Gyroscopic Investing

Do you guys think that our Federal Reserve's back-door way of funding government (by buying bonds already on the market instead of directly funding the treasury) leaves us open to any economic risks we wouldn't otherwise be?

HB Reader wrote:Just to clarify something (and I may be wrong), but I think there is something slightly amiss in this discussion about the money creating roles of the USG and the Federal Reserve here.  The Treasury (on behalf of USG agencies) can't spend any money that isn't raised directly by taxes or bond sales first.

When Harry Browne tells us, "So long as the US government has the ability to tax people or print money, there is virtually no credit risk [with Treasury Bonds]"...do you think he got it wrong? HB implied that the Treasury can "print money" to pay it's bills.

Gumby wrote:

HB Reader wrote:Just to clarify something (and I may be wrong), but I think there is something slightly amiss in this discussion about the money creating roles of the USG and the Federal Reserve here.  The Treasury (on behalf of USG agencies) can't spend any money that isn't raised directly by taxes or bond sales first.

When Harry Browne tells us, "So long as the US government has the ability to tax people or print money, there is virtually no credit risk (with Treasury Bonds)"...do you think he got it wrong? HB implies that the Treasury can "print money" to pay it's bills.

I don't know, but I suspect HB was probably just trying to keep the discussion general and not get into a technical "money creation" discussion (i.e., for discussion purposes he was assuming Congress would always raise the debt ceiling and the Fed would always be a buyer of last resort).  He certainly understood the mechanics of the system.  I just brought it up because I saw some of the actual nuts and bolts being discussed in a way I believed to be inaccurate.

The Treasury can print banknotes.  I don't know whether they have the full immediate statutory authority neccessary to just turn around and begin using them to pay bills.  I seriously doubt it (although I wouldn't be surprised if they had some very limited emergency authority they could theoretically use for a very short while, undoubtedly accompanied by severe criticism from Congress).  Congress could easily give them full statutory authority, but Congress could also raise the debt ceiling and deal with budgetary issues in the context of passing a budget.

But even if the Treasury doesn't have any legal or theoretical impediments, I believe the day-to-day practical problems (lack of a security infrastructure to physically move the money, the task of immediately creating and printing higher denomination bills, the amendment of operational procedures and guarantees with all affected parties in the financial markets, etc.) would immediately begin grinding our financial system to a halt.  Slowly, at best.  Very quickly, at worst.

With financial institutions failing, I can't imagine the dollar obligations of corporate or municipal parties faring any better than Treasuries (which would presumably be first in line to be paid when order was restored).  I also can't imagine the flood of litigation that would ensue as all the interlocking guarantees in the our system began to unravel.  Early in the debacle, cash (banknotes) would probably be king, but it probably wouldn't take long for gold, silver and popular barter items to follow suit.   

I don't expect this stuff to happen, but who knows?  As MT described it, it would be like a person drowning face down in two inches of water because he was too stubborn to roll over.  I doubt even HB would have expected our Congress to be so stupid as to let that happen.  Or even come close.  

These are just my views, of course.  I did work at the Treasury, but I was in a different area so I am certainly open to anyone's corrections or clarifications.  

 

     

   

Gumby wrote: When Harry Browne tells us, "So long as the US government has the ability to tax people or print money, there is virtually no credit risk [with Treasury Bonds]"...do you think he got it wrong? HB implied that the Treasury can "print money" to pay it's bills.

You've got primary dealers forced to participate in Treasury auctions and the Fed trying to achieve their interest rate target.  Those two forces acting in concert virtually guarantee that the bonds will get purchased.  The combination of can't-fail Treasury auctions and POMO make it pretty much impossible to work otherwise.

HB Reader wrote:

Gumby wrote:

HB Reader wrote:Just to clarify something (and I may be wrong), but I think there is something slightly amiss in this discussion about the money creating roles of the USG and the Federal Reserve here.  The Treasury (on behalf of USG agencies) can't spend any money that isn't raised directly by taxes or bond sales first.

When Harry Browne tells us, "So long as the US government has the ability to tax people or print money, there is virtually no credit risk (with Treasury Bonds)"...do you think he got it wrong? HB implies that the Treasury can "print money" to pay it's bills.

