
n o tes n o t backed by gold. T h e re fo re , a c tu a lly a l l
i n t e r e s t payments to th e F ed eral Reserve System accrue to
th e b e n e f it o f th e government i t s e l f .
This same type o f reaso n in g could be a p p lie d to th e
i n t e r e s t payments re c e iv e d by th e government investm ent
t r u s t funds. The le g a l arrangem ent fo r th e government to
pay i n t e r e s t on th e se funds i s r e a l l y a method fo r d i r e c t
ing g e n e ra l ta x revenue in to th e se funds. As a r e s u l t o f
th e se i n t e r e s t payments th e v a rio u s programs can be c a r r ie d
o u t a t a lower c o n trib u to r c o s t. This u se o f an i n t e r e s t
subsidy from th e g e n e ra l tax fund g iv es a d is t o r t e d
p ic tu r e o f tru e c o s ts o f th e v a rio u s s e rv ic e s involved.
I f th e se funds a re to re c e iv e an i n t e r e s t payment, i t
should r e f l e c t an a c tu a l in c re a s e in Gross N atio n al
P roduct.
The i n t e r e s t payments re c e iv e d by commercial and
savings banks, p e n sio n s, and in su ran c e companies a ls o
in clu d e an elem ent o f s o c ia l v a lu e . I f th i s s o c ia l v alu e
i s d eserv in g o f a government subsidy i t would a ls o be
p re fe ra b le th a t such h elp be given d i r e c t l y r a th e r than
39
Annual Report of the Secretary of the Treasury,
1950, p. 180.
indirectly through interest rate payments.
Even d isre g a rd in g th e p o s s ib le r e d is t r i b u t i o n
e f f e c ts o f th e i n t e r e s t payments on th e fe d e ra l d e b t,
th e re a re s t i l l t r a n s f e r f r i c t i o n s . These in clu d e a d d i
tio n a l government bookkeeping, a c o n sid e ra b le degree o f
tax p ay er i r r i t a t i o n , and p o s s ib le e f f e c ts on th e in c e n tiv e
to work in the p r iv a te s e c to r o f th e economy. The debt
s e rv ic e payments re p re s e n t a la rg e fix e d charge o f over
$9.3 b i l l i o n as o f June 30, 1960. I t has clim bed more o r
le s s s te a d ily sin c e th e end o f th e w ar, when t o t a l i n t e r
e s t stood a t $4.7 b i l l i o n in 1946. At th e beginning o f
40
the war in 1941, i t had been only $1.2 b i l l i o n .
Most o f th e in c re a s e in g ro ss i n t e r e s t on the
fe d e ra l d eb t has been due to th e growing c o s t o f borrowed
funds r a th e r than to th e growth in o u tsta n d in g d e b t. This
growth o f i n t e r e s t c o s ts is l ik e ly to co n tin u e. One
reason is th a t th e r a te o f i n t e r e s t on savings bonds
in c re a se s as they approach m a tu rity . A lso, an in c re a s in g ly
la rg e p o rtio n o f th e d eb t re p re s e n ts th e accum ulation o f
many Government T ru st Funds in v ested a t an average i n t e r e s t
^ Annual Report of the Secretary of the Treasury,
1960. p. 38.
286
r a t e which i s h ig h er than th e p re se n t average r a t e o£ th e
t o t a l d e b t.
On June 30, 1940, th e average i n t e r e s t r a te had been
2.51 p er c e n t. At th e end o f th e w ar, on December 31,
1945, th e average r a t e had been 1.96 p er c e n t. The drop
in th e average r a te o f i n t e r e s t was due to th e f a c t th a t
World War I I had been financed a t an average r a t e o f 1-3/4
p er c e n t, which was f u ll y ta x a b le . This compares w ith an
average r a t e o f i n t e r e s t on World War I borrow ing o f 4 -1 /4
p er c e n t , when a l l o f th e s e c u r i t i e s were e i t h e r w holly o r
41
p a r t i a l l y tax exempt. The p re se n t average I n t e r e s t r a t e
is 3.30 p er c e n t.
I n t e r e s t Rate E ffe c t on the
C y c lic a l F lu c tu a tio n s
Consumption and investm ent b oth a f f e c t the supply
o f and th e demand fo r goods and s e rv ic e s . An excess o f
e f f e c tiv e demand in r e l a t i o n to a supply o f goods c h a ra c
te r i z e s i n f l a t i o n . T h e re fo re , how a re consumption and
investm ent a ffe c te d by changes o f i n t e r e s t ra te s ?
41
Childs, op. cit.. p. 305.
Consumption i s g e n e ra lly f e l t to be im pervious to
§ O
flu c tu a tio n s o f i n t e r e s t over a range o f p r a c t i c a l r a t e s .
In v estm en t, on th e o th e r hand, may be s l i g h t l y in flu e n c e d
by th e i n t e r e s t r a t e . E m pirical evidence seems to de-
emphasize th e im portance o f th is v a r ia b le in th e investm ent
43
d e c is io n . One reaso n fo r the i n s e n s i t i v i t y to i n t e r e s t
r a te s was th e urgency o f investm ent in th e immediate p o s t
war y e a rs and th e h ig h m arginal e f f ic ie n c y o f c a p it a l .
A nother f a c to r prom oting investm ent i n s e n s i t i v i t y to
i n t e r e s t r a t e f lu c tu a tio n s was th e growth o f such develop
ments as i n te r n a l fin a n c in g and high c o rp o ra te ta x a tio n .
The p re s e n t 52 p er c e n t c o rp o ra te income ta x serv e s to c u t
i n t e r e s t c o s ts to th e firm in h a l f . There is some sugges
tio n th a t p o s s ib ly th e e f f e c ts o f i n t e r e s t on investm ents
o p e ra te w ith a r a th e r long la g . F a ilu re to allow f o r t h i s
lag i s p a r tly re s p o n s ib le fo r th e i n a b i l i t y to uncover
i n t e r e s t r a t e in flu e n c e s on investm ent. This is not much
o f a c o n so la tio n fo r e i t h e r debt management p o lic y or
42
H a r r is , op. c i t . , p. 17; Henry C. Murphy, N atio n al
Debt in War and T ra n s itio n (New York: McGraw-Hill Book
Company, I n c ., 1950), p. 286; Sm ith, op. c i t . . p. 8.
43
Edwin Kuh, The Investm ent D ecision (Cambridge:
Harvard U n iv e rsity P re s s , 1957), Appendix to C hapter 2.
288
m onetary p o lic y . The e x is te n c e o f lag s c r e a te s e rio u s
44
problems in conn ection w ith th e tim ing o f p o lic y a c tio n .
The c r u c ia l is s u e i s th e e x te n t o f in flu e n c e o f
changes in r a te s o f i n t e r e s t upon i n f la tio n a r y and d e f la
tio n a ry tre n d s . I f a r i s e in i n t e r e s t r a te s w ill
e f f e c ti v e l y squelch in f la tio n a r y p re ss u re s then th e
in c re a s e in th e c o s t o f one te n th o f th e government
e x p e n d itu re s , i . e . , i n t e r e s t paym ents, would be more than
o f f s e t by th e d ec rease in th e p o te n tia l c o s t o f th e rem ain
ing n in e te n th s o f th e government e x p e n d itu re s .
According to th e Keynesian form ula, p ro d u ctio n is
in c re a se d by e i t h e r low ering th e i n t e r e s t r a t e o r r a is in g
th e m arginal e f fic ie n c y o f c a p i t a l . E x p ectatio n s o f a
r i s e in i n t e r e s t due to a t i g h t money p o lic y w ould, t h e r e
f o r e , tend to d isco u rag e r a th e r than encourage investm en t.
I n f l a ti o n can be checked by a d ecrease o f consump
tio n e x p e n d itu re . I t i s d o u b tfu l w hether o rd in a ry
consumer ex p e n d itu re i s a f fe c te d when i n t e r e s t r a te s a re
in a m oderate range.
In l i g h t o f th e f a i l u r e o f re c e n t i n t e r e s t r a t e
r i s e s to sq u elch i n f l a t i o n , i t would seem th a t a
44
Smith, op. cit. , p. 98.
289
re-exam in ation o f th e emphasis o f monetary p o lic y upon
i n t e r e s t r a t e changes was in o rd e r. The o r ig in a l o b je c tiv e
o f i n t e r e s t r a te in c re a se s was to s t a b i l i z e debt ownership
and to p revent th e m o n etizatio n o f th e d eb t. The o th e r
fa c e ts o f monetary and f i s c a l p o lic y should now be r e li e d
upon more h e a v ily to accom plish th i s end.
The fu n ctio n o f a fre e m arket fo r the a llo c a tio n o f
c a p it a l could b e s t be p reserved by in s u la tin g th e govern
ment debt from the p riv a te sphere. The p re se n t p o lic y o f
in term in g lin g government and p riv a te s e c u r i ti e s on a non-
p r e f e r e n tia l b a s is in th e same m arket has p e r s i s t e n t l y
re s u lte d in one o f two problem s. F i r s t , th e p o lic y o f
su pporting the p ric e s o f government s e c u r i ti e s meant th a t
r a te s o f i n t e r e s t in a l l s e c to rs o f the economy were h eld
too low and too s t a b l e , and th e i n t e r e s t r a t e ceased to
f u l f i l l i t s ra tio n in g fu n c tio n . Second, allow ing the
p riv a te m arket p lace fre e re ig n in s e ttin g i n t e r e s t r a te s
re s u lte d in much e r r a t i c m ean in g less, and harm ful i n t e r e s t
f lu c tu a tio n occasioned by th e m a rk e t's attem pt to a n t i c i
p ate the a c tio n s o f i t s la r g e s t com ponent--the government.
The process o f in s u la tin g th e fe d e ra l debt has been
successfully carried out in the United Kingdom with the
primary aim being to establish a rate differential. Other
290
European n a tio n s in which in s u la tio n o f th e governm ental
debt has been more o r le s s e f f e c tiv e a re th e N e th e rla n d s ,
45
Sweden, Belgium, F ran ce, and I t a l y .
Debt in s u la tio n could be accom plished in th e U nited
S ta te s by means o f a fix e d i n t e r e s t r a t e consol c a lla b le
46
a t th e o p tio n o f th e government. Being a c o n so l, such
an in stru m en t would remove th e d is ru p tin g in flu e n c e o f
T reasury refu n d in g o p e ra tio n s from th e f r e e m arket.
R etirem ent o f iss u e s would be com pletely determ ined by th e
d i c t a t e s o f f i s c a l and m onetary p o lic y . The T reasury
would have com plete c o n tro l o f th e tim ing and th e volume
o f re tire m e n ts . The d e te rm in a tio n o f which p a r t i c u l a r
s e c u r i ti e s were to be r e t i r e d could be accom plished by
u sin g s e r i a l bonds and r e t i r i n g them in sequence. I f
d e s ir e d , th e l o t t e r y form o f re tire m e n t could a lso be used.
Issu e s o f new s e c u r i t i e s a t a fix e d r a t e o f i n t e r e s t
could be so ld i n i t i a l l y to th e F ed eral Reserve System.
45
Annual Report o f th e S e c re ta ry o f th e T re a s u ry .
1951. p. 386.
46
An e a r ly argument fo r th e u se o f co nsols to
fin an c e th e fe d e ra l d eb t i s co n tain ed in "Our Debt
P o lic y ," by Henry Simmons, Jo u rn a l o f P o l i t i c a l Economy.
L II (December 1944), 356.
291
Once in the sy stem 's p o r t f o l i o , such s e c u r i ti e s could then
be re so ld to p r iv a te in v e s to rs a t w hatever p o te n tia l
y ie ld s the fo rc es o f supply and demand in th e p r iv a te
market p lace in c o o rd in a tio n w ith open market p o lic y saw
f i t to e s ta b lis h . In th is manner, th e value o f open m arket
o p e ra tio n s would be p reserv ed . The use o f such debt
instrum ents in th is manner would e f f e c tiv e ly d iv o rce th e
r a te o f i n t e r e s t on government debt from the r a t e o f
i n t e r e s t in th e p r iv a te sphere. Y ields in the two areas
would s t i l l be r e la te d sin c e th e y ie ld on p e r p e tu itie s
would a c c u ra te ly r e f l e c t p r iv a te money market c o n d itio n s.
The F ederal Reserve would assume the fu n ctio n o f u nder
w ritin g the governm ent's c r e d it. F ederal debt management
would thus become a v alu ab le supplement to both f i s c a l and
monetary p o lic y .
I I I . SU M M A R Y
The tr a d i t i o n a l concept is t h a t th e Treasury com
p e te s in a fre e m arket p lace fo r funds. The supply o f
funds in such a fre e market is determ ined by th e i n t e r e s t
r a te . The i n t e r e s t r a te is determ ined by th e p ro d u c tiv ity
o f the c a p ita l funds as r e f le c te d in the investm ent demand
292
sch ed u le, the consumption fu n c tio n , th e l iq u id ity p r e f e r
ence sch ed u le, and th e q u a n tity o f money.
Under d e fla tio n a ry co n d itio n s the lack o f r i s k in
fe d e ra l o b lig a tio n s r e s u lt s in com paratively low i n t e r e s t
r a te s . Under in f la tio n a r y co n d itio n s the r i s k fa c to r is
le s s im portant. The r e s u l t has been th e decrease in
a ttr a c tiv e n e s s o f fe d e ra l s e c u r i tie s in th e p re se n t i n f l a
tio n a ry p erio d . Faced w ith a decrease in the fre e m arket
flow o f funds to th e government s e c to r o f the economy, i t
becomes n ecessary e i t h e r to make government s e c u r itie s more
a t t r a c t i v e by i n t e r e s t r a te changes o r to r e s o r t to m arket-
support te c h n iq u e s.
The very ex p e ctatio n o f a change in i n t e r e s t ra te s
may have a d is ru p tin g r a th e r than a s t a b i l iz in g e f f e c t on
th e m arket. To the e x te n t th a t in v e s to rs s i t back and
w ait fo r r a te s to reach t h e i r l e v e l , r a t e changes may do
more harm than good. A lso, th e emphasis on i n t e r e s t r a te
changes tended to underem phaslze the e f f e c t o f Treasury
a c tio n s upon th e m arket, due to th e s iz e o f th e government
d eb t.
I t is obvious th a t le a d e rsh ip i s th e n a tu ra l r o le o f
the T reasury in th e market p la c e . However, th e T reasu ry ,
293
o u ts id e o f wartim e and th e post-W orld War I I p e rio d , has
re fu se d to accep t th i s r e s p o n s i b il i ty . The r e s u l t has been
t h a t th e m arket has been m arred by s p e c u la tiv e excesses as
in v e s to rs endeavored to a n t ic i p a t e changes in T reasury and
F ed eral Reserve p o lic y . I t i s adm itted th a t th e T re a su ry ,
backed by th e F ed eral R eserv e, has th e power e i t h e r to
reduce o r in c re a s e th e m arket r a t e o f i n t e r e s t f o r a
p e rio d o f tim e. The T reasury has been accused o f both
types o f a c tio n s on v a rio u s o cc asio n s.
The F ed eral Reserve in flu e n c e s the i n t e r e s t r a te
through m onetary p o lic y . Complete sup port is p o s s ib le fo r
lim ite d p erio d s as dem onstrated by wartim e ex p erien ce.
However, th e F ed eral R eserve a ls o p re fe rs to emphasize th e
fre e m arket as th e m ajor in flu e n c e on i n t e r e s t r a t e s .
Lack o f d e s ir e on th e p a r t o f th e F ed eral Reserve to
c o n tro l i n t e r e s t r a te s is ex em p lified by th e v io le n t
f lu c tu a tio n s o f v e ry -s h o rt-te rm r a t e s . These flu c tu a tio n s
a re a d i r e c t r e f l e c t i o n o f th e m a rk e t's a n tic ip a tio n o f
m onetary p o lic y changes.
Congress a lso may in flu e n c e th e m arket r a te o f
i n t e r e s t . C o ngressional s t a t u t e s have i n d ir e c t l y r e s u lte d
in reduced i n t e r e s t r a te s as a r e s u l t o f ta x and banknote
294
c i r c u la ti o n p ro v is io n s . D ir e c tly , Congress has in flu e n c e d
i n t e r e s t r a t e s by en a c tin g i n t e r e s t r a t e c e il i n g s .
The m ajor p o in t o f d is p u te , th e n , i s th e a b i l i t y o f
th e government to c o n tro l i n t e r e s t r a t e s should i t choose
to do so. Chairman M artin o f th e F e d e ra l R eserve Board o f
Governors and S e c re ta ry o f th e T reasury Anderson exem plify
the view point t h a t e f f e c tiv e c o n tro l cannot be e x e rc ise d
except in th e very s h o rt run. Former Chairman E ccles and
Former S e c re ta ry o f th e T reasury Snyder a re o f th e o p p o site
v ie w p o in t, em phasizing th a t e f f e c tiv e c o n tro l can be
e x e rc ise d except in th e very long run.
There appears to be c o n sid e ra b le doubt o f th e
r e d i s t r i b u t i v e a f f e c t on incomes o f m oderate changes in
i n t e r e s t r a t e s . To th e e x te n t t h a t i n t e r e s t r a te s a f f e c t
consumption and in v estm en t, they may a f f e c t c y c lic a l
f lu c tu a tio n s . Consumption i s u s u a lly judged to be
u n a ffe c te d by m oderate changes o f i n t e r e s t r a t e s . A lso,
m oderate changes in i n t e r e s t r a te s did no t appear to be a
m ajor d eterm in an t o f in v estm en t, alth o u g h they d id e x e rt
some in flu e n c e .
