In hopes of extracting concessions from the rest of us, radical anti-governmental elements of the GOP have taken the nation’s debt limit hostage and are threatening to seriously harm America’s financial system. The last time they did this, they obtained the sequester as their concession. R.J. Eskow thinks that this time the president will again offer cuts to Social Security and/or Medicare benefits. The point of this diary is to analyze and evaluate the president’s alternatives to such
caving “grand bargaining.”
Background. Per Article 1 Section 8 of the U.S. Constitution: “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; … To borrow Money on the credit of the United States; To coin [issue] Money, regulate the Value thereof … .” And, per Section 9, “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law.” In other words, Congress controls the purse strings.
But, Congress delegated much of that power, with restrictions, to the Treasury. And, in 1913, following the pattern of the rest of the world at that time, Congress created the Federal Reserve (Fed) to be the central bank of the U.S., and delegated various powers to it, including the power to issue money. Per the Wikipedia: “A central bank, reserve bank, or monetary authority is a [state-mandated, not-for-profit] institution that manages a state’s currency [including coins], money supply, and interest rates … also usually oversee the commercial banking system of their respective countries.” Central banks also provide banking service to financial institutions including commercial banks and various government entities.
The 2014 budget hasn’t been finalized but, per the Wikipedia, the 2013 budget had $3.8 trillion in appropriated expenditures, of which $2.3 trillion are mandatory, and $2.9 trillion in projected revenue, a deficit of $0.9 trillion (5.5% of GDP). That revenue comes in at the rate of $7 billion per day, mostly from income-tax withholding.
Interest on the national debt was $0.4 trillion (14% of revenue). Visibly, there would be no excuse for missing an interest payment. Moreover, when Treasury securities are cashed in, they can be rolled over, i.e., new debt can be sold to pay off their principals, which instantly disappear from the national debt. There has been way too much crazy talk about the specter of a U.S. debt default. For this looming crisis, “U.S. debt defaults” are the new “mushroom clouds.”
The alternatives for circumventing the debt-limit law (31USC3101) fall into four general categories: (1) cancelling some Fed-held government debt, (2) coining new money, specifically platinum-coin seigniorage (PCS), (3) selling negligible-debt securities, (4) ignoring and/or challenging the debt-limit law.
(1) Cancelling some Fed-held government debt was proposed by Ron Paul in 2011 to circumvent the debt limit by giving the Treasury headroom to continue borrowing. Dean Baker endorsed that proposal, but most other commentators criticized its economic soundness and/or moral propriety. I suspect that this maneuver would be illegal, but the only such claim I’ve seen is this comment by letsgetitdone.
There is a prevalent and (IMHO) incorrect notion that Fed-owned Treasury debt is, in effect, cancelled when it matures. Per the Wikipedia:
The government treasury must pay off government debt either with money it already holds or by financing it by issuing new bonds which are sold to either the public directly or the central bank, in order to raise the funds required to repay bonds that have come due. The central bank may purchase government bonds by conducting an open market purchase, i.e. by increasing the monetary base through the money creation process.
If government bonds that have come due are held by the central bank, the central bank will return any funds paid to it back to the treasury. Thus, the treasury may ‘borrow’ money without needing to repay it. This process of financing government spending is called ‘monetizing the debt’.
Central banks are usually forbidden by law from purchasing debt directly from the government. [This is so for the Fed] For example, the Maastricht Treaty (article 104) expressly forbids EU central banks’ direct purchase of debt of EU public bodies such as national governments. Their debt purchases have to be from the secondary markets. Monetizing debt is thus a two-step process where the government issues debt to finance its spending and the central bank purchases the debt, holding it till it comes due,
and leaving the system with an increased supply of money.
This above quote is excellent background, but the portion that I have struck out violates a basic principle of bank accounting: payments on the principal of a loan vanish into the same thin air from which the principal was originally loaned — that money no longer exists and hence cannot be “returned to the Treasury.” (Interest payments, on the other hand, are considered profit of the Fed, all of which is periodically remitted to the Treasury.) FWIW, the way the bank “vanishes” that money is by decrementing the value of that asset (e.g., loan) on the bank’s balance sheet and decrementing the same amount of credit from the account on which the payment is drawn, which is a liability — the books still balance but the money (credit) is gone, and the mind is left reeling.
So what happens if the Fed holds a bond to maturity? In that case, the Fed presumably receives the principal payment from the Treasury and then sends that back to the Treasury too. In effect, the government has simply canceled its own debt.
It can certainly be argued that it shouldn’t cause a ripple, that once the Fed has bought US bond with newly created money, the debt has already been canceled. But central banks like to do these things, step by step, as quietly as possible, and Bernanke has once again succeeded in making radical policy sound so boring that everyone slumbers as he announces it.