I don't know, but I suspect HB was probably just trying to keep the discussion general and not get into a technical "money creation" discussion (i.e., for discussion purposes he was assuming Congress would always raise the debt ceiling and the Fed would always be a buyer of last resort).  He certainly understood the mechanics of the system.  I just brought it up because I saw some of the actual nuts and bolts being discussed in a way I believed to be inaccurate.

HB didn't just say it in his on air discussions. He also wrote it in his books! These are direct quotes...

From Harry Browne's Fail Safe Investing, p.110:

Bonds

For the bond portion, you don't want to have to monitor credit risk, so buy only U.S. Treasury bonds. So long as the U.S. government has the ability to tax people or print money to pay its bills, there is virtually no credit risk (although the bonds can fall in price or lose purchasing power to inflation).

The Treasury has issued a series of bonds that mature (will be paid off) at various dates over the next 30 years. The longer the time to maturity, the greater effect changes in interest rates have on the bond's price.

Since there will be times when the bond category will have to carry the entire Permanent Portfolio, you want a bond with the potential for big price movements. So put the 25% in the Treasury bond issue that currently has the longest time until it matures. That will be close to 30 years. Ten years later, the bond will have only 20 years to maturity, at that time replace it with a new 30-year bond.

...And on page 354 of "Why The Best Laid Investment Plans Usually Go Wrong," Harry Browne wrote:

U.S. Treasury Bonds

United States Treasury bonds are ideal for the long-term bond portion of a Permanent Portfolio.

They are virtually free of credit-risk, since the U.S. government, if needs to, can print the money to pay them off.

I don't think HB could have been more clear about it! He wrote it in very plain english.


Furthermore, Wikipedia defines a "Risk-free Bond" as:

A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. The rate of return would be the risk-free interest rate. In practice, government bonds are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt. For instance, U.S. Treasury notes and bonds are considered risk-free bonds, even though investors in U.S. Treasury securities do face a negligible amount of credit risk.
Source: http://en.wikipedia.org/wiki/Risk-free_bond

Wikipedia also defines "Government Debt: Risk" as:

Lending to a national government in the country's own sovereign currency is often considered "risk free" and is done at a so-called "risk-free interest rate." This is because, up to a point, the debt and interest can be repaid by raising tax receipts (either by economic growth or raising tax rates), a reduction in spending, or failing that by simply printing more money. It is widely considered that this would increase inflation and reduce the value of the invested capital. This has happened many times in history, and a typical example of this is provided by Weimar Germany of the 1920s which suffered from hyperinflation due to its government's inability to pay the national debt deriving from the costs of World War I.
Source: http://en.wikipedia.org/wiki/Government_debt#Risk

It is well known that Treasury Bonds have virtually zero credit risk. After all, that is why we hold them in our PP. But, why do you suppose they have virtually zero credit risk is if we can't print money to pay our bills? The way you describe it, there should be a LOT of credit risk — since we could conceivably run out of money if Congress was gridlocked.

And you'd think that Treasury yields would reflect the risk of a Congressional gridlock. But they don't. Even with the debt ceiling potentially not being raised, the bond market still seems to see T-Bonds as having virtually zero credit risk. 4 week Treasury Bills are currently being auctioned off at 0.000%. And those bonds mature on August 4th (2 days after we supposedly default)!

I'm not sure I see how we can say that T-Bonds have virtually no credit risk in one breath and then say that the Treasury could run out of money in the next breath. That doesn't make sense to me.

Gumby wrote:
It is well known that Treasury Bonds have virtually zero credit risk. After all, that is why we hold them in our PP. But, why do you suppose they have virtually zero credit risk is if we can't print money to pay our bills? The way you describe it, there should be a LOT of credit risk — since we could conceivably run out of money if Congress was gridlocked.

And you'd think that Treasury yields would reflect the risk of a Congressional gridlock. But they don't. Even with the debt ceiling potentially not being raised, the bond market still seems to see T-Bonds as having virtually zero credit risk. 4 week Treasury Bills are currently being auctioned off at 0.000%. And those bonds mature on August 4th (2 days after we supposedly default)!

I'm not sure I see how we can say that T-Bonds have virtually no credit risk in one breath and then say that the Treasury could run out of money in the next breath. That doesn't make sense to me.

