Chalk this one up to, "Why didn't I think of that?" Ron Paul has proposed a novel solution to the debt ceiling crisis, and I'm having a hard time figuring out the downside (though I know there has to be a downside). Paul's proposal is that we simply erase the $1.6 trillion in debt created by the various rounds of quantitative easing.
You read that right. Just tear up the debt like it never happened, thus buying the government another couple years before the debt ceiling looms again. How could we possibly do that? Well, it turns out we just kinda owe the money to ourselves. So it's like moving the money from your left pocket to your right. Any interest owed by the Treasury Department to the Fed gets refunded anyway, so it's a net breakeven.
The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself.Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again.
So just wiping out that portion of the debt seems like an elegant solution, no?
I can't help feeling a little queasy about it, though. First and foremost, it sure feels a lot like creating money out of thin air. I know that's the Fed's raison d'etre, but this just feels like blatant counterfeiting. Second, Ron Paul is a notorious Fed antagonist. He even wrote the book End The Fed, so he's hardly an impartial observer. I can't help thinking the old codger has an ulterior (though no doubt Constitutionally legitimate) motive in this proposal.
What am I missing here, guys? Can the answer really be this simple? Has Ron Paul single-handedly solved the debt ceiling crisis by sodomizing the Fed for $1.6 trillion (theoretically the Fed is the loser here, because they'd be giving up the assets)?
Some of you might point out that the Fed had plans to sell the assets to the public to tighten the money supply and control inflation, but they can do that simply by raising rates. Is this the perfect solution?
That's exactly why central banks are independent of their government.
That is a great synopsis, but if we keep overspending like we are now, the 1.6 trillion dollars that we wouldn't have to pay the fed, we would still need to raise the debt ceiling next year.
True. But I think the hope is that we'd somehow get our shit together in the meantime. Of course, there's no historical basis for that expectation.
Then commercial banks + other financial institutions walk away with 1.6T? Imagine the outrage.
The 1.6t was bought by the fed, not banks.
The Fed holds 1.6T in government securities as assets... which they bought from depository institutions.
I'm not sure how wiping out 1.6T on the Fed's balance sheet will lower government debt. What would happen to the 1.6T?
the fed IS the bank, fucking dumbass.
There is no debt ceiling solution. A solution for the debts by higher taxation seems to be possible when republicans were excluded from politcial decision making, which is not procurable.
Since the first gulf war 1991, the debt has more than tripled until now. The USA must change their foreign policy, the current foreign policy is a way too expensive on the long run. Non-interference will be wiser.
US foreign policy cost factors:
Operation Enduring Freedom +1 trillion $ Iraqi War+3 trillion $
http://www.bloomberg.com/news/2011-07-05/treasuries-triple-global-retur…
In all likelihood, that would make the problem worse. Once these politicians and bankers get it into their heads that they can just erase all the debt in a flash, they'll even crazier on QE than they already have. It would be like developing a hangover cure for the central bank. You'll feel better in the morning; until then, go nuts! Who cares?
Putting the economy on QE = Giving a drug addict more dope
short-term effect, long-term hangover
The Pauls continue to be the only members of Congress with any clue about the workings of the Fed.
I agree. Paul has an almost eery knowledge about money and how the Fed works.
If this could work then the entire government debt could be erased by having the fed print money to by it all and then burn it. I don't think that is something I want to be possible.
I don't fully understand the implications of erasing $1.6T of debt either.
What I do know is that the Fed had to print $1.6T of money to buy those bonds. What happens to that money if that debt is erased - does it just stay in circulation, or do they recall all of it?
Also, does the dollar become weaker or stronger if this happens? I would initially think stronger, because there is less debt on the Fed's balance sheet. At the same time (assuming that $ stays in circulation) there is much more money floating around backed by far less credit, so I would think that the dollar would depreciate dramatically.
