"Life without Treasury Securities" by Albert M. Wojnilower, in Business Economics (Oct. 2000), National Assn. for Business Economics, 1233 20th St., N.W., #505, Washington, D.C. 20036.

Should the huge federal budget surpluses expected in coming years, assuming they actually materialize, be used to wipe out the $3.4 trillion national debt? Americans ought to think twice, warns Wojnilower, a former official of the Federal Reserve Bank of New York who now advises two private investment firms. Eliminating Treasury notes and bonds would have "radical implications for the financial system." One possibility: Japanese government securities could eventually emerge as the new international benchmark .

Because Treasury securities are backed by the U.S. government and are thus virtually risk-free, they are the anchor of the financial system. They have taken the place of gold, serving as a benchmark for calculating the riskiness of other assets, a hedge against those risks, and a safe haven in times of uncertainty. The trade in Treasury securities alone, $190 billion a day, generates steady earnings that encourage dealers to "make markets" in less secure bonds issued by corporations, government agencies, and other borrowers—thus expanding the supply of credit. More important, Treasuries are used in hedging: Investment firms that hold other kinds of bonds sell Treasuries "short," reducing potential losses if the other bonds lose value—which also expands the supply of credit.

But it’s in a credit panic such as the one surrounding the 1998 collapse of Long Term Capital Management that Treasuries have their greatest value, says Wojnilower. Such crises trigger a "flight to quality," as people and institutions park their money someplace where its safety and liquidity are guaranteed. That "someplace" has long been Treasuries. Without them, Wojnilower says, investors would look to the few other big lenders in the world, with potentially unhappy results.

One alternative would be to seek the safety of the handful of banks deemed "too big to fail" by national governments. That, Wojnilower fears, would make these banks "inordinately huge and powerful," and would tempt governments to use them "as instruments of domestic and foreign policy." But markets could also seek safety elsewhere—in Japanese securities (if Tokyo finally sets its house in order), or in securities issued by

U.S. government-sponsored corporations, such as the Federal National Mortgage Association (Fannie Mae), which have Washington’s unspoken guarantee behind them. If the corporations succeeded in claiming this role, Wojnilower says, they would have the ability to borrow and lend capital at the cheapest rates around. Inevitably, he fears, Congress would widen the permissible scope of these corporations’ lending (currently restricted mostly to home mortgages), producing dangerously large "universal banks."

What to do? The Treasury could continue issuing securities if Congress stipulated that the proceeds, instead of being used to fund government operations, were to be lent to carefully designated "financial intermediaries." How much should the Treasury borrow? That, Wojnilower says, should be left to the Federal Reserve.