Ron Paul Suggests Using Fed to End Run Debt Ceiling Impasse

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The only reason to think Republicans are serious about their threat to have the Federal government default rather than raise the debt ceiling is that they have an undue fondness for apocalyptic outcomes. I suppose I should actually favor this sort of thing; I’ve long thought the only hope for getting the US freed from rule by financiers was another financial crisis, provided it came soon enough and it was big enough. This one might fit the bill on those scores.

However, with the immediate trigger being pigheaded Congressmen, the banks might look like innocent victims, when the ballooning of public debt around the world was the direct result of their recklessness and the resultant global economy near-death experience. So a debt-ceiling-row-induced great big financial dislocation would probably not produce the opportunity to break the power of banks that yours truly and many others are looking for.

As the hour of reckoning approaches, more and more creative ideas to disarm the Republican weapon are being put forward, and an intriguing one comes from, of all places, a Republican, Ron Paul. As described by Dean Baker in the New Republic last week, Paul’s plan is simple – have the Fed cancel some or all of the Treasuries it got via its quantitative easing programs:

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. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.

Baker points out a second benefit. Canceling the bonds The only use the Fed had for those bonds was to eventually sell them back to the public to soak up liquidity when it started worrying about inflation. But the Fed can achieve that end the old fashioned way, by raising reserve requirements.
So getting rid of the bonds formally in one stroke really would reduce the debt level, because it saves the interest payments that would have been made to investors after the Fed’s Treasury bonds were sold back in the open market.

The Baker discussion says Congress would have to approve this maneuver, and that would seem to put everything back at square zero. But perhaps not. I’m not terribly conversant with the fault lines within the Republican camp, but Ron Paul has a great deal of appeal with voters. The fact that he’s willing to put out a clean, viable third option may suggest that he is not alone in recognizing that his fellow party members are playing Russia roulette with all chambers loaded. And as one of the Fed’s longest-standing critics, for him to say, effectively, that some of the Federal debt has effectively been monetized, why not quit pretending otherwise, is close to a Nixon comes to China moment.

Paul’s gambit is also a clever way to hoist the banks on their own petard. The deficit hysteria has in no small measure been driven by the banks as part of a desire to enforce their new program of insulating bondholders from losses, including those of inflation. State support for policies like that amounts to socialism for rentiers, since the reason bonds pay more interest that Treasury bills is interest rate risk and credit risk. If investors want a premium yield, they should expect to bear the hazards which go with them.

I hope Paul prevails. When a Congressman who has often been depicted as a wingnut has the best idea in the room, you know a serious house cleaning is in order.

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    1. ScottS

      I think the needle on my irony-meter was just pegged.

      It’s quite obvious we are living in a particularly bad Hollywood movie. “You mean the government just destroys its debt to itself? That’s just crazy enough to work! Quick, to the Fed! Bring the Bat-Papershredder.”

      1. Don

        as an additional benefit, it opens up a new game: how much money can the fed print, use to buy debts (of any flavor from any seller), then cancel those debts making everyone instantly totally solvent?

        let me get my garden rake. helicopter ben is being told to make it rain.

      2. Cugel

        THERE IS NO CRISIS! Hence no need for any creative solutions.

        It’s all Kabuki Theater with the outcome having been pre-determined back in 2010 when Obama chose to agree to extending the Bush Tax cuts.

        Cantor told his caucus back in January that “of course” they will have no choice but to raise the debt ceiling. Their Wall Street donors will permit nothing else for one thing — he was publicly admitting that it’s all a huge bluff in order to “reassure the markets.” They don’t want a repeat of last time when the stock market tanked after Congress rejected the first TARP bill.

        Obama has already agreed to everything Republicans demanded 3 months ago. The percentage of benefit cuts versus phony tax loophole closings (that will be evaded or immediately recreated by Congress as “jobs creation measures”), the entire crap sandwich.

        But, Cantor said, despite the transparent nature of their bluff, they will still use the manufactured “crisis” to extract concessions from Obama and the Democrats. That’s why they are demanding more and more concessions.

        Ultimately they are trying to force Obama and the Democrats to shoulder the blame from angry voters for “destroying Medicare”.

        It’s working of course. Obama is now so desperate for his fig leaf that he’ll cut just about any deal — which is why Republicans are determined not to cut any deal that will give him political cover. They will come up with some worthless face-saving formula that Obama can try and sell to the public as “shared sacrifice.”

        It probably won’t be much. Then Congressional Republicans won’t vote for it anyway forcing Obama to whip reluctant liberals and moderate Dems to cut their own throats by voting to cut Medicare. After which the right-wing attack ads practically write themselves. Dems. probably lose another 20-30 seats in the House and 6-10 Senate seats, which will suit Obama fine.

        In 2013 he won’t have to deal with his angry caucus at all. He can cut all the deals he wants with the Republicans to do his “grand bargain” on eliminating Social Security — assuming he hasn’t already rammed it through in the next Congress as part of the 2012 “debt ceiling negotiations.”

        1. placebo junkie

          Good points, Cugel.

          You ever get the feeling that the big banks are looking at this blog and laughing, saying something like, “You financial geniuses continue debating the math, so long as we own the numbers.”? Oh, and “You politicians keep debating the economy, so long as we own the money.”

          If we ‘fixed’ the economy today, they would go to another sector of finance tomorrow and re-‘break’ the system, because ‘fixed’ economies are democratic, without centralization of control.

          When capitalism ceased to provide them with enough control, they withdrew capital (comparatively) and replaced it with credit; when the stock market ceased to allow them enough manipulation, they created the ‘derivative’ market and now private markets to enhance the collusion and fraud; and when the people say enough, they ‘create’ politicians who promise brilliant reforms, but well, you know the how that goes.

          And when countries realize the scheme and try to get off the dollar, they get sent back to the stone age, like Iraq. The banker says it’s so, and the pentagon makes it so.

          The value of every dollar, along with the economic math that tries to ascertain it, is of courase defined in part by its use and social meaning; however, this natural exchange is skewed by the forces of concentrated distribution, fraud, and politics (networking access).

    2. Dan G

      Principled yes. I guess a crackpotwould need to be definede defined as someone principled enough not to be bought off by special interest like the rest of the crony capitalist canidates.

  1. eric anderson

    As Denninger has pointed out — and you seem to agree with him — Paul’s plan is equivalent to naked money printing. It closes off the possibility that those bonds will ever be repaid and the money that was created to buy them neutralized, or extinguished, or whatever Fed-speak term is appropriate.

    Since Paul’s idea would be inflationary (in money supply terms, which tends to cause inflation in commodities), and Paul has been a huge critic of Fed money printing and Fed-caused inflation, his suggestion contradicts what he has been preaching for years. It seems at least more than possible that Ron Paul simply hadn’t thought this idea through very thoroughly.

    Dean Baker’s analysis may be lucid, or not. Casting the Fed as a government agency loaning another government agency money — i.e. the government creating a debt to itself — and then cancelling the debt strikes one intuitively as non-lucid as writing oneself an I.O.U. and then tearing it up. That’s a brilliantly abstract way to accomplish nothing.

    Paul’s plan is at best a legalistic answer to the debt ceiling deadline that fixes nothing in the real world. Isn’t it a desperate time-buying measure? And really, if Ron Paul keeps this up, his supporters may begin to wonder if he’s going senile. As an Iowan, I might conceivably caucus for Ron, but I would like a better explanation of just why he thinks money printing is suddenly so great, after he’s excoriated the Fed for doing it before.

    1. Tertium Squid

      But by extinguishing the bonds, doesn’t the Fed lower its balance sheet by $1.6 trillion? If it had sold those bonds into the market or retired them for interest and principal, it would have used the resulting cash as gambling money. Instead the obligation is extinguished, and $1.6 trillion less money means $1.6 trillion less power.

      I don’t see this as being so inconsistent with Paul’s philosophy. It’s more like making the Fed do an end run around itself.

      1. Cedric Regula

        “it would have used the resulting cash as gambling money.”

        Not so. They basically zero out the electronic money they got from the bond sales. That is the primary way they do monetary policy.

        In the case of interest received on the balance sheet, they turn that over to the treasury, net of Fed operating expenses.

        1. Troy

          yeah, no. You’re wrong. And I mean really, to suggest that you are somehow superior to Ron Paul on this issue, not a snowball’s chance. This man has been preaching to an unappreciative public decades before your inner activist started regurgitating bullshit talking points. No wonder this country is going to shit.

      2. Jim Haygood

        T. Squid has got it right. Shrinking the Fed’s balance sheet by $1.6 trillion is deflationary, not inflationary.

        It would shrink the monetary base to the point of leaving the Fed with negative equity, as well as rendering it unable to pay interest on reserves as it’s doing now.

        Ron Paul is to commended for creative thinking. But if this plan actually went through, you could short the S&P all the way to 400, as housing prices plunge by another 50 to 70%.

        Hello, Depression!