Finally, I think the markets and debt rating agencies would take this as a huge sign that the U.S. is no longer good to pay its obligations. Just deciding to erase debt (whether owe to yourself or another party) when it's inconvenient to pay is a slippery slope and could end up screwing us over big-time.
@MarketParticipant 3 things:
1) They didn't actually print the money, so it isn't really in circulation. It is literally nothing more than an entry on an Excel spreadsheet for both the Treasury and the Fed. The idea was to spur commercial lending, but that never really happened.
2) Since the Fed would actually be losing $1.6 trillion in fungible assets off their balance sheet, it has to be a net negative for the Fed. The Treasury's debt is actually a Fed asset, so the destruction of said debt would be a notional profit to the Treasury and loss to the Fed. This is my reading of the situation, anyway.
3) I think you're absolutely correct here. Even if we have the ability to magically wipe out almost $2 trillion in debt, the ratings agencies couldn't possibly look kindly on that type of workaround.
The only thing that makes me hesitate to dismiss this idea out of hand is where it came from. Ron Paul is probably the sharpest guy in D.C., and it's difficult for me to believe that he would propose anything that wasn't fiscally kosher. That's just the kind of guy he is.
It doesn't erase the long term entitlement debt which MUST be addressed. But it clears the air politically around the debt ceiling discussion (which is mostly a political circle jerk by both Dems and GOPs)
Team Ron Paul Is Smart, But This Won't Change Behavior, So Let's Keep The Pressure On And Force Change Now Rather Than Later
Whats about Subprime 2.0 , household debt still increases.
http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashb…
Eddie-
Thanks for the replies. I agree with your take on #2, and that is what is tough for me to get my head around.
The Federal Reserve NOTE - is an gov't obligation backed by an asset to one institution that is debt to another gov't institution. So what happens to it's value when the underlying assets/debt are partially wiped out?
Also agree on Ron Paul. It seems that he's one of the only people (if not THE only person) in Washington with the conviction to discuss and propose the things that no one else will. It's a shame to see the media portray him as an eccentric rather than responsible representative.
The Fed holds bonds, but those same CUSIPs are held by other non-governmental players. How would you selectively default depending on the owner of the bond? That's the type of shenanigans that gets you a default rating from one/all of the agencies.
In related news, I really hope the S&P declares Greek debt in default regardless of what shenanigans those Europeans pull. It's ridiculous. It's obvious Greek is going to default, and we should take the pain now. These people are crazy...
Agreed. It would be a pretty bad precedent for the CDS market if this wasn't recognized as a default as well.
Yeah exactly. Why even have CDS at this point? If I owned Greek CDS I would be livid right now...
If no one in Europe is ever going to default, then maybe selling CDS on all the PIIGS is a great investment right now...
The whole european parliament seems to be crazy, burning money just for fun.
Who´s next ? Portugal or Spain, maybe Italy ?
That´s a real ponzi scheme, Madoff is just a harmless kid compared to the EU politicians
i guess we should by some inverse NYSE and NASDAQ ETF's, profit off this looming default!
If I'm following correctly, we're talking about wiping out $1.6T in reserves here right? Just because they're finally understanding that you can't push on a string doesn't mean the Fed should pull on it. The problem with all the mistakes the Treasury and Fed have made it that correcting them too soon would simply make matters worse.
Like when I try to get lucky after a night of power drinking.
This would cripple the Feds ability to keep interest rates low by using the proceeds from maturing bonds to purchase more treasuries. The Feds only has a $2.8 trillion balance sheet, so $1.6 is substantial.
Will probably have disastrous consequences on the bond markets and pretty sure rating agencies wont look too kindly on this, Will most likely damage the dollars status as well. Too risky me thinks
Doesn't matter what the Greeks call it for the sake of CDS.
