"Diseases desperate grown are by desperate appliances relieved, or not at all." – Shakespeare, "Hamlet"
Moody's credit rating agency is warning that the U.S. government's AAA credit rating is at risk, because it has taken on so much debt that there are few creditors left to underwrite it. Foreigners have bought as much as two-thirds of U.S. debt in recent years, but they could be doing much less purchasing of U.S. Treasury securities in the future, not so much out of a desire to chastise America as simply because they won't have the funds to do it. Oil prices have fallen off a cliff and the U.S. purchase of foreign exports has dried up, slashing the surpluses that those countries previously recycled back into U.S. Treasuries. And domestic buyers of securities, to the extent that they can be found, will no doubt demand substantially higher returns than the rock-bottom interest rates at which Treasuries are available now.1
Who, then, is left to buy the government's debt and fund President Obama's $900 billion stimulus package? The taxpayers are obviously tapped out, so the money will have to be borrowed; but borrowed from whom? The pool of available lenders is shrinking fast. Morever, servicing the federal debt through private lenders imposes a crippling interest burden on the U.S. Treasury. The interest tab was $412 billion in fiscal year 2008, or about one-third of the federal government's total income from personal income taxes ($1,220 billion in 2008). The taxpayers not only cannot afford the $900 billion; they cannot afford to increase their interest payments. But what is the alternative?
How about turning to the lender of last resort, the Federal Reserve itself? The advantage for the government of borrowing from its own central bank is that this money is virtually free. This is because the Federal Reserve rebates any interest it receives to the Treasury after deducting its costs, and the federal debt is never actually paid off but is just rolled over from year to year. Interest-free loans that are never paid off are basically free money. In 2008, 85% of the interest collected by the Federal Reserve (or "Fed") was returned to the Treasury. The average interest rate on Treasury securities today is only about 3%; 15% of 3% is less than ½% – such a negligible interest as to make the money nearly free.
The Fed does not have to worry about interest, because it does not actually have to acquire the money before lending it, and it knows the government will not default. The Fed originates the money it lends, either on a printing press or with accounting entries. It can purchase Treasury debt simply by writing credits into the "reserve account" of the seller's bank, which then credits the seller's account. The Fed's ability to write numbers into an account is obviously unlimited; but it has normally restricted its purchase of government securities to only so much as is necessary to provide the liquidity needed for banks to cash and clear checks. Funding the government's budget shortfall has usually been left to private lenders; but those loans are drying up, and servicing them is proving expensive. Both this interest burden and the need to continually attract new lenders could be avoided by tapping into the government's credit line at its own central bank.
But wouldn't that be dangerously inflationary? Not in today's economic climate, as will be shown. And if the notion of funding the government through its own central bank seems too radical and unprecedented to be entertained, consider the radical moves the Fed has already been taking in the last year. Without so much as a by-your-leave from Congress, the Fed just "monetized" $1.2 trillion in private debt, turning commercial loans into money. If private banks and private corporations now have multi-billion dollar credit lines with the Federal Reserve, then Congress should have one too. In fact Congress, which gave the Fed its charter to create the national money supply, should have been the first in line.
If the Fed Can "Monetize" Private Debt, It Can Monetize Public Debt.
The Fed has been a hotbed of radical, experimental activity in the past year. Ben Gisin is a former banker who has long been tracking the Fed's statistical releases. He says he has never seen anything like it. Assets have been magically appearing on the Fed's balance sheet, and they are not coming from any traditional source.2