        1. jh

          Um, no. It’s inflationary. “Shrinking the Fed’s balance sheet” is usually deflationary, because the Fed *sells* the bonds, in the process sopping up reserves and reducing the money supply. What’s being proposed here is not selling the bonds, but simply destroying them, which would not affect the money supply one bit.

          In the long run, the inflationary pressure comes from the inability to sell the bonds as usual. Which is why the reserve requirement suggestion is made.

          Also, it’s literally impossible for the Fed to be “unable to pay interest on reserves”. The Fed can create reserves at will.

          1. Jim Haygood

            Simply destroying the bonds would, according to Rep. Paul’s proposal, create $1.6 trillion of debt issuance authority within the existing debt ceiling. At the current deficit run rate, the Treasury would end up selling $1.6 trillion of new debt to the public over the next 18 months.

            Functionally, that would be exactly equivalent to the Fed selling its $1.6 trillion of Treasury debt to the public (reversing QE I/II and then some) and turning the proceeds over to the Treasury. Selling debt to the public is regarded as ‘mopping up liquidity,’ and is quite deflationary.

            Ron Paul understands this, and so I don’t regard his proposal as being serious. It’s more of a populist jab at Bernanke — proposing to declare a selective federal debt Jubilee, at the sole and unique expense of the Federal Reserve.

            An intriguing question raised by Paul’s proposal is whether (as in the current Greek bailout drama) the rating agencies would regard cancellation of $1.6 trillion in Treasury debt as a selective default. The Fed may be the central bank, but it’s also nominally privately owned. From the point of view of the banking cartel, a $1.6 trillion cancellation of Treasury debt held by the Fed would be both injurious and involuntary.

            Like the EC and the ECB, the Fed would be absolutely loath to even have such a discussion. All of its political muscle will be invoked to trash Ron Paul’s proposal, if it’s even serious in the first place. It certainly has entertainment value, though.

          2. Leverage

            This measure is neither inflationary or deflationary by itself, if anything is a little bit deflationary.

            The liquidity has already been injected when the FED bough these bonds at the market. And the interests the government would have to create out of nothing anyway soon or later are inflationary, so not paying them it’s actually a little bit deflationary in the long run.

            So the short story: it does nothing because the liquidity is already on investors hands and is a liability with the government itself so it nets to zero. Basically is ‘frozen debt’. This is only a bypass to reduce total debt from the government to avoid problems temporally with debt ceiling.

            If this is done then maybe people will realize that government can’t go bankrupt for the sake of it and it’s not revenue constrained as an issuer of currency. The ‘only’ problem of spending is inflation and malinvestment then: the first one is really a technical problem and can be solved using functional finance, and is related to the second one: if the spending contributes to production then inflation (= more money chasing fewer goods) can be controlled as long as commodities are in check (demand), but that’s an other problem we need to solve later or before and there is no reason there should be unemployment even if there were real scarcity problems.

          3. R Foreman

            > destroying those bonds

            Who is on the receiving end of those coupon payments ? If the answer is no one, then why do the bonds exist in the first place ? Destroy them.

          4. jh

            “Functionally, that would be exactly equivalent to the Fed selling its $1.6 trillion of Treasury debt to the public (reversing QE I/II and then some) and turning the proceeds over to the Treasury. Selling debt to the public is regarded as ‘mopping up liquidity,’ and is quite deflationary.”

            Turning the proceeds over to Treasury is a key detail here, because that’s not what the Fed does. (Yes, it does turn over profits from interest payments, but not the gross proceeds of bond sales.) When the Fed sells a security, the reserves are gone. (The Fed can of course always create more if it wants.) When Treasury auctions bonds, the reserves are transferred to Treasury accounts, and therefore stay in the banking system. It’s key to differentiate the two when discussing the money supply.

            It’s true that in the short term, there’s basically no effect. The only effect is in the middle/long run, when the Fed may want to take reserves out of the system.

          5. Calgacus

            No, Leverage has it right. This is if anything deflationary, at any time interval. The mistake is the reliance on the mainstream money-multiplier based nonsense that printing/selling bonds/raising interest rates/draining reserves is deflationary compared to printing currency/QE/lowering rates/increasing reserves. The reverse is the (long-term) truth – see Gibson’s paradox. Who you gonna believe, Keynes & your eyes, or the unfortunately bamboozled Baker and the mainstream, which always gets things backwards? Lowering interest rates, buying bonds, can be expansionary, inflationary, raising rates deflationary (by creating unemployment) in the short term, the Fed undoing the damage of high rates when it lowers them. But the best way to think of this is as a paradoxical effect, and the natural effect being the positive correlation between high rates and inflation, mislabeled a paradox.

          6. Mark F

            Um Yes, if the government is allowed to default on the debt owned by the Fed, it would reduce the value of all treasury bonds causing yields to rise. Treasuries set the benchmark for interest rates on all loans therefore causing another credit contraction, reducing the velocity of money and will bring deflation. Inflation may happen down the road when credit starts expanding again but not until all bad debt is written off. This would take years like it did in the 1930’s.

      3. engineer27

        T. Squid: Destroying the bonds only shrinks the _asset_ side of the balance sheet. The _liability_ side of the balance sheet is untouched. So the net equity of the Fed as an institution would shrink.

        Inasmuch as Reserve Notes are claims on the equity of the Fed, their value ought to fall in that scenario, if only due to a general fall in “confidence”. Thus, destroying the bonds should be neutral to inflationary.

        Note that selling the bonds affects both sides of the balance sheet, since the assets (Treasury bonds) are removed at the same time as some liabilities (Reserve Notes or Reserve Deposits) are redeemed. Thus, there is no affect on Fed equity, and the only inflationary/deflationary effect is due to general monetary affects — i.e. market supply and demand for liquidity.

        As for Paul’s motivation, I agree with the speculation below that he intends to demonstrate to all the farce he believes the Fed to be.

      4. Carla

        I wish everyone would watch “The Secret of Oz” DVD and/or read “No More National Debt,” both by Bill Still. The problem is not the Fed; the problem is fractional reserve banking. Milton Friedman told Still years ago “Boy, if you kill the Fed and don’t kill fractional reserve lending, you’ve done nothing.” — “No More National Debt”, page 19.

    2. Tertium Squid

      Oh, and:

      “Casting the Fed as a government agency loaning another government agency money — i.e. the government creating a debt to itself — and then cancelling the debt strikes one intuitively as non-lucid as writing oneself an I.O.U. and then tearing it up. That’s a brilliantly abstract way to accomplish nothing.”

      WE’RE ALREADY THERE. You can decide for yourself how lucid, abstract, or brilliant the arrangement is, but the obligation already exists, and it’s real money.

    3. Svsm

      If destroying the debt would lead to some inflationary calamity, why couldn’t they just roll it over? Isn’t that what the EU banks are doing with Greek debt on a voluntary basis?

      You are right in that it doesn’t solve any problem beyond the debt ceiling problem but that is a huge issue right now. This could buy us some much needed time.

      What would the ramifications of rolling it over like the French banks are doing for Greece be?

      1. Mark F

        It won’t solve anything. Greece is much more likely to default now than it was before they received all these EU bailouts. Nominal interest rates on Greek bonds are still above 20%. The real interest rates must be much higher. Whenever they make draconian cuts, people spend less money, causing revenues to miss projected targets. So the interest on their existing debt obligations are a greater burden when revenues decline. This is why you can’t print your way out a debt problem. The EU can keep buying Greek bonds but then the market makers keep shorting them.

    4. Hugh

      I would disagree with Baker. Selling Treasuries doesn’t soak up liquidity. You and I can’t use a Treasury to pay when we go to the grocery. But from a banking point of view, the two are essentially interchangeable. That was why QEII was bogus. It was a swap of financial assets that were very similar. Indeed as others have pointed out, the overall effect of QEII may have actually decreased liquidity somewhat since interest payments on the Treasuries were no longer being paid –although this may have itself been offset by the premium the Fed paid on them in its purchases. But plus or minus, the net impact on liquidity of these two countervailing tendencies was small.

      The primary effect was psychological, to keep the animal spirits feeling juiced.

      The inflation we see in commodities is due to leveraged speculation, and I think most of the money for that comes as it always has from the ZIRP. But again it is important to remember that commodities inflation has been taking place within the wider pattern of deflation. For us rubes, it is the worst of both worlds. We see inflation where our demand is inelastic at the same time we see our major assets (homes) continue to decline in value.

      1. Mark F

        You’re right. The root of this problem is too many investors trying to make money, and not enough consumers that are willing or able to borrow and spend the money the investors want to make. It’s a sign of money demand being greater than money supply. This is what happens when we have aging demographics. The desire to get out of debt, and save money so one could retire takes precedence over going into debt and buying more stuff. This becomes fatal for a credit based economy. When there is no credit, there’s no cash!

      2. Kraken

        There are a lot of sharp commenters here on NC, but I learn the most from yours. Thanks Man.

