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No longer laughing

26 August 2016 By Edward Chancellor

A little more than 10 years ago, I wrote a piece recommending that the U.S. Treasury extend the maturity profile of its debt. The column teasingly suggested that Washington should issue zero-coupon perpetual bonds, as this would reduce debt service costs. When it appeared in the Breakingviews column of the Wall Street Journal on April 1, 2006, a couple of irate readers wrote in complaining that a zero-coupon perpetual would have no value. I politely pointed out to them the date of publication and all was forgiven.

Much has transpired in the global bond markets since then. Government debt issuance has ballooned everywhere. A sovereign debt crisis erupted, and still lingers, in the periphery of the euro zone. Japan’s public debt has soared past 200 percent of gross domestic product. Policy rates, stuck at or near zero in many countries, have turned negative across much of Europe and in Japan. Some $12 trillion worth of government bonds now sport negative yields.

To cap it all, monetary-policy wonks have seriously revived the zero-coupon perpetual idea. There are currently two conflicting proposals on the table. Ben Bernanke, the former Federal Reserve chairman, on a recent visit to Japan reportedly suggested that Tokyo implement his helicopter-money plans by issuing zero-coupon perpetual bonds. Meanwhile, Kenneth Rogoff, a former chief economist at the IMF and currently a professor at Harvard University, has written a book proposing the abolition of cash in order to facilitate the latest monetary policy fad – negative interest rates. The dollar bill, being an irredeemable non-interest bearing liability of the U.S. Treasury, is basically a zero-coupon perpetual.

In his blog earlier this year Bernanke suggested that the Fed could finance the government by printing money, receiving in exchange irredeemable Treasury scrip. Bernanke’s latest bright idea is that the Bank of Japan, which has bought up close to half the country’s outstanding government debt, should convert its bond holdings into zero-coupon perpetual securities – that is, financial instruments with no intrinsic value.

The difference between a central bank owning zero-coupon perpetual notes and conventional bonds is that the former cannot be sold to withdraw excess liquidity from the banking system. That means the Bank of Japan would lose a key tool in controlling inflation. So as expectations about rising prices blossomed, Japan’s decades-long battle against deflation would finally end. There are further benefits to this proposal. In one fell swoop, Japan’s public-debt overhang would disappear. As the government’s debt-service costs dried up, Tokyo would be able to fund massive public works. Prime Minister Shinzo Abe inclines towards more high-speed train lines and defense spending.

Meantime, in his forthcoming book, “The Curse of Cash,” – and for slightly different reasons than Bernanke – Rogoff inveighs against the only zero-coupon perpetual instrument known to all of us: cash. At first sight, it seems strange to propose abolishing the mighty greenback. The $100 note costs a little over 10 cents to manufacture. Roughly half of the $1.4 trillion of U.S. dollar bills outstanding are held abroad. That represents hundreds of billions of dollars of pure profit for the federal government.

Yet Rogoff argues that cash facilitates all sorts of illicit activity, including terrorism, drug dealing, illegal immigration and tax evasion. More to the point, getting rid of cash would prevent people from hoarding the stuff, and thus allow central bankers to push interest rates even deeper into negative territory. “The whole premise,” writes Rogoff, “of (significant) negative rates is to turbocharge the economy out of a deflationary recession.” This begs the question. After all, the decline of interest rates in developed market economies to zero and beyond has been associated with weakening economic growth. It’s not clear why rates deeper into negative territory would improve the situation.

A world without cash would look very different. Beggars would have to be provided with debit card readers (as is already the case in progressive Sweden). With interest rates set at negative levels “without limit” (in Rogoff’s words), cheques would lie around uncashed. People would rush to file their taxes early and even overpay them. There would be no restraints on investment. As the Nobel Prize-winning economist Paul Samuelson once observed, with a perpetual negative rate it would make sense to level the Rocky Mountains to save the cost of extra gasoline expended by motor cars on steep inclines.

There would be some drawbacks, of course. The poor and disadvantaged, many of whom lack bank accounts, would have to be coerced into entering the world of electronic payments. Many of them would lose their livelihoods as much of the semi-licit underground economy disappeared. In a cashless world, the government would have a record of every transaction in a person’s life, from a child’s first purchase of tooth-destroying candies onwards. While Rogoff recommends initially abolishing only large-denomination dollar bills, he envisages a day when every citizen would have their own bank account with the Fed. A brave new world indeed.

Even in this era of radical monetary-policy experimentation and unprecedented state snooping, Rogoff’s proposal to abolish cash is probably a step too far. Bernanke’s plans, on the other hand, have a depressing inevitability. What’s more they’ll probably succeed in their primary aim of dispelling deflation. Revolutionary France was able to create inflation and wipe out its national debt by issuing vast amounts of assignats, an earlier type of the zero-coupon bond.

Still this is no free lunch. Households holding cash and other forms of paper wealth would see their capital evaporate. The long-suffering middle classes would become even more stretched – and almost certainly a great deal angrier. Ten years ago, the notion that zero-coupon perpetual securities should make a comeback seemed like a good April Fools’ joke. Now, it’s no laughing matter.


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