15 votes

How to Defuse the Debt Ceiling Time Bomb

The $16.3 trillion national debt is partly an illusion, because the Federal Reserve owns $1.6 trillion, which it purchased through its quantitative easing (QE) operations. 



The Fed has been earning about $80 billion a year in interest income from these Treasury holdings and will earn more like $100 to $110 billion this year which will simply be remitted back to the Treasury.



In other words, this is debt that the Government owes itself! Our children and grandchildren aren’t even involved and they will not be saddled with this debt as long as the Fed holds on to it. This raises the question about why this $1.6 Trillion of Treasury debt held by the Fed should apply to debt ceiling. 



After all, what difference is there between the Treasury issuing debt only to have the Fed buy it back, vs. theTreasury not issuing that debt in the first place?

Is there any good reason why the Treasury and Federal Reserve couldn’t simply wave a magic wand over this $1.6 Trillion debt held by the Fed and in effect cancel it? This would reduce the outstanding debt to about $14.7 Trillion which is well below the current statutory debt ceiling of $16.394 Trillion.

The idea of canceling some portion of national debt held by the central banks seems to be gaining traction in part because it finds support from both the left and right ends of the political spectrum. Here is post-Keynesian economist Mike Norman of the Modern Monetary Theory (MMT) school of thought suggesting debt cancellation as a way to defuse the fiscal cliff time bomb..... 



http://www.youtube.com/watch?v=-BKiIflAr-4

Meanwhile, at the other end of the political spectrum Ron Paul sees government debt cancelation as a means to bring lasting savings to the federal budget....

http://www.tnr.com/article/politics/91224/ron-paul-debt-ceil...

There are also these articles which appeared more recently ( mid-Oct ) in the FT blog and Seeking Alpha....



http://blogs.ft.com/gavyndavies/2012/10/14/will-central-bank...?

http://seekingalpha.com/article/925171-will-central-banks-ca...


Instead of driving off the fiscal cliff like Thelma and Louise, the Treasury and Fed could give Congress the means to slam on the breaks. This would buy policy makers another year or so of valuable breathing space to formulate sensible fiscal policy for economic growth rather than causing a self inflicted wound on the economy and millions of American workers and businesses. 



Mr. Bernanke, if you seek transparency and accountability for the Fed…. If you seek prosperity for the American people then come to Congress and tell our law makers that the Treasury debt held by the Fed should not apply to the debt ceiling. Mr. Bernanke TEAR UP THIS DEBT!



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Michael Nystrom's picture

Bump

for the Rombach Report!

He's the man.

The Debt Ceiling and the

The Debt Ceiling and the Fiscal Cliff are all phony baloney panic buttons the politicians love to push to get voters to fall in line. Idiots!

Request for Bid: New Roof. US Capitol Building, Capitol Mall, DC

Paying Debt w/ More Debt

Whereas: The United States Congress has spent wildly, like a drunken sailor.

Whereas: Congress continues to indenture our nation, even the sailors return to their ship broke.

Whereas: The United States Capitol building roof leaks like a sieve.

Whereas: The ceiling underneath is dangerously moldy.

Whereas: Patching up the old roof is prohibitively expensive.

Be it enacted: The United State requests for bid a new roof. This roof must keep the Capitol building dry from the impending doom... a tidal wave of liquidity. This roof must meet or exceed all applicable standards & codes.

Submit bids to: Rosie Rios, United States Treasurer Capitol Mall, Washington DC USA

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

Q and A

"Is there any good reason why the Treasury and Federal Reserve couldn’t simply wave a magic wand over this $1.6 Trillion debt held by the Fed and in effect cancel it?"

Inflation.

I imagine that the Treasury and Fed will conspire to inflate the debt away, but not obviously and illegally like that.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

Fix the roof!

The ceiling fix can be done after the roof stops leaking!

Is there a roofer in the house?

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

the debt will be delt will

and economic boom will inflate the debt away is coming -buy hard assets such as real estate but watch for bubbles

Government is supposed to protect our freedom, our property, our privacy, not invade it. Ron Paul 2007

Honest Question...

If the Federal Government can just manufacture more "money" why do they need our tax money at all?