    5. charles 2

      I think you are underestimating Ron Paul. His goal is not to implement a metallic standard, at least not directly. What he wants is free competition in currencies, I.e. the abolition of legal tender laws, (see and any taxation on capital gains made on any alternative currency. Anything could go and try to compete, tax-based currency (I.e. the dollar), foreign currencies, metallic currencies, or even bitcoin !
      When one wants to destroy a monopoly, it is good strategy to suggest steps that may undermine the value of the products of the said monopoly. In the case of the dollar, this value sits entirely in the trust that the monetary authorities will not devaluate it.

      Any “cancellation of treasuries” package will have to be associated with a “Free Competition in Currency Act” in his mind. You have to understand what it means : if there are no legal tender law, the Federal Government cannot any more force a supplier to receive a payment in dollar or in treasuries, thus putting a serious constraint in its ability to stimulate the economy by way of deficit. Dean Baker fails to see the other side of the coin…

    6. Rex

      Eric said, “Paul’s plan is equivalent to naked money printing. It closes off the possibility that those bonds will ever be repaid and the money that was created to buy them neutralized, or extinguished, or whatever Fed-speak term is appropriate.”

      Why are you so fixated on this one particular clump of fictitious money? Since the big crash, I have been trying to figure out where all the money went. I was invested in mutual funds and bonds. One day I had a lot of money and a few days later a whole bunch of it was gone. The strange thing to me was that I figured that if I lost a lot of money, then someone else must now have my money. But as near as I could figure, almost everyone had lost money. Nobody seemed to have the money I and others lost.

      Did the “money” really exist? Near as I can figure, no, not in the sense that it deserved to exist because it represented something physical or even something productive that was done.

      I was fooled into thinking I was buying a share of companies that were actually making or owning stuff. The first bubble I participated in was the internet. A new way to talk to other people and share information. People’s real money got invested but the financial part was hugely multiplied by the traders. A good new idea, but how did the net create anything we really needed? Boom — some reality hit.

      Then real estate filled in. A real thing at the bottom and some extra even got built (too much). But most of it was from that trading multiplier that jacked up prices and got multiplied on multiples by derivative schemes and scams.

      Eric again, “Paul’s plan is at best a legalistic answer to the debt ceiling deadline that fixes nothing in the real world.”

      You are now talking like Obama. You are coming close to saying that the government needs to get the same discipline on its finances that all the families have been forced to do. Sounds logical but is total crap and shows Obama as either a fool or a manipulator.

      Our economy is largely based on the financial industry which adds very little but takes very much. The real world has played very little part in what we’ve been engaged in for decades.

      In the big scheme, why worry about this vaporization of some chunk of “money” that we both own and owe?

      1. Linus Huber

        For Rex:

        There is a difference between debt and money. To expand the basic money is to inflate away debt. If this should become common practice, the dollar would collapse and the rate of interest would rise considerably.

        If this would have been done all the time, specifically, instead of adding the yearly deficit to the total dept of the USA but simply monetizing the deficit on a regular basis, the US would have saved a lot of interest paid out over the past many years. On the other hand, interest rates would definitely be higher as the currency is continuously diluted in a serious way.

        The point I want to make here is that either way is ok but what I dislike is the change of rules in the middle of the game, allowing again the closely connected (corrupt) parties (probably banks again) to reap another round of unfair benefits in that they will certainly know in advance what is going to happen.

      2. reslez

        Since the big crash, I have been trying to figure out where all the money went. I was invested in mutual funds and bonds. One day I had a lot of money and a few days later a whole bunch of it was gone.

        No, you’re confusing asset prices with money. If you had stocks and they were worth X, and the price of those stocks went down so they are now worth X-Y, that’s not money you lost, it’s a decrease in asset prices.

        The money didn’t go anywhere because it wasn’t money.

        Yes, you did buy shares in companies that were making/owning stuff. That doesn’t mean you can sell those shares to other people for some arbitrary value because you want to.

      3. Jeffry

        Rex, thank you.

        Could someone, would someone, can someone, please refer me to a site that shows exactly what is going on with the printing of government obligations. Like a man with
        rubber teeth, I just can’t get a grip on this process.
        This ideal site would explain everything without any
        assumption of knowledge…

        1. Jay B

          Yes. There is such a site. billy blog You can find it at:
          The site contains many tutorial chapters for explaining, as you say, “everything without any assumption of knowledge”
          And better yet, yesterdays post titled “It’s a pity that he doesn’t know the answer himself” walks you through this subject, Ron Paul suggestion, plus Dean Baker’s view of it and Greg Mankiw’s take. He carefully explains how the Fed works, operationally. And he carefully explains what Baker, Paul and Mankiw didn’t get right.

        2. Cedric Regula

          You might also try The St. Louis Federal Reserve. They used to have some good primers there on how the Fed does monetary policy. It’s accurate, and it’s good to read how they do it first. Then next you can get into the subject of money and credit creation in a fractional reserve banking system. Mishkin, a-hole that he has turned out to be, is credited with writing the defining text Economics of Money, Banking, and Financial Markets.

          Then you have the basis to know why it works the way it does and know exactly why you don’t like it.

      4. eric anderson

        Sir, I am not “fixated” on anything. I am responding to the topic presented by our host in this post. If anything, I am concerned about the inherent dishonesty of creating currency with no backing. This devalues the holdings of every saver of that currency. Of course, honest money does not interest the dishonest of the world, which would include most of those in our government, who serve the banking elites and their profitable money-creating scam through the Federal Reserve system. At any rate, we only need to look at exchange rates and commodity prices to see the effect of the Fed’s expansion of its balance sheet, i.e. massive money printing over the few years since the financial crisis. If you can’t see cause and effect, then I really can’t help you.

        1. Ed Seedhouse

          “If anything, I am concerned about the inherent dishonesty of creating currency with no backing.”

          This only shows that you don’t know what money is. In fact what is “dishonest” (or to be less inflammatory, “deluded”) is to claim that any money “has backing”, or should have.

          Money has no value at all, it is merely a measurement of wealth as inches are a measurement of length.

          Wealth itself is an abstract idea, not a thing. Nothing has any inherent value, humans value things and the “value” resides in their abstract thoughts but not in the things themselves. Since nothing exists that has an inherent value there is nothing that can be used to “back” money.

          We will never solve our financial problems as long as we are the captives of delusions about the world.

          1. eric anderson

            The notion that people will forever continue to believe in money without backing of some sort is itself a delusion. Currencies can and do collapse. Even if they do not, the manipulation of currencies for the benefit of the financial elites is much easier in a fiat system. I would prefer to take away that option. There is no perfect system or perfect money. However, you cannot deny that the expansion of the money supply by the Fed — by fiat — has been accompanied by a drop in the dollar’s value against other currencies, and a consequent rise in the cost of raw materials. What a double insult to people in today’s job market. Fewer jobs, stagnant wages, forced low interest rates on savings, higher prices. I take that back. It’s a quadruple insult. Have you no heart?

    7. F. Beard

      As Denninger has pointed out — and you seem to agree with him — Paul’s plan is equivalent to naked money printing. eric anderson

      The money has ALREADY been “printed” and spent. Borrowing from the Fed is always naked money printing. The bonds are just so the money can be mopped up if necessary. But raising reserve requirements makes mopping unnecessary.

      1. bs23

        I’m confused on this point — the Fed doesn’t print money, right? So borrowing from the Fed doesn’t increase the money supply, since the Fed first had to get the money from someplace. Perhaps what I’m missing here is that the Fed can credit Uncle Sam’s account without debiting someone else? (i.e., the Fed can create money electronically)

        1. F. Beard

          Perhaps what I’m missing here is that the Fed can credit Uncle Sam’s account without debiting someone else? (i.e., the Fed can create money electronically) bs23

          Yep, that’s it. The Treasury “prints” up some bonds and the Fed “prints” up some FRNs to buy them with.

          Thomas Edison was aware of this scheme and hated it:

          “If the Nation can issue a dollar bond it can issue a dollar bill. The element that makes the bond good makes the bill good also. The difference between the bond and the bill is that the bond lets the money broker collect twice the amount of the bond and an additional 20%. Whereas the currency, the honest sort provided by the Constitution pays nobody but those who contribute in some useful way. It is absurd to say our Country can issue bonds and cannot issue currency. Both are promises to pay, but one fattens the usurer and the other helps the People.” from

        2. F. Beard

          I’m confused on this point bs23

          That is intentional. Bankers love to shroud their filthy business with mystery and indirection.

        3. Nathanael

          You are quite mistaken. The Fed literally does print money. Please read the text on your dollar bill — it’s a “Federal Reserve Note”!

          The US government could do the same thing (they’re called “US Notes”) except Congress only authorized $300 million of them.

          Because of ridiculous shenanigans back in 1913, the Treasury supposedly “owes” money to the Federal Reserve (T-bills, bonds, etc) and then Federal Reserve prints the money — instead of the US just printing the money.

          Ron Paul just showed how to get out of this ludicrous situation. If the Federal Reserve just burns the Treasury bonds, then the US doesn’t owe the Fed anything. Problem solved — debt limit irrelevant.

          This would legally be a gift from the Fed to the Treasury. The only question is whether the *Fed* can legally do this. (The Treasury certainly can.)

