10/9/13 – A Modest Proposal to Solve the Debt Ceiling Problem

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Oct 9, 2013 8:59:40 AM

and tagged Debt Crisis, Politics and the Economy

Leave a comment

I’ve been reviewing my posts and articles from the last time we went down the debt ceiling crisis road, and marveling a bit. Trillion-dollar coin indeed! That post proved to be prescient in a lot of ways, although 10 months early. The options I outlined there remain the most probable this time around, but no one has been trotting them out so far. Instead, the discussion has revolved around how to make payments once we run out of money.

I don’t like the spirit of despair that this kind of planning reflects, and I think I have a better idea about how to solve the problem. It requires no issuance of coins, no scrip rather than cash—although the difference is small—and no constitutional confrontation.

It is simplicity itself: Have the Federal Reserve forgive the Treasury debt that it owns.

Once the debt is forgiven, it goes away. Poof! The Treasury immediately has more room under the debt ceiling to issue new debt, and actual debt service costs remain the same on a net basis, since the Fed was rebating the interest payments to the Treasury anyway. The debt ceiling is no longer a burden, at least for a while—which could be a long time, depending on how much debt the Fed forgives.

Frivolous arguments can and will be made against this proposal, of which four deserve comment, if only to refute them.

  1. It amounts to monetizing the debt. Very true, but hasn’t that ship already sailed? The difference between the Fed injecting money by buying securities and holding them for years, possibly until maturity, and holding them forever (i.e., forgiving them) is minor in the grand scheme of things—especially since the Fed already rebates interest payments. The net monetization will be in the interest payments, which is small.
  2. It will be inflationary. This point follows directly from the first and, from the Fed’s perspective, can actually be viewed as a benefit. The Fed has a stated policy of boosting inflation, and it has not yet succeeded. If this plan did generate significant inflation—which it probably wouldn’t, again per point 1—it would play into the Fed’s current policy goals and could always be addressed later with interest rate policy.
  3. The Fed will become insolvent if it forgives the debt. The difference between the Fed becoming insolvent in this way, as opposed to becoming insolvent when interest rates rise, is a question of months, not years. The solvency of the Fed has always been a notional issue, and planning is well along for exactly that event when rates rise. Insolvency is inevitable; the question is whether the country can benefit from it.
  4. There is no end to this kind of policy! As opposed to the current, open-ended quantitative easing approach? This plan would, of course, be a one-time event, justified only by the current emergency conditions—just like the original QE.

Clearly, this is the one policy action that can solve the present problem. Are there obstacles? Of course, multiple ones—legal, operational, and, no doubt, moral. The clear benefits, however, justify surmounting them as quickly as possible. At that point, Congress could come together in a spirit of civic compromise and solve the spending problems, without worrying about an impending deadline, so that we never have to face this kind of dilemma again.

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®