If President-elect Donald Trump’s economic growth plan — slashing business and personal marginal tax rates and rolling back costly business regulations — is achieved next year, the economy could break out with 4 to 5 percent growth. And that means much higher interest rates.
This rate rise will be growth-induced, a good thing. Higher real capital returns will drive up real interest rates. And inflation will likely remain minimal, around 2 percent, with more money chasing even more goods alongside a reliably stable dollar-exchange rate.
We’re already seeing some of this with the big post-election Trump stock rally occurring alongside a largely real-interest-rate increase in bonds.
However, looking ahead, 4 percent real growth plus 2 percent inflation could imply 6 percent bond yields in the coming years. That’s a big jump from the 2 percent average of most of the past ten years.
And what that says is the time to act is now.
The average duration of marketable Treasury bonds held by the public has been five years for quite some time. Almost incredibly, Treasury Department debt managers have not substantially lengthened the duration of bonds to take advantage of generationally low interest rates. Hard to figure.
Treasuries held in public hands have moved up from 32 percent of GDP back in 2008 to 74 percent today. Interest expense for fiscal 2016 is nearly $250 billion. So if Treasury debt managers had significantly lengthened their bond maturities, they would have saved taxpayers a bundle.
Now, with new economic-growth policies poised to drive up average Treasury rates to perhaps 6 percent, the Treasury folks better get moving fast to capture today’s historically low yields. Up to now they’ve been sleeping at the switch.
The key point? Start issuing much longer bond maturities. Much longer. If possible, the U.S. should experiment with 50-year debt issuance, and maybe go out as long as 100 years.
And this better happen fast.
Other countries have been smarter than us. Ireland and Belgium issued 100-year debt. Austria issued 70-year debt. Italy, France, and Spain issued 50-year debt. And Japan pushed out a 40-year maturity with rumors that it’s considering 50 years.
And Mexico, incredibly enough, has done three 100-year issues since 2010. The sizes were small, and the bonds were sold in foreign currencies. But it can be done.
Britain is probably the best benchmark. (The Brits are a lot like us, speaking even the same language!). The U.K. Treasury has issued 40- to 50-year bonds seven times. The latest auction was October 2015, with the issuance of 50-year debt with a coupon of 2.5 percent. (Thanks to economist Conrad Dequadros for this great debt info.)
Some more numbers. The CBO estimates that interest costs over the next ten years total $4.8 trillion, with the debt rising from the current $14 trillion to $23.1 trillion in 2026. They estimate the 10-year Treasury rate will average 3.3 percent. And the average rate on all debt increases to 4 percent.
Now, with some very rough back-of-the-envelope calculations, under President-elect Trump’s growth program, suppose 10-year Treasury rates rise to average 5 percent over the next ten years, rather than the CBO’s 3.3 percent guess? The average interest rate for all debt would increase to 4 percent over that period rather than CBO’s 2.6 percent. The total interest-rate expense would be around $7 trillion rather than the CBOs $5 trillion.
However, if the U.S. issued 50-year debt, with the same rate as Britain’s 2.5 percent, by front-loading some longer-term issuance to hold the average interest rate to 3.5 percent, there would be a $1 trillion savings on budget-interest expense over the ten-year horizon.
That’s not chump change.
Skeptics will ask who exactly will buy 50-year U.S. paper. It’s a good question. But remember, insurance companies and pension funds need long-dated liabilities to match long-duration assets. And foreign institutions might also be interested in ultra-long U.S. Treasuries, provided the U.S. dollar is reliably stable.
This is entirely new ground for U.S. debt management. But since a lot of foreign countries have successfully sold 50-year paper, we know it can be done.
And for the U.S. it must be done.
And if we sell out a bunch of 50-year offerings, why not try 100-year paper? A century bond. The budget savings would be incalculable. And under new policies, if the U.S. returns to its long-term annual growth trend of 3.5 percent, which prevailed in the prior century, America’s debt-to-GDP ratio could plunge to 30 or 40 percent instead of skyrocketing to 150 percent or more.
Stronger growth and much longer bond-maturity issuance will snatch fiscal victory from the jaws of defeat.
– Larry Kudlow is CNBC’s senior contributor. His new book is JFK and the Reagan Revolution: A Secret History of American Prosperity, written with Brian Domitrovic.