  2. Hugh

    There is an interesting dichotomy at work here. What Paul, the goldbud, is advocating is a post-gold standard policy. At the end of last year, we saw something similar. One week, the Cat Food Commission came out with its entitlement slashing agenda. The next, Obama, the Democrats, and the Republicans came together as one big happy family for a tax cut deal costing in the hundreds of billions. When the kleptocratic powers that be want to sling around hundreds of billions, even trillions, for their own ends, they all start sounding like MMTers because, whatever else it is, MMT is the one theory that deals seriously with what the post-gold standard world looks like. But when it comes to us rubes, suddenly they revert to gold standard arguments about the unsustainability of debt and deficits, how painful cuts are painful but necessary, how austerity for us is the only responsible course, how we can not afford Social Security and Medicare, how we must learn to live within our means, how government spending is like a household budget, etc., etc.

    And that’s the dichotomy: a post-gold standard world for them, a gold standard world for us.

    1. Skippy

      “And that’s the dichotomy: a post-gold standard world for them, a gold standard world for us.”

      Cough…two tier world..cuts for you…more for me[s.

      Skippy…once certain life standards are achieved, its a matter of life or for me[s and gods timing for you[s.

  3. Cedric Regula

    Well, I think Ron Paul (the goldbug hard money Ron Paul?) and Dean Baker better get together and compare notes.

    This is an absolutely essential part of the plan, which form the post above seems to be Baker’s idea, and not proposed by Ron Paul.

    “Baker points out a second benefit. Canceling the bonds The only use the Fed had for those bonds was to eventually sell them back to the public to soak up liquidity when it started worrying about inflation. But the Fed can achieve that end the old fashioned way, by raising reserve requirements.”

    The Fed still needs a mechanism to control monetary policy.

    Other than that, it beats the hell out of zeroing out social security.

    But I’m a little afraid we may need a constitutional amendment to keep congress from doing it every year. There has to be something that goes wrong if they keep doing that over and over again. Like maybe the reserve requirement goes to 100%? Who knows. This monetary policy stuff doesn’t really work right anyway.

    1. Cedric Regula

      Also, I remember from my ancient econ book that the Fed doesn’t like using reserve requirement increases because it is rough on the banking system. There are Haves and HaveNots. The HaveNots get pushed into insolvency (not that we need to worry about that nowadays). So they decided the kinder, gentler way is to manipulate the cost of money with short term rates.

      Course the Chinese do it all the time.

    2. F. Beard

      Like maybe the reserve requirement goes to 100%? Cedric Regula

      Anything less than 100% reserves allows the banks to counterfeit – to create so-called “credit”.

      Many folks are in favor of 100% reserve banking. Why not? Let the government create new money and let the banks just lend out money that has been genuinely lent to them. Let maturities match with no “lender of last resort”.

  4. SteveA

    If Ron Paul understands accounting, he is suggesting that the Fed make itself insolvent. If he does not understand accounting, a fair surmise, he should visit his grand intellect on a new hobby.

    1. Foppe

      You seem to be under the mistaken impression that accounting and economics are fields that require honesty and consistent behavior in order to function. They aren’t. Yes, this choice of action could cause problems, but the only case in which it will is if large institutions or banks start complaining about it. If they do not, nothing will happen, and the world will keep turning without anyone but the little people going broke over it.

      1. SteveA

        The Fed writes of $1.6 trillion and is insolvent.

        The member banks must purchase shares worth $1.6 trillion to recapitalize the Fed. Sadly, the banks cannot afford $1.6 trillion.

        No problem. The government gifts $1.6 trillion to the banks to pass along to the Fed.

        What an elegant solution to make $1.6 trillion in govt obligations disappear.

        But thanks for your concern about my mistaken impressions.

        1. Linus Huber

          Yes Steve, I feel the same as you. It is disgusting how they simply change the rule of the game if this should go into effect. I am not sure whether Ron Paul is proposing this to simply show to everyone how corrupt the whole system is and that the only real measure of wealth may soon be gold if we continue on this particular road.

        2. Foppe

          Who says it needed to be elegant? But it’s no more or less political than fucking over benefits recipients because the GOP wants its pound of flesh in return for raising an arbitrary debt ceiling.

        3. F. Beard

          The Fed writes of $1.6 trillion and is insolvent. SteveA

          Since when does a counterfeiter need to be solvent?

          But in any case, since the interest on those bonds is remitted to the Treasury how can they be called assets?

          1. Jim Haygood

            ‘I guess [the Fed’s Treasury] bonds are non-performing assets as far as the Fed is concerned.’ — F. Beard

            MWA HA HA HA! Quote of the day award goes to F. Beard!

            The Bernank’s ears are burning.

        4. Nathanael

          Wrong, and kind of dumb.

          The Fed writes off 1.6 billion dollars.

          To compensate, the Fed prints 1.6 billion dollars in Federal Reserve Notes. Poof, the Fed is solvent. Money creation!

          Isn’t it interesting what you can do when you can literally PRINT MONEY? Normal accounting ceases to have meaning.

  5. appointmetotheboard

    Interesting discussion.

    I’m from the UK, and not really able to follow this as closely as you guys, but my gut feeling is that the Democrats will blink first, making the need for a ‘3rd way’ a bit academic.

    I just wanted to say how much I agreed with the closing paragraph about interest rates and risk. Or lack of it. That’s a point that just isn’t made enough, even in relation to Greece.

  6. Linus Huber

    It is correct that over the longer term there will be no other way but to partially monetize the debt. A lot of interest could be saved in this way. However, it would have been honest to do this from the beginning, so people would have known all the way that instead of producing debt due to deficits, the US government simply monetizes the yearly deficits. Now, it is another dilution of the currency and another grand theft where the population is being ripped off. Changing the rules of the game again and again is just part of the present corruption going on. When, my god, when will the American people finally wake up?

    1. Jason Rines

      When will the people wake up en masse Linus? $7.00 gas and/or food stamp reductions, in other words when they start to starve. Give it a few more years. In-between, I will do all I can to warn “Those with an ear.”

      Back in 2008 my friends and family practically shunned me. for attempting to look after them and not take the big equities haircut and prepare their minds for a diminished quality of life. Everyone always wants to shoot the messenger :)

      It bugged me a bit but now they ask my advice. Sometimes, it is about planting a seed. What do I tell them to do? Get involved in local politics, charities that feed people. Make connections and changes where they CAN be made. It’s actually quite a bit of good times along with helping those in need.

      1. Cugel

        Sounds exactly like my family when I started sending them E-mails back in 2006 pointing out that the housing bubble was tottering and that history suggested a massive crash in home prices over the next two years.

        I remember sending an article to my brother and sister-in-law who owned about 6 investment properties in Phoenix about how home prices in Naples Fla. were about 60% over valued and how the whole tottering structure was about to collapse.

        Boy did I get an angry response that “everything you’ve said doesn’t apply to Phoenix. We’re just fine.”

        They don’t like me to remind them of those warnings now.

  7. Middle Seaman

    The conflicting and mutually cancelling arguments in the discussion above drive me to take Yves’ and Baker’s side of the argument. I don’t, however, believe that state support of socialism for rentiers is in danger. The latter is at the foundation of the policies of the ruling elites in the US and Europe. I believe that those policies will be demolished only after catastrophic collapse financially or socially.

  8. Brick

    It suggests to me that Ron Paul either does not really understand what the federal reserve is or that he is suggesting the US should print money to get itself out of making decisions. From my point of view what happens is that banks deposit their reserve cash with the federal reserve. The federal reserve has decided through QE to swap that cash for treasuries and agency debt to help keep interest rates down.
    If the FED cancels out those treasury debts then if a bank asks for its deposits back, which it might if its a foreign bank and it questions whether the FED can pay back then the FED would have to print money to repay them. The problem is that others holding treasury debt would most likely see this as a monetarisation of debt and might decide that it is in their interests to remove themselves from the market. Suddenly the FED no longer has control of interest rates. You might as well print the money and give everybody in the US 50,000 dollars at least this way you get some consumer demand to combat the negative effects of interest changes.
    The bottom line is that the rules governing the FED prohibit this and any attempt to achieve this would undermine the indepedance of the FED. What Ron Paul may actually be suggesting is the disolution of the FED by the back door.It just may be that FED independance (despite whether the FED has made mistakes) might just be the pillar taking a lot of the weight of the market at the moment. This just gets the government out of a jam without really helping the US citizen in my view.

    1. Nathanael

      Monetization of debt has been the correct thing to do *all along*. It’s *always* the right thing to do in a deflationary crisis.

      It’s startling how many commentators at Naked Capitalism, who one would hope to be well-informed, have missed this key historical fact. Every major deflationary crisis was dealt with partly by money-printing or things equivalent to money-printing. This is kind of obvious when you think about it.

