Thursday, August 30, 2012

The Republican Party Platform, the Gold Standard, and Alan Greenspan

The Republican Party Platform contains a plank concerning a possible return to the gold or other metallic standard (silver?) that probably no one who holds or is likely to hold a responsible policy position on monetary issues in the Administration or at the Federal Reserve, no matter which political party is in power, takes very seriously.

The relevant paragraph of the platform states: "Determined to crush the double-digit inflation that was part of the Carter Administration’s economic legacy, President Reagan, shortly after his inauguration, established a commission to consider the feasibility of a metallic basis for U.S. currency. The commission advised against such a move. Now, three decades later, as we face the task of cleaning up the wreckage of the current Administration’s policies, we propose a similar commission to investigate possible ways to set a fixed value for the dollar."

I remember the Gold Commission of the early 80s.  I was working at the Treasury Department in Domestic Finance and among my responsibilities was analyzing proposed new debt instruments.  It was never in much doubt that the Gold Commission would not recommend reestablishing the gold standard, since its composition guaranteed that result.  Its chief purpose was political -- to placate supply-siders, some of whom were also enamored with gold.

Of interest to me was a private sector consultant who recommended that the Treasury issue notes indexed or backed by gold (I believe the recommended maturity was five years).  He claimed that the Treasury would save money by issuing such notes and that it would be a first step to establishing the gold standard.  He not only made this recommendation to the Gold Commission but also wrote an op-ed article on this subject for the Wall Street Journal.  Treasury staff, including me, did not agree that gold-backed notes would save the Treasury money, nor did we favor restoring the gold standard.  With respect to the saving money argument, among other counterarguments, we could point to the disastrous experience of the French government, which issued gold indexed notes under President Giscard d'Estaing.

The private sector consultant was, of course, Alan Greenspan, whom President Reagan later appointed as the replacement to Paul Volcker as Chairman of the Board of Governors of the Federal Reserve System.  There  is no evidence he ever changed his mind about the gold standard; I remember reading an article quoting him as saying he was probably the only economist at the Fed who held this opinion.  Greenspan was, though, politically savvy and he knew better than to push this idea.  

Perhaps Greenspan was still under the influence of some of the ideas to be found in Ayn Rand's Atlas Shrugged, but it is difficult to find many economists, whatever their political preferences, who support a return to the gold standard.  The Republicans probably included this plank as a supposedly harmless way to placate Ron Paul supporters, but it is not encouraging that one of the two major U.S, political parties is flirting with a return to the monetary arrangements of the 19th and early 20th centuries.

As for Greenspan, his luck ran out.  He was at one time praised as perhaps the best central banker ever; I think even Alan Blinder may have said that at one point.  At this point, it looks like the judgement of history will not be that favorable.

Monday, August 6, 2012

Treasury Floating Rate Notes, Treasury Debt Management, and TBAC

As a former Treasury official, who at times worked on debt management issues including the introduction of new products, I am disappointed with the decision Treasury announced last Wednesday (August 1) to sell floating rate notes ("FRNs"). The new notes will not make their appearance for some time though, since the Treasury said it would take at least a year to get ready. Also, no matter what happens in the Presidential election, there will be a new Treasury Secretary next year, since Tim Geithner has indicated that he will be leaving. Thus, it will be up to the next Secretary to decide whether to proceed with FRNs, though by the time he or she is confirmed, there would likely be both bureaucratic momentum for and market interest in the product.

As I have noted previously, the case for floating rate notes is not convincing. The Treasury argues that this is another way to extend the maturity of the public debt while at the same time providing short-term collateral to investors, such as money market mutual funds, without a continual need to rollover the securities. This is obviously in the interest of investors, who would likely receive a higher yield than available on Treasury bills without the operational hassles of rolling over securities. But why is it in Treasury's interest? The Treasury would be paying more than it does on bills and would not have locked in an interest rate. Moreover, Treasury has no trouble rolling over bills; it does this every week of the year. If the FRNs could be sold at a yield less than Treasury bills as compensation by investors for removing the need to rollover securities, then a case could be made for Treasury issuing them. No one, though, thinks this is likely.

