Shh: Let’s Not Talk About That

A deeply understood, but not enough talked-about aspect of Federal borrowing, is that the Federal government need not pay interest on its debt.

Current law requires the Treasury Department to auction debt in  the public market. The Federal Reserve (FED), the Nation’s central bank, repurchases a portion of this debt in its efforts to target interest rates,  and indirectly, to influence the money supply. Federal Reserve earnings, after meeting basic capital cushions, are turned-over to the Treasury Department. Therefore,  FED earnings on its Treasury securities’ holdings are turned-over to the Treasury Department. Stated differently, the Treasury, i.e., you and I, get an interest free loan when the Treasury debt is held within the FED’s  portfolio. The Treasury pays interest to the FED, the FED returns this interest to the Treasury when it pays its earnings over to the Treasury. From 2009 to 2019 FED earnings turned-over to the Treasury Department averaged $77 billion annually.

All of this raises the obvious question: why not issue all Federal debt directly to the Federal Reserve (FED) and have the FED hold this debt until maturity? This would enable the Federal government to borrow interest free which would open up space for greater public investment in other needed areas.

Depending on one’s  sense of cynicism, the answer to the above question is somewhat obvious; there are,  however, a couple of different facets to the answer. The financial and business class fear direct, interest free Treasury borrowing from the FED would expand government beyond what they perceive to be a healthy sized government. Treasury debt issuance into the public markets enables the private sector to exert discipline over the public sector. The private sector prefers to hoard economic activity to itself, often  with good intentions, however mistaken these intentions may be.  The scheme is ultimately a private sector vs. public sector battle for control over the Nation’s economic activity.

There are other private sector advantages through the issuance of Federal debt in the public markets. Treasury securities are a convenient tool for interest rate targeting. The FED buys and sells Treasuries, pushing their prices up and down as these securities flow back and forth between the private and public sectors. Through this process the FED is fairly able to control interest rates and through interest rate control the FED is able to direct economic activity: somewhat. 

Also the private sector is greatly advantaged through ownership of risk free Treasury securities. These risk free assets when held within an investment portfolio stabilize investment returns, and enable investment managers to leverage  this solid foundation of risk free assets into higher risk, and hopefully higher return, private sector investments. The Treasuries can quickly be turned into cash as situations call for this action.

As you can see, the private  sector is greatly advantaged by Federal debt issuance which bypasses the Federal Reserve and goes directly into the hand of the private sector. The broader public gains little advantage through this arrangement, unless the broader public believes that a dominant private sector is in its self-interest, and is willing to pay for this belief through higher taxes in order to pay these private sector interest earnings. One’s view on this design is probably closely associated with one’s class affiliation. 

The problem is, the Federal government’s ability to borrow interest free, is not part of our general knowledge and likewise it is not part of our daily discussions. Public auctions of Federal debt issues seems like one of those issues that if fully understood by the broader public, the public would then  take action to rearrange  Federal  borrowing practices. Meanwhile, we are being led astray by market price proponents who would have us believe that private market pricing of federal debt, which actually no longer even exists when one considers  FED interventions over the past 12 to 13 years, is worth you paying over your tax dollars to the holders of this debt. Quite an incredible argument when you think about it. 

We could take this line of reasoning a step further and recognize that Congress could also simply write new law which states that direct Treasury borrowings from the FED pay no interest at all, which would relieve the system of unnecessary accounting associated with interest rates on Treasury debt held by the FED. Or better yet, Congress could simply write new law which enables the Federal government to deficit spend without funding the deficit gap. Federal government spending under this scenario would then  be viewed as the source of new money creation while taxation would be viewed as a money destruction device necessary to prevent inflation. This is the Modern Monetary Theory (MMT) view of the world and when monetary theory is viewed through this lens, new fiscal possibilities arise. Meanwhile, this issue should no longer be shushed away. There are great possibilities for creative  monetary structures for those nations with their own monetary systems. Sovereign monetary structures can be created and molded in a manner  which  fits the public’s needs. We can’t do this, however, until we break the silence around several truths with regards to the Federal debt. One of those truths: we need not pay interest on Federal debt.

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