  9. Nate

    Say if the debt ceiling is raised by $2.5 T, that will last no more than 2 yrs and then we are faced with the same question and argument all over again. Say if we default, that will wipe out all the debt and pay the debt holders small fraction of the debt with a new money that will be printed. The scenario of default is not very clear but most likely all the banks will be nationalized until the new money is printed. But the US dollar being the global reserve currency, the default will have much wider consequences. Unless the current financial system is overhauled no amount of debt ceiling raised or default will solve any problem permanently but only delays the inevitable. What is wrong with the current financial system and our mode of capitalism ? It has the systematic problem that has a positive feedback so the system will eventually blowup. We have to redesign it so that it has a negative feedback so the system will settle into a steady state. Simply said the overhead to maintain the system is greater than what it takes to keep the system running. The system is always in a lossy and that loss is compensated by the inflation of money in function of time. Time is money has to be rethought. And don’t write insurance that guarantees the future of any investment that has to have a risk factor that is unpredictable and subjective.

  10. financial matters

    The mandate of the Fed is mainly to deal with monetary policy which relates to the amount of money available to the economy by increasing money supply and influencing interest rates…. Fiscal policy which is how taxpayer money is spent is a mandate for Congress… (elected officials rather than a few bureaucrats in the Fed).

    The Fed seems to have stepped very strongly into fiscal policy by putting taxpayer money at risk for very questionable bank bailouts. Canceling the Treasuries they hold as a countervailing QE for Social Security and Medicare would seem very reasonable. Maybe some of their fiscal policy should be oriented towards the rubes paying the taxes. Who really controls the Fed, Congress or its member banks? Should monetary and fiscal policy benefit the banks or the electorate?

    1. Jason Rines

      Not one penny of my money should be used to subsidize overseas bonholders. I am not invited to directly become a shareholder in the global CB system so see no need to support it.

      Back in early 2008 there was sixty trillion in U.S. CDS. The settlement for Bear came in at 1.75% if I remember correctly. That was ONE counter-party that got paid their fee. So if the other-counter party also got 1.75% that is 3 1/2%. Multiply that times $60T and you get $21T. That and another two trillion of indirect bank recapitalization give $23 T. So what the bank-led government is telling it’s citizens is that there will no possibility for growth for a decade or more as the amount of the CDS swaps are settled on the taxpayers back. The currency will continue to be devalued to get there so the patterns will be W times four. Three more recessions and W’s till 2020’s. Each high will go higher for commodities and each low will go lower for equities. Like steps up, getting harder and harder.

      I wrote about this on a bunch of commentary on Seeking Alpha back then. How the American people will NOT keep running up a debt-incline treadmill:

      Releasing the details of this information to the public requires an audit of the FRB. It will implicate a lot of current and past politicians but I do believe the audit will begin in 2014 timetable. The battle with the enemy within has begun. What is the difference between American financeers and Chinese financeers? Hint: It’s a trick question.

  11. Diogenes

    Wouldn’t cancelling a portion of the Treasury debt held by the Federal Reserve be a backdoor route to accomplishing what Abraham Lincoln did when he directly issued greenbacks?

    As such wouldn’t this put Paul at least in the vicinity of some of the saner MMT types?

    While debt equals money, the converse is not axiomatic: money does not have to equal debt. All told, my first impression of this idea is that it is rather brilliant and that the mainstream GOP will never understand its implications.

    1. Calgacus

      Not clear what you are saying about money equalling or not equalling debt, Diogenes. Money is always a kind of debt, it is assignable, tradeable debt. Government debt, e.g. bonds or currency, because of the power of governments, is therefore the best kind of money.

      1. F. Beard

        Money is always a kind of debt, it is assignable, tradeable debt. Calgacus

        Nope. At least two kinds of money require no debt – government fiat which is backed by the government’s taxing power and common stock which is a means to consolidate capital without the need for conventional money/debt.

        1. Calgacus

          Again, F. Beard, you are wrong. Government fiat money (redundant phrase – all government money is fiat money) is a form of government debt. Common stocks are not money, and have never been used as such. The ONLY thing the human race has ever used as money is debt. This isn’t me, or MMT in particular. Some of the best, clearest thinking on this is very old, like Henry Dunning MacLeod or John R. Commons. They have not been mined as much as they should have by the MMTers or creditary economists like Geoffrey Ingham or Geoffrey Gardiner. The old Institutionalists knew damn well what they were talking about. If you understand this, make this conceptual leap, everything in MMT follows and is intuitively natural. My own curmdugeonly prejudice is that MMTers don’t know much modern mathematics or classical philosophy, so they don’t realize how much everything depends on getting chapter 0, the foundations, right down to the Flaubertian placement of commas.

          1. F. Beard

            Government fiat money (redundant phrase – all government money is fiat money) is a form of government debt. Calgacus

            Government money is a means to pay taxes. The “debt” is from the taxpayers to the government so it is incorrect to call government money “government debt”.

            Common stocks are not money, and have never been used as such. Calgacus

            Common stock could easily be used as money if the capital gains tax was abolished. And if we ever break the filthy relationship between government and the banks, I predict that corporations would be forced by competitive pressures to issue new common stock and spend it as money.

          2. Calgacus

            Debts are cancelled by debts going the other way. Tax debts, your debt to the government – are cancelled by government debt, the government’s debt to you, which we call money. This is absolutely fundamental to understanding what money is and how it works.

            Stocks conceivably could become money-like, though they never really have, but probably only if they become more debt-like. (Usually the conversion is the other way, debt to stock, as with convertible bonds and bankruptcies.) It’s a bit of a wild-eyed idea. Sound understanding of how money has worked for the last few centuries and millennia is more important.

  12. Anonymous

    I don’t think most federal policymakers understand the basis of the essential mechanism in this kind of move — the relationship between debt and money, and the fundamental role it plays in monetary policy. I’m surprised Ron Paul himself does, given his gold standard/fiat currency scaremongering. And while I think almost all federal democrats could be convinced or cowed into going along with just about anything, I think the nutty rightists in DC would react to this solution with, ‘oh em gee, our money’s not real, no monetary policy games, give us a gold standard.’ (Notice how much that sounds just like Ron Paul’s usual shtick? That’s right — he’s just as big a bullshitter as the rest of these losers.)

    Also, frankly, the rightists like the brinkmanship — in many cases, their decision-making has been purposely designed to engineer just this kind of debt scenario. It gets them one huge step closer to, ‘drown[ing] the beast,’ and ushering in the fascist, theocratic utopia that makes their little dicks so stiff. And, it goes without saying, democrats like the president (that is, almost all of them) are too daft to understand this plainly obvious element in the rightists’ gameplan.

    This solution makes far too much sense for this bunch of politicians. I’m not at all optimistic.

    1. Anonymous

      Also: The politicians have allowed (and/or designed) the public discussion about federal debt to be so fatalistic for so many decades that I have a very difficult time seeing how they could sell this sort of imminently rational solution to the public absent an extraordinary (that is, depression-like) market event. I’m not sure many Americans could rationalize the implications of such a move without becoming further disillusioned about the capriciousness, unseriousness, and legitimacy of contemporary US government.

      What we really need is a well-resourced activist class and political party that advocates for policy objectives based on these essential realities about how currency works.

      1. Yearning to Learn

        I’m not sure many Americans could rationalize the implications of such a move without becoming further disillusioned about the capriciousness, unseriousness, and legitimacy of contemporary US government.

        why would the typical American need to rationalize the implications of this move? Americans couldn’t care less.

        All we’d have to say is this
        “Hey, we’re in trouble. We need to raise the debt ceiling but can’t. Thus we have two options, either put Grandma on Cat food OR we simply cancel some debt that the government owes itself!”

        (american): “uh, how much will that cost?”


        1. Anonymous

          >>>why would the typical American need to rationalize the >>>implications of this move?

          Because of 30 years of scarce money propaganda.

          >>>All we’d have to say is this
          >>>“Hey, we’re in trouble. We need to raise the debt >>>ceiling but can’t. Thus we have two options, either put >>>Grandma on Cat food OR we simply cancel some debt that >>>the government owes itself!”

          >>>(american): “uh, how much will that cost?”


          That circle has to be squared.

          Govt: ‘If we don’t raise the debt ceiling, we might have another depression.’

          Americans: ‘So, we’re doomed?’

          Govt: ‘Well, not quite. We’ll just cancel $1 trillion in debt we owe to ourselves.’

          Americans: ‘Why are we borrowing our own money, then cutting public services to afford repaying principal plus interest to ourselves?’

          The answer is, ‘for no reason at all.’ But for 30 years, the rightists have been saying we can’t afford anything, and have been running up massive debts to make their bullshit a self-fulfilling prophecy, and the democrats have been dumb enough to play along. That, plus our whole system, and every individual American’s life, is oriented around doing whatever you must to get more paper money, come hell or high water. If the politicians come on tv one day and say, ‘no biggie, we made it out of thin air, so it doesn’t matter, we’ll just make it disappear,’ I’m sorry, there are lots of broke people out there that will be completely heartbroken by that, and will wonder 1, why low and middle income peoples’ challenges can’t be solved that easily (the answer is, ‘they can be’), and 2, why the fuck the politicians have been yelling at the top of their lungs about the government being broke for 30 years.