Unless your CDS was very poorly structured/written, it should be clear what constitutes a default for the sake of getting your money, regardless of what any govt claims
As to the Fed thing, all that happens is that we withdrew the promise of ever pulling that $1.6T in Fed created money out of the system or replacing it with $1.6T in productivity. This would cause a significant (though how significant I'm not sure) fall in the dollar. If we were expected to pull this shenanigan more than once, the greenback would fall through the floor.
Accepting that this would work without any credit worthiness effects, it does not address the fundamental problem of deficit creation. Congress, unions, the welfare state, military-industrial complex, and every other interest group would merely view it as a godsend that allows them unlimited access to the treasury's teat.
Paul is probably hoping that this would undermine international and public confidence in the FED and thus beget a reduction or outright revocation of their powers. Imagine how much gold would spike if this came to pass.
Or maybe we could cut spending and learn to do with less. The economy will eventually rebound and the increased tax revenue, combined with the lower spending levels, will allow us to pay down the deficit.
Naaaa.
Alright--I'm going to explain some shit here because you all are meant to know something about finance, and there is some real nonsense being spouted here.
Firstly, Greece should default. The Europeans should be looking for a way to allow Greece to leave the Eurozone without too much trouble, and should use that system to transition the rest of the PIIGS out of the system as well. The idea of a 'two speed' Europe is absolutely true. But the Germans should remember that they're not Greece's saviors. No one has benefitted more from the euro than the Germans, so if they want to let it fall apart, they shouldn't be upset when it turns out that is a big negative for their economy.
Secondly, the Federal Reserve Bank DOES NOT PRINT MONEY. For the love of whatever god you pray to, learn how the fucking banking system works. That means doing something beyond touching yourself while looking at the Goldman Sachs Careers Website. The U.S. Mint (part of the Treasury) mints coins. The Bureau of Engraving & Printing (also part of the Treasury) prints notes. The Bureau of the Public Debt (also part of the Treasury) issues all debt in the US. The Fed just dicks around with interest rates through open market operations. They control the money supply. And guess what? Each of the 12 reserve banks have to post collateral for the amount of currency they have in circulation. They have done so since before any of us were alive. They do so through purchases of US treasuries and gold certificates, so quantitative easing wasn't even that novel.
And what's more, the VAST MAJORITY of money spent on QE went to excess reserves at the Fed which all depository institutions have to hold anyway. To be fair, most are now holding reserves far in excess of what is required by law, but that was exactly the point. QE didn't come into existance to increase lending and free up the credit markets. At least, that wasn't the only purpose. It also allowed banks to shore up their balance sheets and prepare for upcoming changes to capital requirements in Basel III and Dodd-Frank. That's why QE and QE2 didn't actually do anything to spur lending.
Now, Ron Paul's plan--it sucks for a lot of reasons, the main one being the fact that U.S. Treasuries held on the Fed's balance sheet are ASSETS. Excess reserves held at the Fed by depository institutions are LIABILITIES. If you simply wipe clean the assets on their balance sheet, but maintain the liabilities, the Fed would become insolvent. And, since the Fed DOES NOT HAVE THE ABILITY TO PRINT MONEY, it cannot print its way into balancing its accounts. Ergo, it would have to do one of two things: ask the Treasury to print more notes to simply give them or return the excess reserves to US depository institutions. The former is the EXACT SAME as the U.S. Treasury printing money in the Bureau of Engraving and Printing and buying treasuries from the Bureau of the Public Debt. THAT is printing money, and it's immediately dilutive to the strength of the US dollar.
The latter case is far more plausible, though exceptionally unpalatable. The Fed could return excess reserves to depository institutions, though it has never before done so. That would basically be the same as a complete unwinding of QE1 & QE2 all at the same time (since, as I said above, most of QE resulted in stockpiling of excess reserves held at the Fed). Think of it this way--mostly, the Fed is meant to slap the markets around a bit through open market operations. That implies buying or selling treasuries in exchange for cash. It's how they control the velocity of money. Returning excess reserves to banks to eliminate balance sheet problems through wishing away the Fed's assets is the exact same as selling a shitload of treasuries all at the same time.