Is this a good question to ask people to wake them up, or is there a flaw in that thinking?

That has been tried before.

That has been tried before. The money goes to zero-value at an astonishing rate.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

Research "Coin of the Realm" :: Contrast w/ "$2 quadrillion"

Are solutions obvious?

With film, talking-picture-boxes, computer & the like, images may be projected... No money required. But, where does a money-elevator stop? What floors? What ceiling? Does it go to the roof? Is there a beer garden up there? Please find out & report back.

Why do you suppose Dr Ron Paul went to all the trouble of writing his best-selling book, "End the Fed?"

1913 forward: Since our sound money of gold & silver was rolled over to bank notes... promissory notes... Federal Reserve Notes, no manufacturing is required. The Fed Notes are promises that someone must pay the Federal Reserve.

Honesty may be the best policy for family matters. When it comes to banking & high finance, the higher amounts go, the greater the "art of deception."

How is it that we pay for this $16 trillion woman's spend thrift ways? Rosie Rios US Treasurer (as our agent, she signs our life away to the Fed)

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

I think it's an excellent question to wake people up.

If creating money has no negative consequences, why not abolish all taxes and let the government finance itself exclusively through inflation? For that matter, why not print up enough money to send everyone a check for, oh, a million dollars? This is fine reductio ad absurdum argument...assuming people don't call your bluff and say "yea, count me in!" (eek)

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Good Question! I'm Glad You Asked.

"If creating money has no negative consequences, why not abolish all taxes and let the government finance itself exclusively through inflation? For that matter, why not print up enough money to send everyone a check for, oh, a million dollars"

Here's an exchange that took place between Paul Ryan and then Fed chairman Alan Greenspan in one of his last semi-annual testimonies before Congress.

PAUL RYAN: “Do you believe that personal retirement accounts can help us achieve solvency for the system and make those future retiree benefits more secure?”

ALAN GREENSPAN: “Well, I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody. The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase.”

Ed Rombach

Defaulting on treasuries...

...owned by the Fed or on intra-governmental treasury holdings would not change the fiscal situation of the government at all. As the OP says, this is money which the government owes itself, essentially an accounting fiction. So what would be the point? It would suddenly lower the debt subject to the limit, allowing the government to borrow more money. Do we want them to borrow more money? I don't, so I certainly cannot support defaulting on these treasuries as a scheme to get around the debt ceiling.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Oh, but it would change the

Oh, but it would change the situation. When the loan is repaid, the Fed is obligated to return the money into the thin air it came from. If they do not, that is pure inflation of high-powered money.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

Michael Nystrom's picture

Paging the Rombach Report

Ed, what do you make of this latest development with the Fed. It is being spun as "The Fed is running out of bullets."

He's the man.

Fed Out of Bullets?

The biggest policy action the Fed has been taking in recent years has been QUANTITATIVE EASING (QE). I am sure that many here at the Daily Paul see QE as inflationary, but I think not. In financial market jargon, QE is nothing more than an asset swap. The Fed gives currency reserves in exchange for Treasury notes and bonds. Those currency reserves do not circulate in the economy but rather find their way back to the Fed as EXCESS RESERVES earning a mere 0.25% as an over night deposit. In fact, if anything QE is deflationary because interest income on Treasury debt that would otherwise have been earned by commercial banks instead is paid to the Fed which subsequently remitted back to the Treasury.

I like to think of QE as much ado about little. Even a 2004 Fed research paper authored by none other than Bernanke himself along with co-authors Sack and Reinhardt, "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment", casts doubt on the effectiveness of QE when interest rates are at the zero bound

http://www.federalreserve.gov/pubs/feds/2004/200448/200448pa...

Basically Fed ran out of monetary bullets when they drove rates to 0%, but they needed to “do something” to at least appear to be relevant not to mention to justify the cost of keeping all those PhD’s on the payroll. This explains in part why the economic recovery has been so tepid despite unprecedented fiscal spending, (maybe because of it?). It’s the Japanese scenario all over again and let's not forget that Japan pioneered the practice of QUANTITATIVE EASING and look what it what it got them.... two lost decades and deflation.