          We need to shift away from our money-as-debt monetary policy. But that’s a four-decade retooling and civic information process — four years, maybe, at a clip. But four weeks? I think you underestimate how deeply embedded scarce money ideology is for almost all Americans, even the ones who know better.

          JUST TO ADD: The ’08 investment bank rescue isn’t really analogous here, because despite Bernanke saying he made the money from nothing on 60 Minutes, in the public consciousness, it’s still imagined that the government borrowed all that money from China, or that the cash was sitting around in a savings account somewhere. I add that just to make the point that there’s really no recent example of this being done so plainly, and especially with as easy an explanation as the one you advocate.

          1. Yearning to Learn

            Americans: ‘Why are we borrowing our own money, then cutting public services to afford repaying principal plus interest to ourselves?’

            I wish.

            instead it would be:
            Americans: “why are we… uh wait, is that Bristol Palin on Dancing with The Stars!?” and “Ooh look at scary muslin terrorists!” and “OMG, Lindsey Lohan is SUCH a mess”.

            there is a reason why this 30+ year experiment has been allowed. Because Americans neither care or worry about such things.

            That’s why there are still sizable numbers of people who believe that Saddam Hussein was allied with Al Qaeda and had WMD’s, and why people believe that Obama was born in Kenya, and why people believed in 2002 that FRANCE was our mortal enemy and that we should combat them by renaming our food “Freedom Fries” and “Freedom Toast”.

          2. Anonymous

            @YEARNING TO LEARN: Eh. I don’t think most Americans are stupid, is all. I think large modern states with sprawling markets breed huge information overload, and our politicians aren’t paring down the data and pitching it clearly, effectively, and in good-faith to Americans so that more men and women can make informed, well-considered decisions at the ballot box.

            But if it could be made to work your way, I’m fully onboard.

  13. F. Beard

    The only use the Fed had for those bonds was to eventually sell them back to the public to soak up liquidity when it started worrying about inflation. But the Fed can achieve that end the old fashioned way, by raising reserve requirements. Yves Smith

    Bingo! Furthermore, just as debt from the Treasury to the Fed is bogus so is the population’s debt to the bankers also bogus. But instead of cancelling that debt which would do nothing for the much abused savers, the entire population should be bailed out with new, debt-free fiat instead. And to preclude a serious inflation risk, reserve requirements should be increased to compensate.

    And I can’t help pointing out to you libertarian bashers that Ron Paul is more a libertarian than a Republican.

    Your apology is accepted.

    1. FJ_2

      Mr Beard’s comments always sound intriguing — something about the ways he gets to the bottom line. And making it sound simple is critical (things get over my head, plus only simple things, even if false, can ever be popular or widely held).

      However, would like to hear some of the steps by which he gets to that bottom line. It may be redundant but I must have missed those steps along the way.

      1. F. Beard

        However, would like to hear some of the steps by which he gets to that bottom line. FJ_2

        Whenever a bank extends so-called “credit” it is creating temporary money. But where does the purchasing power for that new money come from? It comes from all dollar holders especially those who can’t or won’t borrow themselves. Thus the banks are counterfeiters and thus the debt to them is not morally valid.

  14. Bruce Krasting

    The Fed does not have any money to lose. Much less $1.6 trillion. They borrowed the money to buy these bonds. So if the bonds are now worthless the Fed would have a loss. As the laws are now written Treasury would have to recapitalize the Fed for its loss. So Treasury would have to borrow $1.6T to pay back the Fed.

    This plan goes no where and is a dumb idea.

    But it might work if you did the same thing with the assets of the Social Security Trust Fund (or any of the other intergovernmental accounts.)

    If all of a sudden SS had nothing on the shelf it would cost the Treasury $50b in 2011 and about 600b over the next ten years. We could afford that.

    Of course by the end of the ten years there would be some lines crossing. So something would have to be done by year 8.

    But no one on this blog wants to touch SS. Too bad. If you wanted to get creative with the Nation’s finances SS is the place to tinker.

    1. F. Beard

      The Fed does not have any money to lose. Much less $1.6 trillion. They borrowed the money to buy these bonds. Bruce Krasting

      The Fed does not borrow money; it either loans or spends money into existence.

      Or do you think that because the Fed pays interest on bank reserves that it is borrowing those reserves? But those reserves are demand deposits so there is no loan.

    2. Yearning to Learn

      But no one on this blog wants to touch SS. Too bad. If you wanted to get creative with the Nation’s finances SS is the place to tinker.

      You’ve got to be kidding me. We’ve been “tinkering” (aka looting) the SS fund for decades.

      how about this: I agree we should tinker with SS. We should recapitalize it immediately or at least show an honest accounting of it to show that it is nowhere near insolvent nor will it be for decades.

    3. Jim Haygood

      Bruce Krasting is correct about the Fed’s insolvency under this plan.

      Quoting from Dr. Hussman’s weekly commentary: ‘The Fed now holds assets $2.87 trillion, versus $52.87 billion in capital, putting it just north of 54-to-1 leverage.’

      If the Fed’s assets are haircut to only $1.27 trillion, while its liabilities remain $2.82 trillion, then the Fed ends up with $1.55 trillion negative net worth after Ron Paul’s plan is executed.

      Of course, since its most important liability is unredeemable currency, insolvency is not necessarily a show stopper for the Fed, as long as it can generate cash flow.

      After all, by GAAP accounting, the U.S. government is insolvent to the tune of $100 trillion. But thanks to cash flow, it remains a going concern. And AAA rated to boot — just like those CDOs that crashed European banks!

  15. P FitzSimon

    By not raising the debt limit isn’t congress simply returning to the pre 1917 environment where every expenditure by the government would need congressional approval. If this happens the government still pay its bills but Geithner will need approval on a regular basis from congress. I imagine this will become tedious and politically volatile very quickly as debates over paying grannies Medicare or paying the troops become a regular topic of the news media.

  16. Pro Wermacht Van Hellen

    If we’re going to take politicians seriously, then we might as well toss out more ridiculous blather:

    “the banks might look like innocent victims”

    Ron Paul is pushing for *massive* defense spending cuts, this terrifies the hell out of the death loving Democrats since they are dependant on imperial bloodshed. Wise US blokes know their politicians are indifferent, paid off scum. The wealth they spend on death machinary could house, feed, educate and retire entire generations.

    1. alex

      “this terrifies the hell out of the death loving Democrats”

      Death loving Democrats? As opposed to peace loving Republicans? With a few possible exceptions like Ron Paul, PLR’s are hard to find.

      “The wealth they spend on death machinary could house, feed, educate and retire entire generations.”

      Hardly. Military spending is around 5%/GDP. Perhaps a colossal waste, but hardly enough to “house, feed, educate and retire entire generations”. Hyperbole does not help your argument.

      1. Bipartison Warfest

        The United States spends nearly as much on military power as every other country in the world combined, according to the Stockholm International Peace Research Institute. It says that we spend more than six times as much as the country with the next highest budget, China.

        • The United States maintains troops at more than 560 bases and other sites abroad, many of them a legacy of a world war that ended 65 years ago. Do we fear that if we pull our bases from Germany, Russia might invade?

        • The intelligence community is so vast that more people have “top secret” clearance than live in Washington, D.C.

        • The U.S. will spend more on the war in Afghanistan this year, adjusting for inflation, than we spent on the Revolutionary War, the War of 1812, the Mexican-American War, the Civil War and the Spanish-American War combined.

        1. Chris Van Spooky

          The U.S. military budget for 2010 was $693 billion.
          However, when you throw in all “off budget” items and other categories of “defense” spending not covered in the Pentagon budget you get a grand total of somewhere between $1.01 and $1.35 trillion spent on national defense in 2010.
          U.S. military spending is greater than the military spending of China, Russia, Japan, India, and the rest of NATO combined. Total U.S. military spending makes up approximately 44 percent of all the military spending on the entire globe. The Pentagon currently gobbles up 56 percent of all discretionary spending by the federal government.

          1. Massive Underwater Iceberg

            Oh yes, there’s the black budget too. (FEMA, NSA, CIA, Treasury etc, etc) The budget is kept secret for ‘national security reasons.’

  17. alex

    Ron Paul the MMT advocate? Wow, truth is stranger than fiction.

    As for all those who are aghast at the idea of the Fed monetizing debt, consider how much debt they’ve already monetized. They bought over a trillion in commercial trash that will never sell for what they paid for it. That’s monetizing debt. The difference is that it’s monetizing the banks’ debt, which Serious People seem to think is a good idea, while this plan would monetize government debt. Can’t have the Fed doing anything that might help the Have Nots, can we.

  18. Jeff

    I’ll restate someone else’s idea.

    If we can create trillions to save the bankers’ asses, then we can create trillions by the same mechanism to save social security and medicare.

    1. F. Beard

      If those trillions had been given to the general population it would have fixed EVERYONE including the banks. It’s still not too late.

  19. Tom G

    Holy hell, does this guy ever get tired of being right? First, he warns about all this before it happens, years ahead of anyone else. Then, he proposes a solution that would not only bail us out but cause discomfort to the people that got us in this mess and begin to wind down these financial shenanigans.

