On January 1, 1835, Andrew Jackson, the founder of the Democratic Party, paid off the entire US national debt.
However, as most MMTers know, running federal budget surpluses, like President Jackson did, is asking for economic trouble.
Similar to a private sector ‘deleveraging’ of debt (‘destroying’ of dollars) which can create a ‘paradox of thrift’, it can also trigger a full-blown ‘deflationary spiral’. So it’s never a good idea for the federal gov’t to pay down debt (to ‘destroy’ dollars)—unless federal policymakers intentionally want to slow the economy.
That’s why it isn’t a coincidence that all six depressions in US history, including The Panic of 1837, were preceded (were started) by sustained federal budget surpluses that decreased debt. Furthermore, it also isn’t a coincidence that the 2008 Great Recession and those six depressions were succeeded (were ended) by sustained federal budget deficits that increased debt.
In the post-gold standard, modern monetary system, there’s another way to pay down federal debt that doesn’t ‘destroy’ dollars. Let’s call it ‘Quantitative Redemption’ (QR).
If alive today the 7th President of the United States would love this.
In a QR, the Fed would announce that the $2.4T in Treasury bonds presently on their balance sheet are, effective immediately, redeemed (‘called’ before maturity date). We are only redeeming the Treasury bonds (20yr< maturity) and Treasury notes (10yr – 20yr maturity) on their balance sheet, not the other $1.8T in Agency bonds and Mortgage Backed Securities (MBS) the Fed also bought and are also on their balance sheet.
How this QR works is ridiculously easy. There is nothing to actually do, except announce that instead of continuing to keep these Treasury bonds ‘impounded’ (held on the Fed’s balance sheet) from the Large Scale Asset Program (LSAP) / a.k.a. ‘Quantitative Easing’ (QE), the Federal Open Market Committee (FOMC) has declared all these Treasury bonds redeemed, and no longer exist (or the FOMC may decide to do this piecemeal, whatever). This QR wouldn’t be anything new. Redeeming bonds is not an exotic concept, it’s done all the time by everyone, the only difference being that this would be the first time the federal gov’t is doing it with Treasury bonds. For example, other bond issuers like businesses that issue debt (‘corporate bonds’) and municipalities that issue debt (‘muni bonds’) have called their bonds before maturity date. This happened a lot since the credit crisis (since the LSAP program) because prevailing interest rates fell way below the rates being paid out to bondholders, so these particular issuers exercised what is known as an embedded call option. Similar to an ‘assignment’ in any option trade that is exercised, if bonds are called by the bond issuer, the bondholder has no say in the matter. Bondholders are simply notified that their bonds are being returned to the issuer and the bondholders then receive a cash payment in full for the entire bond principal (‘par value’) plus any remaining accrued interest at the financial institution where the bonds are held (‘registered’). This is exactly what the Fed did to Wall Street bondholders during LSAP. A Main Street example of a bond call, if a homeowner decides to pay off a mortgage before the term (‘prepayment’), same thing, the homeowner called the ‘bond’ (the debt owed) from the issuer (the lender). What Ben Bernanke did during LSAP was also not much different from a company purchasing its own shares (‘buyback’), which if not retired, are held on the company’s balance sheet (‘Treasury stock’). In fact, as a US Treasury bond broker during the QE years, whenever I spoke to primary dealers or confirmed trades with their settlement departments, ‘buybacks’ is exactly what they called QE. Most of the folks on Wall Street (correctly) referred to QE as ‘Fed buybacks’ while The Very Smart People on cable news & talk radio (incorrectly) called it ‘debt monetization’. The beauty of this QR idea is that this buyback step is already done. There is *literally* nothing the Fed has to do. All of the $2.4T in Treasury bonds were already called; all of the Wall Street bondholders were already paid back their $2.4T; all of the markets already had their ‘temper tantrum’; and even though that net addition of $2.4T into the banking system (by the Fed to pay for those bonds) had an inflationary bias, it caused no inflation whatsoever (because the economy was so weak it vaporized on impact like a brief sun-shower at high noon).
