In light of the current debate in Congress over additional fiscal support for workers and the broader economy, and the debate this has sparked over Federal debt levels, it is important to have a clear understanding of Federal debt issues.
The Federal debt is highly manageable and a significant portion of it could easily be extinguished. Currently the Federal government’s total debt level is roughly $26.5 trillion. Of this amount, the Federal Reserve holds Treasury debt equal to roughly $4.3 trillion; other branches of government hold close to $6 trillion of U.S. Treasury debt. This is significant because Federal Reserve earnings on its U.S. Treasury holdings are paid-back to the Treasury Department: this amounts to an interest-free loan to the Federal Government. Earnings on Treasury debt held by other branches of government, such as the Social Security Administration, is like taking a $5 bill from your right pocket and placing it into your left pocket, there is no net cost to the Federal government on the issuance of this debt.
The debt can be approached in numerous ways. First, Treasury debt held by the Federal Reserve (FED) can sit on the FEDs balance sheet in perpetuity. As mentioned above, Treasury debt which sits on the FEDs balance sheet is an interest free loan. If it sits there forever, it is like no loan at all. It would be similar to you or me going to our respective bankers to request a loan. The banker states: “No problem, here’s the loan, we will charge you no interest, and you will never need to pay the loan back.” Would either of us pay the loan back? It’s free money, pure money creation: which some will argue will or would be inflationary, but which is not inflationary. The Federal expenditures associated with the Federal debt currently held by the FED have already occurred and have brought us to our current state of low inflationary pressure. Repayment of the Federal debt, to the extent it were to crowd-out other Federal expenditures, given our low inflation environment, would actually be deflationary; indeed, without Federal deficit spending generally, we would undoubtedly be faced with strong deflationary pressures. So the maintenance of current Treasury debt on the FEDs balance sheet into perpetuity will have no inflationary impact; that money has already had its inflationary impact. That is not to say that increased spending associated with future debt issuance, debt subsequently purchased by the FED, would not be inflationary: it could be inflationary.
Another way to deal with Federal debt would be the trillion dollar coin option previously discussed on this Page. This idea, given serious consideration during the 2011 debt ceiling crisis, and also proposed in the recently introduced “Automatic BOOST to Communities Act”, by Michigan House Representative Rashida Tlaib, is to have the U.S. mint–a division within the Treasury Department– stamp a platinum coin with the value of 1 trillion dollars. The Treasury would then use the trillion dollar coin to purchase or extinguish a trillion dollars of debt held by the Federal Reserve. This is perfectly fine under the U.S. Constitution according to the well established Harvard Constitutional Law Professor Laurence Tribe. The idea has also been endorsed by serious economic and financial minds which include New York Times Columnist Nobel Prize winning Economics’ Professor Paul Krugman. Once again, this is pure money creation but not inflationary for the same reason discussed above. The money associated with the proposed debt payoff will have already been spent.
Another option, the Federal Reserve, directed by Congress, could simply extinguish Treasury debt currently held in its portfolio: poof, gone; it is that easy. Former House Representative and Libertarian Ron Paul of Texas, father of Kentucky Senator and Libertarian Rand Paul, proposed such a solution in the proposed “Debt Crisis Resolution Act of 2011”.
Under conventional accounting rules, however, debt extinguishment would create a problem for the Federal Reserve. The elimination of the Treasury debt which is an asset on the FEDs balance sheet, without a corresponding decline in a liability elsewhere on the FED balance sheet, would quickly overwhelm the FEDs roughly $40 billion of equity capital. In the private sector this would amount to insolvency generally followed by some form of bankruptcy. Not a problem for the FED, however, the FED would use a creative accounting procedure called a “deferred asset account” for any such eventuality. Under this scenario, FED losses which exceed its equity capital are placed in this asset account. Read that real slowly: FED—losses—which—exceed—its—equity—capital—are placed—in—this—asset—account. Losses are turned into an asset in order to accommodate Federal Reserve operations. Creative, right? The idea is that future FED earnings, rather than being paid to the Treasury Department, would be used to pay down the balance in the deferred asset account. In other words, previous losses would be paid-off with future earnings. This, of course, would rob the Treasury of these future earnings so the net effect would be that the Treasury is paying off the debt it ordered the FED to extinguish. What would be the point?
This, however, could easily be overcome. The FED, under authority of Congress, perhaps even under its own authority, could create an offsetting intangible asset account equal to the value of the extinguished debt. There is an intangible benefit to the public through the elimination of debt. The private sector uses intangible asset accounts for such things as goodwill and intellectual property values. An intangible asset account at the FED, which would represent the reduction of Treasury debt, might appropriately be labeled the “Give the Nation a Brake” asset account, or my favorite “Prevent the Revolution” asset account. This would enable the FED to eliminate Treasury debt held within its portfolio without incurring a loss and without the corresponding cost to the Treasury.
The above solutions solve the Treasury debt “problem” to the extent the debt is held by the Federal Reserve. What about the other $16 trillion of debt held by the public: individuals, institutions, foreign central banks and elsewhere? That’s still a lot of debt! Not really, it’s roughly proportionate to what nations have historically carried as a percentage of GDP without any damaging results. Furthermore, the FED could enter the market, purchase additional chunks of Federal debt currently held by the public, then repeat one of the options discussed above.
Additional FED purchases of publicly held Treasury debt, however, would be inflationary, not in the goods and services sectors, but in the asset markets. Sometimes inflating an asset simply maintains the asset’s current value, but in any event, holders of assets: stocks, bonds, property, have had, and would have, their asset values lifted to levels which exceed the assets’ real economic values through additional Federal Reserve asset purchases. This is obviously an advantage to those who hold assets, and from a supply side perspective, maybe also for those who are dependent on the supply side owners: in other words, all of us.
The danger here is that inflated asset bubbles tend to burst and if the FED enters the market through additional Treasury Security purchases, the added liquidity will further inflate asset values, raising the risk of a bubble burst with all of its consequent economic destruction. The Treasury purchases could go forward without inflating asset values through a corresponding drain of liquidity in the asset sector and the way to achieve this is through taxation targeted in a manner which drains money out of this market. Follow the drift, taxation is not necessary to fund the debt elimination, taxes would be needed to deflate, or to counter the inflationary pressure from the FED asset purchases. It is all about controlling the flow of funds in a manner which prevents inflationary pressure in all of the markets: goods, services, and assets, while preferably obtaining an equitable distribution of resources.
The point of all of this is: the creator of a thing can create that thing however the creator pleases. In the final analysis, this is all about accounting, and we can craft the accounting however we want to craft it in order to serve the Nation’s needs.
The additional debt associated with the Federal supplemental unemployment benefit and other fiscal measures is not the issue; it can be managed. The real issue is whether the additional money placed into the hands of the unemployed, from a money-flow’s perspective, creates inflationary pressure in the goods and services sector. If it is determined that people must go hungry and homeless in order to prevent the damaging impact of adequate, but inflationary, income support, then the system will once again have proven itself incapable of meeting everyone’s needs.