Gumby --

As I said, the Treasury CAN print dollar banknotes.  So technically there is no credit risk.  But they can't do it indefinitely.  Despite many practical legal and logistical problems (only a few of which I mentioned), they could probably find some way to create dollar banknotes to meet obligations for a period of time.  The problem is how long and the conditions that would likely result.  If the Treasury could simply print money, the debt ceiling would be irrelevant. 

Until Congress acts, whether it's to raise the debt ceiling or perhaps craft some other acceptable guarantees that obligees of the USG will ultimately be made whole (which seems unlikely), the situation will be inherently unstable and will become increasingly unsustainable.  Unless net Treasury debt issuances immediately become flat or decline (or, put another way, USG tax and other income immediately equals or exceeds legally due USG expenditures), every short-term "solution" will very quickly become a new problem.  I say it will happen very quickly because most of the "easy" short-term solutions (like Treasury borrowings from existing Trust funds and the short-term juggling of discretionary payment obligations) are being exhausted as we converse.   

As in any unstable economic situation, exactly how it unfolds in the marketplace is unpredictable.  IMHO, the most important market to watch is the currency (and, by extension, gold) market, not the debt market.  The currency markets are far less distorted by routine government or central bank activities.   Right now, participants in the equity, credit and currency markets are viewing (probably correctly) all of this stuff as political theater.  If that sentiment starts shifting, the term "market volatility" (up and down) will take on a new meaning for this generation of investors.       

In other words, there is no "credit" risk in dollar-denominated Treasury securities, but there is certainly "dollar" risk. 

The dollars in circulation now -- Federal Reserve notes and demand deposits  -- are legal tender in the US and are obligations backed by the Federal Reserve System (the FED).  In short, dollars are entries on the right hand side of the Fed's balance sheet.  They arise from the Fed's purchase of the assets (mostly USG obligations) that grace the left hand side of the FED's balance sheet.  The Treasury could begin to print all the new legal tender "dollars" they want, but unless they are explicitly backed by some body (like a credible and solvent central bank, or a political pledge like "the full faith and credit of the United States"), or some thing (like gold or silver or some other transferable asset), they will have little to no value to people outside of the US.  Even banana republic currencies have an explicit backing, usually of a central bank stuffed full of bogus assets.

A best case scenario in the event Congress takes no action of any kind:  The practical and legal problems of physical currency movements are overcome and nobody domestically or internationally notices (or chooses to question) that the Treasury is printing and spending the obligations of a very different intstitution, i.e., the FED.  At best, this scenario could only last until the net new Treasury debt issuances exceed the FED's existing equity (i.e., how much its assets exceed its liabilities) and the FED becomes insolvent.

I don't have the figures in front of me, but I know the FED's balance sheet is leveraged something like 45 to 1.  The FED could independently delay the insolvency for a period, but only by buying the existing (and now shrinking) stock of Treasury obligations outstanding with newly created money.  (Buying non-Treasury obligations would only increase the leverage.)  However the situation were to play out, the effects on interest rates (both up and down, real and nominal) would be monumental.  Even this could not go on forever, however, as the supply of Treasury obligations would eventually dry up.  The twists and turns while all this played out are impossible to predict, but ultimately it would probably end in something rivaling the 1930's. 

A conceivable variation:  The Treasury issues some other kind of legal tender fiat dollar banknotes.  But it can't issue "United States Notes" or similar obligations (like the original greenbacks in the 1860's) backed by a USG political pledge or promise of some kind without violating the debt ceiling.  What other kind of fiat dollar banknote could be issued?

Another conceivable variation: The Treasury might be able to issue gold or silver certificates again, but the bullion backing would have to extend to the whole worldwide stock of dollars in existence in order to achieve fungibility.  Implementation of this without Congressional participation and/or approval is inconceivable to me. 

At any rate, I'm sure there are far more scenarios or possibilities than I could ever come with but I doubt any of them would ever prove practical or sustainable.  It seems clear that right now that the marketplace is confident Congress will take some kind of remedial action before we fall into the abyss.  I hope (and expect) they are right, but I do fear we might tread too close before the idealogues on one side or the other realize it.  We desparately need tax and spending, and possibly monetary, reforms but not by Congressional inaction on the debt ceiling.

I don't consider any of the above musings inconsistent with HB's writings.  They only reinforce the logic of having a permanent portfolio.  HB did say the USG could print money (whether directly or through debt creation), but he never said or implied it could be done indefinitely without consequence.     

