By Izabella Kaminska and Cardiff Garcia
How does one buy time when trying to avoid a US debt ceiling-related default?
Why not by repo-ing the Treasury’s $300bn worth of gold stocks?
It’s one solution that’s currently being touted by former Federal Reserve official and current Peterson Institute economist Joseph Gagnon, by way of columnist Bruce Bartlett‘s blog.
As Bartlett notes:
One idea comes from Peterson Institute economist Joseph Gagnon, a former Federal Reserve official. He suggested to me that the Federal Reserve could temporarily buy some of the Treasury’s $300 billion stock of gold. This would allow the Fed to create cash that the Treasury could use to pay its bills until the debt limit is increased, at which time Treasury could simply buy it back. It would be a purely paper transaction that would have no real effect on the price of gold or anything else. The Fed could simultaneously sell an equal amount of securities from its portfolio to prevent the money supply from rising more than it desires.
A more radical solution would be to simply disregard the debt limit altogether on constitutional grounds, an idea I suggested in the Fiscal Times on April 29. University of Baltimore law professor Garrett Epps made a similar suggestion in The Atlantic on May 4.
Though, admittedly, you’d have to convince the extremist goldbugs that the gold was there in the first place. Or rather, that this sort of thing hasn’t actually been done already.
But if you thought that was radical, there are a few other ostensibly “out there” solutions doing the rounds.
Bartlett, for example, also suggests ignoring the debt ceiling altogether.
The essence of the argument involves section 4 of the Fourteenth Amendment to the Constitution, which reads: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” In my view and that of Prof. Epps, this means that the president would have constitutional authority to take extraordinary measures to protect the public credit and prevent a debt default even if it means disregarding the debt limit, which is statutory law subordinate to the Constitution.
All of which sounds very Roman Republican in terms of emergency powers.
That said, there’s also an intriguing proposal from Republican Representative Ron Paul flying around. Why not have the Fed extinguish the bonds it’s acquired from quantitative easing operations to make way for new bonds?
As the New Republic reported:
The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself.
Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.
Of course, if the Treasury did do that — it might as well do away with the concept of quantitative easing via asset purchases altogether and let the Fed literally roll the printing presses Zimbabwe style. There would, after all, be no illusion that QE was anything other than money printing from thin air.
The whole point of keeping hold of the Treasuries, after all, is connected to the Fed having the power one day to soak up the additional money supply it has created. Without the bonds, it would be restricted on the tightening measures it can deploy.
Though, in the opinion of Ron Paul, other measures like raising the reserve requirements for banks — otherwise known as the Chinese school of tightening — would be sufficient. But it’s possibly best to see how it works out for the Chinese first, no?
And there’s another issue, one that Tyler Cowen points out — in the aftermath, this could well lead to the expansion of the shadow banking system at the expense of the non-shadow banking system:
So if the Fed has its stock of bonds destroyed, it wishes to recapitalize itself, in part because it doesn’t fully trust the indirect option on recapitalization through Congress and it wishes to restore its financial power base. It can do this in a number of ways, but the simplest is to print up more money and buy something valuable. We get QEIII, though on which assets is unclear. The shadow banking system expands, while the higher reserve requirements (assuming a penalty rate of interest) contract the non-shadow banking system. Overall that’s a bad mix, though we have temporarily solved the debt ceiling problem.
Finally, also via Cowen, legal scholar Michael Abramowitz wrote an intriguing letter to Freakonomics focussing on the opacity of the word “questioned” in the “shall not be questioned” clause of the 14th.
The idea is that the word may apply “not just to direct repudiation of the debt, but at least also to default on the debt — in which case it would render unconstitutional not just the entire debt limit statute itself (the Epps/Bartlett position) but also “the entire statutory fiscal scheme.”
As I understand it, Medicare alone, if untouched, would eventually become such a burden that a default would follow. Of course, that won’t happen; trends that can’t continue won’t. But my paper emphasizes that the argument for finding the debt limit unconstitutional is the same as the argument for finding an unsustainable fiscal policy unconstitutional. Each puts the nation on a path to default that can be averted only by congressional action.
But Abramowitz doesn’t recommend anything quite like the Fed’s buying the Treasury’s gold or destroying its bonds. Instead he recommends a
selective and preferred nuanced interpretation of the amendment (emphasis ours):
These considerations make me think that a modest approach for the President to take would be not to conclude that the debt limit is facially unconstitutional, but rather that it would be unconstitutional as applied, to the extent that it would prevent payment of interest on the debt. If the President took that position, the Administration would in effect continue to raise the debt limit as necessary to make payments on the debt. But when other bills came due, if there were insufficient funds to pay them, that would not justify the issuance of additional debt. The consequences of such nonpayment are sufficiently severe that the President and Congress could continue to play their game of chicken, but the worst case scenario would be a government shutdown, rather than a default. Perhaps the President can accomplish this even without invoking the Public Debt Clause, simply by prioritizing payments on the debt over other payments that come due, but his ability to do that depends in part on the timing of revenues and expenditures, and an announcement that the President will make payments on the debt despite the debt limit statute no matter what would calm the markets. Perhaps the Office of Legal Counsel will issue an opinion helping the President to do this, but if not, President Obama has shown a willingness to seek out other legal opinions to allow him to reach the ends he seeks.
We still think the most likely outcome here is that some kind of deal will be reached at the last minute. But as we’ve emphasised, the details of an eventual deal matter too — and we could be dealing again with the debt ceiling issue sooner rather than later.
Best to keep these unorthodox solutions handy, then.
Ron Paul’s Surprisingly Lucid Solution to the Debt Ceiling Impasse – The New Republic
It’s the BIS – FT Alphaville
Debt limit deal not out of reach – Reuters
The impossible debt ceiling rollover – FT Alphaville
Debt ceiling dealing – FT Alphaville