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?