Sorry, I didn't mean to ramble on.  I am tired of writing.  Like those of everyone else, these hypotheticals are only opinions.

   

HB reader, when Bernanke "marked up" the accounts of banks wasn't it in return for purchases of totally worthless CDOs? In effect Bernanke just marked the accounts of banks period and the CDO "purchases" were just a charade? Could it be argued that, in the event of the debt ceiling not being raised,  "maintaining price stability and full employment" could be served by Bernanke just "marking up" the USG account without the need for the Fed to purchase anything in return?

stone wrote: HB reader, when Bernanke "marked up" the accounts of banks wasn't it in return for purchases of totally worthless CDOs? In effect Bernanke just marked the accounts of banks period and the CDO "purchases" were just a charade? Could it be argued that, in the event of the debt ceiling not being raised,  "maintaining price stability and full employment" could be served by Bernanke just "marking up" the USG account without the need for the Fed to purchase anything in return?

Stone --

I assume you are referring to one or more of the FED's pre-QE2 purchases?  If so, you bring up a general question that I've also been pondering.  How does (or did) the FED value the various MBS securities they purchased and hold?  Few, if any, have a market value like a Treasury security.

Without having the facts in front of me I don't know that I'd characterize their puchases as a charade, but given their mission to protect the banking system I think we can safely assume the FED purchased most of the MBS securities at above realistic market values.  How far above?  I don't have a clue.  This raises obvious questions about the current strength of the FED's balance sheet and whether or how these QE measures could ever realistically be "unwound" (which they claimed was their ultimate intention) without large losses being incurred.  I doubt anyone has ever seriously expected to see much of the QE's unwound, but some token sales in the future shouldn't surprise anyone.   

With respect to your specific question about similar transactions being used to "prop up" USG accounts, there could be some FED purchases of Treasury assets -- this morning CNBC reported rumors of possible FED purchases of Treasury gold.  There are probably a few actions (call them "tricks" or "emergency measures," depending on  your point of view) like this that could be taken, but I doubt they could be sustained or amount to enough to get beyond a few days.  Under different circumstances where it was clearly to everyone's advantage, more expansive emergency measures could probably be taken.  But as I mentioned earlier, most of the relatively "easy" emergency measures are rapidly being exhausted now.

It seems to me that the overriding reality here is that if Congress really wants to, it can shoot the US Government.  And in any place it decides -- from the foot to the head.  You can throw the President in with the Congressional inmates if it suits your personal politics, but it is ultimately Congress that holds the gun.  I really can't see Bernanke or anyone else jumping in to take the bullet -- Congress would just shoot again.   

As investors, there isn't much you or I can do about it other than keep some cash and gold in a dry and safe place.  Hopefully Congress will holster the gun, or at least miss the vital organs.  Treasuries will probably still remain the safest place to keep most of your dollar holdings. 

       
               

     

HB reader,  I just had a look at the Fed's web site and it comes across to me that the AIG bailout was was a simple case of creating fresh money out of thin air to give to AIG so that AIG could pay off the CDS owed to Goldman Sachs etc.
Am I correct in understanding that when the Fed "extends a  line of credit" that means creating new monetary base?

From the Fed's web site:
"On September 16, 2008, the Federal Reserve announced that it would lend to AIG to provide the company with the time and flexibility to execute a plan that would allow it to restructure to maximize its value. Initially, the FRBNY extended a line of credit to AIG for up to $85 billion. The revolving credit facility was established to assist AIG in meeting its obligations as they came due and to facilitate a process under which AIG would sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy."

Of course it is possible that the Fed considers propping up Goldman Sachs to be part of its mandate but that propping up the USG doesn't fall under the remit of "maintaining full employment and price stability".

So what do y'all think about this most excellent idea:

Pragmatic Capitalism: QE3, Treasury style – go around, not over the debt ceiling limit

[quote=Pragmatic Capitalism]The following is a description of how the process would work and the implications for monetary operations:

1. The Treasury mints a $1 trillion coin, or whatever amount is desired.

2. The Treasury deposits the coin into the Treasury’s account at the Fed. The Fed’s assets (coin) and liabilities (Treasury’s account) increase by the same amount. As Beowulf notes later in a comment to the same post from Cullen, were the Fed to resist, the Federal Reserve Act clearly states that “wherever any power vested by this Act in the Board of Governors of the Federal Reserve System or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary.”? The Fed is legally an agency operating at the pleasure of the government, not vice versa. Regardless, the actions I describe here and below by the Treasury in no way interfere with the normal operations of monetary policy (explained in various places below).