Since th e A ccord, th e f l e x i b l e i n t e r e s t r a t e and
t i g h t money p o lic y has n o t dem onstrated th e a n tic ip a te d
success in promoting economic s t a b i l i t y . T h erefo re, th e
prop osal to in s u la te government debt from th e c r e d it
m arket m e rits in v e s tig a tio n . Such in s u la tio n may prove to
be an aid to the e f f e c tiv e im plem entation o f monetary and
f i s c a l p o lic y .
CHAPTER VIII
THE FISCAL A N D M O N ETA RY ASPECTS OF FEDERAL
DEBT M A N A G EM EN T OPERATIONS
In th e previous c h a p te rs the s i z e , r e l a t i v e burden,
d i s t r i b u t i o n , m a tu rity , and i n t e r e s t p a tte r n s o f the
e x is tin g debt were examined. The im portant ta s k rem aining
is to analyze th e d e le g a tio n o f debt management p o lic y -
making a u th o rity and th e method through which p o lic y
a c tio n s a re implemented. Both o f th e se fa c to rs have a
decided in flu e n c e upon the e ffe c tiv e n e s s o f debt manage
ment p o lic y as a supplem ent to f i s c a l and monetary p o lic y
under v ary in g economic c o n d itio n s .
The T reasury has been d e le g a te d a u th o rity to c a rry
out th e f i s c a l o p e ra tio n s o f th e fe d e ra l government.
E xpenditures a re d isp e rse d through the T reasu ry . R eceipts
a re c o lle c te d by th e T reasu ry . Should ex p en d itu res exceed
r e c e ip ts , th e r e s u ltin g d e f i c i t fin an c in g i s conducted by
th e T reasury . The tech niques and tim ing by which th e se
296
297
d u tie s a re accom plished a re la r g e ly th e p re ro g a tiv e o f th e
T reasury. C ongressional s ta tu to r y p ro v isio n s today m erely
p la c e a c e ilin g on the t o t a l d eb t and an upper i n t e r e s t
r a t e lim it on T reasury bonds.
On th e o th e r hand, Congress has d eleg a te d to th e
F ederal Reserve c o n tro l o f th e supply o f money w ith in th e
n a tio n . No r e s t r i c t i o n on techn iq ues o r tim ing encumber
t h i s d e le g a tio n o f a u th o r ity o th e r than th e r i g h t o f
C ongressional review . The mix o f m onetary and f i s c a l
p o lic ie s can have s i g n i f ic a n t e f f e c t s . I t i s , th e r e f o r e ,
v i t a l th a t debt management make i t s f u l l e s t c o n trib u tio n
toward im plementing f i s c a l and monetary p o lic y d e c is io n s .
I . FISCAL POLICY ASPECT OF DEBT M A N A G EM EN T
F is c a l p o lic y may be d e fin e d as the development o f
ta x a tio n , ex p en d itu re and d eb t as a s e t o f to o ls to a f f e c t
c o n sc io u sly th e economic system . The f i e l d o f f i s c a l
p o lic y is r e l a t i v e l y new and u n te s te d . P r io r to th e
d ep ressio n o f th e 1 9 3 0 's, th e m ajor economic emphasis was
upon a balanced budget. However, f i s c a l p o lic y en v isio n s
the budget as a s t a b i l i z a t i o n to o l. I f th e economy is
ex p erien cin g i n f l a t i o n , th e cure is a budget s u rp lu s . A
d e f la tio n could be countered w ith a budget d e f i c i t . An
298
attem p t to m ain tain a balanced budget in th e fa ce o f
d e c lin in g income, employment, and ta x r e c e ip ts i s co n sid
ered i l l o g i c a l . *
A nalysis o f th e Budgetary P rocess
By d e f i n i t i o n , th e budget i s regarded as balanced
i f , d u rin g a given p e rio d , ex p en d itu res do not exceed
revenue. The d e f i n i t i o n , however, g iv es r i s e to s e v e ra l
p e r tin e n t q u e s tio n s.
What le n g th o f tim e should be chosen as th e b u d g et
ary accou nting period? The y e a rly tim e p e rio d has been
t r a d i t i o n a l . However, th e re is much to be s a id fo r e i t h e r
a s h o r te r o r a lo n g er p e rio d o f tim e. When th e govern
m en t's c r e d i t and f in a n c ia l a d m in is tra tiv e c o n tro l i s
weak, a s h o r te r p erio d could be advantageous. I f th e
c y c lic a l p e rio d s a n d /o r c y c lic a l v a r ia tio n s tended to
balan ce one a n o th e r, a longer p erio d would be more in d ic a
tiv e o f th e n a t i o n 's economic s t a t e . The U nited S ta te s has
f a il e d to balance th e budget on e i t h e r a y e a rly o r c y c lic a l
*W alter H. H e lle r , Why a F ed eral Debt L im it?
Proceedings o f th e F i f t y - f i r s t Annual C onference on Taxa
tio n o f th e N atio n al Tax A sso c ia tio n (H a rrisb u rg , • *
Pennsylvania: N atio n al Tax A s so c ia tio n , 1959), p. 253.
299
b a s is . The post-W orld War I I budget o f th e U nited S ta te s
has ranged from a su rp lu s o f $8.4 b i l l i o n in 1948 to a
d e f i c i t o f $12.5 b i l l i o n in 1959. The accum ulative admin
i s t r a t i v e budget d e f i c i t fo r th e post-W orld War I I
1946-1960 p erio d i s $25.2 b i l l i o n .
The budget makes no e f f o r t to d is tin g u is h between
ex p en d itu res as to th e purpose fo r which funds a re being
d isb u rse d . There is c e r t a i n ly a v a s t d iffe re n c e between
such item s as n e t repayment o f d eb t and th e normal con
n o ta tio n o f th e word "sp e n d in g ." On the o th e r h an d , in
to ta lin g r e c e ip ts , such sources as proceeds from th e s a le
o f fe d e ra l p ro p e rty a re a ls o n o t excluded o r d i s t i n c t l y
la b e le d .
The m ajor budgetary problem today is th a t c o n tro l
over spending i s hampered by th e sh ee r s iz e o f th e fe d e ra l
budget. There i s l i t t l e o p p o rtu n ity in Congress to con
s id e r a p p ro p ria tio n b i l l s in term s o f annual ex p en d itu res
2
in view o f estim ated revenues. S everal recommendations
have been advanced to improve our budgetary p ro c e ss. The
c o n so lid a te d g e n e ra l a p p ro p ria tio n p ro p o sal p ro v id es th a t
U.S., Senator Harry F. Byrd, Congressiona1 Record,
84th Cong., 1st Sess. (1955), p. 5694.
300
a l l g e n e ra l a p p ro p ria tio n s fo r each f i s c a l y ea r be combined
in one b i l l . Congress could then weigh a l l programs
sim u ltan eo u sly and apply a form o f s o c ia l m arginal u t i l i t y
a n a ly s is to t o t a l e x p e n d itu re . Such a procedure c o o rd i
nated w ith revenue e stim a te s would allow fo r a more
3
p re c is e e x e rc is e o f f i s c a l p o lic y . I t would avoid the
u n in te n tio n a l accum ulation o f a la rg e budget d e f i c i t . The
$12.5 b i l l i o n d e f i c i t o f 1959 was fo re c a s t as e a rly as
August 15, 1958 by th e S e c re ta ry o f th e T re asu ry , b u t
Congress n e ith e r trimmed ex p en d itu re nor in cre ased
ta x a tio n . I f such a d e f i c i t were an in te n tio n a l p a r t o f
f i s c a l p o lic y , Congress f a ile d to acknowledge i t as such.
Another budgetary p ro p o sal is to earmark revenues
fo r s p e c if ic e x p e n d itu re s. This has h i s t o r i c precedence.
To a ssu re h o ld e rs o f new fe d e ra l d eb t is s u e s th a t i n t e r e s t
payments on t h e i r h o ld in g s would c o n tin u e , th e Act o f 1790
O
John C harles M e t t le r , "P ropo sals fo r Improving
C ongressional C o n sid eratio n o f th e P r e s id e n t's Budget"
(unpublished Ph.D. d i s s e r t a t i o n , C lark U n iv e r s ity ) , in
D is s e r ta tio n A b s tr a c ts , XX, No. 7 (1960), 2633-2634.
^U.S., Treasury, Annual Report of the Secretary of
the Treasury, 1958 (Washington: Government Printing
Office, 1958), p. 253.
301
earmarked c e r ta in items o f fe d e ra l revenue to th is
purpose.^ Today, tax c o lle c tio n s fo r th e Old-Age Survivor
Insurance program are au to m a tic a lly a p p ro p riated to th e
F ederal Old-Age Survivor Insurance T ru st Fund and are by
law excluded from o rd in ary r e c e ip ts . I t has been suggested
th a t government p ro je c ts which a re to be debt financed be
sep arated from the budget e n t i r e l y , along w ith th e revenue
sources assigned to them. In th is manner, ta x a tio n can
fo rce the pu b lic to decide whether i t r e a lly d e s ire s
in creased government s e rv ic e s . The c lo se and apparent
re la tio n s h ip between s p e c if ic tax r e c e ip ts and fe d e ra l
expenditures could promote f in a n c ia l r e s p o n s ib ility on the
p a rt o f the American people and t h e i r e le c te d re p re s e n t
a tiv e s.* ’ However, ca re must be taken to avoid undue f i s c a l
r i g i d i t y due to the use of earmarked revenues.
A com bination o f the two prop osals is worthy of
in v e s tig a tio n . I f th e t o t a l a p p ro p ria tio n b i l l were passed
^George Rogers T a y lo r, Hamilton and the N ational
Debt (Boston: D. C. Heath and Company, 1950), p. 4.
6
James M . Buchanan, P ublic P rin c ip le s o f th e P ublic
Debt (Homewood, I l l i n o i s : Richard D. Irw in , I n c ., 1958),
p. 172; M arshall A. Robinson, The N ational Debt C eilin g
(Washington: The Brookings I n s t i t u t i o n , 1959), p. 36.
302
in one u n i t , i t would then be p o s s ib le to apply a tax r a te
to n a tio n a l income, fo r example, s im ila r to th a t ap p lie d
on th e lo c a l p ro p e rty assessm ents. Thus earmarked funds
going to s p e c if ic areas o f fe d e ra l ex p en d itu re would be th e
components which determ ined th e f i n a l com posite ta x r a te .
O ther types o f t a x e s , such as e x c ise t a x e s , can be e a r
marked s e p a ra te ly fo r s p e c if ic d e f i c i t financed p r o je c ts .
One f i n a l su g g estio n fo r achiev ing f i s c a l i n t e g r i t y
e n v isio n s th e use o f flu c tu a tin g tax r a te s tie d to th e
consumer p ric e index and ap p lied through th e w ithholding
tax mechanism.^ In 1960, th e T reasury under P re s id e n t
Eisenhower opposed any p ro p o sal fo r an arrangem ent th a t
would perm it some s o r t o f e x e cu tiv e a d m in is tra tiv e v a r i -
Q
a tio n in tax r a te s to co u n ter c y c lic a l tre n d s . The new
a d m in is tra tio n o f P re s id e n t Kennedy has re q u ested ta x -
c u ttin g a u th o rity on a standby b a s is . The re q u e st drew a
h o s t i l e re a c tio n from Congress d e s p ite a h is to r y o f p a s t
su p p o rt fo r such a measure by th e C ouncil o f Economic
^U .S ., C ongress, House, Freedom Revenue A c t, 87th'
C ong., 1 st S e s s ., May 1, 1961, H.R. 6720, p. 4.
Q
Address b e fo re th e American F inance A sso ciatio n
and th e American Economic A sso ciatio n a t W ashington, D .C .,
December 29, 1959, by S e c re ta ry o f th e T reasury Anderson,
c ite d in Annual Report o f th e S e c re ta ry o f th e T re a su ry .
I9 6 0 , p. 285.
Advisors and the Commission on Money and Credit.
303
Debt Management E ffe c ts on T axation
C reatio n o f debt is th e r e s u l t o f avoiding the
a l t e r n a tiv e s o f ta x a tio n , is s u in g c u rre n c y , o r c u ttin g
government ex p en d itu re. However, d e f i c i t fin an c in g through
commercial o r F ederal Reserve Banks' demand d e p o s it c r e a
tio n w ill have th e e f f e c t o f ta x in g a l l h o ld e rs o f money.
These moneyholders lo se by th e d e p re c ia tio n o f currency
purchasing power th e exact amount o f what th e government
gains. Since, in a re p r e s e n ta tiv e democracy, ta x re d u c
tio n has a g r e a te r popular appeal than debt re d u c tio n , the
tendency has been to n e g le c t th e l a t t e r .
There have been s e v e ra l o ccasions sin c e th e end o f
World War I I when the e x is tin g tax s tr u c tu r e p re se n ted
o p p o rtu n itie s fo r s iz a b le budget s u rp lu s e s . When th is has
o c c u rre d , tax es have been reduced r a th e r than m ain tained.
Such a tax re d u c tio n took p lace in 1948 under a Democratic
9
Wall S tr e e t J o u r n a l, January 12, 1962, p. 3.
^K an-C hi M ui, "The E ffe c ts upon Commercial Banks
and on Banking P o lic y o f D e f ic it Financing in World War I"
(unpublished Ph.D. d i s s e r t a t i o n , P rin c e to n U n iv e rs ity ,
1955), p. 11.
304
a d m in is tra tio n , and again in 1954 under a Republican
regim e. There is a r e a l danger th a t the a l te r n a tiv e o f
debt c re a tio n may r e s u l t in a r e t r e a t from an exhaustive
program o f ta x a tio n .
During wartime some debt c re a tio n is unavoidable
though r e g r e tta b le . T axation can avoid th e p ilin g up of
liq u id a s s e ts in the form o f debt in strum ents which p ress
a g a in s t d i r e c t c o n tro ls . However, to tax on the le v e l
n ecessary to cover the e n tir e c o st o f th e war would be
p o l i t i c a l l y , p s y c h o lo g ic a lly , and econom ically im possible.
A d d itio n al income provides an in c e n tiv e fo r g r e a te r e f f o r t
which is e s s e n tia l fo r maximum war p ro d u ctio n . F in a lly ,
p o li tic i a n s fe a r th a t too bold a tax p o lic y may have
adverse p o l i t i c a l rep ercu ssio n s fo r t h e i r own c a re e rs .
P rogress has been made in in c re a sin g th e percentage
o f war c o sts d eriv ed from ta x a tio n . Debt issu e paid fo r
70 per cent o f th e C iv il War, 61 per cent o f World War I ,
54 p er cen t o f World War I I , and the Korean War was v i r
tu a lly a pay-as-you-go war. The l a t t e r rem arkable
perform ance was in a la rg e p a rt due to th e promptness w ith
which new tax laws were passed a f t e r the war b e g a n .^
^Robinson, op. cit. , p. 21.
305
An A nalysis o f Tax-Exempt S e c u r itie s
With th e advent o f World War 11, a l l fe d e ra l
s e c u r i ti e s were made s u b je c t to fe d e ra l income ta x e s.
However, the tax-exem pt s e c u r ity i s s t i l l th e fo c a l p o in t
o f co n tro v e rsy today. The case fo r tax exemption is based
p a r t i a l l y upon th e r i g h t o f s a n c tity o f c o n tra c t. To tax
bonds is m a n ife stly to tax o r to keep back a p o rtio n o f
th e p r in c ip a l o r i n t e r e s t s tip u la te d to be p a id . To do
t h i s on w hatever p r e te x t is not to do what is e x p l i c i t l y
prom ised; i t i s , th e r e f o r e , to v i o la t e th e prom ise given
to th e le n d e r. Should a government re se rv e th e r i g h t to
tax i t s own bonds , th e u n c e rta in ty a tta c h in g to such
p ro p e rty would depress i t s p ric e ; th e r e f o r e , th e pu rch asers
o f tax-exem pt s e c u r i ti e s pay t h e i r tax in the enhanced
12
p ric e they pay fo r tax-exem pt bonds. Taxable bonds might
re q u ir e premiums o f such s iz e as to exceed th e amounts
re tu rn e d in ta x e s. This would be e s p e c ia lly tru e as the
in cre ased i n t e r e s t r a te s a t t r a c te d fo re ig n in v e s to rs to
12
Samuel McKee, A lexander H am ilton’s Papers on
P u b lic C r e d it, Commerce, and Finance (New York: L ib e ra l
Arts Press, 1957), pp. 160-161.
306
13
whom tax es did not apply. F in a lly , th e power to ta x is
14
th e power to d e stro y . T h e re fo re , a l l fe d e ra l s e c u r i t i e s
should be exempt from s t a t e ta x a tio n and v ic e v e rsa .
The lead in g arguments a g a in s t a l l forms o f tax
exemption culm inated in th e passage o f th e P u b lic Debt Act
o f 1941. This Act p ro h ib ite d th e T reasury from is su in g
tax-exem pt s e c u r i t i e s . The i n t e r e s t in c re a s e r e s u ltin g
from th e e lim in a tio n o f th e tax-exem pt p r iv ile g e was
15
estim ated to range from 1/8 to 3/8 o f 1 p er c e n t. This
i s a low p ric e to pay fo r th e removal o f th e tax-exem pt
p r iv ile g e .
