WASHINGTON -- Last summer, economist Cynthia Latta was crunching her forecasts for the burgeoning federal budget surplus when her projections reached a landmark simply too mind-boggling to accept: early in the next century, the publicly held federal debt would simply disappear.
In a panic, the principal U.S. economist for Standard & Poors' DRI -- its forecasting division -- did what she expects Congress to do. She threw in some tax cuts, some extra government spending, and to her relief, the debt was back -- that is, until last week, when President Clinton announced that he planned to eliminate it by 2015.
It was a startling announcement, and one that most economists greeted not with hosannas, not with disbelief, but with real concern. As politically popular as it might sound, the elimination of the federal debt would have far-reaching and unexamined consequences for international investors and federal monetary policy, and even for corporate planners and individual investors.
Staples of the American economy -- and of many households -- like savings bonds and the Treasury bonds that provide havens for middle-class investors would simply disappear. Tools the Federal Reserve uses to stabilize the economy would be gone, too. And the government would have to figure out what to do with the extra money.
"I don't think it's a particularly good idea," Latta said of the elimination of the debt, adding that it was time for politicians and economists to take the consequences seriously.
Alan Blinder, a Princeton University economist and former Clinton adviser, agreed: "These 15-year projections are going to be wildly inaccurate, but some people are reading the wrong message and saying this will never happen, that the debt will run back up."
"Really," he said, "the surprises could come the other way," with the debt disappearing even faster.
Dealing with the problem of solvent government is "what the president would call a high-class problem," said Gene Sperling, chairman of the White House's National Economic Council. But it is a problem nonetheless, he acknowledged.
To be sure, with a $3.7 trillion debt still in the hands of foreign and domestic investors, its elimination seems remote. Yet at the rate the surplus is growing, the problem should not be ignored, economists say.
The Congressional Budget Office predicted Thursday that without policy changes, the publicly held debt would dwindle to $865 billion in 10 years, half the debt predicted by the White House for that year.
Safe options
For as long as there has been a federal government, the Treasury Department has financed its debt by issuing Treasury bills, bonds and notes, now considered the safest investment options in the world. In 1791, the debt was more than $75 million, though it dipped to its lowest level, $33,733.05, in 1835.
The Federal Reserve Board tries to control inflation and the money supply by buying and selling hundreds of billions of dollars worth of Treasury bonds a year. It holds $500 billion worth of federal debt in reserve. And because Treasury bonds are so secure, corporations use them as benchmarks to set the interest rates their bonds will pay.
Without them, "the whole credit rating system would have to be changed," said Dimitri Papadimitriou, president of the Jerome Levy Economics Institute at Bard College. "You'd see a complete transformation of the financial markets."
As the federal debt dwindles, the Treasury Department would stop issuing bonds as it pays off those that come due. In the past year, Treasury cut back its bond issuances from $500 billion to $380 billion. The Treasury Department is examining whether it should go into the marketplace within the next year or so to buy back bonds at a premium so it can continue issuing new ones, said Gary Gensler, undersecretary of the Treasury for domestic finance. Only with newly issued bonds can the Treasury Department set interest rates that businesses need as benchmarks to set their own rates.
Outstanding bonds
By 2011, when the administration forecasts the public debt to shrink to $944 billion, all the outstanding bonds will probably be held by the Federal Reserve, state and local governments and savings-bond holders, Gensler said. In other words, in 12 years, no more bonds will be on the public market.
As the supply dwindles, the Federal Reserve would face the biggest problem, Blinder said. The Fed could try to control interest rates by buying and selling relatively safe corporate bonds, but the signal the Fed would send by trading in, say, AT&T; Corp. instead of International Business Machines Corp., would almost certainly distort the marketplace, he said.
"If you had the choice between buying some random corporate bond or buying the bond the Fed is buying, which would you buy?" asked Bruce Bartlett, a senior fellow at the National Center for Policy Analysis, a think tank.
Having the government hold a huge stake in a private corporation presents its own philosophical problems, Papadimitriou said, because an administration might be tempted to dictate corporate policy.
And if the Federal Reserve decided to lower interest rates by dumping billions of dollars worth of a corporation's bonds on the market, other investors would likely panic and sell theirs, causing the price of that bond to crash.
Haven of choice
"I just don't believe you can conduct monetary policy based on these bonds," Papadimitriou said.
Disappearing Treasury bonds would also deprive investors of a safe place to park their money in rough financial times or between investments.
International investors have made U.S. bonds the haven of choice, flooding the U.S. economy with capital, lowering interest rates, and sparking long-term corporate investments that have fueled economic growth.
As that haven disappears, investors would search for another one, probably the European Union's new Euro bonds, said Lowell Bryan, a McKinsey & Co. director and the leader of the consulting firm's global practice. That would strengthen European currencies, lower interest rates and spur growth at European competitor firms.
"It would probably hurt our pride, if nothing else," Latta said.
If the United States does not need the money, it would not matter, said Bryan. The U.S. dollar would likely remain strong because of the country's economic strength.
"Whichever bond is viewed as the safe haven will benefit, because they're going to get cheap capital," Bryan said. "But does that really matter for a country that doesn't have to import capital? I don't think so."
Real dilemma
The real dilemma would come not necessarily when the government ran out of debt but when it began running a real cash surplus, Latta said. That money would have to go some place, like the stock market, real estate, or a bank, since it could not be parked in Treasury bonds.
The Asian economic crisis arose in part from just such a situation. Because Asian governments were being flooded with cash, they ran surpluses and did not have to issue their own bonds. Without a government benchmark, Asian companies did not issue corporate bonds, relying instead on foreign banking sources that dried up suddenly, sending their economies tumbling.
Gensler said the administration has considered all these questions.
New vehicles for monetary policy are beginning to emerge, such as government-backed bonds from quasi-private companies like Fannie Mae or Freddie Mac, an administration official said. Over the next 10 to 15 years, new pricing benchmarks will also emerge, from companies like those, or Fortune 100 companies like AT&T.;
Private sector
And Gensler suggested that international investors would not abandon the United States for Europe, but instead would pump money directly into the private sector. That would help the economy even more than the purchase of Treasury bonds, he said.
The "enormous positives" of a sharply declining debt should outshine fears for the future, Sperling insisted. Interest payments this year will consume 12 percent of the federal budget, or $227 billion. As that number declines, more money will be freed up for spending, tax cuts, or still more debt repayment. Interest rates would decline as the government seeks less and less investment. And national savings rates would go up.
As for the "variety of unprecedented issues" created by zero debt, Sperling said, "what a great problem for the country to wrestle with over the next 15 years."