Monday, August 1, 2011

Repudiate Federal Debt? What An Idea

Here, P F Cwik provides a really interesting perspective on what to do about U.S. Treasury debt.  Repudiate it!

What would happen if the Congress did repudiate all or part of outstanding U.S. Treasury debt?  Scratch your head for minute, think hard, then think some more.

First, by repudiating federal debt, Congress would be imposing an ex post tax on whoever holds the debt repudiated.  So, who is holding all that $14.3 trillion in federal debt these days?  A bit of information about that can be found here, but if you're expecting names, forget about it.

Through March 2011, we find that of the $14.270 trillion in outstanding federal debt, ownership of the securities was distributed as follows:

Federal Reserve Banks  --- $1.4 trillion
Federal Agencies ----------- $4.6 trillion
Foreigners ------------------- $4.5 trillion
Private Americans---------- $4.4 trillion
            Total -----------------$14.3 trillion or thereabouts

Every bit of the debt held by the Fed could be repudiated without removing a dime from any American citizen's pocket.  That part of the debt is utterly monetized.

Federal agencies that hold U.S. Treasury debt include the Social Security Trust Fund, the Medicare Trust Fund, the Federal Employees Retirement System, and so on.  Repudiation of this category of federal debt would mean that Congress would have to tax all citizens to pay future dollar benefits promised by these agencies, or that promised beneficiaries of future dollar benefits would get stiffed, thereby bearing the tax that federal debt repudiation would impose.

You can bet that Congress would never ever,  even in its wildest moment of recognition of stark reality, repudiate that portion of federal debt held by government agencies like the Social Security Trust Fund.  I don't have to tell you why; you already know why.

If Congress repudiated the portion of debt held by foreigners, be they individuals, businesses, or sovereign accounts, Congress would be imposing a tax on foreigners.  It's not hard to see that repudiation of foreign-held U.S. Treasury debt would have immediate and resounding consequences.

Central banks all around the globe hold substantial amounts of U.S. Treasury debt, which is an interest paying substitute for holding actual U.S. dollars.  Central banks around the world hold either U.S. Treasuries or U.S. dollars in substantial quantities, because the U.S. dollar is the world's reserve currency.  Central banks use a reserve currency to settle international currency exchange.

Currency exchange is critically important to international trade and capital flows.  If Congress repudiated federal debt held by foreigners, the U.S. dollar would immediately NOT be the world's reserve currency going forward.  Whether loss of the U.S. dollar continuing as the world's reserve currency would be a good thing, a bad thing, or an indifferent thing depends on so many factors, it's really hard to make any overarching summary statements about it.

The fact that the U.S. dollar is the world's reserve currency gives American kings and king makers considerable power and leverage around the world, since only the Federal Reserve can manufacture U.S. dollars, and since the Fed is controlled ultimately by America's kings and king makers.

If Congress repudiated that portion of federal debt held by ordinary U.S. citizens and businesses, Congress would be imposing a tax directly on those citizens and the owners of businesses that hold U.S. Treasuries.

This much can be said; if Congress repudiated part or all of the U.S. Treasury's debt, Congress would be imposing a tax on very identifiable individuals.  That's precisely why it seems unlikely that debt repudiation will occur.  Money creation is a much safer way for Congress, in concert with the Fed, to reduce the federal debt.  Inflation, and depreciation of the U.S. dollar around the world, quite effectively reduces the real burden of American federal debt.

A second, highly predictable consequence of federal debt repudiation would be an immediate unwillingness of people, sovereign states, central banks, and businesses to purchase U.S. Treasuries at current prices.  That is not to say that the Treasury could not sell additional debt.  It could, but the yield to maturity on that debt would likely be rather high --- perhaps somewhere around the level of credit card interest rates for college students in their early 20s.

The market rate of interest that federal debt would have to carry to be sold following debt repudiation cannot be predicted accurately, but we can be sure it would be much higher than it is today.  Yet, a dramatic increase in the price of using other people's money (i.e.,  Treasury interest rates or yields) would not be a bad thing, although it is certain that the 545 and the mainstream media would decry rising Treasury rates in loud voices.

Some weeks ago, I wrote in EconoBlast a solution to the federal debt issue.  You can read it here if you're interested.  Nothing important about the issue of federal debt has changed in the ensuing weeks of political gum flapping by members of Congress and the President about raising the debt ceiling.

Until Congress has a definite, unavoidable budget constraint --- just like you and I have --- federal spending will continue rise, both absolutely and perhaps as a percentage of GDP.  Why do we keep reelecting the  members of the 545 who keep increasing federal spending?  You will have to look into your own mind to answer that question. 

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