3. The Treasury buys back bonds (thereby retiring them) until total market value purchased is equal to the dollar value of the newly minted coin. The result is a decrease in the Treasury’s account at Fed and an increase in bank reserve balances held at the Fed.

...

8. The debt ceiling crisis is averted, as US debt outstanding has been reduced by the dollar value of the minted coin, and can continue to be reduced as desired.
[/quote]

jmourik wrote: So what do y'all think about this most excellent idea:

Pragmatic Capitalism: QE3, Treasury style – go around, not over the debt ceiling limit

Pragmatic Capitalism wrote:The following is a description of how the process would work and the implications for monetary operations:

1. The Treasury mints a $1 trillion coin, or whatever amount is desired.

2. The Treasury deposits the coin into the Treasury’s account at the Fed. The Fed’s assets (coin) and liabilities (Treasury’s account) increase by the same amount. As Beowulf notes later in a comment to the same post from Cullen, were the Fed to resist, the Federal Reserve Act clearly states that “wherever any power vested by this Act in the Board of Governors of the Federal Reserve System or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary.”? The Fed is legally an agency operating at the pleasure of the government, not vice versa. Regardless, the actions I describe here and below by the Treasury in no way interfere with the normal operations of monetary policy (explained in various places below).

3. The Treasury buys back bonds (thereby retiring them) until total market value purchased is equal to the dollar value of the newly minted coin. The result is a decrease in the Treasury’s account at Fed and an increase in bank reserve balances held at the Fed.

...

8. The debt ceiling crisis is averted, as US debt outstanding has been reduced by the dollar value of the minted coin, and can continue to be reduced as desired.

Very interesting article.

The author points out, the Federal Reserve Act (Section 10.6) gives the Treasury the power to force the Fed's hand:

Nothing in this Act contained shall be construed as taking away any powers heretofore vested by law in the Secretary of the Treasury which relate to the supervision, management, and control of the Treasury Department and bureaus under such department, and wherever any power vested by this Act in the Board of Governors of the Federal Reserve System or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary.

Source: http://www.federalreserve.gov/aboutthef ... n%2010.htm

I think this may explain why Treasury Bonds have virtually no risk. HB was very keen on avoiding investments that relied on Congressional action.

Also.. Cullen Roche — who is one of MMTs most vocal supporters, and first posted the article $1 Trillion coin idea, had this to say in the comments of that article:

If we want to be realistic we should realize that the $1T coin is never going to happen. In all likelihood, the politicians will come to some silly agreement in the coming weeks, everyone will breath a big sigh of relief, and we’ll move along as if these boneheads just saved us all from some major world crisis. CNN will write “CRISIS AVERTED”? in big bold text on their front page. Someone will be crowned the winner, someone else the loser, and in the end every American will likely be worse off (except for the political hack who tricks a bunch of Americans into thinking that these debates have been productive). I’ll read all of this, crap my pants, probably vomit a little bit and then wonder why I am not in 150 foot water in La Jolla fishing for halibut….Oh wait, I remember now – we all have to work twice as hard to overcome the ignorance of our govt because we’ve been thrown into a perpetual recession thanks to 30 years of ignorany govt policy….

And the beat (read: political sham) goes on. The guy who raises the biggest fuss and tricks the most people will be the big winner. It’s pretty clear who that is so far….Economics, in case you haven’t noticed, is so damn complex that even the smart people don’t really understand it and the average American is just treading water trying to understand what their 401K statement says. It’s really a big fat joke and the better I understand all of this stuff the less I care about it because the divide between reality and perception is so wide that I am pretty sure I will die having the same daily ridiculous back and forths with people about why the economy sucks and why our leaders are worse.