    People please vote for this guy. The only thing he needs is a good strong technical legal mind (ideally a “democrat”) to shake up this nonsensical red team/blue team bullshit. I suggest Elizabeth Warren.

    1. Lins

      I’ve thought the very same thing….Paul / Warren 2012….what a wonderful way to start in a new political direction (read away from the false right/left bs).

  20. George Washington

    I love it! Good article.

    Quantitative Easing = Money Printed from Nothing.

    Ron Paul 2012

  21. steelhead23

    I too find this an interesting option. What folks appear to miss is that those T-bills produce a revenue stream that offsets the Fed’s losses on its MBS portfolio. It is quite possible that if one removed those T-bills from the Fed’s portfolio, they would effectively be insolvent. That is, today, the Fed and Maiden Lane are the SIV “Bad Bank”. They have already announced that they intend to offset any losses from the sales of the MBS they purchased. I happen to believe that those purchases were outside of the chartered operations of the Fed, and thus should not be viewed as liabilities of the U.S.A., but I believe Congress would be the only ones with standing to pursue such a case (a Doozy). Certainly, if Congress erased the CUSIPS for those bonds, the Fed and its true owners (the big banks) would go apoplectic because its balance sheet would look real bad. Sometimes Ron Paul seems a tad simple-minded, at other times, pure genius. This is one of those times.

  22. joebhed

    Got here really late to this party, but am immensely pleased by the debate on what money is, what government debt represents, whether either the Treasury OR the Fed actually has a Balance Sheet that needs balancing, and whether the Fed is part of the government or has the private ability to eradicate government debt.
    Is there such a thing as a national monetary system?
    This Fed-debt-eradication question came up in a Coffee With Joe just a week or so ago.

    Have a great go.
    Heading for the beach.

  23. Jesse

    I am a little surprised that Yves has come out in favor of this.

    It does make sense. I looked at Denningers comments on this based on the above, and he is, as when he occasionally becomes a little agitated, probably wrong and talking his book.

    The only thing that bothered me about his argument is his appeal to justice and the 14th amendment in this case, but then glibly arguing that default on the Social Security bonds the Treasury holds is just fine. But it really is just argument serving the desired ends, which is often lacking in consistency. When he is good he is very good, but when he is bad he can be rather ‘difficult’

    When the Fed expands its balance sheet it is creating money out of nothing, ‘printing’ if you will.

    When it destroys bonds by writing them off it is technically reducing the money supply in the form of the adjusted monetary base. Since it owns the bonds it can do so without violating any laws.

    However, this is likely to be labeled a default by the ratings agencies, unless the Treasury reins them in. What if the ECB bought the Greek debt and then wrote it off? What would they say?

    Still, the US seems to be using the Agencies like its bully boys these days, so it might be feasible.

    Effectively the bonds it holds

    1. Jesse

      oops. as I was saying…

      However, effectively the bonds it holds are in a non productive segment of the money supply, used as it has been said above for future utility, so there would be no deflationary effect if they wrote them off, no impact on reserves.

      If the banks themselves wrote off Treasuries that would be deflationary, but again, this is not the case with the FEd.

  24. Joe Firestone (LetsGetitDone)

    Ron Paul’s may be the best idea in the room if the room is Congress, but I think Jumbo Coin Seigniorage is a better idea because Congress doesn’t have it involved, and also because its use will demonstrate that it is the Federal Government that makes the money and so cannot go broke.

    Here are two recent pieces on this alternative, originally suggested by beowulf:


    1. Peripheral Visionary

      Hang on, wasn’t this suggested by Pat Buchanan when he was running for President back in the day? He had the support of Murray Rothbard, who is a long-time advocate of debt repudiation.

  25. Bam_Man

    The entire world is awash with worthless paper claims on future “wealth” that will never exist.

    We are only beginning the process of coming to grips with that sobering fact.

    The proposed “solutions” to this problem will become increasingly more unorthodox (and amusing).


    1. Jason Rines

      It would be hillarious if the Justice System wasn’t also perverted from top down.

      Slave labor is resurfacing, be it .20 cents an hour at prisons or the old way “reeducation camps”.

      The brutal reality is that portions of the middle and lower class will go from working for little to working for nothing. Did you think it made sense for homie Eric Holder to bug out about pot smoking in California? Yeah, he never inhaled…

      I doubt the resistance and backlash to the breakdown of the rule of law will be very funny. Nor will the governments response to the backlash phase by extending current conflicts into world war as misdirection away from revolution.

      But even some of the top in charge are now concerned about a glowing nuclear playground.

  26. LJR

    So in future the government can sell bonds to the primary dealers, the fed will immediately buy the bonds for freshly printed cash and then tear them up.

    Nice kind of loan if you can get it. The Greeks would love this scheme and it’s worthy of them.

  27. Peripheral Visionary

    Yves, check your sources. The New Republic piece left out one critical facet of Paul’s announcement: his call to cancel debt is part of a call for the U.S. to openly declare bankruptcy. It does not surprise me that “canceling Treasuries” would be more popular than “declaring bankruptcy”, but the latter is a more accurate description of the process.

    1. Yves Smith Post author

      The idea of the US declaring bankruptcy is barmy and Paul’s solution works just fine without that feature so I ignored it.

      First, the US can never go bankrupt, it is a sovereign currency issuer. It might choose to stiff its creditors, just like a company with lots of money might decide to see if it can get away with not paying its bills.

      Second, it can also not go bankrupt because bankruptcy is an adjudicated process, and there is no court that has dominion over the US. When the UK defaulted on some of its debt in the Great Depression, it was called a default, ot a bankruptcy.

  28. wunsacon

    Ron Paul’s idea is not as good as another: convene a meeting of the central bankers of the world to forgive each others’ debts. Global mutual debt forgiveness.

    (When you see nations pull private debts onto public balance sheets, global mutual debt write-offs become easier. So, I’ve been wondering for a while whether this isn’t Ben’s 5 or 10-year plan.)

    I prefer global mutual debt forgiveness idea over Ron Paul’s idea, because his idea does nothing about what we owe China, Japan, Germany, etc. and therefore makes their holdings MORE valuable — a bigger percentage of a shrinking pie of Treasury debt — than it is now. Who wants to increase the real value of our debt to foreigners? Not Wunsacon.

    1. wunsacon

      Oops.. As Peripheral Visionary points out, Ron Paul’s idea isn’t just for the Fed to forgive the debts. So, in my prior post, I’m criticizing an idea championed by no one. (Well, at least, not Ron Paul.)

      Still, global mutual debt forgiveness is another way to proceed. In terms of goals, it’s similar to declaring bankruptcy: reduce the debt burden, clean up the balance sheets of central banks.

  29. RebelEconomist

    I assume that this scheme works because Fed liabilities do not count as government debt and government obligations to the Fed can simply be cancelled because the government effectively owns the Fed. If so, it might as well be taken to its logical conclusion in which the US issues exactly the same bonds as it would have, but simply labels them as Federal Reserve Bonds, and the Fed gifts the proceeds to the government. Hopefully, even the Republicans would then see that the debt ceiling is no more than a national embarrassment for the US and agree to abolish it.

  30. Hush Hush

    Fannie Mae officials never reported fraud to law enforcement or anyone outside the company. Internal memos, court papers, and public testimony show it sought only to rid itself of liabilities and cut ties with one particular mortgage firm (or thrift or bank) selling loans “that had no value.”

  31. engineer27

    Destroying the bonds only shrinks the _asset_ side of the balance sheet. The _liability_ side of the balance sheet is untouched. So the net equity of the Fed as an institution would shrink.

    Inasmuch as Reserve Notes are claims on the equity of the Fed, their value ought to fall in that scenario, if only due to a general fall in “confidence”. Thus, destroying the bonds should be neutral to inflationary.

    Note that selling the bonds affects both sides of the balance sheet, since the assets (Treasury bonds) are removed at the same time as some liabilities (Reserve Notes or Reserve Deposits) are redeemed. Thus, there is no affect on Fed equity, and the only inflationary/deflationary effect is due to general monetary affects — i.e. market supply and demand for liquidity.

    As for Paul’s motivation, I agree with the speculation below that he intends to demonstrate to all the farce he believes the Fed to be.

    1. Jesse

      That is an excellent point and I thank you for it.

      The liabilities which increased with the expansion of assets seems to be largely “Other deposits held by depository institutions”

      the Federal Reserve Notes themselves are relatively stable in size and would not be affected except perhaps to potentially further degrade their backing by the assets held by the Fed.

  32. Jim Haywood

    ‘at the same time as some liabilities (Reserve Notes or Reserve Deposits) are redeemed.’

    No, the liabilities are not redeemed. If they were, then private sector holders of currency and reserves will face write-offs, and the effect will be massively deflationary.

      1. Anti-communist MMTer

        In 45 years I have yet to meet a commie in the USA but I’ve heard they’re everywhere!

        Someone told me there could be as many as 6, possibly even 12 commie f*gs spread out over the US of A, threatening to undermine our capitalist way of life!