Lewis also mentions that:
When Adair Turner, a candidate for governor of the Bank of England last fall, said that the BOE would consider canceling some of the government’s bonds, this was considered a bit shocking, and the job went to Mark Carney instead. Now Bernanke has in effect announced an intention to cancel US bonds, and it doesn’t cause a ripple.
I have no idea why Lord Turner, then head of Britain’s Financial Services Authority, made that recommendation; the U.S. and Denmark are the only countries that have debt-limit laws.
- The concept is very simple and intuitive and involves no accounts other than those of the Fed and the Treasury — no private-sector accounts are involved.
- No new money gets printed, minted, or coined (other than that which was generated when the Fed originally purchased those bonds).
- If a central bank cancels too much of its treasury’s debts, it could end up with a negative balance, which would certainly cause a scandal if not a crisis — for example, see this by Joe Weisenthal at Business Insider.
- When debt gets cancelled, the Fed no longer has those bonds to sell back to the open market in order to raise interest rates. But, the Treasury can always auction more bonds to raise the interest rates, provided that it has sufficient headroom under the debt limit.
- It might not be legal. And, at a minimum, it will likely require the consent and cooperation of the individual Federal Reserve Banks.
(2) Platinum-coin seigniorage (PCS). It is a quirk of U.S. central banking that the Fed buys its coins from the Treasury and pays face value for them:
[W]hen the Fed receives currency from the Treasury, it pays only for the cost of printing the notes. However, coins are a direct obligation of the Treasury, so the Reserve Banks pay the Treasury the face value of the coins.
The Treasury has been funding a portion of congressionally appropriated expenses through that markup (seigniorage) on coins ever since the founding of the Mint in 1792 — that portion was roughly ten-billion dollars in 2012.
Historically, Congress has specified a small face value (denomination) for the coins that it authorized the Treasury to mint, which placed a de facto practical limit on the amount of such money that the Treasury could issue. But, in 1996, Congress pass 31USC5112(k), which allows the Secretary of Treasury to specify whatever denomination he/she pleases for platinum coins and, thereby, removed all limits on the amount of money the Treasury can issue and deposit into its “General Account” at the Fed (the TGA), from which it ultimately pays the government’s bills. Here (in order of decreasing likelihood of adoption) are some options regarding what to do with this platinum-coin seigniorage (PCS):
- The minimalist option is to buy some bonds back from the Fed instead of cancelling them. This option has the feature that it does nothing to private-sector accounts, and Paul Krugman has suggested a variant wherein the Treasury buys the platinum coins back from the Fed with borrowed money as soon as the debt limit is lifted, in which case all accounts, both governmental and private, wind up exactly where they would have been if the debt limit had been raised earlier.
- The pragmatic option is to pay the government’s bills with the proceeds from PCS and to borrow however much is both permissible and deemed optimal.
- The maximalist option, proposed by letsgetitdone, is to use PCS to pre-fund the TGA with $60 trillion thereby notifying everyone that we are not broke and won’t be for decades to come — also to provide near-term insurance against repeal of 31USC5112(k).
So, let’s do the pros and cons:
- PCS cannot put the Fed into a negative balance, as debt cancellation can.
- The Krugman variant doesn’t touch any private accounts and leaves governmental accounts where they would have been had there been no debt limit. So, it can’t introduce any new risks of inflation.
- The legality of PCS has been meticulously documented in Joseph Firestone’s recent book. The key facts are: (1) ever since 1792, revenue from coin seigniorage has funded a portion of government spending and (2) the wording of 31USC5112(k) is unambiguous:
(k) The Secretary may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time.
Some complain that 31USC5112(k) was intended only for low-value commemorative coins, but unintended consequences are a long-accepted fact of life in statutory interpretation. Per the Wikipedia:
U.S. Supreme Court: “We begin with the familiar canon of statutory construction that the starting point for interpreting a statute is the language of the statute itself. Absent a clearly expressed legislative intention to the contrary, that language must ordinarily be regarded as conclusive.:” Consumer Product Safety Commission et al. v. GTE Sylvania, Inc. et al.,447 U.S. 102 (1980). “[I]n interpreting a statute a court should always turn to one cardinal canon before all others. . . .[C]ourts must presume that a legislature says in a statute what it means and means in a statute what it says there.” Connecticut Nat’l Bank v. Germain, 112 S. Ct. 1146, 1149 (1992). Indeed, “when the words of a statute are unambiguous, then, this first canon is also the last: ‘judicial inquiry is complete.’” 503 U.S. 249, 254.
- The Budget Control and Impoundment Control Act of 1974 requires the president to conduct all expenditures of any given budget, but 31USC3101 (the debt-limit law) denies him/her the power to cover that budget’s deficit through borrowing. Those two laws would be mutually contradictory were it not for 31USC5112(k), which provides an alternative way to cover that deficit, namely PCS.