The $1T coin, while proving the silliness of this entire charade, is just not going to happen. So, we don’t have to worry about hedge funds crashing the dollar and crisis ensuing. More likely, we need to worry about the Euro and China. That’s where the real risks are in my opinion. This whole debt ceiling thing, while entertaining, is a pure political charade meant to garner political support for particular people and expose others as worthless leaders. Nothing material will come of it in terms of market moves and global economic impacts (aside from a bit more austerity in the USA).

stone wrote: HB reader,  I just had a look at the Fed's web site and it comes across to me that the AIG bailout was was a simple case of creating fresh money out of thin air to give to AIG so that AIG could pay off the CDS owed to Goldman Sachs etc.
Am I correct in understanding that when the Fed "extends a  line of credit" that means creating new monetary base?

From the Fed's web site:
"On September 16, 2008, the Federal Reserve announced that it would lend to AIG to provide the company with the time and flexibility to execute a plan that would allow it to restructure to maximize its value. Initially, the FRBNY extended a line of credit to AIG for up to $85 billion. The revolving credit facility was established to assist AIG in meeting its obligations as they came due and to facilitate a process under which AIG would sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy."

Of course it is possible that the Fed considers propping up Goldman Sachs to be part of its mandate but that propping up the USG doesn't fall under the remit of "maintaining full employment and price stability".

Stone --

All else being equal (i.e., in the absence of countervailing actions by the FED), I would assume the extent to which a line of credit is drawn upon would create new money.  We don't know (from that item) how much of the $85 billion was borrowed or repaid.  I would guess that some of it was drawn upon and was later repaid, but I don't know. That information (at least in the aggregate) is probably available somewhere.  You might check AIG's website and annual reports for the last few years.    

       

[quote=Cullen Roche]Nothing material will come of it in terms of market moves and global economic impacts (aside from a bit more austerity in the USA).[/quote]

Balancing the budget and austerity measures might send the USA in a deeper recession though. So by next year November unemployment will be 11.3% and the president-elect could be Ms. Bachmann. So it could end up being quite material...

Clive, don't you think what we now seem to have is a very peculiar type of "socialism" where all of the government mediated intervention is directed at supporting banks rather than the traditional type with support for steel plants or whatever. This new phenomenon comes across to me as a much more slippery fish and it really is breaking into historically unprecedented territory. Japan might be the closest example but Japan is a major net exporter whilst the USA and UK are net importers. Also previously Japanese banks could slowly patch themselves together  with carry trade profits from fueling the housing bubbles over here. If the whole world is a near zero interest rate zone, then what happens?

I find trying to put names on things (socialism/capitalism) often stops what could be productive debates in their tracks.  If there is a market failure/inefficiency (often in the form of informational assymetry), the discussion should be had of if/how to address it.  Any government action could be labelled "socialism" in some sense, so why even try... let's discuss the issue and not try to label things.

I like capitalism for the most part for 1) the moral implications of private property and liberty, as well as 2) the functional/societal implications of people taking care of what they own and being responsible for their own life, thereby contributing to the society as individually responsible people.

Sometimes the functional/societal implications of lazzais fair capitalism break down (in my opinion), and then all you're left with is the rigid moral arguments that liberty/private property are pure and can't be touched.  Those arguments are flawed (again, in my opinion) when taken to the extreme because 1) a lot of natural resource wealth was here before any of us were, and the act of initial distribution of that land & resources is inherantly flawed, and 2) the very judicial/military system set up to protect private property requires the first use of force by the government (aka, I have to pay the police to protect my neighbor's property).

Does this make governmnet regulation/taxation pure or perfect?  Hardly, but it does lead one to wish to dispense with tired labels that try to simplify complicated issues and serve to delegitimize the opposing viewpoint.

Clive wrote: Socialism works until you run out of other people's money - Margaret Thatcher

Nope, look at Greece. They ran out of money so now they'll start auctioning off assets...

Gumby wrote:

jmourik wrote: So what do y'all think about this most excellent idea:

Pragmatic Capitalism: QE3, Treasury style – go around, not over the debt ceiling limit

Pragmatic Capitalism wrote:The following is a description of how the process would work and the implications for monetary operations:

1. The Treasury mints a $1 trillion coin, or whatever amount is desired.

2. The Treasury deposits the coin into the Treasury’s account at the Fed. The Fed’s assets (coin) and liabilities (Treasury’s account) increase by the same amount. As Beowulf notes later in a comment to the same post from Cullen, were the Fed to resist, the Federal Reserve Act clearly states that “wherever any power vested by this Act in the Board of Governors of the Federal Reserve System or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary.”? The Fed is legally an agency operating at the pleasure of the government, not vice versa. Regardless, the actions I describe here and below by the Treasury in no way interfere with the normal operations of monetary policy (explained in various places below).