An attem p t to apply th e fe d e ra l tax in g power to
s t a t e and lo c a l s e c u r i ti e s was n o t s u c c e s s fu l. Proponents
o f fe d e ra l ta x a tio n o f s t a t e s e c u r i t i e s argued th a t ta x -
exempt bonds were unw ise, u n ju s t, and c o s tly . Such
13
R obert T. P a tte rs o n , F ed eral Debt Management
P o l i c i e s » 1865-1879 (Durham, N. C.: Duke U n iv e rsity
P re s s , 1954), p. 146.
14
McCulloch v. M aryland, c ite d by J . Rogers
H ollingsw orth and B ell I . W iley, American Democracy--
A Documentary Record (New York: Thomas Y. Crowley
Company, 1961), p. 262.
^ A lf r e d G. B u e h le r, P rin c ip le s o f Finance ( th ir d
e d itio n ; New York: McGraw-Hill Book Company, I n c ., 1948),
p. 649; U.S., House, Committee on Ways and Means, H e a rin g s.
P u b lic Debt C e ilin g and I n t e r e s t Rate C e ilin g on Bonds ,
86th Cong., 1st Sess. , June 10-12, 1959, p. 235.
307
tax-exem pt s e c u r itie s furnished to one sm all segment o f
the p op ulation the o p p o rtu n ity to avoid i t s c o n trib u tio n
to the support o f the government. The volume of tax-exem pt
issu e s has increased from $13.7 b i l l i o n in 1945 to $50.9
b i l l i o n in 1958.16
S ecu rity i n t e r e s t r a te s designed to a t t r a c t the
m arginal in v e sto r are h ig her than those necessary to
a t t r a c t th e h ig h e st income in v e s to r. Those income b rack ets
above the m arginal bond p u rc h aser, th e re fo re , experience
a w in d fa ll g ain. The lo ss in tax revenues su ffe re d by the
fe d e ra l government exceeds the i n t e r e s t savings achieved
by s t a t e and lo c a l governments. Furtherm ore, the ta x -
exempt p riv ile g e e x iste d fo r the l i f e o f the s e c u r ity ,
s e rio u s ly dim inishing the fu tu re ta x a b le c a p acity o f the
n a tio n .
The proposal to e lim in a te a l l tax-exem pt s e c u r itie s
has been recommended by every a d m in istra tio n from 1921 to
1 9 4 1 .^ The Supreme Court d ec isio n s su b je c tin g s ta te
^ Survey o f C urrent B u sin ess, May 1959, p. 12.
^ U . S . , House, Committee on Ways and Means,
H ea rin g s, P ublic Debt Act o f 1941, 77th Cong. , 1 st Sess. ,
January 29, 1941, p. 103.
308
employees' s a l a r i e s to fe d e ra l ta x a tio n lends credence to
th e b e l i e f th a t income from s t a t e bonds may a ls o be s u b je c t
to ta x a tio n under the C o n s titu tio n as i t now sta n d s . The
S ix te e n th Amendment to th e U nited S ta te s C o n s titu tio n
a u th o riz e d Congress to levy tax es on income from w hatever
18
source d eriv e d .
I f the above arguments be g ra n te d , then th e con
tin u ed e x iste n c e o f tax exemption fo r s t a t e and lo c a l
s e c u r itie s must r e s t upon th e d e s i r a b i l i t y o f fu rn is h in g a
fe d e ra l subsidy to th ese p o l i t i c a l s u b d iv is io n s . As a
subsidy program i t behooves th e tax p ay er to in q u ire in to
the most e f f i c i e n t form o f su bsidy. G ranting continued
tax exemption appears to be a very i n e f f i c i e n t and c o s tly
form o f subsidy and should be re p la c e d by a d i r e c t subsidy.
A f i n a l argument a g a in s t tax-exem pt s e c u r i ti e s
r e s t s upon the d e s ir e to promote p r iv a te e n te r p r is e . Tax
exemption lowers i n t e r e s t r a te s a t which governments can
borrow , thus p la c in g p r iv a te borrow ers a t a d isad v an tag e.
To the e x te n t th a t i n t e r e s t r a te s a re th e d e c is iv e
18
R ichard N. C u rre n t, T. Harry W illiam s, and Frank
F r e i d e l , American H is to ry , A Survey (New York: A lfred A.
Knopf, Inc., 1961), p. 633.
309
investm ent c r i t e r i a , th is would in e f f e c t d iv e r t funds
from p riv a te e n te r p ris e to government.
I I . M O N ETA RY POLICY ASPECTS OF DEBT M A N A G EM EN T
Monetary p o licy seeks to a f f e c t th e supply o f money,
c r e d i t , and th e r a te o f i n t e r e s t . The goal o f monetary
p o lic y is to achieve economic s t a b i l i t y and growth w ith
f u l l employment. Debt management may in flu e n c e the opera
tio n o f monetary p o licy fa v o ra b ly , u n fa v o rab ly , o r have a
n e u tra l e f f e c t. On the o th e r hand, compensatory monetary
p o lic y is capable of o f f s e ttin g th e in f la tio n a r y or
d e fla tio n a ry e f f e c ts o f debt management.
D eterm inants o f Monetary P o licy
The growth and d i s t r i b u ti o n o f fe d e ra l debt may
serve to stre n g th e n th e in flu e n c e o f monetary p o lic y .
The government s e c u rity m arket provides a s e n s itiv e
v e h ic le which ra p id ly tra n sm its the changes o f monetary
p o lic y to a l l p a r ts o f th e economy. For example, as bond
p ric e s f a l l , bondholders who s u f f e r a re d u c tio n in the
m arket value o f t h e i r a s s e ts a re le s s w illin g to s e l l the
s e c u r i ti e s . They may even be le s s w illin g to spend or
in v e s t cash funds because t h e i r li q u id it y p o s itio n has
310
been reduced. Manipulation of the size and form of the
fe d e ra l debt has an immediate impact on th e l i q u id i t y o f
la rg e segments o f th e economy. To a p r iv a te e n te r p ris e
economy w ith o u t a n a tio n a l d e b t, b u t b e s e t w ith problems o f
economic s t a b i l i t y , th e economist m ight p o ssib ly purposely
propose th e c re a tio n o f a n a tio n a l debt as a device fo r
19
th e prom otion o f s t a b i l i t y .
On th e o th e r hand, th e fe d e ra l d e b t 's impact on
m onetary p o lic y may serv e to weaken th e e ffe c tiv e n e s s o f
monetary c o n tro ls . When c r e d i t is tig h te n e d , f in a n c ia l
i n s t i t u t i o n s can co n vert liq u id government s e c u r i ti e s in to
cash. For example, between December 1954 and September
1957, bank loans expanded by roughly $28 b i l l i o n even
though the p u b lic ly h eld money su p p ly , i . e . , demand depos
i t s and c u rre n c y , a c tu a lly d e c lin e d by alm ost one b i l l i o n
d o ll a r s . The major p o rtio n o f t h i s expansion was achieved
by banks liq u id a tin g t h e i r p o r tf o lio s o f government
20
s e c u r i t i e s . Thus, th e fe d e ra l debt can cause i n f l a t i o n
^ A u r e liu s M orgner, "The N atio n al Debt and Economic
S ta b ility " (unpublished Ph.D. d i s s e r t a t i o n , U n iv e rsity o f
M innesota, 1956), p. 207.
20
Warren L. Sm ith, Debt Management in th e United
S ta te s , U.S. C ongress, 86th C ong., 2d S ess. , J o in t
Economic Committee, Study Paper No. 19 (Washington:
Government P rin tin g O ffic e , January 28, 1960), p. 130.
311
y ea rs a f t e r I t was o r i g i n a l ly in c u rre d and w hile th e t o t a l
debt i s n o t changing s i g n i f i c a n tl y .
S im ila r ly , c o rp o ra tio n s and in su ran ce companies have
used t h e i r government p o r tf o lio s to n eg ate th e e f f e c ts o f
a t i g h t m onetary p o lic y . The heavy r e lia n c e by th e
T reasury upon redeem able and v e ry -s h o rt-te rm d eb t has
im paired f i s c a l c o n tro l o f th e t o t a l amount o f liq u id
a s s e ts o u tsta n d in g . One o f th e c r u c ia l is s u e s re g ard in g
the p o te n tia l e ffe c tiv e n e s s o f monetary p o lic y r e l a t e s
both to th e a b i l i t y and th e w illin g n e s s o f th e F ed eral
Reserve System to implement p o lic y m easures c a lc u la te d to
a f f e c t bo th bank and nonbank p o r tf o lio s o f fe d e ra l
21
s e c u r i t i e s .
The e x iste n c e o f a la rg e fe d e ra l d ebt a ls o a f f e c ts
the tim ing o f m onetary p o lic y . The F ed eral Reserve System
attem p ts to m ain tain an even k e e l in th e money m arket a
few weeks b e fo re and a f t e r each m ajor T reasury fin a n c in g .
This is done to avoid a l te r in g th e b a s ic supply and demand
r e la tio n s h ip o r in v e s to r s ' e x p e c ta tio n s d u rin g th e fin a n
cing p e rio d . This approach means th a t th e F ed eral Reserve
21
W illiam P ig g o tt I I I , "Monetary and Debt Manage
ment P o l ic ie s , 1953-1955" (unpublished Ph.D. d i s s e r t a t i o n ,
U n iv e rsity o f W ashington, 1957), p. 75.
312
has had to squeeze I t s own p o lic y a c tio n s in to th e p erio d
22
between T reasury o p e ra tio n s . However, i f th e m arket
fe e ls th a t th e even k ee l p erio d i s n o t in d ic a tiv e o f con
d itio n s a f t e r th e T reasury d eb t o p e ra tio n s a re concluded,
th e re a c tio n would be one o f w ait and see. Since y ie ld s
a re expected to r i s e a t th e end o f the s u b s c rip tio n p e rio d ,
the f a c t th a t they do n o t r i s e d u rin g th e p erio d w ill make
23
l i t t l e im pression.
P u b lic psychology today in flu e n c e s h e a v ily th e
flu c tu a tio n s in demand d e p o s its and th e q u a n tity o f c u r
rency in c i r c u la ti o n . I t a n tic ip a te s fe d e ra l p o lic y , and
by i t s a c tio n s in th e government s e c u r ity m arket a f f e c ts
monetary p o lic y . For example, in th e event o f an i n t e r
n a tio n a l c r i s i s , a quick d e c lin e in th e m arket v alu e o f
s e c u r i t i e s would tend to dampen th e in f la tio n a r y movement.
Monetary p o lic y would re q u ir e more time to a c t e f f e c tiv e ly .
Thus , although form al monetary p o lic y i s th e p re ro g a tiv e
o f th e F ed eral Reserve System, i t is ap p aren t th a t in
22
T ilfo rd C. G aines, "The Techniques o f T reasury
Debt Management" (unpublished Ph.D. d i s s e r t a t i o n , Columbia
U n iv e rs ity , 1960), p. 526.
23
Deane Chalmers Carson, "Federal Reserve Support
of Treasury Refunding Operations" (unpublished Ph.D.
dissertation, Clark University, 1956), p. 123.
313
a c tu a l p r a c tic e many fo rc e s a c t as d eterm in an ts.
M onetizing the Debt
The most d i f f i c u l t problem in an aly zin g d eb t manage
ment p o lic ie s is th e se p a ra tio n o f debt in to th e two
c a te g o rie s o f r e a l d eb t forms and pseudo money forms. In
our form o f government, Congress has been given th e a u th o r
i t y to is s u e paper money in w hatever q u a n titie s i t w ishes
to do so. A ll moneys id e a lly perform fo u r fu n c tio n s.
They serv e as a medium o f exchange, a s to r e o f v a lu e , a
u n it o f acco u n t, and a stan d ard fo r d e fe rre d payments.
A c o n tra d ic tio n o f monetary p o lic y has occurred
h i s t o r i c a l l y between th e fu n c tio n o f money as a s to r e o f
v alu e and money as a medium o f exchange. In a complex
economy th e o ccasion o fte n a r is e s when an in c re a se in th e
volume o f the c i r c u la tin g currency per se would c o n trib u te
to economic growth. F a ilu re to p ro v id e s u f f i c i e n t currency
in h ib its economic growth and c o n trib u te s to re c e s s io n . At
th e same tim e th a t an in c re a s e in currency would be d e s i r
a b le from th e view point o f th e te c h n ic a l accommodation o f
commerce, th e c r e a tio n o f such currency must ad v e rsely
a f f e c t the fu n c tio n o f currency as a s to r e o f v alu e.
314
The problem o f a tta in in g some f l e x i b i l i t y o f th e
money supply o f th e n a tio n , even a t the expense o f th e
s to re o f value fu n c tio n , f i n a ll y re s u lte d in the passage
o f th e F ederal Reserve Act in 1913. P rio r to th i s tim e,
two h i s t o r i c a l monetary developments were o f im portance in
i l l u s t r a t i n g the re la tio n s h ip o f debt to th e need fo r a
growing money supply.
The C iv il War greenback, a n o n in te re s t-b e a rin g ,
sm all denom inational forced lo a n , c re a te d much d istu rb a n c e
a t th e tim e o f issu an ce. I t s value had quickly d e p re c ia te d
in terms o f gold. At th e end o f the C iv il War, as the
economy p ro sp ered , i t s value rebounded. F in a lly , by 1878,
j u s t th ir te e n years a f t e r the end o f the C iv il War, the
re tire m e n t o f greenbacks was p ro h ib ite d sin c e th i s o r ig in a l
debt form had become an e s s e n tia l p a r t o f the money supply
of th e n a tio n . To th is day, th e o u tstan d in g t o t a l o f over
one th ir d o f a b i l l i o n d o lla r s o f greenbacks co ntin ues to
be shown in the d a ily Treasury statem en t. An e f f o r t to
refund th ese C iv il War greenbacks in to in te r e s t- b e a r in g
time o b lig a tio n s occurred in 1901 b u t was h ig h ly
u n su cc essfu l.
The second in sta n c e o f d e b t's re la tio n s h ip to the
money supply occurred in the pre-W orld War I p erio d . The
315
T re a su ry 's a c tio n s determ ined th e e x te n t to which th e
money supply was composed o f s p e c ie , currency backed by
s p e c ie , T reasury Notes and C e r t i f i c a t e s , o r f i n a l l y ,
n a tio n a l banknotes backed by fe d e ra l bonds. As th e s iz e
o f th e d eb t d im in ish ed , th e sh o rta g e o f fe d e ra l bonds led
to i n t e r e s t r a te s on th e fe d e ra l d eb t which were more
in d ic a tiv e o f th e v alu e o f the c ir c u la tin g n o te p r iv ile g e
than o f th e c r e d i t stan d in g o f th e government i t s e l f .
With th e in a u g u ra tio n o f the F ed eral Reserve
System, c o n tro l over th e amount o f money a v a ila b le in th e
economy became th e d eleg a te d p re ro g a tiv e o f th e F ed eral
Reserve System. The G la s s -S te a g a ll Act o f 1933 p erm itted
th e use o f fe d e ra l s e c u r i t i e s as c o l l a t e r a l s e c u r ity fo r
F ed eral Reserve N otes. B esides th e d i r e c t is su e o f
F ed eral Reserve N o te s, th e F ederal Reserve System employed
re se rv e requirem ent ch an g es, d isc o u n t r a t e changes , and
open m arket o p e ra tio n s as the m ajor to o ls to c o n tro l the
money supply.
A n a tu r a l r e s u l t o f th e se p o lic ie s was th a t th e
F ed eral Reserve System a lso became re sp o n sib le fo r the
24
C. F. Childs, Concerning United States Government
Securities (Chicago: C. F. Childs and Company, 1947),
p. 87.
316
re g u la tio n o f th e m o n etizatio n o f both p u b lic and p riv a te
o b lig a tio n s . This r e s p o n s i b i li ty was n e ith e r accepted nor
acknowledged u n c o n d itio n a lly by th e F ed eral Reserve except
under wartim e stim u lu s.
S e c u rity purchases by f in a n c ia l i n s t i t u t i o n s in
World War I I were encouraged by s e v e ra l d e v ic e s. The
"posted T reasury B ill r a te " provided th a t th e F ed eral
Reserve Banks would purchase in th e open m arket a l l
T reasury B ills o ffe re d a t a r a te o f 3/8 p er c e n t , and a lso
stood ready to r e s e l l to the o r ig in a l owner a t 3/8 p e r
cent a t th e in v e s to r 's o p tio n . By th i s o p tio n procedure
T reasury B ills became, fo r a l l p r a c t i c a l p u rp o ses,
in te r e s t- b e a r in g money. This made i t p o s s ib le to o b ta in
w ith a b so lu te c e r ta i n ty a r a t e o f 3/8 p e r c e n t on money
in v ested in T reasury B ills even fo r a day o r two. When
B ills were h eld in safekeeping fo r th e member banks a t
F ederal Reserve B anks, as was th e u su a l c a s e , a telegram
was a l l th a t was n ecessary to co n v e rt B i ll s in to re se rv e
25
funds o r v ic e v e rsa .