- Fear of inflation #1: PCS involves the overt printing (minting) of money, which immediately engenders knee-jerk fears of runaway inflation. But PCS has no effect on spending; the president has to make all and only the expenditures that Congress appropriates. (And, contrary to popular belief, appropriations do not allocate funds, and that’s where taxation, borrowing, and the coining of money come in.)
- Fear of inflation #2: Krugman (among others) believes that borrowing from the non-bank private sector provides a buffer against inflation by replacing dollars with Treasury securities (e.g., T-bonds), which are presumably harder to spend. MMTers point out that there is an efficient market for converting bonds to bank-issued money, created from thin air, just like PCS. So whether Net Financial Assets are held in the form of dollars or T-bonds makes no difference. Krugman counters that in that case, the Fed couldn’t manipulate interest rates by buying and selling T-bonds. Other economists have pointed out to me that, at the onset of inflation bonds lose their value much more quickly and severely than do dollars, as interest rates shoot up. I think that’s a valid point but have no idea as to how significant that buffering might be. Under Krugman’s variant of PCS, once the debt limit is reach, total value of treasuries held by the private sector would dwindle, as they mature and get cashed, but would quickly be restored once the debt limit is lifted.
- Fear of looking weird to the rest of the world and jeopardizing the dollar’s status the world’s reserve currency. PCS depends on two nonstandard quirks of the U.S. monetary system: (1) our central bank pays our treasury face value for coins and (2) there’s no limit on the face value our treasury can place on platinum coins. The same effect can be obtained by most any central bank through quantitative easing (QE), which involves buying treasury debt on the open market. The only difference is that PCS is not posted as debt, even though its a liability.
(3) Selling neglibigle-debt securities, e.g.:
- Short-term options on U.S. government property to the Fed. Per Yale law professor Jack Balkin:
The government … could sell the Federal Reserve an option to purchase government property for $2 trillion. The Fed would then credit the proceeds to the government’s checking account. Once Congress lifts the debt ceiling, the president could buy back the option for a dollar, or the option could simply expire in 90 days.
Granted, such options contributed nothing to the national debt. But, the sale of government property is notoriously cumbersome business, and the Fed must make its purchases and sales on the open market. Also, if the Fed sells the option back to the president for a dollar or lets it expire, we have the same problem that we have with cancelling debt, a big loss of capital by the Fed.
Premium bonds, which are those whose interest rates are sufficiently high relative to their principal that they are expected to sell at a premium (i.e., negative discount), bringing their full issue price (principal plus premium) to the Treasury while adding only their principal to the national debt. Per the debt-limit law (31USC3101):
(a) In this section, the current redemption value of an obligation issued on a discount basis and redeemable before maturity at the option of its holder is deemed to be the face amount of the obligation.
(b) The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than …
(c) For purposes of this section, the face amount … of any obligation issued on a discount basis that is not redeemable before maturity at the option of the holder of the obligation is an amount equal to the sum of — (1) the original issue price of the obligation, plus (2) the portion of the discount on the obligation attributable to periods before the beginning of such month (as determined under the principles of section 1272(a) of the Internal Revenue Code of 1986 without regard to any exceptions contained in paragraph (2) of such section).
The trick is to sell, on a discount basis (e.g., at auction), bonds that are redeemable and thus subject to Section (a). If they have a high enough interests rate (coupon) to get a premium (negative discount), their face value gets added to the national debt, but the Treasury gets to pocket the premium as well, with no additional debt. Matt Levine at dealbreaker.com goes into the details regarding the government rules that apply to premium bonds.
The interest on premium bonds that get bought by the Fed gets remitted to the Treasury. But the Fed would suffer some loss of capital, since the value of such a bond would decline from its issue price to its face value over its term (lifetime). So from the Fed’s perspective, the longer the term, the better. And, in some other countries, e.g., Britain, there are variants of premium bonds, known as perpetuities or consols, that have infinite terms, which would be beneficial in the case of the Fed.
Standard consols are callable, irredeemable bonds with no maturity date and no principal. All of their interest is guaranteed by the government; and it is vacuously true that the government guarantees every dollar of their principal. So, Section (b) applies. Also, any security sold at auction is de facto sold on “a discount basis” — the discount being the principal (in this case $0) minus sale price, and negative discounts are called “premiums.” So, Section (c) applies, and the “face amount” is at least “the original issue price of the obligation.” However, beowulf, who is an excellent lawyer and introduced the idea of using standard consols to circumvent the debt limit, claims that they are not subject to the debt-limit law.
Let’s look at the pros and cons:
- Premium bonds entail little-or-no loss of capital by the Fed.
- There is international precedent for buying and selling premium bonds.
