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April Fools: Creative finance

31 March 2006

Treasury Secretary John Snow, who has had a lackluster tenure to date, is looking out for his job. One predecessor, Larry Summers, made his mark by launching inflation-protected bonds in the late 1990s. These turned out to be popular with investors and have lowered the cost of government financing.

To secure his future at the Treasury, Mr. Snow needs to do something even more imaginative. Recently, the Treasury re-issued the 30-year government bond. However, Mr. Snow’s European counterparts have been bolder in tapping investor appetite for long-dated bonds with low yields.

Last year, France sold a 50-year bond with a yield of only 4%. Britain quickly imitated. Since then, the UK has helped finance its burgeoning deficit by issuing 50-year index-linked bonds, which have a real yield of less than 1%. Even consols, British government perpetual bonds which have been around since the 18th century, pay investors little more than 4%. By contrast, the US Treasury must now stump up 4.8% on its 10-year bonds.

European governments enjoy a lower cost of funding. That doesn’t make much sense considering America’s dominant position in the global financial system. What’s Mr. Snow to do? Well, the best performing Treasury issues of late have been zero-coupon bonds. These securities make no annual cash payments. Last year, the zero-coupon bond due in 2027 returned a mouth-watering 17%. The Treasury should consider extending the duration of its zeroes.

How about issuing a zero-coupon perpetual bond? Such a bond would have several attractions. Since it pays no coupon and never redeems, it would save the Federal government a packet. It would also satisfy the apparent willingness of global investors to snap up low-yield, risky paper. Last, but not least, an undated zero-coupon security would be the ultimate expression of US financial hegemony.

 

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