Hearing of the House Ways and Means Committee: Fiscal Year 2006 Budget

HEADLINE: HEARING OF THE HOUSE WAYS AND MEANS COMMITTEE

SUBJECT: FISCAL YEAR 2006 BUDGET

CHAIRED BY: REPRESENTATIVE BILL THOMAS (R-CA)

WITNESS: JOHN SNOW, SECRETARY OF THE TREASURY

LOCATION: 1100 LONGWORTH HOUSE OFFICE BUILDING, WASHINGTON, D.C.

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Mr. TANNER. Thank you very much, Mr. Chairman. I will try to be brief. I have got some questions in writing I would like to submit, Mr. Secretary, in the interest of time. When you were here in 2003 before the Committee, I asked you about the debt, part of the publicly held debt held by foreigners.

Mr. SNOW. Right.

Mr. TANNER. In 2001, that was about 30 percent of our outstanding debt; in 2003, it was 37 percent. Now it is 44 percent. I wanted to ask you, is there any point at which foreign holdings of U.S. publicly held debt pose a problem, in your opinion?

Mr. SNOW. Not at the current levels, Congressman Tanner.

Mr. TANNER. At what level, sir, would you say?

Mr. SNOW. I don't know that I want to draw a line there and identify any particular level.

Mr. TANNER. Well, it is something less than a hundred, I would assume.

Mr. SNOW. Sure. But I do not think it is helpful for me to draw a line and say, anything above that is where the alarm bells go off. Foreign governments are interested in holding U.S. paper for reasons we talked about earlier. I think Congressman McCrery laid it out well. It is the best paper in the world. It is the safest, most secure investment in the world, and foreign governments have investment profiles that cause them to want to hold this gilt-edge paper in the United States.

Mr. TANNER. I agree. The reason I asked that question is, there have been some comments in the London Financial Times and from Asia recently that, really, prior to 4 or 5 years ago, 3 or 4 years ago, there was not an alternative for Reserve currency to the dollar. We are now seeing people talk about the euro being an alternative. The reason I ask, at what point do you see this, and I understand why you cannot answer in this forum, this not--this being a problem, is, because once they shift or begin to shift, if they do, from the dollar to the euro, we have got a major problem in refinancing that debt. I want to follow that up with you at some point, and not in this setting. Let me move quickly to--

Mr. SNOW. I would be happy to do that, Congressman.

Mr. TANNER. One other question. Under this budget, we will incur an additional $1.3 trillion of publicly held debt under the budget that you have submitted. In 2001, the privately held debt upon which we write interest checks every year was about $2.96 or about $3 trillion. Of that number, we were paying about $120 billion in interest. Today, it is $4.42 trillion. We are now up to about $160 billion a year that we write checks for in interest. You are going to add to that another $1.3 if your budget is true. Now, Mr. Secretary, at what point is the interest that is coming out of the current tax base going to impact, or is it already impacting directly our ability to meet the obligations of the United States Government with regard to investments in human capital and infrastructure? We are diverting billions of dollars from productive, hopefully, expenditures to interest.

Mr. SNOW. Right. Congressman--

Mr. TANNER. This is a matter of real of concern to me. We have talked about it before, about what we are doing is creating a tax that cannot be repealed called interest.

Mr. SNOW. Well, I am glad you raised the whole issue. Despite the rising debt of the United States, which we need to keep focused on, I agree with you, interest obligations as a fraction of the deficit are falling, reflecting the very favorable interest rate environment we enjoy today, and which we would expect to enjoy for the future, because we have such low inflation in the United States. Inflation is low. Interest rates are low. That has created a very favorable environment. Even as the debt levels rise here in the years ahead, in the budget that we put forward, you will see that the interest obligation portion of the deficit remains fairly modest, because of low interest rates. But it is something that we very much need to keep attuned to. I agree with you.

Mr. TANNER. I just hope you are right about that assumption, because if you are not, this thing can explode on us. As interest rates rise, there is nothing that we can do about it.

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Questions Submitted by Representative Tanner

Question: At the hearing, I asked about the increase in foreign holdings of United States debt. As you know, foreign holdings of U.S. debt have increased from approximately $1 trillion to nearly $2 trillion in only 4 years. Considering foreign central banks control the bulk of foreign ownership of U.S. debt, their ability to affect our economy seems very real. I think this poses an economic and national security threat, should these governments choose to sell large volumes of U.S. securities on the open market resulting in valuation issues and interest rate escalation.

As of November 2004, foreigners owned 44 percent of the debt held by the public. I asked you at what point foreign holdings of U.S. debt could become a problem for the U.S. economy and our national security. You responded that you wanted to avoid answering my question in a public forum. Therefore, I ask you to provide me with information regarding the Administration's view of what, if any, percentage of foreign ownership of our publicly held debt creates a financial vulnerability with national security implications.