        Kill all commies!
        F*CK all the commies
        Drop dead you commie f*gs

      2. Philip Pilkington

        Capitalism died a long time ago. A long time before Communism, which is also now dead. I wonder how long it will take people to begin the mourning process…

  33. razzz

    Just trying to kick the can down the road.

    They have had plenty of time to make a budget, what is the guarantee that they will make any progress 2 years from now?

    Congress will need their backs against the wall with rioters at the door before they do anything.

    Bring back proper accounting methods then let those to big to fail, fail. Then start a new banking system.

  34. Benign

    The FED needs to restructure the Treasury debt as zero coupon perpetuities, and call it a day.

  35. scraping_by

    Whether Mr. Paul’s idea is predicated on some sort of Federal BK (an entirely abstract notion, really) it has one thing going for it. The Fed’s lendings are in ex-nihil dollars while Treasury bonds are paid back in head-earned real money taxed from the middle class. While the U of Chicago crowd might not see the difference, in the real economy, it’s pretty obvious.

    It would be better to throw off the complications and simply default or forgive the debt. A USG default can be that precise, while Fed forgiveness could happen in a computer flick.

    Indeed lending in made up money while collecting in real money sounds a better than average scam. Creating value is fraught with difficulties, while tapping out a few more numbers is clerical.

    The distinction between earned dollars and created money can also show up in the foreign trade arena. Imports are cheaper here mostly because foreign governments subsidize the goods, often to below the cost of materials. If we slapped a proper tariff on goods and services, it would be in reality, just taxing the foreign government not the American consumers. Wal-Mart could bully all they wanted, and the larger society would still get its share.

  36. Paul Tioxon

    This idea goes back to populist radio talk shows, pre Rushky era, when there was a free for all political talk melting pot of ideas. The idea presented was to buy up the stock of the Federal Reserve and then cancel all of the debt the government owed itself, reducing interest payments and presumably the need for taxes going to public debt. The “Atlas Shrugged” of this tax resister movement was a book called “The Creature from Jekyll Island”, which will give you tremendous insight into Ron Paul, as he promoted it in his newsletter.

    In the simple act if rejecting the obvious lies of the establishment, these populist set out to understand the Fed, by looking at its founding, its history and a simple description of what it does do. Canceling its own debt is strait forward enough because it is based on objective facts, the simple observation that the debt issued by the fed, its promise to pay through a note, when bought back by the Fed, places the promise to pay as a promise to pay itself. If it cancels the note as the owner, it does not have to pay itself, there is no counter party in the transaction. Populists have two eyes, and two ears, and can see and hear well enough, since they have not been socialized to believe false consciousness.

    1. Dapper Dodd's Countrywide

      Oh wow Paul, what do we do now? I mean which populists should we dutifully acknowledge during voting-theater?
      “The politicians are put there to give you the idea that you have freedom of choice. You don’t. You have no choice. You have owners. They own you. They own everything.”

      1. Paul Tioxon

        Dear Dopper Dodd, don’t do anything at all, just like yr writing. You need to beef up on yr withering responses, not much value add.

  37. don

    two things forgotten:
    1. the bankers own the Fed
    2. they lika da interest
    oopps 3. their puppets in washington will..forgetabatit!

    1. Nathanael

      Correct, of course.

      The big bankers — what they called the “Money Trust” in the 19th century and early 20th — own the Federal Reserve. The deal in 1913 was that the Money Trust got the seignorage, and the government got to set monetary policy.

      But now the big bankers own the government too. So they will not print money, as they ought to, and they will certainly refuse to give up the seignorage (which is what the debt cancellation would result in).

      I’m a Greenbacker. Eliminate the limit on authorized US Notes and all this “government debt” nonsense becomes irrelevant.

      But we’re up against the big bankers. Even though money printing helps *everyone* in the current deflationary situation, it makes the big bankers less powerful, and doesn’t help them much (while it helps everyone else lots). So the big bankers, being greedy, oppose money printing.

      1. False Comparator

        From what I can tell there’s been a buttload of money printing lately. You have another take on quantitative easing?

  38. F. Beard

    Stocks conceivably could become money-like, though they never really have, but probably only if they become more debt-like. Calgacus

    I think I agree. Common stock might also have to be redeemable in the corporation’s goods and services to eliminate the need for conventional money.

    Sound understanding of how money has worked for the last few centuries and millennia is more important. Calgacus

    Government should get out of the private money business and let the free market innovate. Government money could still be used for private debts and probably would be if it were managed well enough. If it wasn’t managed well enough then the government would only hurt itself and its payees since the private sector could escape via private monies.

  39. GCT

    I am still trying to wrap my head around this one. But the private sector does not print money only the fed can create it. The Fed does need to stay out of picking businesses that are to survive and those that fail. Things would be alot better.

    The private sector does not own any money fiat or other wise. The government has that monopoly.

    The bonds the Fed does hold are not helping out either investors, the private sector, or the government. I say Destroy them. Nothing is going to happen when they do as no one owns these but the fed and most are toxic and will have to be destroyed sometime. Bond buyers will not take these toxic assets off the fed. Go take a look at the last POMO and the fed’s decision to retain these as no one wants them.

  40. LG

    Aside from the monetary implications, what would the legal implications of this plan be? Could lawyers argue this is a default? I’m not trying to invite a flame war of “it is technically a default!” / “No, it isn’t” — I’m asking could it potentially trigger all kinds of conditional provisions written into private/commercial contracts all over the world. Wouldn’t a some loan docs indexed to a treasury rate likely provide for special terms in the event of a U.S. default. This could be Pandora’s box.

  41. Ransome

    This is the flaw in our system of credit based currency. If too much credit is issued, you can’t get it out of the system easily. We intentionally make it difficult. Mellon wanted to liquidate the effects of too much credit out of the system. That was thought to be counter productive. Even with a gold backed system you can create too much credit using leverage and collateral. Debt deflation is credit backed by a declining asset. We can dutifully pay off the debt deflation for the next 30 years with our labor. On the other hand someone might ask why? The only answer is that it is the right thing to do. It isn’t an economic issue, it is a moral issue. A corporation is a legal construct that insulates a man from his moral obligations. Corporations reorganize.

    The trick here is that the Fed bought back the credit without causing inflation. In a normal economy, this would not work. Part of the mess in Europe is the cross border exchange of debt. It is a relic of the age of gold.

  42. Steve Roth

    Buy all the bonds/bills (replacing them with interest-free bills, a.k.a. dollar bills), and cancel them all.

    If banks/companies/people/funds/pensions want to hold risk-free assets, they can hold dollars (physical or electronic). If they want to keep ahead of inflation, they can invest in something with risk.

    Simplistic, but it’s the essence of MMT.

  43. za

    So, days later, what’s the concensus? Is there one?

    My simpleminded view, I see this as an analogue to the early 90s, when the RTC assumed $500b in MBS. The deficit looked terrible until it began to sell those assets and eventually recovered $400b.

    In this case, Fed/Treasury/GSEs have all been a proxy for the RTC. They bought a big batch of C/RMBSs that should now be sold for whatever they can recover, then they bought a big batch of debt that was created solely for the purpose of recapitalizing the banks. That program’s over, now the bonds should be destroyed.

  44. minchoff gomorkovsky

    As I see it, eliminating some or all of the US Treasury debt held by the Fed would have a negligible effect (outside of reducing the overall US Treasury debt level) since the only use of that debt, as pointed out by Baker, would be to eventually sell it into the private market in order to absorb money supply – and the Fed has other alternatives that can achieve the same objective.

    What I find interesting is the international trade value of the dollar and the history behind the dollar’s being the primary reserve currency of central banks. It goes back of course to the Bretton Woods agreements of the 1940’s where the US dollar was agreed to be redeemable by central banks in physical gold and linked to a $35/oz gold price, and all major currencies were tied to the US dollar in exchange value. This established US dollars as the de-facto international trade currency of the world.

    Nixon ended the gold redemption arrangement of Bretton Woods in 1971 when France and speculators began executing the gold redemption on a large scale and US gold reserves were at risk of eventual exhaustion. But while it lasted, the Bretton Woods system served as a mechanism that effectively limited foreign trade deficits over time. Today there is no such mechanism and the US dollar remains as the primary reserve currency, but huge trade imbalances are now allowed to grow without restraint since the US dollar can be created ad-infinitum by the Fed.

    Because of the reserve currency status of US dollars, when the Fed expands the US dollar denominated money supply today, it is as much the money supply of the entire world that is increased as of our own nation. Recent analysis implies that the entire QE2 monetary expansion by the Fed, upwards of $600B, was passed through US branches of foreign banks back to their home country banks. So, in net, none of that $600B monetary US dollar expansion benefited US domestic interests. So QE2 really was a worthless approach for stimulating the US economy and only served to provide a market for US Treasury bonds that wouldn’t have existed otherwise ( thus inflating bond prices and therby reducing interest rates).

    The situation is much more complex than this, but the danger is that it is so complex that congress cannot understand it themselves and will drive toward the simple approach of home spending and finance without regard to the nuances of monetary policy.

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