3. The Treasury buys back bonds (thereby retiring them) until total market value purchased is equal to the dollar value of the newly minted coin. The result is a decrease in the Treasury’s account at Fed and an increase in bank reserve balances held at the Fed.

...

8. The debt ceiling crisis is averted, as US debt outstanding has been reduced by the dollar value of the minted coin, and can continue to be reduced as desired.

Very interesting article.

The author points out, the Federal Reserve Act (Section 10.6) gives the Treasury the power to force the Fed's hand:

Nothing in this Act contained shall be construed as taking away any powers heretofore vested by law in the Secretary of the Treasury which relate to the supervision, management, and control of the Treasury Department and bureaus under such department, and wherever any power vested by this Act in the Board of Governors of the Federal Reserve System or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary.

Source: http://www.federalreserve.gov/aboutthef ... n%2010.htm

I think this may explain why Treasury Bonds have virtually no risk. HB was very keen on avoiding investments that relied on Congressional action.

People are deluding themselves if they believe the Treasury can (or will try to) engage in net new issuances of debt once the debt ceiling is reached.  As an emergency measure the Treasury might be able to buy some time and use some existing asset, like gold, to sell or make a deposit in the FED but creating a new fiat monetary instrument like a trillion dollar coin (which would have the inherent backing of the United States Government) would violate the debt ceiling.

The law quoted above might allow the Secretary of Treasury to call the hand of the Chairman of the Federal Reserve System, but it doesn't trump Congressional authority.  The Federal Reserve was created by Congress.  It is not a separate branch of government.

I really think we are misinterpreting what HB and others mean about Treasuries having no risk.  The obligations of the US Government have no credit risk, but only if the US Government ITSELF is WILLING to tax, borrow or print the money to back them.  If Congress wants to, it can force a default.  It controls the purse strings of the US Government.  Period.

A person standing on the top of a tall building will continue to live and thrive as long as he acts rationally as we assume most people will and doesn't step over the edge.  Getting too close to the edge to prove a point or resolve a dispute that can be resolved elsewhere (like Congress appears to be doing) is exhibiting borderline rationality.            

No asset is without risk.  If you want a fungible asset beyond the control of a particular government, like HB I'd suggest gold.




 

jmourik wrote:

Clive wrote: Socialism works until you run out of other people's money - Margaret Thatcher

Nope, look at Greece. They ran out of money so now they'll start auctioning off assets...

I wonder how much someone would pay for the Parthenon? Might be a nice investment, but I think it could use a little renovating

HB Reader wrote:...but creating a new fiat monetary instrument like a trillion dollar coin (which would have the inherent backing of the United States Government) would violate the debt ceiling.

Why would that be? They are not issuing debt?

Looks like the Republicans just found an escape hatch to vote against the debt ceiling and still raise the debt ceiling:

http://www.politico.com/news/stories/0711/58801.html

Well, I guess that's the political theater that everyone's been talking about. Pretty ugly stuff.

jmourik wrote:

HB Reader wrote:...but creating a new fiat monetary instrument like a trillion dollar coin (which would have the inherent backing of the United States Government) would violate the debt ceiling.

Why would that be? They are not issuing debt?

Yes, they are.  They are issuing a US Government dollar obligation. 

Where's the obligation, HBR?

If someone hands me a dollar, I don't see an obligation there by anyone...

moda0306 wrote: Where's the obligation, HBR?

If someone hands me a dollar, I don't see an obligation there by anyone...

It is an obligation of the Federal Reserve.  That is why it called a Federal Reserve Note.  It is also shown as a liability on the balance sheet of the Federal Reserve System.

Another interesting article:

The U.S. Treasury will not default -- KURT BROUWER'S Fundmastery Blog

[quote=Kurt Brouwer]Despite all the rhetoric and posturing we see in the media and in Washington D.C., it is safe to say categorically that the U.S. Treasury will not default on its debt after August 2nd, even if the debt ceiling is not raised.  Not only will the Treasury be able to pay interest on U.S. debt obligations, but there is money for other essential programs as well.  However, there will be some serious cutting that has to happen because spending clearly exceeds revenues.[/quote]