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Background. Currently, the Treasury sells bonds, notes, bills, etc. (treasuries) to cover deficits. I propose that we simply decouple those activities, i.e., that we sell whatever amount of treasuries is optimal from an economic perspective taking into account interest costs, inflation, interest rates, etc. And, that we then cover any remaining deficit with freshly issued Treasury dollars, which is permitted by existing law.
Problems with the current policy. First of all, the U.S. government currently pays about $500 billion per year in interest on the national debt, and that will significantly increase when interest rates return to their normal levels. Secondly, “our crushing mountain of debt” is used as an excuse for cutting government benefits and services for the 99%. Third, the GOP Tea Party repeatedly tries to use the debt limit to force the cutting of government benefits and services for the 99%.
What about inflation? There is an on-going debate over the proposition that wealth in the form of treasuries is less inflationary than the equivalent amount of wealth in the form of dollars. There can be no doubt that there are delays and costs in liquidating treasuries for dollars, which are the very definition of “liquidity” and that those will increase in times of inflation. From there, however, it becomes an empirical question: How much do those delays and costs inhibit inflation? My proposal is that we sell the optimum amount of treasuries taking all such economic factors into account.
What if current policy turns out to be economically optimal? Even so, it remains suboptimal to let the GOP Tea Party crazies hold the nation’s credit rating hostage to their agenda of impoverishing the middle class. All I’m asking for is that Obama use existing law to go around them. And, there is no down side unless he shares that agenda. During the campaign, he needs to be asked:
Mr. President, if the GOP Tea Party again tries to hold the nation’s credit rating hostage to their agenda of impoverishing the middle class, will you direct your Secretary of Treasury to use his authority under Title 31 Section 5112 Item k to issue money to pay the nation’s bills?
UPDATE: Here is a concrete implementation plan. Since the possibility of inflation is the only the argument against funding deficits with Treasury-issued money and the Federal Reserve is the agency charged with controlling inflation, let’s let the Fed decide how many of which kind of treasuries to sell. In fact, let’s put them in charge of selling them, with the proceeds going directly to the Treasury just as now. After that, we’d cover any remaining deficit with “freshly issued Treasury dollars.”
UPDATE 2: Couldn’t the same thing be done via “quantitative easing”? Quantitative easing involves the purchase of treasuries on the open market with freshly issued Fed-dollars (a.k.a. “reserves”). But:
- Treasuries owned by the Fed still count toward the debt limit, so the GOP could still hold the U.S. credit rating hostage.
- Although interest paid on Fed owned treasuries flows back to the Treasury at the end of the year, some amount of overhead is taken by the Federal Reserve banks.
- The Fed cannot purchase treasuries at auction. Rather it must purchase them from a dealer, which involves various fees.
If the Fed were to buy up all treasuries in excess of the optimum, the two plans would be equivalent except for the three bullet points above.
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The problem with the federal budget and its deficit is that there is no separate capital budget. And there is no asset account, because valuation of federal assets is almost impossible. How much is the National Park System worth? How about all of the land in the West that has never been granted but is currently leased? There are Constitutional reasons why budgets are this way, but any approach to the issue that ignores this background is sure to get mired down in faulty analogies with the way business manages money (or households manage money).
The Federal Reserve, not the Treasury, currently is responsible for controlling inflation through use of its Open Market Committee mechanisms. Treasury is responsible for the debt, although the Federal Reserve uses lending and repayment from the Treasury as part of its manipulation of the money supply. And Treasury uses the Federal Reserve as a lender of last resort.
The problem of the interest on the national debt is a serious one because it constitutes a $500 billion transfer payment to the holders of the national debt, who are either foreign governments, government agencies like the Social Security Trust Fund, wealthy individuals, or corporations who wholesales, retail, or hold the government securities–which then have an aftermarket related to the expectations of future national debt or repayment. Except for the interest on the $3 trillion of the national debt held by the Social Security Trust Fund, the interest on the national debt is pretty much a dooH niboR (reverse Robin Hood) mechanism of, say, $300 billion of trickle-up each year. The interest-rate compounding is implicit, not explicit in the accounts. So we really don’t know how much compounded interest we inherited from Bush’s blowing a hole in the Clinton surplus. Or how much the debt reflects the compounding from the last time the US had a balanced budget.