If the Fed had any meaningful monetary bullets in their gun holster, WHY would they not have already used them? In my opinion Fed QE is nothing more than the Fed doing a rain dance.

Ed Rombach

That's incorrect

I am sure that many here at the Daily Paul see QE as inflationary, but I think not. In financial market jargon, QE is nothing more than an asset swap. The Fed gives currency reserves in exchange for Treasury notes and bonds.

1. Treasuries are not money! Buying treasuries with newly created federal reserve notes is not an "asset swap," it is monetization. Moreover, the Fed has bought many hundreds of billions of non-treasury securities.

2. The inflation is plain to see. Look at M1, it was $1368.2 billion at the start of 2008, and it is currently $2420.8 billion, that's an increase of $1052.6 billion, or 77% in just five years.

Those currency reserves do not circulate in the economy but rather find their way back to the Fed as EXCESS RESERVES earning a mere 0.25% as an over night deposit.

Suppose the Fed buys some securities from Joe Blow. Joe Blow deposits his proceeds in ABC Bank. ABC bank, not willing to lend in this economic environment, puts the money on deposit at the Fed to earn some interest. You're correct that the reserves on deposit at the Fed are not circulating, but you've forgotten about Joe Blow's money! He still has access to it, it's in his checking account, being spent regularly on goods and services he buys. The high level of excess reserves means that the money the Fed creates does not get multiplied through fractional reserve lending as it normally would, but the Fed is still creating money. Again, take a look at M1.

In fact, if anything QE is deflationary because interest income on Treasury debt that would otherwise have been earned by commercial banks instead is paid to the Fed which subsequently remitted back to the Treasury.

There's nothing deflationary about that. The money the Fed remits to Treasury doesn't get destroyed, it gets spent: on SS, and Medicare, and DoD contracts, and employee salaries, etc.

If the Fed had any meaningful monetary bullets in their gun holster, WHY would they not have already used them? In my opinion Fed QE is nothing more than the Fed doing a rain dance.

You seem to be under the mistaken impression that the Fed or federal government can spur economic growth. Without opening up that can of worms, I'll just explain what the Fed is really doing, and why. Basically, it has two goals: support the value of bank assets and finance the federal debt. That's it. To do this, it needs to monetize lots and lots of debt, especially treasuries and MBS, which it has been doing in earnest for several years. It's really a rather simple operation, though it gets muddled by the mountains of BS they create to maintain the illusion that they're working in the public interest.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Buying treasuries with newly

Buying treasuries with newly created federal reserve notes is not an "asset swap," it is monetization.

Actually it is an asset swap because the total amount of liabilities of the fed and Treasury remain unchanged. It is an exchange of an interest bearing financial asset like Treasuries, MBS or GSE debt for another type of financial asset, in this case currency reserves which do not pay interest..... unless of course those reserves end up as excess reserves which most of them do.

”ABC bank, not willing to lend in this economic environment, puts the money on deposit at the Fed to earn some interest.

Actually bank lending is on the upswing as indicated by the increase in C&I loans according to data compiled by the the St. Louis Fed.

http://research.stlouisfed.org/fred2/series/BUSLOANS/

“Suppose the Fed buys some securities from Joe Blow. Joe Blow deposits his proceeds in ABC Bank...... but you've forgotten about Joe Blow's money! He still has access to it, it's in his checking account, being spent regularly on goods and services he buys.”

Fed does not buy treasuries or other assets from Joe Blow. Fed QE operations purchase assets from banks, so Joe Blow’s money is not an issue.

”The money the Fed remits to Treasury doesn't get destroyed. It gets spent: on SS, and Medicare, and DoD contracts, and employee salaries, etc.”

Actually, the money the Fed remits to the Treasury is extinguished in the sense that it ceases to exist. Remember that it is only fiat and hence there is no intrinsic value associated with it. I gets accounted for as if the Treasury is receiving something of value but I submit to you that this is merely an illusion. Fiat money, i.e. currency reserves are created by deficit fiscal spending of the federal government. The government literally spends these reserves into existence. The fed facilitates the whole process by merely clearing the checks, which means crediting a reserve account at some commercial bank and debiting the Treasury’s account at the fed. It’s mostly all done via electronic entries on a spreadsheet.
In connection with this, the issuance of Treasury debt is simply a statutory legacy of when the US was still on the gold standard. The government, as it functions today, spends first and then any of that spending that is not covered by current tax revenues must by law be “financed” by debt issuance. The only other thing that the fed does is to target interest rates, but they cannot target interest rates and control the money supply at the same time. That would be like trying to hit two birds with one arrow.

