Canadian Debt

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Corey Garriott, Sophie Lefebvre, Guillaume Nolin, Francisco Rivadeneyra and Adrian Walton at the Bank of Canada have issued a thoughtful and crisply written proposal for restructuring Canadian government debt, titled Alternative Futures for Government of Canada Debt Management.

Their third and fourth ideas are the most radical and attractive to me: Replace all government debt with 1) a set of zero-coupon bonds issued on a fixed schedule and/or  2) a long perpetutity, a long indexed perpetuity, and fixed-value, floating-rate short term debt, essentially the same as interest-paying central bank reserves or a money market fund. (Naturally I like it, since it draws on my “new structure for Federal Debt”)

Why? Well, a simpler and smaller set of securities would be more liquid.
…investors will pay more in the primary market for assets they believe will be more liquid. Thus, issuing assets that are more liquid would decrease the issuer’s costs. … a decrease in the total cost of funding of just one basis point would save the government $68 million annually
There is a social benefit as well. We hear a lot about “safe asset shortage,” and the need for liquidity. Well, the easiest way to create safe liquid assets is to make the safe assets more liquid!


Canadian bonds, like US bonds, are liquid when first issued (on the run) but then become much more illiquid. Two wonderful graphs illustrating this phenomenon.

Source: Garriott, Lefebvre, Nolin, Rivadeneyra andWalton


 Source: Garriott, Lefebvre, Nolin, Rivadeneyra andWalton

The set of three perpetuities allows all government debt to consist of three securities, rather than hundreds in the US and over 70 in Canada, making each much more liquid.

The classic example: A 10 year bond that is now 5 years old is a 5 year bond. But it carries a slightly different coupon than the current 5 year bond, and if you short one you can’t deliver the other. So teh 5 year bond market is cut in half.

They deal nicely with the most common objection from industry:
A common objection to reallocating or simplifying the debt structure is that the current structure exists for a reason—to satisfy clienteles. Clienteles are groups of investors who have a strong or narrow preference to hold bonds with specific maturity dates or coupon structures..
A set of zero coupon bonds would allow intermediaries to swiftly and cheaply create packages of debt to fit customer demands, while maintaining the simplicity and liquidity of the underlying bonds. If people really want happy meals, the government can supply burgers, drinks and fries, and not necessarily the happy meals themselves.  The paper expresses this clearly:
…a government’s comparative advantage in debt issuance is its ability to issue safe assets and not its ability to serve clienteles. The government’s advantage in issuing safe assets derives from its ability to tax, which is a more reliable means to obtain revenue than that of most issuers. But the government has no special advantage in client service compared with private intermediaries, who are better positioned to work with clients because intermediaries are paid for these services…. The more standardized the securities in the debt portfolio, the easier it is for private intermediaries to assign payments flexibly to the clientele who currently prefers it. In contrast, securities designed to satisfy one clientele are forever less desirable to the others. In time, such securities may even become undesirable to their original targets.
Without getting too conspiratorial, there is also the possibility that industry likes the current system because they like earning large bid-ask spreads on slightly illiquid securities, the bid-ask spread on frequent roll-over of securities (which perpetuities would end) and the lack of transparency in the current system. The paper is far too polite to say any of this. This is Canada, after all!

The first and second ideas are less radical, so less exciting to me, but much more likely to be adopted as a result
the first idea is to reopen the issuance of scarce bonds, and the second is to conduct more switch operations (exchanges of less liquid GoC securities for new, more liquid bonds).
Yes.