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Replacing the National Debt with Equity

Wednesday June 24th, 2015   •   Posted by Craig Eyermann at 7:19am PDT   •  

Please Sir, May I Have Some Equity? What if, instead of borrowing money to sustain its spending, the U.S. government instead sold equity shares of the future performance of the U.S. economy?

Evan Schulman, the president and founder of Tykhe LLC, who received a patent in 2006 for his concept of sales participation certificates — a way for businesses and other entities to raise capital to fund their operations — offers an intriguing proposal:

The problem with the federal debt is not only its size but when it needs to be refinanced. A shade less than 70% of the $16 trillion of outstanding federal debt matures in 5 years or less. A 2% rise in rates would, very quickly, almost double Treasury’s interest costs.

Why doesn’t Treasury extend the maturity of this debt to protect us? Interest rates on longer term debt are greater than on short term debt. Every 1% increase in rates today will cost the taxpayer $10 billion annually per $1 trillion; Treasury officials are playing the current low short term rates for every penny. So far they have been correct.

However, let’s ask: “Couldn’t financial engineers design a better instrument than debt?” Debt saddles the issuer with fixed costs, offering no relief if the future does not live up to expectations; and debt exposes the investor to the ravages of unanticipated inflation.

Let Treasury offer a more equity-like instrument, one that paid the investor a constant percent of nominal Gross Domestic Product (“GDP”), and nothing more, for, say, 30 years. Then the investor would have protection from inflation, Treasury would get some relief when the economy was in recession and, since it self-liquidates, there would be no need to refinance the issue; hence we would no longer burden our progeny with our profligate ways.

It’s an intriguing proposal because the U.S. government’s revenues, from which equity payments would be made, have represented a relatively stable percentage of the nation’s GDP for decades — about 17.5% of GDP with a standard deviation of 1.2% of GDP. So long as the equity payments are a fraction of that percentage, it would be a sustainable replacement for debt.

But there is a downside to equity financing a national government this way. Investopedia explains using the example of a business that has used equity financing:

The downside is large. In order to gain the funding, you will have to give the investor a percentage of your company. You will have to share your profits and consult with your new partners any time you make decisions affecting the company. The only way to remove investors is to buy them out, but that will likely be more expensive than the money they originally gave you.

On the plus side, it would make for an interesting episode of Shark Tank if the U.S. President and Treasury Secretary showed up together looking to make a deal.

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June 2015