As you may noticed, the U.S. needs to borrow vast amounts of money. Which raises an interesting question: how should we finance that debt?
The Government Accountability Office (GAO) has taken note of this question and has begun a series of reports on debt management. In its first report, released today, the GAO provides a ringing endorsement of inflation-indexed bonds, aka TIPS (Treasury Inflation Protected Securities). The title of the report pretty much summarizes its conclusions: “Treasury Inflation Protected Securities Should Play a Heightened Role in Addressing Debt Management Challenges.”
The report provides a nice history of the TIPS program, which dates back to 1997, and the challenges it has faced. The number one challenge? Liquidity. Regular Treasury securities are the most liquid in the world and, as a result, investors are willing to pay a premium to own them. U.S. taxpayers thus benefit from the low interest rates our government has to pay on its debt. Unfortunately, TIPS are much less liquid and thus don’t enjoy the same benefit. GAO thus suggests that actions to improve liquidity (e.g., more frequent auctions) could help bring down interest costs.
GAO also recommends that longer-dated TIPS be issued as the U.S. moves to lengthen the maturity of its debt. As noted in the following chart, the current maturity structure of U.S. debt is heavily skewed to short maturities:
More than $3 trillion of U.S. debt will come due by the end of 2010 alone.
The reliance on short-term debt makes sense when near-term interest rates are incredibly low, as they have been lately. But interest rates will rise again one day (perhaps sooner than many anticipate according to a recent op-ed by Fed Governor Kevin Warsh), and the government should therefore be evaluating how it will lengthen maturities. GAO believes that TIPS should be part of that.