- Premium bonds do not require the use of any quirks of the U.S. monetary system.
- Premium bonds do not necessarily involve the Fed, except that the proceeds from their sale wind up in the Treasury’s General Account at the Fed.
- Options to purchase property have to be sold to the Fed via the open market somehow and involve a significant loss of capital by the Fed.
- More research need to be done on the legal issues surrounding both premium bonds and standard consols.
(4) Challenging the debt-limit law:
“31USC3101: [T]he face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than $14,294,000,000,000, outstanding at one time.”
It is claimed that, unless the Treasury obtains money by further borrowing and/or some other means, e.g., PCS, there will eventually be a violation of Section 4 of the 14th Amendment (“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned … .”) Unfortunately, only outstanding Treasury securities are considered to be “public debt,” other obligations such as accounts payable are not. And, as I showed in the background section, 14% of the revenue stream can cover the interest payments on Treasury securities (treasuries), and the principal payments can be covered by rolling them over. And that goes for treasuries held by the various government trust funds, e.g., for the near and medium term Social Security payments can be cover via in-coming revenue and rolling cashing some of the Treasury bonds held in the SS Trust Fund.
Some recommend that the president appeal to “exigent circumstances” and/or to the apparent conflict between the debt-limit law and the Impoundment Control Act of 1974 and continue selling treasuries in violation of the debt-limit law, defying Congress and the courts to stop him. There are precedents, including the Louisiana Purchase by Jefferson, the suspension of Habeas Corpus under Lincoln, and the internment of Japanese Americans under Roosevelt.
- If the debt-limit law 31USC3101 were struck down, it could never be taken hostage again, and the world’s economic system would be much safer.
- As mentioned in the background section above, I see no excuse for defaulting on public debt in violation of the 14th Amendment, given currently projected revenues.
- To get the 31USC3101 struck down, someone whose invoice didn’t or wouldn’t get paid because of the debt limit would have to take the case to court. And that’s a long and tedious process.
- If the president continued selling Treasury securities in violation of the debt-limit law, who would purchase them given their dubious legality? And how much they would pay? Perhaps, the Fed could somehow buy them up at an artificially inflated price, but I wouldn’t count on it.
Conclusion. Debt cancellation and expiring options diminish the Fed’s capital, so the Fed and/or the commercial banks that hold stock in the regional Federal Reserve banks would likely resist either of these and have a sound case for doing so.
IMHO, the Executive Branch should immediately announce who will not get paid when the debt limit is reached. That list should include some powerful entities that can get the matter into court by seeking an injunction and from there attack the validity of the debt-limit law with assistance of the DoJ. But that will be a slow and tedious process.
That leaves PCS and premium bonds as the only viable options to circumvent the crisis. I’ve not yet studied such premium bonds enough to recommend them. But I do recommend the Krugman variant of PCS simply because IMHO it has the highest likelihood of adoption; once it has been demonstrated that the debt-limit has no teeth, there will plenty of time to decided whether and how best to further exploit the government’s ability to print money through platinum-coin seigniorage (PCS) and quantitative easing (QE).
Also, until 31USC3101 is struck down or repealed, I recommend that no president ever again sign a budget or appropriation bill that lacks an amendment raising the debt ceiling enough to cover the resulting revenue-deficit. (Note that PCS is revenue.)
Final note. On 10/02/2013 under the title “Can Obama Ignore the Debt Ceiling?” the New York Times has published the opinions of six scholars. I particularly like the one by James K. Galbraith and disagree with the one by Eric Posner.
Also, there’s this by Mark A. Patterson, a fellow at the Center for American Progress, who was chief of staff at the Treasury Department from 2009 until May 2013 and insists that the Executive Branch has no options. With respect to PCS, he claims:
But, as the law’s sponsor, former Rep. Mike Castle (R-Del.) has pointed out, the law was intended only to provide for minting of commemorative coins for collectors. The argument that it can be stretched to trump the debt-limit law, which is a direct exercise of Congress’s borrowing authority under the Constitution, is weak. And in any event, as the Treasury determined after consulting with the Federal Reserve, the Fed would not cooperate in such a maneuver.
The First Amendment was not intended to allow us to watch porn on our iPads, but it has been interpreted that way. And, PCS adds nothing to the national debt and would exercise powers explicitly and unambiguously delegated by Congress to the Treasury. Patterson was chief of staff under Tim Geithner who likely did not want to see the
Washington Kabuki Grand Bargaining disrupted by some round chunk of metal.
Acknowledgement. This post has been inspired and informed by the many excellent postings of letsgetitdone on this and related subjects, e.g., here and here. I take full credit, however, for all errors and misconceptions contained herein.
UPDATE: In 2011, the debt limit was raised to $16.4 trillion but I’ve not yet found the exact legislation.