And I'm not wrong on this. The $1.6 trillion of debt we're talking about the Treasury owing the Fed. It's entirely comprised of excess reserves. Take a look at this:
http://www.fixedincomelive.com/2011/06/07/where-oh-where-are-those-exce…
$1.6 Trillion in excess reserves at the moment. Not a coincidence.
As such, QE actually REDUCED the velocity of money in circulation. But it had all of you short bus-riding, extra chromosome having Neanderthals thinking it did the opposite. It's because you fools learn your finance from CNBC. The people on camera aren't meant to know much. Not really. Do your homework. I'm actually really angry with the utter lack of knowledge I've seen in these posts.
We were talking about a VERY simple balance sheet issue. All of you should have been able to figure this out. Read a fucking book.
ey,
I also take a dump while looking at the GS Careers Website
simultaneously? that takes talent.
http://www.ritholtz.com/blog/wp-content/uploads/2011/07/debt-ceiling-pr…
dazedmonk, the ISDA disagrees: http://www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/07/05/bloomberg13…
Ed, read this article by Rand Paul. Good read...
http://www.randpaul2010.com/2011/07/senator-paul-floor-speech-on-washin…
This is just off the top of my head, but I think the term "tear up the debt" makes the solution sound more elegent then it really is. What would really be happening is that the US Govt would default on 1.6trln worth of debt that is currently held by the Fed. Because the Fed is leveraged massively (i think the NY Fed runs like 35-1 leverage) I am pretty sure this default would entirely wipe out the capital of the Fed, which would have to be bailed out/recapitalized if it were to continue in its current function. Also I am pretty sure the rating agencies would consider this a default and the US credit rating would be impaired. Foreign holders of US Treasuries would also probably freak out and start unloading US debt and we all know the death spiral from there...
I could be wrong about the above but thats my first thougth about why its not feasible...
Fed runs 51-1 leverage, Data from May 2011
Also, to the above poster who rants about the Fed not printing money...yes the Fed does not actually print money, but they instruct the Treasury as to how much to print. The Treasury prints at the behest of the Fed...in effect the Fed "orders" currency from the Treasury. So while the Fed does not print money, they do control the amount of hard cash in circulation and the fact that they dont do the printing is somewhat of a technicality.
Also, just because the fed has always had a matching asset for every liability doesnt mean that QE was not something new in the US. Massive expansion of the Fed balance sheet exposes the bank to all kinds of risks including poltical risks such as the Ron Paul plan above...just ask JC Trichet who bought PIG debt and now faces the possibility of that debt being defaulted upon. If things go the wrong way the ECB could need a recpitalization at some point and its independence could absolutely be compromised in the process....the same thing could happen at the Fed if things go wrong. To just say that QE is normal and the Fed can remain in control of everything with such a large balance sheet is totally disresctful to the unkowns of the future and even to what is going on right now in the present. Unfortunately, i think Bernanke shares your arrogance.
I don't think anyone here was talking about printing (or minting) physical currency, but great explanation with regards to the excess reserves brother bear
Goodbread, what I was saying is that one way or another the terms of any CDS should be clear on what constitutes a material credit event that would trigger payments. Get your point though that the bailout could be structured specifically to avoid triggering the standardized agreements used for (most?) of them.
Greg Mankiw on Ron Paul's proposal: http://gregmankiw.blogspot.com/2011/07/good-exam-question.html
My solution, cut defense spending back to 2000 levels. In 2000, TOTAL defense spending was just over 300 billion. Today, the DoD spends 700 billion, by itself. Don't forget that we also have a a new federal department and tons of "defense" spending that is essentially for spying on Americans. Total defense spending last year was over 1 trillion dollars. Tell me, are we safer today than in 2000? I don't think so.
Barry Ritzholtz
http://www.ritholtz.com/blog/wp-content/uploads/2011/07/graph-images-ed…
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