25
Henry C. Murphy, N atio n al Debt in War and
T ra n s itio n (New York: McGraw-Hill Book Company, I n c . ,
1950), p. 99.
317
The open support of the government security market
by th e F ederal Reserve a lso served to promote fe d e ra l d ebt
p u rch ases. The F ed eral Reserve s ta te d :
. . . [ i t was] prepared to use i t s powers to a ssu re
th a t an ample supply o f funds i s a v a ila b le a t a l l
tim es fo r fin a n c in g th e World War I I e f f o r t and to
e x e rt i t s in flu e n c e toward m ain tain in g c o n d itio n s
in th e U nited S ta te s Government s e c u r ity market
th a t a re s a t i s f a c to r y from th e sta n d p o in t o f the
Government's re q u ire m e n ts.26
A guaran teed government m arket a t p ar fo r bonds which had
been r e je c te d during and a f t e r World War I was thus
embraced. The u ltim a te e f f e c t o f the p o lic y was to give
v i r t u a l l y th e s ta tu s o f money to th e e n t i r e d eb t. From
the beginning o f World War I I u n t i l the summer o f 1947,
a l l government s e c u r i ti e s p ric e s were given continuous
support by th e F ed eral Reserve System, and from th e l a t t e r
d a te to March 1951, long-term government bond p ric e s were
supported a t o r above p a r . ^
Of th e $217 b i l l i o n in c re a s e in m ajor liq u id a s s e ts
over th e s ix -y e a r p erio d from June 30, 1940 to June 30,
Board o f Governors o f th e F ed eral R eserve System,
Annual R e p o rt. 1941 (Washington: Government P rin tin g
O ff ic e , 1941), p. 1.
27
Annual Report of the Secretary of the Treasury,
1953, p. 261.
318
1946, 60 per c e n t , o r $131 b i l l i o n , was placed d i r e c t l y in
fe d e ra l s e c u r i t i e s . The rem aining 40 p er c e n t, o r $86
b i l l i o n , was placed in money s a v in g s , th e m a jo rity o f
which in d i r e c t l y found i t s way in to fe d e ra l s e c u rity
investm ent through th e medium o f banking system
28
in v estm en t.
The appearance in p r iv a te hands o f g re a t holdings
o f government s e c u r itie s , to g e th e r w ith th e f a c t th a t th e
p ric e s o f th e se o b lig a tio n s were f i x e d , in e f f e c t i n t r o
duced a new elem ent in to investm ent and p ro p e rty management.
In th e minds o f many p o r tf o lio m anagers, tr u s te e s and
tr e a s u r e r s o f b u sin ess co n cern s, th e government p o r tf o lio
became v i r t u a l l y a secondary cash account. The inducement
•»
o ffe re d by a s ta b iliz e d m arket to co n v ert cash in to an
earning a s s e t widened the range o f procedures f e a s ib le in
p r iv a te f in a n c ia l management. Not th e l e a s t c o n s id e ra tio n
was the lack o f r i s k involved in p la c in g tem p o rarily
29
su rp lu s funds in th e government s e c u r i ti e s m arket.
28
Annual R eport o f the S e c re ta ry o f the T re a s u ry ,
1946, pp. 69-70.
29
C harles C ortez A bbott, The F ed eral Debt (New York:
The T w entieth Century Fund, 1953), p. 54.
319
Another device to a ssu re th e s a le o f fe d e ra l
s e c u r iti e s during World War I I was to g ra n t perm ission to
th e F ed eral Reserve System to purchase $5 b i l l i o n in
s e c u r iti e s d i r e c tl y from th e T reasury. This p ro v isio n is
s t i l l e f f e c tiv e today. I t has been used to d a te only fo r
extrem ely b r i e f p erio d s when Treasury read ju stm ents neces
s i t a t e d i t . Suggestions have been made th a t i t be used
more l i b e r a l l y sin c e i t s use could r e s u l t in b e t t e r debt
management tim ing and a reduced d e b t-s e rv ic e c o s t. This
type o f fin an cin g has even been recommended as an a l t e m a -
30
tiv e fo r ta x a tio n .
The d i r e c t purchase o f fe d e ra l s e c u r i ti e s by the
F ederal Reserve System is e q u iv a le n t to the p r in tin g of
money. I t must be remembered, however, th a t under the
p re se n t arrangem ent o f monetary c o n tr o l, a co n sid erab le
p o rtio n o f the t o t a l monetary supply o f th i s country stems
from the expansion o f fe d e ra l d eb t. Our monetary h is to ry
provides l i t t l e b a s is fo r optimism as to a l te r n a tiv e
30
Abba P. L e m e r, "F u n ctio n al Finance and th e
F ederal D ebt," S o cial R esearch . X, No. 1 (February 1943),
50.
320
31
ro u te s to monetary adequacy. For example:
I f th e p u b lic debt h e ld by commercial banks were
r e t i r e d by th e government and th e commercial banks
expanded p r iv a te loans by th e ex a ct amount t h a t
t h e i r loans to th e government were reduced w hile
th e money supply would rem ain th e same th e l i q u i d i t y
o f th e economy would be re d u c e d .32
Reducing th e L iq u id ity o f th e Debt
The l i q u id i t y o f th e d e b t, th e n , is th e prim ary
f a c to r which must be c o n tro lle d . I t i s in t h i s area th a t
sound d eb t management can make i t s most s i g n i f ic a n t con
tr i b u t io n to monetary p o lic y . What is needed i s a p o lic y
which d i f f e r e n t i a t e s between tr u e debt and q u asi money
form s, and reduces th e supply o f h ig h ly s h i f t a b le liq u id
a s s e ts in th e economy. Refunding by s a le to th e F ederal
Reserve o f p e r p e tu itie s redeem able a t th e governm ent's
o p tio n would f u l f i l l t h i s p o lic y s u c c e s s fu lly . Such
in stru m e n ts , when re s o ld in th e m arket p la c e , would provide
an a d d itio n a l instru m ent fo r c r e d i t c o n tro l in th e p riv a te
s e c to r . The F ed eral Reserve would be a b le to support
government o p e ra tio n s a t w hatever le v e l was ordained by
31
Seymour E. H a r r is , The N atio n al Debt and the New
Economics (New York: McGraw-Hill Book Company, In c .,
1947), p. 10.
Morgner, op. cit. , p. 113.
C ongressional budgetary d e c is io n s w ith o u t n e c e s s a rily
c r e a tin g s im ila r m onetary c o n d itio n s fo r th e p r iv a te
s e c to r o f th e economy. S im ila rly , a tig h te n in g o r lo o sen
ing o f p r iv a te c r e d i t would n o t n e c e s s a r ily r e s u l t in a
s im ila r expansion o r c o n tra c tio n o f sou rces o f fe d e ra l
c r e d i t . Such a s e p a ra tio n o f e f f e c ts becomes in c re a s in g ly
im portant as m onetary p o lic y i s a p p lie d more v ig o ro u sly to
promote economic s t a b i l i t y . Under th e p re se n t circum
sta n c e s , a c tio n s meant to a f f e c t m arginal investm ent funds
a re r e f le c te d in th e fe d e ra l d eb t and a re d e trim e n ta l to
and d ero g ato ry o f government c r e d i t .
The d i r e c t purchase o f T reasury s e c u r i ti e s by the
F ederal Reserve System has been proposed p re v io u sly . Such
su g g estio n s u s u a lly a n tic ip a te th a t any i n f la tio n a r y asp e ct
o f such a c tio n s would be compensated fo r by in c re a s in g
re se rv e req u irem en ts. Aside from fe a r o f abuse o f th e
c e n tr a l bank p r i v i l e g e , th e m ajor o b je c tio n to such a
procedure l i e s in th e p o s s i b i l i t y o f sev ere d is lo c a tio n s
and d istu rb a n c e s in the c r e d i t m arkets. F ed eral Reserve
checks used to pay fo r government s e c u r i t i e s would c r e a te
Annual Report of the Secretary of the Treasury,
1960, p. 286.
322
excess re s e rv e s . However, th e se excess re se rv e s would n o t
be d is tr ib u te d In e x a c tly th e same manner as th e r i s e in
re se rv e requ irem ents ca n celin g th e s e re s e rv e s .
There a re s e v e ra l p o s s ib le rem edies fo r such a
s i t u a t io n . The sim p le st s o lu tio n would be to u se T reasury
d e p o s it accounts to remove any sev ere d is lo c a tio n o f funds.
The flow o f huge amounts o f T reasury r e c e ip ts and expendi
tu re s in e v ita b ly a f f e c ts th e s iz e and d i s t r i b u t i o n o f
m onetary re se rv e s in th e commercial banking system and has
34
a fa r-re a c h in g e f f e c t upon the p r iv a te c r e d i t s tr u c tu r e .
The conscious use o f such accounts to c o r r e c t any in e q u i
t i e s due to re se rv e requirem ent changes would serv e to
stre n g th e n both monetary p o lic y and debt management p o lic y ,
and has been used in t h i s c a p a c ity on o ccasio n in the
- 35
p a s t.
Another remedy would be a v a r ia tio n o f th e lo an -
expansion re se rv e p lan . Such a p lan could perm it loan
expansion above re s e rv e requirem ents as a stopgap measure
in s p e c if ic cases o f d is lo c a tio n o f funds. Once the
34
Annual Report o f th e S e c re ta ry o f th e T re a su ry »
1951, p. 203.
35
Abbott, op. cit. , p. 35.
323
re se rv e requirem ent adjustm ents had f i l t e r e d throughout th e
e n t ir e system , such stopgap in d iv id u a l ex cep tio n s could be
removed.
Whether o r n o t d i r e c t s a le to th e F ed eral R eserve
by th e T reasury is in v o lv e d , some s e l e c t i v i t y in th e
a p p lic a tio n o f monetary p o lic y i s n ecessary and d e s ir a b le
in our p re se n t economy, as a r e s u l t o f i n s t i t u t i o n a l
f a c to r s and market im p e rfe c tio n s , th e in cid en ce o f g e n e ra l
monetary c o n tro ls which change th e t o t a l supply o f money
and bank c r e d i t is uneven. Some s e c to rs o f th e economy
a re a ffe c te d stro n g ly and o th e rs a re l e f t alm ost untouched.
T hus, th e d i s t in c ti o n between g e n e ra l and s e le c tiv e con
t r o l s is la rg e ly an i l l u s i o n sin c e s o -c a lle d g e n e ra l
c o n tro ls have s e le c tiv e e f f e c ts .
In a d d itio n , g e n e ra l c o n tro ls o fte n do n o t produce
the r e s u l t a n tic ip a te d by the m onetary p o lic y m akers. For
example, when re se rv e requirem ents were doubled in 1937,
th e F ederal Reserve Board s ta te d t h a t th e re should be no
e f f e c t on long-term i n t e r e s t r a t e s . C ontrary to ex p e c ta
t io n , th e m ajor impact was upon government s e c u r i t i e s .
The r e s u l t a n t drop in s e c u r ity p ric e s caused an in c re a s e
36
Smith, op. cit. , p. 121.
324
in average long -term T reasury bond y ie ld s from 2.46 p er
ce n t a t th e beginning o f th e y e a r to 2.84 p er c e n t e a rly
in A p ril. This in c id e n t dem onstrated how a program o f
c r e d i t r e s t r a i n t may have l i t t l e e f f e c t upon bank lending
p o lic y even though i t may have f a i r l y sharp e f f e c ts on
37
th e y ie ld s o f government s e c u r i t i e s . The in cre ased
q u a n tity o f r e l a t i v e l y liq u id government s e c u r i t i e s as a
r e s u l t o f World War I I made i t im p erativ e t h a t th e F ed eral
R eserve a c q u ire a d d itio n a l powers to make m onetary p o lic y
more e f f e c tiv e .
Secondary re se rv e re q u ire m e n ts. With th e end o f
World War I I , th e problem o f continued su p p ressio n o f
i n f l a t i o n became th e forem ost concern o f th e n a tio n as th e
a n tic ip a te d d e f la tio n f a ile d to m a te r ia liz e . A tremendous
in c re a se and wide d i s t r i b u t i o n o f h ig h ly liq u id a s s e ts had
o ccu rred . As a means o f in c re a s in g th e e ffe c tiv e n e s s o f
o v e r - a ll monetary c o n tr o ls , th e Board o f Governors o f th e
F ed eral R eserve System in i t s 1945 Annual R eport re q u ested
C ong ressional approval o f methods designed to cope w ith
37
Annual Report of the Secretary of the Treasury,
1951, p. 305.
325
th e problem o f m ain tain in g th e m arket fo r government
s e c u r i t i e s a t th e same time as e x e rc isin g monetary p o lic y .
One recommended measure would empower th e Board o f
Governors to re q u ir e a l l commercial banks to hold a
s p e c if ie d p ercen tag e o f T reasury B ills and C e r t i f i c a t e s
w ith o r ig in a l m a tu r itie s under two y ea rs as secondary
re se rv e s a g a in s t t h e i r n e t demand d e p o s its . Although t h i s
pro p o sal was no t a c c e p ta b le to C ong ress, th e Board
re p e a te d ly urged i t s adoption in i t s subsequent annual
38
re p o rts and in v a rio u s p u b lic sta te m e n ts.
Such a program o f s p e c ia l re se rv e requ irem ents has
been adopted by a number o f n a tio n s in c lu d in g Belgium,
F ra n c e , I t a l y , th e N etherlands , Sweden, In d ia , the
P h ilip p in e I s la n d s , B r a z il, C h ile , Mexico, and Uruguay.
Reserves in th e se c o u n trie s c o n s is t e it h e r o f government
s e c u r i ti e s alone o r o f varying p o rtio n s o f government
s e c u r i t i e s , c a sh , and im m obilized b alan ces w ith th e c e n tr a l
bank. In a few c o u n tr ie s , nongovernment s e c u r i ti e s o r
o th e r a s s e ts can a ls o be counted as re s e rv e s . In th i s
m anner, types o f loans which th e government a u th o r itie s
38
Board of Governors of the Federal Reserve System,
Annual Report, 1945 (Washington: Government Printing
Office, 1945), p. 7.
326
wish to promote add a q u a l i t a t i v e a sp e c t to th e secondary
re s e rv e req u irem en t.
The U nited Kingdom i s th e only n a tio n to in s u la te
e f f e c t i v e l y a p o rtio n o f th e government d eb t from th e
p r iv a te s e c to r o f th e economy w ith o u t th e use o f form al
re s e rv e req u irem en ts. This i s accom plished by m oral
su asio n which i s e f f e c tiv e in th e lim ite d f in a n c ia l s e c to r
39
which e x is ts in th a t co u n try .
Those who favor th e secondary re s e rv e requirem ents
p ro p o sal p o in t out th a t th e re a re many advantages to be
d eriv e d from the ad o p tio n o f such a p lan . The government
s e c u r i t i e s m arket would be p a r t i a l l y in s u la te d from F ed eral
Reserve r e s t r i c t i v e c r e d it p o lic y . Banks would become
more re sp o n siv e to F ederal Reserve a c tio n s to expand or
c o n tra c t c r e d i t . Debt management o p e ra tio n s and d i f f i c u l t
refu n d in g problems would be eased. R eserves to meet th e
new requ irem ents would c o n tin u e to be b ank-earning a s s e ts .
A p o rtio n o f th e commercial bank re so u rc e s would be chan
neled to th e T reasury. D ire c t re c o u rse o f th e T reasury to
th e c e n tr a l bank fo r fin a n c in g could be avoided.
Annual Report of the Secretary of the Treasury,
1951, pp. 335-391.
327
The d isadvan tages o f the secondary re s e rv e r e q u ir e
ment p lan emphasize the need to m ain tain the b a n k 's freedom
o f a c tio n which would be r e s t r i c t e d by the compulsory
s a le s . Such a requirem ent could r e s u l t in T reasury abuse
in the form o f reduced i n t e r e s t r a t e s . A lso , applying
secondary re s e rv e requirem ents to j u s t one s e c to r o f the
f in a n c ia l system would d is c rim in a te in favor o f those
f in a n c ia l i n s t i t u t i o n s such as in su ran ce com panies, which
a re the b a n k 's co m p etito rs in making funds a v a ila b le to
in d u s try .
Another F ed eral Reserve su g g estio n a f t e r th e war
would have allow ed th e F ed eral Reserve Board to r a i s e
re se rv e requ irem ents above the le g a l maximum. This was
f i n a l l y adopted by Congress on a lim ite d b a s is as an
emergency measure in 1948. However, a f t e r th e T reasury-
F ed eral Reserve Accord o f March 1951, th e sup port o f the
F ed eral Reserve fo r a u x ilia r y monetary a u th o rity in the
form o f secondary re se rv e requirem ents and in cre ased
re se rv e lim its ceased. Emphasis now re tu rn e d to the
e x is tin g monetary to o ls w ith prim ary c o n s id e ra tio n being
^ J o s e p h Aschheim, "Supplem entary S e c u rity Reserve
Requirements R econsidered," Jo u rn al o f F in a n c e . X III
(December 1958), 473-487.
328
given to open market operations.