The Treasury has not specified the terms and conditions of the FRNs, including to what short-term rate it would be linked. The Treasury Borrowing Advisory Committee ("TBAC"), a group of individuals with high-level positions at prominent firms active in the Treasury market on both the sell- and buy-side, recommends the GCF (General Collateral Financing) Repo Index, a new index published by the Depository Trust and Clearing Corporation ("DTCC") since November 2010. This index is based on the rates of repo transactions cleared by the Fixed Income Clearing Corporation ("FICC"), a subsidiary of DTCC. The major dealers in Treasury securities are members of FICC. A futures contract on the DTCC GCF Repo Index began trading last month on NYSE Liffe U.S., a fact which TBAC cited in their July 31 report to the Secretary of the Treasury.

In fact, the DTCC GCF Repo Index has been suggested as a substitute for Libor, though there is skepticism about that. The problem that some have pointed out with using the GCF Repo Index is that the rate could reflect significant counterparty risk in the event of a financial crisis. In a financial crisis, Treasury yields usually go down reflecting a "flight to quality," but FRNs might pay more if the GCF repo rate were to increase.

Why is TBAC unanimously advising that Treasury issue FRNs and providing a questionable recommendation as to the rate on which the FRNs should be based? This advisory committee is supposed to give advice to Treasury that is in the public interest, not in the interest of the firms that employ its members. There is a question whether they have done this with respect to FRNs.

One of the justifications for the existence of TBAC is that having individuals from different firms provides a check, since if one individual seemed to be providing self-serving advice, the other members would call that person on it. This may not work though if all the firms have the same interest.

A problem with TBAC is that the members for the most part enjoy being on the committee. Unfortunately, this can create the impression that TBAC's advice may at times be skewed. In order to ensure that the committee, whose existence has been questioned in the past by members of Congress, continues to survive and that the individuals on the committee remain members, there is an incentive to provide the advice that members believe Treasury officials want to hear.

It is of course helpful, indeed necessary, for Treasury to speak to major investors and market makers in its securities. However, given the advice that it has proffered on FRNs, there is a question about the usefulness of having a TBAC. While TBAC members may provide useful insights, either formally or informally, on technical issues, it has not done its reputation any good on the FRN issue. If the TBAC members genuinely believe that FRNs are a good idea and that they should be linked to the GCF repo rate, they should have made a better case. 

Wednesday, August 1, 2012

A Quick Comment on Treasury's Decision to Issue Floating Rate Notes

In its quarterly refunding announcement today, the Treasury announced plans to develop floating rate notes ("FRNs").  In the press conference following the announcement, Treasury Under Secretary Mary Miller indicated that there was demand for high quality short-term collateral and that FRNs would both help satisfy that demand while extending the maturity of the public debt.  The tension in this argument is obvious, as I noted here.

Reuters quotes Stephen Stanley of Pierpont Securities saying in this regard:

"Sell-side participants love it because FRNs represent a new product to trade and one that will be much less liquid and thus may exhibit juicy bid-ask spreads. Buy-side participants love FRNs because they are starving for yield at the short end and FRNs will undoubtedly yield noticeably more than comparable conventional securities.

"Of course, those two reasons, among others, are exactly the reasons that Treasury should never have had any interest in this program…"

Mary Miller did not offer any better arguments for issuing floating rate notes.

Since the Treasury does not plan to issue any FRNs for at least a year and since Secretary Geithner plans to leave whatever the result of the November election, the next Treasury Secretary will have to decide whether to call a halt to a program which by next year will have achieved both some interest among major financial market participants and a degree of bureaucratic momentum within Treasury and perhaps the Federal Reserve.

This decision looks like a favor to Wall Street firms and money market mutual funds at taxpayer expense. Treasury has been criticized for being too close to the Street; this decision will serve to reinforce that view.