Guest post by David Gerlitz.
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There's been a lot of discussion going around recently about the Central Bank ripping up the portion of National Debt they hold, thereby reducing the amount of debt of Governments. (See here, here, here and here).
Some of the arguments suggest this would be inflationary, even possibly hyper-inflationary. But consider the accounting in such a scenario (using the US as the example): The Fed is not allowed to buy bonds directly from the Treasury. They buy the bonds from the private sector in exchange for reserves. As is well known by now, this is purely an asset swap. Far from being inflationary, it could be considered deflationary by reducing the amount of interest Treasury pays on the bonds to the private sector. By paying the interest to the Fed instead, and then having the Fed turn around and send it back to the Treasury, the repo (or QE) essentially performs the act of tearing up the bonds already. Further, the 'restraining effect,' or 'crowding out' of bonds on private expenditure is largely a myth. Given that Treasuries can be leveraged just as easily as cash, what's lacking in the private sector isn't cash to make investments, but rather profitable investments to risk that capital on. Now consider what happens if you take the extra step and actually destroy the bonds. Now you've got an accounting problem because you destroyed an asset without destroying the liability. One approach then is to simply leave those reserves in the system and have a mismatch between cumulative deficits and debt outstanding. This would maybe be Wray's or Lerner's approach. But let's say you wanted to keep the accounting clean: Assuming you're not going to take back 1.6T from the Treasury (which would defeat the purpose) and you're not going to take back those dollar reserves from the private sector (again, deflationary and absurd), then the only place left to take the liability is from central bank capital. What are the liabilities of the central bank? 1. The reserves they create and 2. The equity they issue. In the US, the Fed is "owned" 100% by the banks. If you wrote that equity value down, then you have to write the value of it down from the banks balance sheets as well. The fact we've gotten this far should show how absurd this line of reasoning is and that it's never going to happen anyway. But ultimately the result is not inflationary. So reducing the debt outstanding in this way isn't helpful because repo's and Quantitative Easing perform the task already. They're exactly equivalent to "ripping up the debt." It doesn't increase the deficit or create wealth for the private sector. Now, Beowulf makes the point that policy makers may feel better with less outstanding debt--if you can get past the accounting issues--and thereby lead to more fiscal spending. But again, I'm not sure that's the case. Reducing the cumulative total of outstanding debt isn't going to change the minds of those who have an ideological bent against government spending, debts or deficits. They'll fight the spending just as hard. But that's exactly what's needed--what's always been needed: better counter-cyclical fiscal spending designed around jobs and increasing private sector incomes, not accounting gimmickry. |
It is very likely that the government’s total debt is now peaking thanks to sustained QE. This means the total amount of dollars in the hands of the private sector will be shrinking and any additional spending cuts or tax increases will only hasten that shrinkage.
This could end up being a challenge for the economy, but it also could be super bullish for the dollar because it will create shortages of dollars. It’s exactly what happened in Japan and one of the reasons why the yen is so strong.
