Saturday, July 16, 2011

Thoughts on The Suggestion to Repudiate All the Treasury Securities Held by the Federal Reserve

You little bomb thrower you.
I'm reminded of a situation I watched back in the day. A trader sold a position to another firm a few minutes before a trading halt. The news was negative. The buyer D.K.'ed (Don't Know) the trade, meaning we'd still own the position, at which point the head of the firm got on the phone and told his counterpart "I don't want the shit, whyd'ya you think I sold it to you?"
From the von Mises Institute:
Defaulting on the Fed's Bonds
Ron Paul recently made (another) splash among economic pundits with his suggestion that the Treasury simply cancel the $1.6 trillion in its debt held by the Federal Reserve. Many of Paul's longstanding critics seized on the proposal as reckless and said it was further evidence that Paul doesn't understand financial markets. However, Paul received unexpected praise from the progressive economist Dean Baker.

In the present article I'll explain the basics of Dr. Paul's proposal. It's hard to say what its ultimate impact would be if enacted, because the analysis depends on our assumptions. Even so, we can sketch some of the main considerations to at least build a framework for evaluating his suggestion.

Ron Paul's Modest Proposal
At the 10:00 mark in this interview with radio host Jan Mickelson, Paul says that one quick solution to the stalled debt-ceiling negotiations is for the Treasury to simply cancel the roughly $1.6 trillion in its securities currently on the balance sheet of the Federal Reserve. That would immediately reduce the outstanding federal debt by the same amount, thus freeing up room for Treasury Secretary Geithner to continue meeting the government's financial obligations even without a Congress-approved increase in the statutory debt ceiling.
Paul argues that this debt cancellation is acceptable because the Fed just printed up the money out of thin air to buy the bonds in the first place. In other words, it's not as if the Treasury would be reneging on its debts held by hardworking, frugal investors.

Furthermore, Paul briefly mentions that the move would neuter the Fed's power going forward. After all, the textbook "open-market operations" through which modern central banks conduct monetary policy are the buying and selling of government debt. If the Federal Reserve could no longer trust that the Treasury would honor its debt once the Fed had acquired it, then the entire enterprise of US central banking might be jeopardized. For Ron Paul, of course, that is a virtue of his proposal.

The Critics
As usual, most of the pundits thought Ron Paul's idea was absurd. Greg Mankiw thought it was a "crazy" idea that amounted to an accounting gimmick that effectively raises the debt ceiling by $1.6 trillion without the trouble of voting on it, while Karl Denninger thought it was an endorsement of the "raw printing of money," and "functionally identical to FDR's … gold devaluation."

The first thing to note is that Mankiw and Denninger can't both be right: Ron Paul's idea can't simultaneously be an accounting gimmick and a wildly inflationary policy that wrecks the dollar. Even so, let me explain their (different) points of view....MORE
From Lew

Ron Paul's Proposal To Repudiate T-Bonds at the Fed
A few comments on Bob Murphy's interesting Defaulting on the Fed's Bonds. To make clear my own position: I agree with Ron's proposal. Indeed, I think Murray is right: all federal debt should be repudiated.
1. "Purists will rightfully object to his classification, because in reality the Fed is a quasi-private entity with private shareholders." No it is not. (It is not clear whether Bob agrees with this parenthetical statement.) Mankiw is right and the unnamed purists are wrong. The Fed is a government agency, and a rogue one at that, with no Congressional oversight.

2. Unmentioned is the fact that Ron's proposal would deprive the Fed of the $40-$50 billion per year in interest payments out of which it takes its plush, self-designated budget, returning the rest to the Treasury. It would now have to go to Congress hat in hand for funding like any other government agency....MORE
From Free Advice:
Follow-Up on Ron Paul’s Proposal to Cancel the Fed’s Treasury Holdings
Lew Rockwell wrote a response to my Mises Daily article on Ron Paul’s proposal. I’ll address some of his criticisms one at a time, though not in the order Rockwell listed them:
4. The discussion in the next-to-the last section claiming that Baker’s proposal to raise reserve requirements is tantamount to “stealing money from the banks” is wrong. The Fed has been systematically lowering reserve requirements from almost its inception, permitting the banks to pyramid ever-greater amounts of demand deposits upon their reserves, thus expanding the money supply and fattening their interest incomes. There can be nothing wrong in reversing almost a century of bank thievery.
Yep, mea culpa on my use of the loaded term “stealing.” As Blackadder (I think) pointed out in the comments here when the piece first appeared, it’s a bit weird to say the Fed would be “stealing” when at worst, it would be destroying the banks’ assets without benefiting itself in the process. (So maybe “vandalism” would be more accurate.) And as Rockwell points out, to say “stealing” implies a moral judgment that the banks rightfully deserve the current situation, when I of course don’t believe that....MORE