By not having a capital budget, years of high infrastructure investment that lowers the cost of doing business in the economy can be pawned off as profligacy. And wars, which represent the destruction of previously created assets and inventories, can be counted as economically helpful.
So, what if only domestic capital expenditures could be financed by debt. And non-capital and military capital expenditures financed by printing of money, but within a balanced budget, including debt service. (We have a lot of military capital assets, such as bases, that we could very well sell to finance new military capital spending.) That would be a reasonable way to a mixed system like you propose.
First of all, how does the newly created Treasury money get distributed? The obvious first mechanism is through the federal governments purchase of goods and services, including its civil service payroll. That seems perfectly matched to expenditures, but if there is underlying inflation in the economy, say from the private sector’s creation of “free money” though a bubble, how would the federal government, which now has to pay inflated prices and thus issue more Treasury money be able to avoid spiraling costs? And how does the fact that federal money tends to encourage private featherbedding and fraud going to be dealt with? Note that featherbedding and fraud are inherently inflationary – it takes more money to buy the same real goods and services. Not that we don’t have that issue now.
The housing bubble is proof that issuing money as debt doesn’t fight inflation. Especially when you issue it, allow derivative securities, and don’t regulate the money that is created through those securities. (Did I say that featherbedding and fraud are inherently inflationary?)
Coming back to my first question about distribution, a second but less obvious way is to buy back the national debt with those issuances of Treasury money and time the repurchases to keep the money supply from outstripping the stable value of real production.
The second question is should it be the policy of the Treasury to try to manage full employment and inflation through the size of the federal budget? I have already argued for a policy of keeping the issuance of money inflation-neutral. But should this be seen as a tool for managing the economy? This is where the Treasury would have to be concerned about the relation between the timing of the release of money and the timing of the delivery of the goods and services resulting from that infusion of cash into the economy.
I would like very much for President Obama to be asked that quoted question in your last paragraph. It would show that the questioner had done their homework and it would introduce actual policy discussion into the debate. Two reasons I’m not holding my breath in expectation.
Hey TD. Thanks.
Regarding the question of how Treasury money would be distributed, that money would be deposited into the Treasury’s general account at the Federal Reserve from which the Treasury pays the government’s appropriated expenses. There it would be co-mingled with tax revenues and the proceeds from the sale of treasuries. Recall, that an “appropriation” is (only) permission to spend from that account and doesn’t put money into it. So, in a word, the Treasury dollars would be “spent” into the economy through payment of the government’s appropriated expenses.
Among the expenses that Congress could appropriate would be paying down or paying off the national debt, i.e., purchase of outstanding treasuries, probably via the Fed, which already owns about 11% of the outstanding treasuries (i.e. national debt).
Background:
Only permitted through using Proof Platinum Coin Seigniorage (PPCS). Otherwise treasury doesn’t have the authority.
Problems with the current policy:
Right now interest costs are running at about $200 billion, if I’m not mistaken. I expect the FY to end with no more than $250 B in costs. This corresponds to an average interest rate of about 1.5% on the debt.
What about inflation?
It is an empirical question, but factors suggesting that bonds are more inflationary than cash include: bonds can be leveraged moe than once as collateral in borrowing; and also, the $250 B interest paid on bonds is an injection of new reserves into the private economy; so that’s inflationary.
What if current policy turns out to be economically optimal?
Then I agree that politically it’s still sub-optimal because people freak out over the debt.
But the three bullet points are important, of course.
Thanks for the feedback.
As I mentioned earlier, IMHO coins are shiny objects that distract from the topic at hand. But, in the putative question to Obama, I did specifically cite “Title 31 Sect. 5112 Item k.”
Possibly so. The numbers I got from the Wikipedia were $404G, $433B, $454B, and $381B for 2006, 2007, 2008, 2009. Your data is likely more recent.
Once that direct coupling between deficits and borrowing is severed, we will necessarily get into the fine points of what amount of federal borrowing is optimal. But, I’d prefer to fight one battle at a time.
On the interest costs: the debt has been going up, but the average interest rate is very much lower than in 2009. There’s a huge amount of 3 month debt being floated and the overnight rate is near zero. So the three month rate is falling to under 1% and that’s a lot of the total debt. $59 T in debt has been redeemed this FY through 8/16/12.
$59T of what debt, redeemed in what sense? Are we talking about the paying down or refinancing of household debt? If so, that’s wonderful.