As e a rly as 1790, Congress had a u th o riz e d th e p u r
chase o f p u b lic debt s e c u r i t i e s in o rd e r to reduce the
d e b t, to b e n e f it th e c r e d ito r s o f the U nited S ta te s by
r a is in g th e p ric e o f s e c u r i t i e s , and to save money fo r th e
governm ent. Again in 1914 th e F ed eral R eserve Banks,
under ru le s and re g u la tio n s p re s c rib e d by th e F ederal
Reserve Board, re c e iv e d a u th o riz a tio n to purchase govern
ment bonds as they m ight s e e - f i t . However, i t was not
u n t i l 1939 th a t open m arket o p e ra tio n s in th e c a p it a l
m arket were used to in flu e n c e monetary c o n d itio n s d i r e c t l y .
P rio r to t h i s time th e p r a c tic e had been to m ain tain a
c o n sta n t amount o f s e c u r i t i e s in th e F ed eral Reserve
42
System account. During World War I I , open m arket o p e ra
tio n s were used by th e F ed eral Reserve to fu rn is h the
a d d itio n a l re se rv e s n ecessary to fin an ce th e war. Upon
the r e tu r n to p e a c e , th e F ederal Reserve wished to re tu r n
to th e prewar c o n d itio n s o f v a r ia b le s e c u rity p ric e s as
determ ined by th e m arket p la c e . The T reasury wished to
r e ta in a guaranteed government bond m arket supported by
411 S t a t . (1790) , 186.
^ C h i l d s , op. c i t . . pp. 107, 299.
329
F ederal Reserve a c tio n . I t was th is d is p u te over the
a d v is a b ility o f re tu rn in g to a system of flu c tu a tin g
i n t e r e s t r a te s th a t f i n a l l y culm inated in the Accord o f
March 4 , 1941.
The T reasury-F ed eral Reserve Accord. In analyzing
the arguments both fo r and a g a in st market s u p p o rt, i t must
be remembered th a t the economic and p o l i t i c a l co n d itio n s
o f the postw ar p eriod were h ig h ly u n c e rta in . Under th ese
co n d itio n s the T reasury f e l t th a t any change in market
support p ra c tic e s would be harmful to the governm ent's
c r e d it. The F ederal Reserve f e l t th a t the c r e d it o f the
government in the long run would be fu rth e re d by removal
o f F ederal Reserve su pp ort. The p e r s is te n t d e c lin e in the
purchasing power of fe d e ra l s e c u r i tie s would cause more
ir r e p a r a b le damage than any sudden shock to in v e sto rs due
to the f a il u r e to support the government s e c u rity m arket.
The F ederal Reserve p o s itio n assumed th a t a f l u c t u
a tin g market fo r s e c u r iti e s r e s u ltin g in y ie ld changes
would be e f f e c tiv e in p rev en tin g i n f l a t i o n . Thus, the
F ederal Reserve wished to r e ly p rim a rily upon open market
o p eratio n s as i t s monetary to o l. The T reasu ry , on the
' m
o th e r h and, was convinced th a t i t was a d elu sio n to th in k
330
th a t f r a c tio n a l changes in r a te s o f i n t e r e s t would be
e f f e c tiv e in fig h tin g i n f l a t i o n .
The F ederal R eserve, having been denied th e power
by Congress to c r e a te secondary re se rv e re q u ire m e n ts, was
concerned w ith th e m o n etizatio n o f the d e b t. The ra p id
i n f l a t i o n which follow ed the ou tbreak o f h o s t i l i t i e s in
Korea heightened th is concern. The T reasury p o in ted out
t h a t th e F ed eral Reserve had reduced i t s p o r t f o li o o f
government s e c u r i ti e s in th e f i r s t h a l f o f 1950, in
a d d itio n to a $4.5 b i l l i o n d e c lin e in 1949. This was the
o p p o site o f m o n etizatio n o f th e d eb t. A lso, in th e f iv e -
y ear p erio d up to th e Korean War, long-term bonds had been
in demand fo r about four y e a rs. Support o p e ra tio n s had
43
been n ecessary in only one y ea r--1 9 4 7 -4 8 . This support
a c tio n had been caused by a d is ru p tio n in th e government
s e c u r ity m arket due to the r a is in g o f th e s h o rt-te rm r a te
o f i n t e r e s t and the dropping o f long-term s e c u r i ti e s p ric e
su p p o rts to p ar. Although the F ed eral Reserve had hoped
th a t the 1947 a c tio n would reduce s e l l i n g o f b ond s, the
o p p o site r e s u l t was achieved. In v e sto rs made p o r tf o lio
43
Annual Report of the Secretary of the Treasury,
1951, p. 297.
331
sw itches to p ro te c t them selves a g a in s t fu r th e r p ric e
d e c lin e s . Some l i f e insurance companies, fo r example,
trad ed holdings o f tw e n ty -y e a r, 2.5 per cent bonds fo r
three-m onth, 1 p er cent Treasury B i ll s .
The T reasury feared th a t a p ric e d e c lin e o r i n t e r e s t
r i s e under Korean wartime co n d itio n s would d estro y the
s t a b i l i t y o f the s e c u rity m arket a t the very time th a t i t
was im perative th a t government fin an cin g o p e ra tio n s be
c a rrie d through s u c c e s s fu lly . The F ederal R eserve,
although i t agreed to a ssu re the success o f wartime fin a n
c in g , was not w illin g to be frozen in to a low, ste e p ly
sloped i n t e r e s t r a te s tr u c tu r e fo r the d u ra tio n o f what
might p o ssib ly be World War I I I .
The F ederal Reserve did not fe e l th a t government
s e c u rity h olders would r e s o r t to mass s a le s as bond p ric e s
dropped. The T reasury feared th a t th is would occur and
the r e s u l t would be the impairment o f c a p ita l h eld by
in v e s to r s , a r i s e in the c o st o f debt s e rv ic e , and the
com plications o f the refunding p ro cess. The Treasury
p o s itio n receiv ed l i t t l e encouragement from th e 1950
44
Ibid., p. 260.
332
Subcommittee on M onetary, C re d it, and F is c a l P o lic ie s ,
c h a ire d by Senator D ouglas, which s ta te d :
W e b e lie v e t h a t the advantages o f avoiding
i n f l a t i o n a re so g re a t and th a t a r e s t r i c t i v e
monetary p o lic y can c o n trib u te so much to t h i s
end th a t th e freedom o f th e F ed eral R eserve to
r e s t r i c t c r e d i t and r a is e i n t e r e s t r a te s fo r
g e n e ra l s t a b i l i z a t i o n purposes should be re s to re d
even i f th e c o s t should prove to be a s ig n i f ic a n t
in c re a se in s e rv ic e charges on th e F ed eral debt
and a g r e a te r inconvenience to th e T reasury in
i t s s a le o f s e c u r i ti e s fo r new fin a n c in g o r
refu n d in g p u rp o se s.^5
The e s s e n tia l f a c to r around which th e d isp u te
c e n te re d , th e r e f o r e , was th e c o s ts and b e n e f its to be
d eriv e d from a f le x ib l e i n t e r e s t r a t e p o lic y in th e govern
ment s e c u r ity m arket. The F ed eral Reserve System having
been denied C ongressional approval to in c re a se g en e ral and
s e le c tiv e c o n tro ls d e s ire d to r e a c tiv a te e x is tin g q u a n ti
t a t i v e c o n t r o l s , p a r t i c u l a r l y th e p r ic e f l e x i b i l i t y o f th e
government s e c u r ity m arket. The T reasury f e l t th a t q u a li
t a t i v e c o n tro ls should be emphasized. I t p o in ted out th a t
the r e s u l t s achieved by doubling re se rv e requirem ents in
1937 had c a s t se rio u s doubts upon th e e ffe c tiv e n e s s o f
g e n e ra l c o n tro ls when such a la rg e volume o f liq u id a s s e ts
^ Annual Report of the Secretary of the Treasury,
1957. p. 123.
333
e x is te d in th e economy. A lso , under c o n d itio n s as they
e x is te d during re co n v ersio n and th e Korean War, g en e ral
c o n tro ls to be e f f e c tiv e might have an adverse e f f e c t upon
th e very areas o f th e economy which should be expanding to
a ssu re fu tu re economic growth and p o l i t i c a l freedom.
The d iffe re n c e s o f o pinion r e s u lte d in an open break
in th e r e la ti o n s o f th e T reasury and th e F ed eral Reserve
System. The f i r s t c o n f li c t a ro se in August 1950. The
T reasury refu n d in g o f fe rin g co n tain ed r a te s which were
id e n tic a l w ith th e terms o f prev io u s is s u e s . S ubsequently,
th e T reasury p o in ted out th a t th e refu n d in g is s u e terms
were in lin e w ith th e m arket on th e day o f th e refund in g
announcement and met th e needs o f the m arket fo r a s h o rt-
/j, ^
term s e c u r ity .
The problem a ro se when th e F ed eral Reserve System
announced an in c re a se in the d isc o u n t r a t e on the same day.
The F ed eral Reserve had d isc u sse d such a c tio n s s e v e ra l
days e a r l i e r . The F ed eral Reserve emphasized t h a t th e
T re a s u ry 's fin an c in g announcement was made two weeks
e a r l i e r than would have been u s u a l , su g g estin g th a t th e
46
Annual Report of the Secretary of the Treasury,
1951, p. 267.
334
T reasury was informed o f the F ederal R eserv e's plans and
was attem p tin g to f o r e s t a l l the F ederal Reserve System 's
a c tio n s . The T reasury s ta te d th a t i t s prem ature a c tio n
re s u lte d from a T reasury b e l i e f th a t F ederal Reserve
arguments fo r c r e d it r e s t r a i n t were being made known to
th e market and were r e s u ltin g in downward p re ssu re on
p ric e s and upward p re ssu re on y ie ld s .
I t thus became apparent to the government bond
m arket th a t one fe d e ra l a u th o rity was endeavoring to
adhere to the e x is tin g i n t e r e s t r a te p a tte r n , w hile
an o th er a u th o rity was determ ined to use a l l o f the fo rces
a t i t s command to change th a t r a te . As a r e s u l t , only
$0.8 b i l l i o n o f a t o t a l o f $13.6 b i l l i o n o f m aturing
s e c u r i ti e s were p resen ted fo r exchange in th e August 1950
refunding o p e ra tio n . The rem ainder were purchased la rg e ly
by the F ederal Reserve Banks a t the same time th a t they
47
sold o th e r Treasury o b lig a tio n s a t lower p ric e s .
In November 1950 the T reasury faced another period
o f refu n d in g . On th is o ccasio n , p r io r c o n s u lta tio n
r e s u lte d in the assurance o f support by Chairman McCabe o f
th e F ed eral Reserve Board of Governors. N e v e rth e le ss, on
47
Gaines, op. cit. , pp. 146-147.
335
th e f i r s t tra d in g day a f t e r th e announcem ent, th e m arket
was p e rm itte d to go o f f sh arp ly w ith a r e s u l t a n t 51 p er
c e n t refu n d in g o f m aturing iss u e s compared to an average
95 per ce n t in prev io u s y e a rs .
E arly in January 1951 th e P re s id e n t, th e S e c re ta ry
o f th e T re a su ry , and th e Chairman o f th e Board o f
Governors met to e s ta b lis h a p o lic y which would reduce the
w idespread rumors and confusio n in th e m arket. On th e
b a s is o f th e Board C hairm an's assu ran ce th a t th e P re sid e n t
need n o t be concerned about the 2.5 per cen t long-term
r a t e , th e S e c re ta ry o f the T reasury announced in a p u b lic
speech th a t th e 2.5 p e r cen t long-term r a t e was f a i r and
e q u ita b le to the governm ent, to th e in v e s to r , and to the
tax p ay er.
P re s id e n t Sproul of th e New York F ed eral Reserve
Bank, which conducts th e g r e a te s t sh are o f open m arket
o p e r a tio n s , p u b lic ly took is s u e w ith S e c re ta ry S nyder's
i n t e r p r e ta tio n th a t th e F ed eral Reserve had accepted th e
fre e z in g o f th e e n ti r e p a tte r n o f y ie ld s on government
s e c u r i ti e s fo r th e d u ra tio n o f th e emergency. This
r e s u lte d in a p u b lic l e t t e r from th e P re s id e n t to Chairman
McCabe thanking him fo r h is "assu ran ce o f f u l l suppo rt fo r
th e T reasury defense fin an c in g program bo th as to refu n d in g
336
and new is s u e s ." The response to t h i s by th e F ed eral
Reserve o f f i c i a l s was t h a t th e " P r e s id e n t's l e t t e r was a
com plete m is re p re s e n ta tio n o f bo th th e te n o r and substance
o f th e m eeting."^®
On February 26, 1951 th e P re s id e n t appointed a
four-member com mittee com prised o f th e S e c re ta ry o f th e
T re asu ry , th e Chairman o f th e Board o f Governors o f th e
F ed eral Reserve System, th e D ire c to r o f Defense M obiliza
t i o n , and th e Chairman o f the C ouncil o f Economic A dvisors.
Mention was a ls o made o f th e extreme powers o f the
Emergency Banking Act o f 1933 and th e T rading w ith th e
Enemy Act o f 1917 , which p e rm itte d th e e x e cu tiv e branch in
tim es o f emergency to r e g u la te th e lending o p e ra tio n s o f
49
a l l f in a n c ia l i n s t i t u t i o n s o f a l l k in d s. B efore th e
P r e s id e n t's com mittee could r e p o r t , th e S e c re ta ry o f th e
T reasury and th e Chairman o f the F ed eral R eserve Board o f
G overnors, on March 4 , 1951, re le a s e d fo r p u b lic a tio n the
d e t a i l s o f th e Accord which they had m utually agreed upon.
In e sse n c e , th e F ed eral R eserve prom ised to m ain tain
an o rd e rly m arket b u t recognized th a t i t s prim ary duty was
^ New York Times , F ebruary 2 and 3 , 1951.
^ Annual Report o f the S e c re ta ry o f th e T re a s u ry ,
1951. p. 271.
337
to s t a b i l i z e b u sin ess a c t i v i t y and n o t the government
s e c u r ity m arket. On March 5 , 1951 i t became ev id en t th a t
th e F ed eral Reserve System was w ithdraw ing i t s support
from T reasury o b lig a tio n s and th e p ric e s o f government
s e c u r iti e s worked to lower l e v e l s . ^ The circum stances
lead in g to th e Accord emphasized th e fa c t th a t firm d i r e c
tio n o f th e fe d e ra l debt management program was lack in g .
I I I . DEBT M A N A G EM EN T DIRECTION
The p o s s ib le c o n f lic ts between debt management
p o lic y and m onetary p o lic y expanded as th e s iz e o f the
debt grew and as th e im portance o f monetary p o lic y became
ap p aren t. With th e advent o f World War I I , both Board
Chairman E ccles and P re s id e n t Sproul o f th e New York
Reserve Bank o b je c te d stro n g ly to th e e s ta b lis h e d p a tte rn
o f i n t e r e s t r a te s , b u t agreed to accep t a T reasury d i r e c
tiv e assuming r e s p o n s i b i l ity fo r th e d e c i s i o n . ^ The only
s ta tu to r y b a s is fo r T reasury p re fe re n c e is found in S ectio n
52
10 o f the F ed eral Reserve A ct. This pro v id es:
^ F ed eral Reserve B u l l e t i n , A p ril 1953, pp. 330-335.
"^Murphy, op. c i t . , p. 97.
5212 U.S.C. 246.
338
. . . [th a t] whenever any power v e ste d by t h i s Act
in the Board o f Governors appears in c o n f l i c t w ith
the powers o f th e S e c re ta ry o f th e T reasury such
powers s h a ll be e x e rc ise d s u b je c t to th e c o n tro l
o f th e S e c r e ta ry .53
This p ro v isio n does not appear to d e a l w ith c o n f l i c t s as
to what c o n s titu te s a p p ro p ria te p u b lic p o lic y . T h e re fo re ,
i t has no t been drawn upon in an e f f o r t to so lv e th e
p o lic y type o f c o n f l i c t .
With the end o f World War I I , the F ed eral R eserve
took ste p s to e lim in a te wartime borrow ing mechanisms.
D espite the o b je c tio n o f the S e c re ta ry o f th e T re a su ry ,
th e p r e f e r e n ti a l d isc o u n t r a t e was e lim in a te d in 1946.
Long-term bonds were p e rm itte d to d e c lin e in p r ic e in 1947.
F in a lly , market support was dropped in 1951. The F ed eral
Reserve thus dem onstrated i t s independence o f T reasury
and P r e s id e n tia l d i r e c ti v e . C o n flic ts between th e
T reasury and the F ed eral R eserve th a t cannot be re so lv e d
by the "g iv e and tak e" method around a d is c u s s io n ta b le
can only be re so lv e d by C ong ressional d i r e c ti v e a c tin g in
response to the fo rc e o f p u b lic o p in io n .
A s im ila r c o n f li c t over th e independent power o f
th e c e n tr a l bank i s tak in g p la c e in Canada in 1961. The
33Ibid.
339
Governor of the Bank of Canada has been asked to resign,
presum ably fo r re tire m e n t pu rposes. The Governor claim s
t h i s reaso n is a su b te rfu g e . The r e a l reason is h is
adherence to what i s c a lle d a " t i g h t money p o licy " a t a
tim e when C anada's unemployment i s 11 p er cen t o f th e
54
n a tio n 's la b o r fo rc e .
