A Modest Proposal: Why Doesn’t the Fed Forgive the Debt?

Categories: History & Geopolitics
W. Bradford McMillan, CFA, CAIA

I’ve been reviewing my posts and articles from the last time we went down the debt ceiling crisis road, and I’ve been marveling a bit. Trillion-dollar coin indeed! That post proved to be prescient in a lot of ways, although 10 months early. The options I outlined there remain the most probable this time around, but no one has been trotting them out so far. Instead, the discussion has revolved around how to make payments once we run out of money.

I don’t like the spirit of despair that this kind of planning reflects, and I think I have a better idea about how to solve the problem. It requires no issuance of coins, no scrip rather than cash — although the difference is small — and no constitutional confrontation.

It is simplicity itself: Have the Federal Reserve forgive the Treasury debt that it owns.

Once the debt is forgiven, it goes away. Poof! The Treasury immediately has more room under the debt ceiling to issue new debt, and actual debt service costs remain the same on a net basis because the Fed was rebating the interest payments to the Treasury anyway. The debt ceiling is no longer a burden, at least for a while — which could be a long time, depending on how much debt the Fed forgives.

Frivolous arguments can and will be made against this proposal, of which four deserve comment, if only to refute them.

  • It amounts to monetizing the debt. Very true, but hasn’t that ship already sailed? The difference between the Fed injecting money by buying securities and holding them for years, possibly until maturity, and holding them forever (i.e., forgiving them) is minor in the grand scheme of things — especially since the Fed already rebates interest payments. The net monetization will be in the interest payments, which is small.
  • It will be inflationary. This point follows directly from the first and, from the Fed’s perspective, can actually be viewed as a benefit. The Fed has a stated policy of boosting inflation, and it has not yet succeeded. If this plan did generate significant inflation — which it probably wouldn’t, again per point 1 — it would play into the Fed’s current policy goals and could always be addressed later with interest rate policy.
  • The Fed will become insolvent if it forgives the debt. The difference between the Fed becoming insolvent in this way as opposed to becoming insolvent when interest rates rise is a question of months, not years. The solvency of the Fed has always been a notional issue, and planning is well along for exactly that event when rates rise. Insolvency is inevitable; the question is whether the country can benefit from it.
  • There is no end to this kind of policy! As opposed to the current, open-ended quantitative easing approach? This plan would, of course, be a one-time event, justified only by the current emergency conditions — just like the original QE.

Clearly, this is the one policy action that can solve the present problem. Are there obstacles? Of course, multiple ones — legal, operational, and no doubt, moral.

The clear benefits, however, justify surmounting the obstacles as quickly as possible. At that point, Congress could come together in a spirit of civic compromise and solve the spending problems without worrying about an impending deadline so that we never have to face this kind of dilemma again.

4 comments on “A Modest Proposal: Why Doesn’t the Fed Forgive the Debt?

  1. Lance Durham said:

    Jonathon Swift penned ‘a modest proposal’ as satire designed to get the rich to help the poor; is this the same? Because inflation has a funny way of hurting people on fixed incomes and being mostly OK for the stockholder class.

    While the debt is already ‘monetized’, it has been monetized at a low ‘velocity of money’. This is why it has not really created vile, inflationary problems. In fact, it is what we needed to prevent deflation.

    However, if the velocity increases and the money never returns to the FED to be destroyed, it can create exactly the inflationary problems we associate with ‘monetization’.


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  3. Ben said:

    1. The Fed cannot be insolvent for the very reason it exists; to print money. How can one be insolvent if you create currency? Simply Ctrl+P and pay back

    2. Deflation is required as part of the natural boom and bust cycle. Household debt in the US is extreme and has to be either (a) paid back or (b) written off. These 2 options will decrease the money supply resulting in deflation. US private household debt totals $42 trillion… mainly to a generation heading on to retirement. Paying back there debts is going to be number 1 priority. The force of this will far outweigh QE measures. Since 2010 Fed has printed $2 trillion to try and artificially stimulate growth. People don’t make decisions based on economic theory like the Fed does. Time to bring in the helicopters Ben

  4. Pingback: 3/4/14 – Back to the U.S. Budget | The Independent Market Observer

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