You seem to be under the mistaken impression that the Fed can spur economic growth.

Trust me. I have no illusions about the fed’s ability to spur economic growth. That’d why I refer to all of their QE operations as nothing more than a rain dance.

Ed Rombach

Now Or Never is right

... and he explained it very well. Read it again.

Ĵīɣȩ Ɖåđşŏń

"Fully half the quotations found on the internet are either mis-attributed, or outright fabrications." - Abraham Lincoln

Show me

Can you be more specific? I covered a lot of ground in that last post.

Ed Rombach

Nope

This is silly. That debt was covered by creating new credit out of thin air. If they cancel it, it just means $1.6 trillion more to print without "increasing the debt," and rest assured we pay for that regardless if it is in ink or not.

Remember, the government is not rational.

Thousands of years of history on debt forgiveness!

Thousands of years of history on debt forgiveness! Ron Paul speaks of the Fed creating National Debt out-of-thin-air.

Additional references:

  • Leviticus 25 Jubilee
  • Mark 5 Jubilee
  • Magna Carta Widows & Orphans, A.D. 1215

Disclaimer: Mark Twain (1835-1910-To be continued) is unlicensed. His river pilot's license went delinquent in 1862. Caution advised. Daily Paul

Yup....

snickodonnell - Just to clarify, the type of money we are talking about here are currency reserves which are created by way of government spending. The federal government literally spends these reserves into existence. However, if the government spends more than it collects in tax revenue it's what we call a budget deficit and by federal law the Treasury must issue government debt to "cover" that deficit.

In connection with this, most people assume that the government must first tax the private sector and borrow if there is a deficit before they can spend the proceeds. Hence Ronald Reagan's political mantra about the TAX and SPEND Democrats, but in reality the causality is more like SPEND and TAX. The legal requirement for the US Treasury to issue debt to cover a federal budget deficit is a legacy from when the US dollar was still on a gold standard.

When the government spends reserves into existence the Fed credits a RESERVE ACCOUNT at a commercial bank. Conversely, when the government taxes and/or borrows from the private sector, the Fed debits a reserve account at a commercial bank. In other words, the Fed is literally EXTINGUISHING RESERVES when it debits a reserve account at a commercial bank. The big point to take in here is that the government doesn't really collect anything when it taxes and nor does it fund anything when it issues Treasury debt. All that is happening is that fiat currency reserves are being extinguished.

I can appreciate that this may sound preposterous, but consider what happens if you pay your tax bill or pay for a newly issued Treasury bond with folding Federal Reserve note cash that you carry around in your pocket. Upon receipt of your cash payment, the Treasury would simply shred it.

Ed Rombach

EMBEZZLEMENT BY THE FED

The conclusion that the main source of income for the Fed is from interest on the national debt ($100 billion annually) is poorly placed.

The major source that is hidden from congress is from the auctions of Treasury securities. All of the handling is by the FRBNY and there is NO reporting or accounting records of disbursements available to Congress or to the public. The hidden profit amounts to $4 billion DAILY. Ref. Federal Reserve Heist, www.scribd.com/doc/101937790 .

Any other institute would be called an embezzler. All profit of the Fed lawfully belongs to the government.

It appears that these hidden profits are used to fund the New World Order scheme. Ref. http://www.scribd.com/doc/115919607/FUNDING-OUR-OWN-SELF-DES...

Is QE Inflationary or Deflationary?

From a Wall Street Journal blog.......

http://blogs.wsj.com/economics/2012/12/27/secondary-sources-...