If the Fed did a QR this year, it’s actually not a redemption of the Treasury bonds this year, it’s only making it official that there was a redemption of Treasury bonds during the LSAP years. On December 29, 2008 the Fed began QE1, and after a combined total $2.4T of Treasury bond buybacks, the Fed ended QE3 on September 24, 2014. Now let’s step back from the picture and take another look at what happened. Prior to the 2008 credit crisis, one arm of the federal gov’t (the Treasury department) sold $2.4T in Treasury bonds, and then after the crisis another arm (the Federal Reserve Bank) bought them back. Except unlike any regular Joe Blow who buys back his own IOUs, instead of ripping them up, the federal gov’t didn’t rip them up. The federal gov’t put those IOUs, their own IOUs, in their own pocket. Then the federal gov’t started making semi-annual interest payments to itself, from itself, on all $2.4T of these Treasury bonds, on its own IOUs (and still does to this day). The point is, that all those Treasury bonds could have been declared ‘paid off’ the day Ben Bernanke created dollars (‘reserves’) and credited the sellers of those bonds long ago, but the Fed didn’t do that.
The difference between Chairman Ben Bernanke and Joe Blow was that Ben did not have the authority from Congress to pay those bonds off. The Fed is only a ‘swap’ desk. Just like any other bank, the Federal Reserve Bank can only create dollars as long as it’s in exchange for a swap of assets. The Congress is the ‘outright’ desk. Only Congress can allow any action that would outright change the cumulative count of previously authorized deficit spending (the ‘national debt’). The Fed cannot usurp the ‘power of the purse’ from Congress. Hence the Fed impounding the bonds during LSAP on the Fed’s balance sheet for a future unwinding (another swap that is ‘printing’ bonds back into the secondary market and simultaneously ‘unprinting’ dollars). So in reality a QR would just be the Fed going through the formality of getting permission to formally declare that the bonds were already redeemed.
If QR was done and the Fed redeems (debits) the Treasury bonds, there must be an equal and opposite ledger entry (credit) to replace them. In other words, something must replace these Fed assets (‘balance sheet repair’). Congress could authorize the Treasury to mint a $2.4T coin to be transferred to the Fed. Again, this would not be anything exotic nor unprecedented (The Gold Reserve Act of 1934 authorized the Fed to transfer all of its gold to the Treasury in exchange for gold certificates denominated in dollars). This would effectively replace the Treasury bonds (dollars with a coupon and a specific maturity date) with a coin (dollars without a coupon and a perpetual maturity date) without needing to create and enter dollars into the banking system (it was already done).
Here’s the best part. This QR, this redemption, this removal of $2.4T of previous ‘Debt Held By The Public’ will mark down the national debt from approx $21.8T to $19.4T, an ELEVEN PERCENT DECREASE, not a bad day’s work. If the US did this, perhaps Japan, a country with a national debt of over ONE QUADRILLION yen, might follow suit. In a single day, the BOJ could announce a quantitative redemption amounting to approx 425 trillion yen of Japanese Government Bonds (JGBs) presently held on their balance sheet as of May 20, 2017. That would be an overnight reduction of their national debt of 43%.
Which would get other people (Swiss National Bank’s Balance Sheet to GDP as of November 2018 is 125%, the ECB’s is 41% and the Bank of England’s is 20%) around the world thinking that the big bad national ‘debt’ problem might not be such a big bad problem after all.
What MMTers have been saying all along.
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P.S. ‘QE unwind’ is Wizard of Oz type stuff. It’s a prototype of end-game Pure MMT. It’s just a matter of time before they pull back the curtain and just level with everyone that federal gov’t DEFICIT spending (that isn’t ‘funded’ by taxes) is ‘cash-financed’—that bonds never have to be issued and sold in the first place. Treasury bonds are needed to be issued and sold to fulfill savings desires, yes; to help keep inflation in check, yes; to keep a running count of and to keep Congress having the ‘power of the purse’ on deficit spending, yes; but to ‘fund’ deficit spending, no. Something like a ‘QR’ is what it will take to change mainstream thinking from where we are now—from today’s MMT phase (where federal deficit spending is cash-financed under a guise of being ‘bond-financed’)—to the after, fully post-gold standard, end-game Pure MMT phase (where we stop saying ‘federal debt’, federal ‘deficit’ spending or even trade ‘deficit’).