In Canada, the U nited Kingdom, New Z ealand,
A u s tr a lia , F rance, the N eth e rlan d s, S pain, and many South
American c o u n trie s th e Governor o f th e C e n tra l Bank is by
s t a t u t e re q u ire d to e f f e c t any d e c isio n s o f th e government
as d ire c te d by th e S e c re ta ry o f th e T reasury. Many
c o u n trie s w ith f u lly form alized T re asu ry -C en tra l Bank
r e la tio n s h ip s have enacted a d d itio n a l s ta tu to r y p ro v isio n s
fo r re so lv in g c o n f li c ts o f p o lic y . In West Germany the
government can demand an eig h t-d a y suspension of C en tral
Bank d e c is io n s . A u s tra lia p ro v id es th a t b oth the C e n tra l
Bank and the T reasury submit w ritte n statem en ts o f th e i r
p o s itio n s in th e advent o f a c o n f li c t o f p o lic y and then
the C hief Executive and h is m in is te rs d ecide th e p o lic y
5^Wall Street Journal. June 16, 1961, p. 4.
340
J 55
to be adopted.
In the United S ta te s , Congress has taken the
o p p o site course o f a c tio n . I t has d eleg ated more and more
a u th o rity to both the T reasury and the F ederal Reserve
Board. Probably in no o th e r m atter o f m ajor im portance do
a d m in istra tiv e o f f i c i a l s have so much d is c r e tio n as in
determ ining debt management p o lic y and monetary p o lic y .
The major j u s t i f i c a t i o n fo r independence o f debt management
p o licy a r is e s from the in h ere n t d i f f i c u l t y o f s e ttin g
fin a n c ia l terms o f fe d e ra l s e c u r i ti e s by a p o l i t i c a l body.
The prim ary reason fo r independence o f monetary p o lic y is
the d e s ire to remove from the p o l i t i c a l sphere th e a b i l i t y
to re g u la te the c re a tio n o f bank d e p o s its .
However, th e growth in fe d e ra l debt and th e
increased im portance o f monetary p o licy has given a new
and much g re a te r s ig n ific a n c e to the t r a d i t i o n a l adm inis
t r a t i v e d is c re tio n of both the Treasury and th e F ederal
Reserve System. The f a ilu r e o f Congress to use f i s c a l
p o licy e f fe c tiv e ly has placed an a d d itio n a l burden upon
monetary p o licy and debt management p o licy in th e
Annual Report of the Secretary of the Treasury,
1951» pp. 345-349.
341
promotion of economic growth and stability.
In view o f th e new im portance o f debt management
p o lic y and monetary p o lic y , i t would be a d v isa b le th a t the
a u th o r itie s who a re d i r e c tl y re sp o n s ib le to th e e le c to r a te
tak e renewed i n t e r e s t and assume g r e a te r c o n tro l o r review
o f th ese e s s e n tia l economic a re a s. In th i s manner the
p u b lic can a t t a i n g r e a te r awareness o f th e problems o f
debt management and monetary c o n tro l. I t is w ith the
p u b lic a c tin g through i t s r e p re s e n ta tiv e government th a t
the f i n a l s o lu tio n to th e problem l i e s , fo r the problem
o f c o n tro llin g the economy is to a g re a t e x te n t a problem
o f p u b lic s e lf - c o n tr o l.
IV. SU M M A R Y
A m ajor problem o f debt management is i t s e f f e c t
upon f i s c a l and monetary p o lic y . As the connecting lin k
between f i s c a l and monetary p o lic y , debt management p o licy
and techniques can c o n trib u te to o r d e tr a c t from economic
grow th.
In r e la ti o n to f i s c a l p o lic y , debt can be used to
expand o r c o n tra c t ta x a tio n and ex p en d itu res. In the
post-W orld War I I p eriod the major problem has been the
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c o n tro l o f e x p e n d itu re s. Budget d e f i c i t s have p e r s is te d
in prosperous tim es and th e d eb t has e x h ib ite d a marked
tendency to p e rp e tu a te i t s e l f . New bud getary procedures
such as c o n so lid a te d g e n e ra l a p p r o p r ia tio n s , earmarked
r e c e ip ts , f lu c tu a tin g tax r a t e s , and g r e a te r f o r ti t u d e in
applying new tax es o r m ain tain in g e x is tin g tax es would
serv e to make f i s c a l p o lic y more re s p o n s ib le . In a d d itio n ,
th e replacem ent o f th e tax-exem ption subsidy o f s t a t e and
lo c a l governments w ith a d i r e c t subsidy would remove a
c o s tly and m ajor tax in e q u ity . Such a c tio n s would make
p o s s ib le a more s a t i s f a c to r y debt management p o lic y and
monetary p o lic y .
The elem entary concept o f F ed eral Reserve d e t e r
m ination o f m onetary p o lic y i s n o t tr u ly in d ic a tiv e o f
e x is tin g c o n d itio n s . Bank in v e s to rs in p a r t i c u l a r now play
a m ajor r o le in determ ining monetary c o n d itio n s as w ell as
nonbank in v e s to r s , th e T re asu ry , and o th e r government
a g e n c ie s .
There has been a p e r s i s t e n t f a i l u r e to s e p a ra te the
two m ajor purposes o f monetary p o lic y , i . e . , to provide
th e needed c i r c u la ti n g medium a t th e same time th a t th e
purchasing power o f money is m ain tain ed . That p o rtio n o f
the debt which has become n ecessary to s u s ta in th e p re se n t
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le v e l o f economic a c ti v i t y should be m onetized. F a ilu re
to do so has re s u lte d in an in c re a se in th e v e lo c ity o f
money. Devices to in c re a se v e lo c ity have caused a d d itio n a l
economic problem s. Today th e re is growing concern over the
in creased use o f bank d r a f t s . The development o f re p u r
chase agreem ents has caused c o rp o ra tio n s and s t a t e and
lo c a l governments to overem phasize th e p r o f ita b le employ
ment o f tem porary accum ulations o f funds.
An unnecessary degree o f li q u id it y c h a ra c te riz e d
the d eb t. The id e a l s o lu tio n would be the issu an ce o f
p e r p e tu itie s redeemable a t the o p tio n o f the government.
Other prop osals include the u se o f secondary re se rv e
re q u ire m e n ts, in c re a sin g p re se n t s ta tu to r y re se rv e r e q u ir e
ment l i m i t a t i o n s , and the re tu r n to market f l e x i b i l i t y in
the hope o f "fre e z in g " bonds w ith p re se n t h o ld ers by p e r
m ittin g t h e i r p ric e s to drop. The f i r s t proposal has y e t
to be t r i e d . The second and th ir d proposals were re je c te d
by C ongress, and the fo u rth proposal re s u lte d in a c o n f lic t
o f i n t e r e s ts between the T reasury and th e F ed eral R eserve,
which f i n a l l y led to th e T reasu ry -F ed eral Reserve Accord
o f March 1951.
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In examining th e s o lu tio n to th is c o n f l i c t , i t was
found th a t th e d ir e c tio n o f debt management p o lic y was
in e f f e c tiv e . Congress had made no p ro v isio n fo r re so lv in g
such c o n f li c t s . I t has provided fo r v i r t u a l l y u n lim ited
a d m in is tra tiv e d is c r e tio n r a th e r than C ongressional debt
management or monetary p o licy le a d e rs h ip . This s itu a tio n
continues today. An e f f o r t is being made by some members
o f the government to provide fo r th e e x e rc ise o f g re a te r
C ongressional and Executive c o n tro l. C ontrol is deemed
e s s e n tia l in view o f the in c re a sin g im portance to the
o v e r - a ll economy o f T reasury and F ederal Reserve adm inis
t r a t i v e a c tio n s . P ro v isio n s fo r c lo s e r l e g i s l a t i v e and
executive guidance were found to be q u ite commonplace
o u ts id e o f th e United S ta te s .
CHAPTER IX
SU M M A R Y OF FINDINGS, CONCLUSIONS, A N D RECOM M ENDATIONS
The preceding economic a n a ly s is o f th e problems o f
fe d e ra l d eb t management has endeavored to s c r u tin iz e
c r i t i c a l l y and o b je c tiv e ly th e v a s t a rra y o f a v a ila b le
m a te r ia l. The fa c ts serve as a b a s is fo r fo rm u latin g
opin io ns o f the c o n trib u tio n s th a t d ebt management can
make toward n a tio n a l economic growth and s t a b i l i t y . The
follow ing summary serv es to h ig h lig h t th e major, fin d in g s
from which a s e r ie s o f recommendations has been d eriv e d .
These recommendations a re made as suggested a re a s o f
f u r th e r c a re fu l a n a ly s is and development r a th e r than as a
fix ed program fo r immediate a c tio n .
I . SU M M A R Y OF FINDINGS
Debt management p o lic y can serv e to re in f o rc e
f i s c a l and monetary p o lic y . However, th e problems o f th e
debt manager have been compounded by f a i l u r e o f re sp o n sib le
345
346
a u th o r itie s to e x e rc ise e f f e c tiv e f i s c a l and monetary
p o lic y . In th e p erio d analyzed th e re has been a n o ta b le
lack of f i s c a l f o r titu d e . Although n a tio n a l income has
r i s e n , Congress has not ap p lied i t s tax in g power. On the
c o n tra ry , tax es have been eased. This seems to in d ic a te
th a t Congress p re fe rs tax re d u c tio n to debt re d u c tio n . As
a r e s u l t , the s iz e o f the debt has in cre ased r a th e r than
decreased fo r the p erio d 1945-1961. Today’ s debt is a t an
a ll- tim e high and s t i l l growing. This is in sharp c o n tra s t
to h i s t o r i c a l precedence. T r a d itio n a lly , th e debt had been
decreased a f t e r every emergency.
Today's debt has d e fie d a l l re c e n t attem p ts to
reduce i t o r c o n ta in i t . S ta tu to ry e f f o r t s through the
a p p lic a tio n o f sin k in g funds have proven in e f f e c tiv e in
the absence o f budget su rp lu s e s. C ongressional attem pts
to c o n ta in th e debt by means o f debt c e ilin g s have only
been su c c e ssfu l tem p o rarily and have re s u lte d in the c o s tly
circum vention of th e s p i r i t o f the law. C e ilin g s have
a lso made debt management o p e ra tio n s more d i f f i c u l t . This
has been p a r ti c u l a r ly apparent in the re d u c tio n o f T reasury
cash b a la n c e s. The major gain from th e debt c e ilin g
lim ita tio n s is the C ongressional review of f i s c a l p o licy
347
n e c e s s ita te d by each change.
A ra p id expansion o f co n tin g en t fe d e ra l debt has
p a r a lle le d the growth of d ir e c t fe d e ra l d eb t. S u b s titu tio n
between d ir e c t and co n tin g en t fe d e ra l o b lig a tio n s conceals
the impact o f the fe d e ra l debt upon the n a tio n 's economy.
"Back door" spending by government agencies and complex
a p p ro p ria tio n processes tend to d is g u is e the tru e ex ten t
o f government spending. Government expend itures have also
a ffe c te d the t o t a l debt in the p riv a te s e c to r. S h iftin g
can and does occur between a l l debt s e c to rs and the a c tio n s
in each s e c to r d i r e c tly in flu en ce c o n d itio n s in a l l o th e r
s e c to r s .
R elativ e Importance o f the F ederal Debt
The fe d e ra l debt s e c to r expanded to 60 per cen t of
the t o t a l of a l l p u b lic and p riv a te debt during World
War I I . I t has sin ce dropped. At the p re se n t time i t is
s li g h tly more than 25 per cent of the t o t a l debt s tr u c tu r e .
The im portance o f the s iz e of the fe d e ra l debt depends
upon the s iz e o f o th e r economic v a r ia b le s . The most
im portant economic fa c to r r e la te d to debt burden is the
n a tio n a l income. The com position of n a tio n a l income as
w ell as the t o t a l is an im portant c o n s id e ra tio n in
348
a sse ssin g th e r e l a t i v e burden o f the fe d e ra l d eb t. A high
and r i s i n g n a tio n a l income is e s s e n tia l to support and
se rv ic e a la rg e fe d e ra l d eb t.
The per c a p ita debt fig u re s tend to be le s s co n clu
siv e as guides to debt burden. Such fig u re s must be
analyzed c a r e f u lly b efo re they a re used.
Although in f la t i o n tends to decrease th e r e l a t i v e
burden o f th e d e b t, th is form o f debt re p u d ia tio n has been
disavowed. The in f la tio n a r y p o te n tia l o f th e debt i t s e l f
depends upon th e re te n tio n o f in v e s to r confidence in debt
o b lig a tio n s as a s to re o f v alu e.
The impact o f the burden o f th e debt is in d is p u te .
Arguments a g a in s t d e f i c i t fin an cin g emphasize the tr a n s f e r
o f debt burden to fu tu re g en e ratio n s and advocate the
lim ita tio n o f debt expansion to emergency c o n d itio n s.
Arguments in favor of d e f i c i t fin an cin g m aintain th a t a t
most only a tr a n s f e r occurs between fu tu re debt h o ld ers
and taxpayers , w ith th e r e a l burden o f debt f a lli n g upon
the p re se n t g e n e ra tio n which gives up re so u rc e s. The
p o s sib le gains from d e f i c i t spending a re a lso emphasized,
and as a r e s u l t l i t t l e concern is expressed over c o n tin u a l
debt expansion.
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Distribution of Federal Debt
Both proponents and opponents o f d e f i c i t fin an c in g
acknowledge th a t an in te r n a l d eb t is le s s burdensome than
an e x te rn a l d e b t. The d i s t r i b u t i o n o f th e ownership o f an
in t e r n a l l y h eld debt r a is e s a d d itio n a l problem s. The most
b e n e f ic ia l d is t r i b u t i o n o f fe d e ra l d eb t would be c h a r a c te r
ized by w idespread ownership and s t a b i l i t y o f h o ld in g s.
Undue c o n c e n tra tio n o f d ebt in any one s e c to r is l ik e ly to
prove both u n s ta b le and expensive. Changes in the p a tte r n
o f debt ownership can produce im portant economic conse
quences re g a rd le s s o f w hether th e debt i t s e l f i s in c re a s in g
o r d e c re a sin g .
T a ilo rin g the d ebt to f i t th e needs o f th e in v e s to r
was designed to promote the s t a b i l i t y o f d eb t ow nership.
T a ilo rin g th e debt a lso c re a te d an oversupply o f h ig h ly
liq u id a s s e ts . The s ig n ific a n c e o f th i s f a c t was not
p erceived u n t i l a f t e r World War I I . This source o f liq u id
a s s e ts tended to n egate and com plicate monetary p o lic y .
Wartime d eb t issu in g p o lic y had endeavored to avoid th is
very problem by r e s t r i c t i n g bank s u b s c rip tio n s to T reasury
issu e s as an in f la tio n a r y check. One r e s u l t o f the
r e s t r i c t i o n s upon d i r e c t purchases by banks was the
350
in c re a se in " f r e e rid in g " p r a c tic e s o f s p e c u la to rs . By
the end o f the war " f r e e rid in g " had developed to such a
p o in t th a t i t s e rio u s ly endangered th e success o f any
fu tu re war bond d riv e s . A fte r th e w ar, " f r e e rid in g "
continued to plague th e government s e c u r i ti e s m arket.
F in a lly , i t r e s u lte d in a fe d e ra l in v e s tig a tio n o f m arket
o p e ra tio n s and lending p r a c tic e s .
The wartime d e c is io n to fin an c e by means o f com
m erc ia l bank d e p o sit c re a tio n meant th a t th e banking
system was given a v i r t u a l government subsidy. A fte r the
w ar, Congress f a ile d to adopt th e F ed eral R e se rv e 's recom
m endations fo r s p e c ia l secondary re s e rv e req u irem en ts and
in cre ased re se rv e requirem ent lim ita tio n s . This caused
the F ederal Reserve to tak e a c tio n s which f i n a l l y re s u lte d
in th e T re asu ry -F ed eral R eserve Accord.
A fte r the A ccord, the F ed eral R eserve re s o r te d
m ainly to open m arket o p e ra tio n s to e f f e c t a t i g h t money
p o lic y . In p erio d s when a p o lic y o f c r e d i t ease was
d e s ir a b le , the F ederal Reserve follow ed the p r a c tic e o f
low ering re se rv e req u irem en ts. In s is te n c e upon e f f e c tin g
c r e d it ease in t h i s manner, r a th e r than by u sin g open
m arket o p e r a tio n s , r e s u lte d in f u r th e r bank s u b s id iz a tio n .
t
351
Banks have tended to use t h e i r new re s e rv e s to purchase
government s e c u r i t i e s in tim es o f re c e s s io n . As i n t e r e s t
r a te s ro se in p erio d s o f i n f l a t i o n , th e se s e c u r i ti e s would
be so ld to prov id e more lo an ab le funds. By such a c tio n s
banks have tended to work in d i r e c t o p p o sitio n to monetary
p o lic y o b je c tiv e s .
By o f f e r in g a "b ask et" o f s e c u r i t i e s c o n ta in in g a
v a r ie ty o f debt forms o f d iv e r s i f i e d term s and c o n d itio n s ,
th e debt managers have succeeded in com partm entalizing the
fe d e ra l d e b t. Debt ownership can be c a te g o riz e d f i r s t as
to bank and nonbank s e c to r s . This serv e s to d is tin g u is h
th e source o f funds which a re th e r e s u l t o f saving from
th o se which a re th e r e s u l t o f d e p o s it c r e a tio n . Each o f
th e se s e c to rs may be f u r th e r c a te g o riz e d as to government
o r nongovernment in v e s to rs . Such a d iv is io n serv es to
d i f f e r e n t i a t e between two d i s t i n c t areas o f fin a n c in g .