It has been the Administration's position that the current U.S. budget deficit is manageable and not large as a percentage of U.S. Gross Domestic Product (GDP). In 2004, the deficit as a percentage of GDP was 3.6%, in 2003 it was 3.5%. Since the end of World War II, the U.S. has only accumulated deficits greater than 3.6% of GDP ten times. Is it the Administration's position that the structural deficits of the federal government, especially given our future demographic challenges, are manageable as a percentage of GDP?

Federal Reserve Chairman Alan Greenspan recently stated, [the deficit] situation suggests that international investors will eventually adjust their accumulation of dollar assets or, alternatively, seek higher dollar returns to offset concentration risk.

It seems to me Chairman Greenspan is saying, we can't go on like this much longer. A borrower who runs up huge debts will become a bigger risk to lenders. Presently, the U.S. is a huge borrower. Last Friday, the Russian central bank confirmed that it has started pegging the ruble to a basket of currencies rather than solely to the dollar. This action will likely provide a major source of long-term euro buying. For the first time in almost 70 years, the dollar has a rival currency in the euro. During the past two years, the world has gone from having only 12% of global bank reserves in euros to 35% today.

Response:

The Administration faces two distinct deficit challenges. The ways to address these two separate problems are different. It would be a mistake to mix the two problems and two solutions together by talking only about whether the deficit is manageable as a percentage of GDP..

We have a short-term deficit problem, which we are addressing in our FY06 budget proposal. We have argued that deficits are sometimes appropriate, and we have been in one of those periods recently. We have had to ramp up defense and homeland security spending to prosecute the war on terror and to improve our domestic security. We cut taxes to stimulate the economy as it struggled through the after-effects of the stock market decline and the uncertainty generated by the initial phases of the war on terror and revelations of corporate malfeasance dating back to the 1990s.

In the FY2006 budget, we've made a strong commitment to spend the public's money appropriately and rein in spending to make long-lasting improvements in the deficit. The FY06 budget proposes a 1 percent cut in non-security discretionary spending and holds overall discretionary spending to 2.1 percent - below the rate of inflation. If we hold the line on spending we expect the deficit to decline to well below 2 percent as a percentage of GDP.

We think that if we don't hold the line on spending and revenue grows as projected then our temporary budget deficits will remain with us for a very long time. In that sense, our deficits could become structural, and not just related to the recent weakness in the economy.

The Administration firmly believes that long-term structural budget deficits do matter. A long string of structural budget deficits strongly suggests that government spending is out of control. Too much government spending for too many years actually slows the long-term growth of the economy, by diverting resources away from the private sector, which is the source of the goods and services and jobs that keeps our nation prosperous, strong, and resilient.

Our longer-term deficit challenge is related to the expected increases in outlays for the Social Security and Medicare programs, which will balloon in the coming decade as the Baby Boom generation retires. OMB estimates that outlays for these two programs alone will rise from 6.6 percent of GDP in 2005 to 16.8 percent of GDP in 2075. Traditional fixes to budget deficits like cutting discretionary spending and/or raising taxes simply cannot do the job of balancing the budget with the current expected increases in outlays for these two programs.

Putting Social Security on a sustainable path is the first step to dealing with the long-term deficit challenge facing the U.S. The administration firmly believes that some form of personal retirement accounts (PRAs) is needed to keep Social Security secure for future generations.

Holdings of U.S. Treasury securities by all foreign residents, as described in the attached table, are estimated to have been $1.9 trillion, or 52.8% of privately held public debt, at the end of December, 2004. The total holdings of all foreign official institutions is estimated to have been $1.1 trillion, or 32.0% of privately held public debt at the end of December, 2004. Foreign holdings of Treasury securities are distributed among many official and private foreign investors.

To put this in perspective of U.S. capital markets, privately held public debt is only about 15% of the domestic nonfinancial credit market. The U.S. capital market is the deepest, most liquid, and resilient in the world.

Our policy remains one of a strong dollar. A strong currency provides a reliable medium of exchange and serves as a stable store of value, which are very much in the interest of Americans.

The increase of the U.S. current account deficit over more than a decade has been linked to domestic U.S. capital formation increasing more than U.S. saving.

U.S. economic fundamentals -- with low inflation, flexible labor markets and vigorous productivity growth -- are extremely strong, especially in international comparison. This combined with an efficient and secure U.S. capital market make the U.S. an attractive foreign investment destination. The Administration is committed to growth enhancing, economic policies that keep U.S. fundamentals strong and maintain the confidence of U.S. and foreign investors in our economy's future.

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