This is another summer rerun piece. I wrote the following post “If the U.S. stopped issuing treasuries, would it go broke?” in November 2009. At the time, I was getting to grip with how the government designed constraints in order to prevent deficit spending. What was and still is clear to me is that while different types of federal government obligation served different operational purposes, they all are identical in that they are a promise to pay the holder of that obligation a specific sum of the money unit of account.
In a world in which government is the creator of that currency and in which the currency has no tether to a physical product like gold, this promise has no tangible financial support other than the full faith and credit of the issuing government supported by its monopoly power to tax in its jurisdiction of control. Put more simply, there is nothing supporting fiat currency besides the coercive power of the state to impose tax and to entrench its obligations’ circulation as legal tender.
When thinking about the debt ceiling debate, the reality then is that the debt ceiling is a purely artificial constraint; Treasury notes or bonds are substantively the same as every other US government obligation. It is interesting that no other major developed economy has such a constraint. I would be interested in readers’ with knowledge of the debt ceiling history explaining why this is so.
In any event, some economists recognize that the US government obligations are all substantively identical promises to repay a specific amount of the currency unit of account backed by nothing but taxing authority. A a result, there has been a lot of chatter about ways of circumventing the debt ceiling by issuing other forms of US government obligations and swapping those with outstanding Treasuries to diminish the number of Treasuries outstanding. Some of these proposals are fairly inventive. See Scott Fullwiler’s here for instance.
I doubt Secretary Geithner would implement any of these schemes, of course. But the larger question I have goes to the reason the debt ceiling exists at all: all deficit spending must be accompanied by the issuance of an equivalent unit of currency amount of Treasuries. Mentally, this ties the deficit spending and the treasuries together so that the layman thinks the Treasuries ‘fund’ the deficit spending.
But, I just told you that all government obligations are promises to repay the currency unit of account backed by nothing but taxing authority. It’s as if you march down to the local government office with your paper IOU with $100 printed on it demanding ‘your’ money and the government hands you another paper IOU with the exact same amount printed on it. That’s substantively how fiat money works. Last summer, I wrote “The Government’s Bank” showing that if I were the monopoly issuer of currency, printing Benjamins in my basement print shop, unless you put artificial constraints on me, I could simply buy things, no funding necessary. So, Treasuries don’t ‘fund’ anything. The US government issues Treasuries only because it is forced to do so to create the artificial tie between Treasuries and deficits and the mental connection we make as a result.
Now, with a default looming, we are seeing that, as artificial as this constraint is, it has real world implications. So the answer to the question in the title is yes.
Original post below.
Here’s another interesting piece from Randall Wray, the economics professor from University of Missouri-Kansas City (that same school which employs Bill Black of “The Best Way to Rob a bank is to own one” fame).
Wray has a lot to say most, but not all, of which I found convincing – but that’s a story for another day.
This is what I found most interesting:
Here is what I propose: let’s support Senator Bayh’s proposal to “just say no” to raising the debt ceiling. Once the federal debt reaches $12.1 trillion, the Treasury would be prohibited from selling any more bonds. Treasury would continue to spend by crediting bank accounts of recipients, and reserve accounts of their banks. Banks would offer excess reserves in overnight markets, but would find no takers—hence would have to be content holding reserves and earning whatever rate the Fed wants to pay. But as Chairman Bernanke told Congress, this is no problem because the Fed spends simply by crediting bank accounts.
This would allow Senator Bayh and other deficit warriors to stop worrying about Treasury debt and move on to something important like the loss of millions of jobs.
What the good Professor is suggesting is that the Treasury doesn’t have to issue bonds at all. In fact, since the Treasury does control the electronic printing press, it could legitimately buy stuff with money it prints out of thin air.
Sounds a bit like counterfeiting, doesn’t it? But, let’s step back for a second: what is the functional difference for the federal government between Treasury securities and bank notes? Both are liabilities of the federal government. But liabilities of what? The only obligation they enforce on the government is the promise to repay with more paper (or electronic bank credits, if you will). For all intents and purposes, bank notes, reserve deposits, and Treasury securities are fungible: they are obligations to be repaid in the same fiat currency.
I’m looking at a five dollar bill right now. It says “Federal Reserve Note" across the top. It has an oversized picture of Abraham Lincoln in the middle. It also says “this note is legal tender for all debt, public and private” in the lower left, signed “Anna Escobedo Cabral, Treasurer of the United States.” On the back, I see “The United States of America” up top and “In God We Trust” underneath with a picture of the Lincoln Memorial in the middle, labelled “Lincoln Memorial” for those who don’t know what it is. But, I’m trying to figure out why Geithner and the gang couldn’t just reel off a bunch of these and some Jacksons and Benjamins and pay people?
Now I’m looking at a Canadian Twenty. It sure is colourful. It has a bunch of French on it and a picture of the Queen. But, other than that, it’s really no different than the American fiver. “Ce billet a cours legal/ This note is legal tender.”
I have some Euros and Mexican pesos too. But these central banks don’t say anything about their obligations. Very dubious! At least they’re colourful like the Canadian money.
How ‘bout a British tenner? Dickens on the front, and the Queen on the back (she’s everywhere). A-ha. Here’s what I’m looking for. It says “Bank of England. I promise to pay the bearer on demand the sum of ten pounds.”
I think that gets me to my point, actually. From the government’s perspective, there is no functional difference between any of its obligations like bank notes, electronic credits, or treasury bills and bonds. As the Ten pound note says, “I promise to pay the bearer on demand the sum of [fill in the blank sum][fill in the blank fiat currency].”
So, the U.S. government could legitimately stop issuing bonds altogether if it wanted to. When people complain about the admittedly enormous government debt, they don’t think of the mechanics of the issue. As I see it, in a fiat money environment, the first function of the Treasury bonds is to serve as a vehicle to add or subtract reserves in the system to help the Federal Reserve hit a target Fed Funds rate. The second is to give holders of government obligations a return on their investment. After all, bank notes or bank reserves don’t pay much if anything.
Am I missing something?
Memo to Congress: Don’t Increase the Government’s Debt Limit! – L. Randall Wray