In one the government must compete w ith th e p riv a te economy
fo r fu n d s. In the o th e r area the government has some
a d m in is tra tiv e o p tio n as a p u rc h aser a t th e same time th a t
i t is th e s o le s u p p lie r o f funds.
Of the v a rio u s c la s s e s o f in v e s to r s , th e commercial
b a n k 's p o r tf o lio tends to be th e m irro r image o f the
352
Federal Reserve p o r tf o lio . Federal Reserve p o lic ie s
a f f e c t the content and siz e o f commercial bank p o rtfo lio s .
Commercial banks have been able to use th e i r s ta tu s as
Treasury d e p o sito rie s to reduce t h e i r s u s c e p tib ility to
Federal Reserve monetary p o lic ie s . O rig in a lly , the
Treasury depository system was inaugurated to avoid the
m a l-d is trib u tio n of c a p ita l funds due to the siz e of
fe d eral re c e ip ts and e x p e n d itu re s.
Among the p riv a te nonbank in v esto rs , the g re a te s t
s t a b i l i t y of t o t a l holdings and in te rn a l composition has
been demonstrated by c la sse s w ith the le a s t investment
s k i l l , such as in d iv id u a ls. Investors w ith g re a te r s k i l l
exh ib ited e ith e r a marked i n s t a b i l i t y in t o t a l holdings or
s *
considerable flu c tu a tio n in types of holdings. Individual
in v esto r holdings of government s e c u r itie s are mainly of
the nonm arketable, redeemable type which are commonly
re fe rre d to as savings bonds. Holdings of savings bonds
are in r e a l i t y a secondary cash reserv e since there is no
danger o f d e fa u lt or monetary flu c tu a tio n . However, th ere
is g re a t danger of purchasing power flu c tu a tio n .
P a trio tis m , spurred by aggressive salesm anship, made these
s e c u r itie s the b e st ad v e rtise d and most widely held
investment medium of all time.
As a consequence of World War I I financing, the
m onetization of a larg e segment of the debt is a t the d i s
c re tio n of the debt h o ld er, ra th e r than fed eral monetary
a u th o ritie s . However, the a n tic ip a te d rapid redemption of
redeemable s e c u ritie s by individu al investors did not
m a te ria liz e in the immediate post-World War I I period.
Indeed, the wartime savings bond program appears to have
become a permanent p a rt of our fin a n c ia l system. This
program proved to be an e ffe c tiv e a n ti - i n f l a t i o n tool
during World War I I . However, at no time has any attempt
been made to use the savings bond program consciously as a
f is c a l policy tool to fig h t d e fla tio n as well as in f la tio n
during peacetime.
Insurance companies, as a c la ss of in v e sto r, appear
to use th e ir government s e c u r itie s p o rtfo lio s as a regu
la to r to balance excesses or d e fic ie n c ie s in the supply of
higher y ield in g p riv a te s e c u r itie s . The dearth of p riv a te
investment demand during the depression and World War II
re su lte d in a build-up of fe d eral se c u rity holdings. The
post-World War I I p riv a te investment demand re su lte d in
the rapid decline of the amount of federal o b lig atio n s held
'354
in insurance company p o rtfo lio s . This d eclin e was spurred
by fed eral debt management p o lic ie s before 1951 of issu ing
short-term s e c u r itie s and o f m aintaining an i n t e r e s t r a te
s tru c tu re on bonds which was not com petitive with long-term
p riv a te o b lig a tio n s .
C orporations, as a c la ss of in v e s to r, tend to
u t i l i z e t h e i r government s e c u r itie s holdings almost
exclusively as a secondary cash reserv e. Most corporate
investment in government s e c u r itie s was merely temporary.
The investment of these temporary accumulations in govern
ment o b lig a tio n s today is encouraged by the s iz e o f the
v ery -sh o rt-term s e c u rity market and by the use of re p u r
chase agreements. S tate and lo c a l governments also tend
to use fe d e ra l debt to sto re tax re c e ip t accum ulations,
temporary co n stru c tio n p ro je c t funds, and pension funds.
In the government nonbank s e c t o r , the Government
Trust Funds have exh ibited a marked increase in th e ir
holdings of fe d eral debt. In f a c t , w ithout the existence
of the fe d eral debt i t is doubtful whether enough s u ita b le
investments a t the approved r a te o f in t e r e s t could be
found to accommodate the growing t r u s t funds. That por
tio n of government i n t e r e s t payment which has not been
355
derived from a c tiv e debt merely re p resen ts a form of
in f la tio n . Such in f la tio n n u l l i f i e s the r e a l meaning of
the insurance aspects o f Government T rust Fund p ro v isio n s.
A lso , the placing o f debt s e c u r itie s in Government Trust
Funds in no way reduces the n e c e ssity of the government
to tax in order to elim inate the o b lig a tio n . Unlike the
old r e n t i e r c l a s s , the pensioner today does not discount
h is accumulation of a sse ts to compensate for the p o ssib le
inroads of tax atio n .
M aturity P a tte rn of Federal Debt
The m aturity p a tte rn of the debt r e f l e c t s the
problems of a tta in in g a d e s ira b le debt ownership d i s t r i b u
tio n . E ffo rts to a t t a i n the o b je c tiv e of reducing the
sh o rt-term m arketable debt s e c to r have been conspicuously
unsuccessful. Today the sh o rt-term debt is la rg e r than
i t was a t the end of World, War I I . Also, the average
m aturity of the debt has exh ib ited a marked tendency to
dim inish. Some debt m aturity extension has re s u lte d from
the inauguration of a m u ltip le -o ffe rin g refunding program.
The average m aturity lengthening th a t has occurred took
place p rim arily in re cessio n ary or early recovery phases
of the business cycle. Such timing u su a lly is considered
356
to have a detrim ental e f fe c t on cou n tercy clical monetary
policy.
A r e a l problem is the in fla tio n a ry p o te n tia l of the
short-term debt. The usefulness of a short-term debt of
the present large siz e is highly questionable. The r o l l
over of Treasury B ills alone amounts to $2 b i l l i o n weekly.
Furthermore, short-term debt no longer represents tempo
rary d e f i c i t s fo r which funds are forthcoming in the near
fu tu re. Today the automatic ro llo v e r procedures make
Treasury B ills v i r t u a l l y equivalent to permanent debt as
fa r as the government is concerned. The siz e of the s h o rt
term market provides an exceptional opportunity to turn
cash into an income-earning a sse t. The use of bank d ra fts
and repurchase agreements in d icates th a t v elo c ity of money
has increased to take advantage of th is opportunity.
Interm ediate-term debt is being expanded to accom
p lis h average m aturity lengthening. Less competition with
p riv a te investment needs occurs in th is area. Financing
in th is area permits debt-management policy to operate in
a manner which re in fo rces ra th e r than negates monetary
policy.
357
H is to r ic a lly , the United S tates has successfu lly
used bonds th a t had no s p e c ific m aturity date and were
payable a t the pleasure of the government. These "perpet-
u i t ie s " were issued in te rm itte n tly during the 1870's and
1880's and were much in demand. At present the Treasury
has not even used the c a lla b le featu re in i t s recent
financing operations. In view of the present high lev el
of i n te r e s t ra te s and the estim ated low a d d itio n a l cost
of the c a lla b le provisions in bonds, i t is d i f f i c u l t to
understand the T reasury's reluctance to use the c a lla b le
featu re. Such a c a lla b le feature would be valuable in the
event th at in te r e s t ra te s dropped.
All long-term financing tends to become meaningless
as long as the government supports the bond market a t par.
L i t t l e long-term financing was conducted u n t i l a f t e r the
Treasury-Federal Reserve Accord. The renewed issuing of
long-term issues was climaxed by a 3 per c e n t, fo rty -y ear
bond in 1955. Despite these is s u e s , the long-term secto r
has experienced u n relen ting a t t r i t i o n . Advance refunding
and regularized long-term o ffe rin g s are now being used to
encourage long-term investors to m aintain and expand th e ir
holdings. Some serious competition with the long-term
358
d ir e c t fe d e ra l debt s e c to r has developed from the govern
ment guaranteed debt. This is p a r ti c u l a r ly tru e o f Federal
Housing A uthority and Veterans A dm inistration guaranteed
mortgages which pay higher i n t e r e s t r a te s .
I n te r e s t Rate P a tte rn of Federal Debt
The t r a d i t i o n a l concept is th a t the Treasury
competes in a fre e market fo r funds w ithout preference.
Competition from o th er s e c u r itie s r e s u lte d in a decrease
in the fre e market flow o f funds to the fe d e ra l government.
I t became necessary e ith e r to make government s e c u r itie s
more a t t r a c t i v e by i n t e r e s t r a te changes o r to r e s o r t to
market support tech n iq u es.
The ex p ectatio n al theory o f i n t e r e s t ra te s empha
siz e s the u n s ta b iliz in g e f f e c t on the market o f r a te
changes. Also, the emphasis upon i n t e r e s t r a te changes
tends to underemphasize the e f f e c t o f Treasury and Federal
Reserve actio n s upon the s e c u r itie s market due to the siz e
of the fe d e ra l debt. Outside of wartime and immediate
postwar periods , the Treasury and the Federal Reserve have
g en e rally refused to accept the government's n a tu ra l ro le
of market lead e rsh ip . The r e s u l t has been a market marred
by sp e c u la tiv e excesses and extremely wide sh o rt-term
359
i n t e r e s t - r a t e flu c tu a tio n s . These re s u lte d from the
attem pts o f in v esto rs to a n tic ip a te Treasury and Federal
Reserve policy.
I t is admitted th a t the T reasury, backed by the
Federal Reserve, has the power to r a is e or lower the market
r a te o f i n t e r e s t . The extent of the period of e ffe c tiv e
market co n tro l is in d isp u te. The major o b jectio n to
government market supports is the r e s u lta n t in fla tio n a ry
p o te n tia l. At the time of the removal of government
supports in 1951, tig h t money and high i n t e r e s t ra te s were
recommended as the cure for in f la tio n . A fter the Accord,
r e s u lts were d isappointing. I n f la tio n p e rs is te d d e sp ite
a fle x ib le i n t e r e s t r a te policy heav ily weighted toward
r a te of i n t e r e s t in cre ases. As r is in g long-term in te r e s t
r a te s approached the lo n g -estab lish ed leg al in t e r e s t
r a te c e ilin g , Congress c o n s is te n tly refused to auth o rize
any change or removal of lim ita tio n s . The r e s u l t has been
c o s tly i n t e r e s t ra te c e ilin g avoidance t a c t i c s exemplified
by re lia n c e upon high i n t e r e s t , short-term fin an cin g , and
advance refunding o p eratio n s. In view of the experience
w ith in fla tio n a ry p ressu res since the Accord, and the
d e s ire to avoid the economic problems re s u ltin g from
government market supports , the proposal to in s u la te
government debt from the fre e s e c u rity market m erits
in v e s tig a tio n . Such in s u la tio n could prove to be an aid
toward the e f fe c tiv e implementation of monetary and f i s c a l
p olicy. A sep aratio n of the e ffe c ts of monetary policy
actio n s upon fed eral and p riv a te c r e d it becomes in c re a s
ingly im portant as monetary p olicy is applied more
vigorously to promote economic s t a b i l i t y . Government debt
should be in su lated because ac tio n s meant to a f f e c t
m arginal p riv a te investment funds are r e f le c te d in the
fe d eral debt and may be d etrim en tal to and derogatory of
government c r e d it. Also, ac tio n s meant to f a c i l i t a t e
fed eral debt management may r e s u l t in the fa u lty a llo c a tio n
of resources in the p riv a te s e c to r of the economy.
Debt Management R elationship to F isc a l
and Monetary Policy
The Treasury has been delegated the a u th o rity to
implement the f i s c a l p olicy of the n atio n . The only
r e s t r i c t i o n s are on the t o t a l amount of debt and long-term
i n t e r e s t r a te s . The Federal Reserve has been delegated
a u th o rity to i n i t i a t e and implement monetary policy with
no r e s t r i c ti o n s o th er than Congressional review.
361
F is c a l p o lic y is hampered by lo o sely d efin in g debt.
This r e s u l t s in f a il u r e to recognize the investm ent q u a lity
of some o f the debt t o t a l . Furtherm ore, the p re se n t p ie c e
meal a p p ro p ria tio n process denies Congress an o p p o rtu n ity
o f co n sid erin g t o t a l expenditure in view of t o t a l r e c e ip ts .
Several remedies are worthy of f u r th e r in v e s tig a tio n .
Where s u i t a b l e , earmarked tax re c e ip ts a re being used and
should be expanded, though care should be used to avoid
undue f i s c a l r i g i d i t y . A gen eral a p p ro p ria tio n procedure
would tend to promote f i s c a l r e s p o n s i b i l i ty . F in a lly ,
some a d m in is tra tiv e d is c r e tio n in varying tax r a te s may be
the answer to the p re se n t C ongressional re lu c ta n c e to
adopt a more exten siv e program o f ta x a tio n .
Monetary p o licy today is faced w ith a fundamental
c o n tra d ic tio n o f o b je c tiv e s . F a ilu re to provide s u f f i c ie n t
money i n h i b it s economic growth and c o n trib u te s to r e c e s
sio n . However, c re a tio n o f such money adv ersely a f f e c ts
the fu n ctio n o f money as a s to re o f value. To a g re a t
e x t e n t , fe d e ra l debt has served to ease the shortage of
money. This is exem plified by th e monetized C iv il War
greenback, th e posted Treasury B ill r a t e o f World War I I ,
the excessive volume of v e ry -s h o rt-te rm fe d e ra l d e b t, the
debt purchased by commercial bank d ep o sit c r e a tio n , and
362
f i n a l l y , the ex istence o f savings bonds redeemable a t the
owner's option. E ffe c tiv e monetary po licy re q u ire s th a t
the Federal Reserve be re sp o n sib le for the re g u la tio n of
the m onetization of fe d e ra l o b lig a tio n s . To th is end the
Federal Reserve asked for the enactment o f a sp e c ia l
secondary reserv e requirem ent or the expansion of e x is tin g
reserv e requirem ents. N either proposal was acceptable to
Congress. The f in a l r e s u l t was the T reasury-Federal
Reserve Accord o f March 1951. This Accord re -a c tiv a te d
open market operations as a monetary policy c o n tro l device.
Monetary a u th o r itie s thus s u c c e ssfu lly demonstrated th e i r
independence but not t h e i r e ffe c tiv e n e s s o r t h e i r respon
s i b i l i t y . That p o rtio n of the fe d e ra l debt which is
comprised of pseudo money forms has not been su c c e ssfu lly
co n tro lle d to date.
The circum stances leading to the Accord emphasized
the fa c t th a t firm d ire c tio n o f the fe d e ra l debt management
program was lacking. I t would be advisable th a t the
a u th o ritie s who are d i r e c tl y accountable to the e le c to r a te
take renewed i n t e r e s t and assume g re a te r co n tro l or review
of e s s e n tia l debt management p o lic ie s as w ell as f i s c a l
and monetary p o lic ie s .
363
I I . CONCLUSIONS AND RECOMMENDATIONS
The major problems o f debt management may be summed
up under th ree c a te g o rie s. F i r s t , the l i q u id ity p o te n tia l
of the fe d e ra l debt is a force which can negate co u n ter
c y c lic a l monetary p o licy . Second, the fe d e ra l ad m in istra
tio n of refunding and issu in g o peratio n s n e c e s s ita te d by
the fe d e ra l debt in te r f e r e s w ith market a llo c a tio n of
c a p ita l resources in the p riv a te se c to r of the economy.
T hird, debt issue has shown a tendency to become an
accepted p a rt of government financing w ith a r e s u lta n t
de-emphasis upon ta x a tio n .
In proposing recommendations to solve these problems
the emphasis is upon those measures already perm issible
under p resen t s ta tu te s and re q u irin g only a d m in istra tiv e
d is c re tio n . Reference is made to d e s ira b le s ta tu to ry
changes , but the program envisioned can be c a rrie d forward
e f f e c tiv e ly without such Congressional ac tio n .
C o n tro llin g the L iq u id ity of the Debt
The key to co n tro l o f liq u id i ty of debt o b lig a tio n s
lie s in the use o f p e r p e tu itie s and c a lla b le bonds redeem
able a t the option of the government. H is to r ic a lly , the
364
United States has successfully used such perpetuities.
This is the most d e sira b le form of s e c u rity from the view
point of the debt manager. I f n ecessary, the use of th is
type o f s e c u rity can be approached g radually by using
c a lla b le bonds and expanding the c a lla b le fe a tu re .
The i n t e r e s t r a te c e ilin g does not permit a r a te of
in t e r e s t high enough to make such s e c u r itie s a t t r a c t i v e to
in v esto rs under present market co n d itio n s. However, i t is
not necessary to r a is e the c e ilin g . Consols redeemable a t
the government's option can be sold to the Federal Reserve
System d ir e c tl y under p resent s ta tu to ry provisions a t what
ever r a te of in t e r e s t deemed d e s ira b le by the government.