"Tyler Durden [Zero Hedge] highlights an interesting report by Stone & McCarthy Research Associates that finds that the Federal Reserve will earn nearly $90 billion in 2012. Of this, roughly $87.5 billion, a new record high, will go back to the U.S. Treasury’s coffers, which should quietly do a little to help the nation’s bloated finances. “The world’s most profitable private entity that is in business to generate profits via speculation in financial markets is, drum roll please, the Federal Reserve,” Durden says. “Since 1947 the Federal Reserve has paid the Treasury roundly $975 billion, about 1/3 of which has been paid over the past 6 years. In other words, the cumulative Federal deficit since 1947 has been reduced by nearly $1 trillion … due to the repatriation of Fed earnings to the Treasury Department.”

Here is my take on why fed QUANTITATIVE EASING may be more deflationary than inflationary in a video I recorded when I worked at Thomson Reuters......

06/06/11 Inflation Alert: QE2 May Be Stoking Deflation, Rombach Says... http://reut.rs/ieLqhn

Ed Rombach

the fed is a business, the

the fed is a business, the more money it has, the less money americans have.

Cancellation of Fed held debt

Cancellation of Fed held debt would show the world an intent to make permanent the devaluation of the dollar, rather than the pretense of borrowing against future production.

Would Cancellation of Fed Held Debt Weaken the Dollar?

I have heard bond traders echo this sentiment, but I have to disagree.

If the fed cancels out Treasury debt purchased in the QE operations, some market participants wonder how the fed will ever be able to drain the $1.5 trillion in excess reserves on account at the fed if, as and when they finally get around to raising interest rates.

When the fed buys Treasuries and mortgage backed securities it pays for them with freshly created reserves. Problem is that with the economy and loan demand still weak, the banks cannot put these reserves to work so they simply come back to the fed as EXCESS RESERVES earning an overnight interest rate of 0.25%.

The fed already has the Term Deposit Facility in place to extend the duration in these reserves to 28 days and longer if necessary. Moreover, the fed won’t need to reverse repo Treasuries (flip side of draining reserves) from it’s balance sheet because all it has to do is raise the interest rate it pays on these excess reserves.

Nevertheless, perception is often reality and if enough market participants believe that fed canceling of government debt is inflationary they will act accordingly and sell dollars, sell bonds, buy equities, credit and commodities. In other words they will go for the “RISK ON” trade.

However, if all the central banks were to undertake a coordinated debt cancelation, the effect on the foreign exchange markets conceptually could be a wash. But what about gold? If the price of gold gallops higher while FOREX rates remain more or less in a holding pattern, it suggests that the market believes that all currencies are being devalued against gold.

Therefore, government debt cancellation which could be seen as a form of fiscal stimulus may have to go hand in hand an increase in the rate paid on excess reserves. In other words expansive fiscal policy along with tighter monetary policy.

Ed Rombach

By raising the rate it pays on excess reserves...

...the Fed can discourage bank lending, but it cannot soak up the increase in M1 caused by QE. M1 has grown by 77% since 2008! The only way for the Fed to shrink M1 is to sell off assets on its balance sheet: such as the treasuries which you're proposing be cancelled. Hence, cancelling those treasuries impairs the ability of the Fed to shrink the money supply in the future, and will be viewed as inflationary.

And though the Fed can tie up excess reserves by paying high enough interest on them for as long as it likes, it cannot shrink excess reserves except by selling assets on its balance sheet. So now think about the longer-term...is the Fed going to keep excess reserves tied up forever? No, of course not. At some point they're going to lower the rate to promote bank lending. What happens then? Inflation. And the longer they wait and the more interest they pay the larger the reserves grow the more inflation in the end.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Nothing Exceeds Like Excess!

NowOrNever - This is good analysis, but I think you would agree that if loan demand rises more than the fed would like, which at some point could become inflationary, all the fed has to do is raise the rate on excess reserves above what banks could charge for originating new loans. The trick for the fed would be in determining that rate. I think that 9 times out of 10 the free market can do a better job of figuring out what the "Goldilocks" interest rate level should be..... "Not too hot & not too cold". Excess reserves held on account at the fed are a liability of the fed, which would replace canceled Treasury debt which is a liability of the Treasury. The only difference is in who pays the interest. In this context, over night interest on excess reserves is functionally the same thing as 1-day Treasury securities.

Ed Rombach