The short-term thinking behind ultra-long bonds

The U.S. Treasury Department is openly flirted with issuing a bond that won't come due for a century. Over the last few months, Treasury Secretary Steven Mnuchin has said 50- or even 100-year bonds are "under very serious consideration" and "could absolutely make sense." But for an idea with with such a long-term time horizon, it’s driven by pretty short-term thinking.

That isn't necessarily a bad thing. But it's indicative of the paradox the economy finds itself in.

To understand why, first you need to understand how government debt works.

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Basically, Congress decides how much money the U.S. government will borrow, through its tax and spending decisions. But the Treasury Department gets to decide how to design that debt.

So let's say Treasury needs to borrow $1,000. It will issue a bond for which the principal is $1,000, and whoever buys that bond will pay that amount to the government. Once the bond matures, the government pays that principal back. In between the purchase of the bond and its maturation, the bond pays interest to the buyer. The interest a bond pays is set at auction, via haggling by the primary dealers — big players like JPMorgan and Goldman Sachs — who initially buy the bonds from Treasury. But Treasury decides what length of maturity to design the bonds with. Ten-year bonds are pretty standard, and for a while now 30-year bonds have been the maximum. Thus a 50- or 100-year bond would be a pretty remarkable thing to introduce into the market.

The next thing to understand is the risks and rewards, for both buyers and sellers, of such a long maturity.

For the U.S. government, the attraction of a 100-year bond is it can lock in low interest payments for a very long time. The Treasury Department is rolling old debt over into new debt all the time. But whenever Treasury does that, it has to have another auction for the new debt, where it might have to accept a higher interest rate on the new debt. Not having to roll the debt over for a century would definitely mitigate that risk.

What interest rate the government can bargain the primary dealers into accepting is driven by wider economic conditions. That rate for U.S. Treasury bonds has been falling for decades, but as of late August, the 30-year Treasury — the longest bond the government now issues — hit a record low. In one survey, investors saying they would accept a bond that takes more than 30 years to mature jumped from 19 percent to 39 percent in just the last two years. To a lot of observers, this looks like the best opportunity the government's ever had to grab those low rates and hold them for an extra long time.

The danger is that, given the recent trend line of interest rates, future opportunities might be even lower. In that case, the government will have locked itself into a century-long interest that's actually higher than it could have gotten away with later on.

For buyers, the attraction is that you're presumably guaranteed regular interest payments, and eventually the principal reimbursement, over a very long time horizon. I say "presumably" because a government's finances could conceivably go bust, forcing it to default. But the U.S. government is widely considered the safest investment in the world. And that guarantee can be a useful financial instrument to have in your portfolio to hedge against other risks.

So what's the problem?

Well, in the case of a 100-year bond, you're talking about a bond that won't mature till after you're dead. That limits its utility to individual investors for obvious reasons. There are big institutional investors — like big pension plans and insurers — that will be around for a lot longer than any human member, and they can make more use of a century-long bond. But it's not clear exactly how many such bonds even those big institutional investors need.

That's the tricky question that's scuttled previous U.S. experiments with these sorts of super-long bonds. If demand isn't that high, the government will soak it all up pretty quickly. Then it will either have to stop issuing the 50- or 100-year bonds or accept higher interest rates on them to keep attracting buyers.

The other thing to remember is that the government is only locking in those low interest rates on the latest debt it’s issuing. Since the U.S. debt load is already at $22 trillion, it would have to issue a ton of 100-year bonds at super low rates to make a serious difference in its future interest payment obligations.

The last risk for buyers is that demand for such super-long-term debt will dry up in the future. In that case, the price other future buyers are willing to pay will drop. And the people who initially bought those bonds will lose money on their investment.

Which brings us to the final issue with ultra-long bonds: We really should want the price of them to drop. Because the reason demand for 100-year bonds is up is that investors are losing confidence in the American economy. While unemployment is still low, other signs of strong growth — wage growth, inflation, labor force participation, prime age employment — are tepid. And matters are much worse on the international scene. The purpose of bonds in financial markets is to provide safety in a turbulent economy. Growing investor demand for these sorts of bonds is simply a depressing sign that the markets don't expect a big improvement in the national or global economic outlook anytime soon.

Basically, 100-year bonds are certainly a great way for the government to assure itself some really low interest payments for the long haul. But it's not clear they'd be attractive to enough buyers to significantly change the makeup of the United States' debt load. And the very fact that such bonds are more attractive than they use to be is thanks to a major failure by policymakers to actually manage the economy well.

All of which suggests the enthusiasm for 100-year bonds will be pretty short-lived.