The Federal Reserve can then market these s e c u r itie s to
? ,Jt * j
e f fe c t a y ie ld "in harmony w ith monetary p olicy. Once in
the hands of in v esto rs such p e r p e tu itie s become p e rfe c t
monetary policy to o ls as w ell as debt management to o ls.
Their l i q u id ity is completely c o n tro lle d as fa r as the
government is involved, fo r they need not be redeemed
unless i t s u its the monetary a u th o r itie s . For the in d iv id
ual in v e s to r, these s e c u r itie s s t i l l r e ta in a degree of
li q u id ity in the microeconomic sense, fo r they can be
traded. Such tra d e s , however, in no way a f f e c t the macro-
economic money t o t a l s . Since redemption would be a t the
365
d is c re tio n of the government, such consols would success
fu lly d if f e r e n t i a t e between tru e investment funds and quasi
money forms.
Assuming th a t the present use of bank d ra fts and
repurchase agreements in d icates an increased v elo c ity
which r e s u lts from the existence of an u n ju s tif ia b le amount
of very-short-term d ebt, then a portion of such debt could
be monetized. The automatic r o llin g over of Treasury B ills
is already an accepted procedure involving d ire c t refunding
between the Federal Reserve and the Treasury. That portion
of the short-term debt held by the Federal Reserve could
be replaced by n o n in terest-b earin g debt o b lig a tio n s.
Reducing the size of the very-sh ort-term se c u rity market
would discourage the use of devices th a t r e s u lt in
increased v elo c ity . No in te r e s t repudiation would be
en ta ile d since the in te r e s t re c e ip ts of the Federal Reserve
are returned to the federal government a t the present time.
That portion of the v ery-short-term debt not mon
etized should be d ir e c tly under the con trol of the Federal
Reserve in order to strengthen monetary c o n tro l. This
could be accomplished by making the Federal Reserve the
only legal re c ip ie n t of federal o b lig atio n s with a m aturity
of ninety days or le ss. This provision could be included
366
in a l l new issues and re q u ires no Congressional a c tio n .
Such a debt instrum ent, then, would be m arketable as at
p r e s e n t , but in i t s f in a l n in ety days of m atu rity could
not be marketed except a t the d is c re tio n of the Federal
Reserve. Such a marketing p rov ision fo r v ery -sh o rt-term
debt would give monetary a u th o r itie s the necessary co n tro l
over a l l money e q u iv a le n ts .
The program envisioned to solve the problem o f the
liq u id i t y p o te n tia l of the d e b t, th e re fo re , is th re e fo ld .
F i r s t , issue p e r p e tu itie s redeemable a t the option o f the
fe d e ra l government to the general in v esto r i f the i n t e r e s t
r a te can be made a t t r a c t i v e enough under p resen t s ta tu to ry
lim ita tio n s . Should temporary in t e r e s t r a te le v e ls negate
th is procedure, then such p e r p e tu itie s could be issued to
the Federal Reserve and discounted so th a t the y ie ld to
in v e sto rs is a t t r a c t i v e under present market con dition s.
Second, provide for the m onetization of a p o rtio n of the
v e ry -sh o rt-te rm debt held by the Federal Reserve. This
should be timed so th a t v e lo c ity of money can grad ually
re tu rn to normal as the supply of v ery -sh o rt-term debt
d isappears. T hird, to assure monetary a u th o r itie s con
tinued c o n tro l of the v ery -sh o rt-term m arket, a l l new
issu es should contain a provision making the Federal
367
Reserve the only le g al re c ip ie n t of debt o b lig a tio n s
during t h e i r l a s t ninety days o f m atu rity . This would
e f f e c tiv e ly sep arate funds a v a ila b le fo r investment from
temporary short-term cash accum ulations.
Aiding Free Market A llocation
of Resources
These provisions fo r c o n tro llin g the l iq u id ity
p o te n tia l o f the debt w ill also serve to permit the p riv a te
se c to r of the c a p ita l market to function more e f f i c i e n t ly .
Market resource a llo c a tio n would be freed from the d i s
ru ptin g e ffe c ts o f government refunding and issuing
o perations. In su la tin g government debt from the p riv a te
s e c to r w ill avoid both the need for market supports and
also m eaningless, e r r a t i c , and harmful r a te of i n t e r e s t
flu c tu a tio n s occasioned by the m arket's attem pt to a n t i c i
pate the actio n s of i t s la r g e s t component, the government.
Monetary policy actions designed to a f f e c t marginal
c a p ita l funds w ill have no adverse repercussion s in gov
ernment financing.
In an e f f o r t to permit market a llo c a tio n o f resources
to operate most e f f e c tiv e ly , a l l in d ire c t su b sid iz a tio n
through debt issue should be abandoned. This would involve
368
the discontinuance o f the i n e f f ic ie n t tax exemption on
s t a t e and lo c a l bonds. A d ir e c t g ra n t- in - a id to the needy
s t a t e and lo cal governments from the fe d e ra l government
should be s u b s titu te d by Congress.
Also, the in d ire c t subsidy to commercial banks
re s u ltin g from the Federal Reserve po licy of lowering
reserve requirem ents to e f fe c t monetary ease should be
abandoned. Other methods of achieving monetary ease should
be i n s t i t u t e d , p re fe ra b ly open market o p eratio n s. In th is
manner the commercial bank p o rtfo lio s of government bonds
can be slowly absorbed by the Federal Reserve. This is
not equivalent to debt re p u d ia tio n . These sums i n i t i a l l y
re s u lte d from d ep o sit c r e a tio n , a method of o rig in a tin g
money by the commercial banks , a t the request of the
government.
Should the fed eral government d e s ire to speed the
retirem en t of the commercial bank fe d eral debt p o rtfo lio s ,
a policy o f in creasin g reserv e requirem ents to p resent
leg a l maximums could be inaugurated. Such re se rv e re q u ir e
ment changes would not c re a te undue hardship. Treasury
Depository Accounts in commercial banks could be con
scio u sly used to c o rre c t any in e q u itie s caused by the
d is lo c a tio n of funds w ithin the banking system. To the
369
ex ten t th a t Congress f e l t th a t the banking system should
be su b sid ized , th is could be done d ir e c tly .
In summary, the fre e market a llo c a tio n of c a p ita l
funds can b e st be fu rth ered by the same measures which
provide for co n tro l o f the li q u id i t y of the fe d e ra l debt.
This occurs because government debt is in su la te d from the
p riv a te economy. The d isru p tin g influence of refunding
and issu in g operations are avoided. In a d d itio n , adm inis
t r a t i v e d is c re tio n can e f f e c tiv e ly stop a l l forms of
in d ire c t bank su b sid iz a tio n . Removal of s t a t e and lo cal
government bond tax exemption may also be p o ssib le w ithout
Congressional a c tio n , but such ad m in istra tiv e step s would
have to be te ste d by the c o u rts. Any su b sid iz a tio n of
these groups which is desired should be performed d ir e c tly
w ith Congressional approval.
F isc a l R esp o n sib ility
The preceding recommendations are designed to make
debt management more e f fe c tiv e and an aid in strengthening
monetary policy a c tio n s. G reater e ffe c tiv e n e ss in managing
the debt should n o t, however, be used as an excuse for
u n n ecessarily p erp etu atin g or extending the fe d e ra l debt.
On the c o n tra ry , f i s c a l r e s p o n s ib ility should r e s u l t in
370
easing the debt management problem. To th is end, sev eral
recommendations o f o th er authors prev io usly discussed to
promote f i s c a l re s p o n s ib ility are enumerated here. Their
adoption would be an aid to debt management po licy .
The prov ision fo r earmarking tax re c e ip ts wherever
p o ssib le is b e n e f ic ia l. This helps dem onstrate the co sts
of s p e c ific programs and gives to the in d iv id u a l more of
the inform ation necessary fo r him to weigh s o c ia l costs
ag a in st s o c ia l b e n e fits . He can then decide whether he
wishes governmental programs expanded, c o n tin u e d , or
scaled down. The d etrim en tal e f fe c ts o f f i s c a l r i g i d i t y
re s u ltin g from such earmarking must, however, be balanced
ag a in st the b e n e fits to be derived from such a program.
D istinguishing between fe d e ra l consumption expenditures
and fe d e ra l investment expenditures would aid in a more
r e a l i s t i c a p p ra isa l of t o t a l debt fig u re s . The c o n s o li
dated general ap p ro p riatio n proposal would be b e n e fic ia l
in forcing Congress e ith e r to economize or acknowledge a
policy of d e f i c i t spending. To be e f f e c ti v e , such a
general ap p ro p riatio n process would include funds a llo c a te d
to government a g e n c ie s, thus removing the impetus to
"back door" spending.
371
In the fin a l a n a ly s is , the extent of the debt
management problem is dependent upon the degree of f is c a l
r e s p o n s ib ility which the v o ter demands from h is elected
re p re s e n ta tiv e s . The problem of c o n tro llin g the economy
has become to a g re a t extent a problem of public
s e l f - c o n t r o l .
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B. PERIODICALS
Ackley, Gardner. "The Wealth-Saving R elatio n sh ip ," Journal
of P o l it i c a l Economy, XIV (April 1951), 154.
Aschheim, Joseph. "Supplementary S ecurity Reserve
Requirements Reconsidered," Journal of F inance, XIII
(December 1958), 473-487.
C ulbertson, J. M . "A P o sitiv e Debt Management Program,"
Review of Economics and S t a t i s t i c s , XLI (May 1959) ,
89.
Hansen, Alvin. "Toward F ull Use o f Our Resources,"
Fortune, XXVI, No. 5 (November 1942), 170.
Kiramel, Lewis H. "Is the Federal Old-Age and Survivors
Insurance Trust Fund Valid?" National Tax J o u rn a l,
V II, No. 4 (December 1954), 327-341.
L e m e r , Abba P. "Functional Finance and the Federal
Debt," Social R esearch, X, No. 1 (February 1943), 50.
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N ation's B u sin ess, June 1958, p. 83.
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on the Banking System," American Economic Review,
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C. UNPUBLISHED MATERIALS
Carson, Deane Chalmers. "F ederal Reserve Support of
Treasury Refunding O perations." Unpublished Ph.D.
d i s s e r t a t i o n , Clark U n iv e rsity , 1956.
Gaines, T ilfo rd C. "Techniques o f Treasury Debt Manage
ment." Unpublished Ph.D. d i s s e r t a t i o n , Columbia
U n iv ersity , 1960.
Hanc, George. "United S tates Savings Bonds and Federal
Debt Management." Unpublished Ph.D. d i s s e r t a t i o n ,
Columbia U n iv e rsity , 1958.
M e ttle r, John C harles. "Proposals for Improving Congres
sio n al C onsideration o f the P re s id e n t's Budget."
Unpublished Ph.D. d i s s e r t a t i o n , Clark U n iv e rsity ,
1959, in D is s e rta tio n A b stracts . XX, No. 7 (January
1960) , 2633-2634.
Morgner, A urelius. "The N ational Debt and Economic
S t a b i l i t y ." Unpublished Ph.D. d i s s e r t a t i o n , U niversity
of Minnesota, 1956.
Mui, Kan-Chi. "The E ffects upon Commercial Banks and on
Banking Policy o f D e fic it Financing in World War I ."
Unpublished Ph.D. d i s s e r t a t i o n , P rinceton U n iv e rsity ,
1955.
378
Parks, Robert H. " P o rtfo lio Operations of Commercial Banks
in the United S tates Treasury S e c u ritie s Markets."
Unpublished Ph.D. d is s e r t a t i o n , U niversity of
Pennsylvania, 1958, in D is se rta tio n A bstracts , XVIII,
No. 6 (1958), 2020.
P ig o tt I I I , William. "Monetary and Debt Management
P o lic ie s , 1953-1955." Unpublished Ph.D. d i s s e r ta tio n ,
U niversity of Washington, 1957.
Sun, Nien Min. "An Economic Analysis of the Burdens of
the Public Debt." Unpublished Ph.D. d is s e r ta tio n ,
The U niversity o f Southern C a lifo rn ia , 1950.
Walker, Charls E. "Federal Reserve Policy and the
Government Security Market." Unpublished Ph.D.
d i s s e r ta tio n , U niversity o f Pennsylvania, 1955.
D. GOVERNM ENT PUBLICATIONS
Board of Governors of the Federal Reserve System. Annual
R eport. Washington: Government P rin tin g O ffice.
For the years 1941, 1945, and 1953.
Federal Reserve B u lle tin . Washington: Government P rin tin g
O ffic e, November 1945; A pril 1953; February 1961;
March 1961.
Treasury B u lle tin . Washington: Government P rin tin g
O ffice, October 1959.
U.S. T reasury. Annual Report of the Secretary of the
T reasury. Washington: Government P rin tin g O ffice.
For the years 1917, 1929, 1943, 1945, 1946, 1947,
1949, 1950, 1951, 1953, 1954, 1955, 1956, 1957, 1958,
1959, and 1960.
379
E. CONGRESSIONAL PUBLICATIONS
Congressional Record. 83rd Cong., 2d S e ss., August 13,
1954, p. 14376.
'_____ . 84th Cong., 1st S e ss., May 4, 1955, pp. 5693,
5694.
. 85th Cong., 1st S e ss., A pril 4, 1957, p. 5074.
. 86th Cong., 1st S ess., June 8, 1959, p. 10163.
_______ . 87th Cong., 1st S e s s., March 16, 1961, p. 3986;
March 20, 1961, p. 3997; March 28, 1961, pp. 4725-4726;
April 26, 1961, pp. 6275, 6298.
U.S. Congress. Jo in t Economic Committee. Debt Management
in the United Sta te s , by Warren L. Smith. 86th Cong.,
2d S e s s., Study Paper No. 19. Washington: Government
P rin tin g O ffice, 1960.
_______ . House. Committee on Banking and Currency.
H earings. Increase Borrowing Power of Commodity C redit
Corporation to 10 B i ll i o n . 83d Cong., 2d S e s s ., 1954.
. House. Committee on Government Operations.
Federal Real and Personal Property Inventory Report as
of 6/30/58. Committee P rin t. 85th Cong., 2d S e ss.,
1958.
. House. Committee on Ways and Means. H earings,
Public Deb t Act of 1941. 77th Cong., 1st S e s s ., 1941.
. House. Committee on Ways and Means. Hearings ,
Increase the Public Debt L im it. 85th Cong. , 2d Sess. ,
1958.
. House. Committee on Ways and Means. Hearings ,
Public Debt C eiling and In te r e s t Rate C eiling on Bonds.
86th Cong., 1st S e ss ., 1959.
380
U.S. Congress. House. Freedom Revenue A ct. H.R. 6720.
87th Cong., 1st S e s s ., 1961.
________. Senate. Committee on Finance. H earings,
In v e stig a tio n of the F inancial Condition of the United
S ta te s . 85th Cong., 1st S e s s ., 1957.
________. Senate. Committee on Finance. H earings, Debt
C eiling In c re a se . 85th Cong., 2d Sess. , 1958.
________. Senate. Subcommittee on Monetary, C re d it, and
F isc a l P o lic ie s of the J o in t Committee on the Economic
R eport. Hearings, Monetary, C red it, and F iscal
P o l ic ie s . 81st Cong., 1st S e s s., 1950.
________. Senate. Subcommittee on S ta b iliz a tio n .
Hearings , United S tates Monetary Policy Recent Thinking
and Experience. 84th Cong. , 2d Sess. , 1956.
F. LA W S AND STATUTES
1 S ta t. (1790) , 186.
60 S t a t . (1946) , 23.
12 U.S.C. 246.
31 U.S.C. 868.
G. NEW SPAPERS
Los Angeles Times, March 14, 1962.
New York Times, February 2 and 3, 1951, March 15, 1959.
Wall S tre e t J o u rn a l, February 9, 1961; June 5, 1961,
June 14, 1961; June 16, 1961; June 22, 1961; July 6,
1961, August 1, 1961; August 28, 1961; August 29,
1961; September 27, 1961.
381
H. OTHER SOURCES
Address before the Academy o f P o l i t i c a l Science, A pril 1,
1948, by U ndersecretary of the Treasury W iggins, c ite d
in Annual Report of the S ecretary of the T reasu ry ,
1948.
Address before the American Finance A ssociation and the
American Economic A ssociation a t Washington, D .C .,
December 29, 1959, by S ecretary of the Treasury
Anderson, c ite d in Annual Report of the S ecretary of
the T re asu ry , 1960.
Address before the Investment Banking A ssociation a t
Washington, D.C. , October 19, 1942, by Undersecretary
o f the Treasury B e l l , c ite d in Annual Report of the
S ecretary o f the Treasury, 1943.
The Bureau o f N ational A f f a ir s , Inc. Report to the
Business E xecutive. Washington, D.C.: The Bureau,
May 25, 1961.
H e lle r, W alter H. Why a Federal Debt L im it? Proceedings
o f the F i f t y - f i r s t Annual Conference on Taxation o f
the N ational Tax A ssociation. H arrisburg,
Pennsylvania: N ational Tax A ssociatio n, 1959.
Monthly L e tte r of Business and Economic C onditions, by
Chairman William M artin, F i r s t N ational C ity Bank,
New York, December 1958.

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Creator Shocket, Sol (author)

Core Title An Economic Analysis Of The Problems Of Federal Debt Management

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Finance,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Anderson, William H. (committee chair), Cannon, Wendell E. (committee member), Morgner, Aurelius (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c18-271226

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