I put this in General Questions on purpose: I’m not asking if this is a good idea, merely if it’s possible.
Inspired by this post by Martin Hyde and this infographic by Planet Money, and obviously noting the impending debt limit issue, I wondered if the Fed can destroy the bonds it holds. For example, if the chairman were to call a press conference and announce that the bonds held by the fed will now be designated “Federal Reserve Board Chairman’s Toilet Paper*”, would the debt held by the US Government now be $2.1T less?
Obviously, this would allow the debt limit to be ignored for a few more years. If we can avoid wandering into GD territory, what would be the commonly accepted results of such an action (if possible?)
*I’m aware that there are probably not physical bonds issued to the fed, but I figured the imagery was amusing.
If this is legally possible, I would guess it would be legally considered a form of debt forgiveness. According to US tax law, forgiveness of debt is often considered a type of income that is taxable to the forgivee - so you might even be able to argue that the value of the destroyed bonds count as government revenue in the year that they were destroyed - we could balance the budget that way!
31 USC 3113 says that people can make donations to pay down the Federal debt. They can make donations of cash, goods [which the government can sell at auction for the express purpose of converting it to cash to pay down the debt], or government obligations that are retired when gifted this way.
So the statute clearly allows for individual persons to send in Treasury bonds to reduce the public debt, when the government receives them they are canceled. But I don’t know how this statute has been interpreted. If it allows for corporations to make similar donations, I’d suspect the Federal Reserve would indeed qualify, as it is technically organized in a corporate form (depositor banks actually hold ownership in it, for example.)
Even if it were possible, and I seriously doubt that it is, you have the problem of that much extra liquidity being in the system which the fed would then be incapable of draining. Why? Because liquidity is pulled out of the system via the FOMC and they do that by selling securities that the fed has on its balance sheet. They trade those for cash. That cash then ceases to exist and is removed from the money supply. Without anything to trade, the fed can’t remove cash.
Didn’t we recently have the problem of there not being enough liquidity? Wouldn’t more liquidity be a good thing in our current economic circumstances?
I do not understand the question. A bond holder is a creditor against the bond issuer who is the debtor. A debt holder destroying the instruments, in this case the bonds, is, in effect, forgiving the debt.
Can the Fed forgive its debtors? I suppose it would need to be authorized by the legislative but if it is so authorized, why not?
There’s currently about $2-3T in EXCESS bank reserves, so no, we’re good on liquidity. Plus the fed is still buying $85B in MBS and Treasuries every month thereby adding to that excess liquidity anyway.
I’ve said this just in another thread. What is strictly legal is of little consequence; what matters is how other bondholders react. If they see this as an accounting gimmick and react negatively, nothing is gained by pursuing such an option.
The Fed could forgive whatever debts the Treasury owes. As Delta said, that would mean it would have no way to drain that money back out of the system later. (Which would be a good thing, not a bad thing.) It would also mean that the Fed was technically insolvent. As practical matter, it’s meaningless, since the Fed can issue whatever dollars it wants to pay for whatever it wants to buy - therefore, in a real sense, it can’t be insolvent. But it’s balance sheet would be negative, and that would freak some people out.
The truth is the Fed could fund the government forever, without anyone paying any taxes, if it decided to do that.
Such an arrangement would only avoid default in the most technical way. Central bank cancellation of its own government’s debt is considered a selective default. When it happens the debt rating agencies immediately (or so they say) consider the debtor country in default.
Of course after the recent retaliation suit against S&P for their downgrade of US debt in 2011, its anyone’s guess as to whether they would actually downgrade to default. Regardless, in any practical sense, its an obvious default.
I won’t even bother with the first part as I think **Hellestal **dealt with that pretty effectively in this thread that you started - after you seemed to ignore my repeated attempts - which I won’t attempt to replicate here as they obviously serve no purpose.
As to the second paragraph, no the fed couldn’t, at least not in any meaningful sense, fund the govt forever since what you describe would amount to a monetezation of the debt. Think Zimbabwe.
The Fed operates much like a normal bank with a balance sheet. Destroying its own assets would make it insolvent. Ignoring whether anyone would care that the central bank no longer had a sensical balance sheet, I’m certain the procedure would be illegal.
It may be good to devise a way to make Teabagger control of the debt ceiling irrelevant. The platinum coin makes more sense, IMHO, than FRB insolvency.
There’s a middle ground between Zimbabwe and increasing the money supply to stimulate the economy. The Fed’s already proven that by issuing a couple of trillion dollars, without inflation, and without even getting us to full employment. Maybe a couple trillion more would do it. It’s worth a try.
FRB regulations include detailed rules to manage its assets prudently.
I’m not going to hunt a specific clause, but for FRB to deliberately forsake its fiduciary duties would certainly be illegal.
If the managers of a private bank burned the bonds in their vaults without authorization from directors or stockholders, do you think that would be illegal? Do you think the Fed’s directors, beholden to government and public, could do the same legally?
Though not a lawyer, I’ve thanklessly hunted down cites from laws for this Board before. In this case it would be an absurd waste of time. Just the boilerplate in the preamble to FRB Act probably forbids such negligence.
Ron Paul introduced a bill to require the Fed to do this, back in 2011. More recently, Alan Grayson has been urging the Fed to do it on its own authority.
OK. I’m not arguing with you. I’ll note, though, that the Fed is not a private bank, its board is nominated by the President, and its authority is derived from Congress. I would think, though I don’t have a cite, that its fiduciary duty would be to the country as a whole, not its nominal shareholders.
Considering the fact that we’ve had this same discussion before in the thread I referenced above, the only reason I’m responding to you is for the benefit of anyone else who may have the same question.
The reason the excess reserves in the system haven’t caused inflation is hinted at by the name EXCESS reserves. They got there by the FOMC buying securities from banks and crediting the reserve accts of those banks. Under normal circumstances, the banks would take that money and use it to make loans. But that’s not what happens when you have a credit crisis. Credit crises corrode the trust on which a financial system is based. As a result it affects the willingness of institutions to lend.
Therefore it doesn’t matter that credit is cheap and rates are low if no one is willing to lend. So why is the fed continuing to buy securities and further adding to the surplus of liquidity you may ask. That’s because the point of the buying program, quantitative easing, is focused on long term securities and on driving down long term rates.
The fed has much more control over the short end of the yield curve than the long end. They can set the fed funds rate which tends to affect the short end, as just one example. Affecting the long end is more difficult and what the bond purchase program is designed to do.
However eventually, even after a credit crisis, lending returns to normal and those excess reserves are like an inflationary time bomb waiting to go off - 3 trillion pounds of black powder rather $3T dollars. Eventually therefore it will have to be drained from the system and if the fed doesn’t have the ability to do this it will be incapable of controlling the inflation that will inevitably result.
So destroying any securities it has on its balance sheet, even if that were an option, would be the height of stupidity and irresponsibility.
The “Monetary Multiplier” theory taught in first-year economics textbooks is wrong. You don’t need to make excuses for why the multiplier theory isn’t working; you just need to recognize it’s wrong.
Excess reserves are not inherently inflationary, either now or in the future. They do allow interest rates to fall, so if you want interest rates to go up, yes, you’d need to drain reserves, in order to force banks to raise rates.
FRB regulations include detailed rules to manage its assets prudently.