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  • Solution to the Debt Ceiling Impasse

    Rather novel idea, destroy the debt ..


    Ron Paulís Surprisingly Lucid Solution to the Debt Ceiling Impasse


    Representative Ron Paul has hit upon a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds. While at first blush this idea may seem crazy, on more careful thought it is actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget.

    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 doesnít have its bonds. In fact, there is no direct loss of income to anyone associated with the Fedís 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.

    In addition, thereís a second reason why Representative Paulís plan is such a good idea. As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed. In this case, the interest payments would be a burden to the Treasury since the Fed would no longer be collecting (and refunding) the interest.

    To be sure, there would be consequences to the Fed destroying these bonds. The Fed had planned to sell off the bonds to absorb reserves that it had pumped into the banking system when it originally purchased the bonds. These reserves can be created by the Fed when it has need to do so, as was the case with the quantitative easing policy. Creating reserves is in effect a way of ďprinting money.Ē During a period of high unemployment, this can boost the economy with little fear of inflation, since there are many unemployed workers and excess capacity to keep downward pressure on wages and prices. However, at some point the economy will presumably recover and inflation will be a risk. This is why the Fed intends to sell off its bonds in future years. Doing so would reduce the reserves of the banking system, thereby limiting lending and preventing inflation. If the Fed doesnít have the bonds, however, then it canít sell them off to soak up reserves.

    But as it turns out, there are other mechanisms for restricting lending, most obviously raising the reserve requirements for banks. If banks are forced to keep a larger share of their deposits on reserve (rather than lend them out), it has the same effect as reducing the amount of reserves. To take a simple arithmetic example, if the reserve requirement is 10 percent and banks have $1 trillion in reserves, the system will support the same amount of lending as when the reserve requirement is 20 percent and the banks have $2 trillion in reserves. In principle, the Fed can reach any target for lending limits by raising reserve requirements rather than reducing reserves.

    As a practical matter, the Fed has rarely used changes in the reserve requirement as an instrument for adjusting the amount of lending in the system. Its main tool has been changing the amount of reserves in the system. However, these are not ordinary times. The Fed does not typically buy mortgage backed securities or long-term government bonds either. It has been doing both over the last two years precisely because this downturn is so extraordinary. And in extraordinary times, it is appropriate to take extraordinary measuresólike the Fed destroying its $1.6 trillion in government bonds and using increases in reserve requirements to limit lending and prevent inflation.

    In short, Representative Paul has produced a very creative plan that has two enormously helpful outcomes. The first one is that the destruction of the Fedís $1.6 trillion in bond holdings immediately gives us plenty of borrowing capacity under the current debt ceiling. The second benefit is that it will substantially reduce the governmentís interest burden over the coming decades. This is a proposal that deserves serious consideration, even from people who may not like its source.


    Dean Baker is the co-director of the Center for Economic and Policy Research. His most recent book is False Profits: Recovering from the Bubble Economy.

  • #2
    Re: Solution to the Debt Ceiling Impasse

    I thought this was part of the plan all along... But not until the fed has a lot more bonds. Heck, according to them automatic earth people, He could buy another ten trillion without causing inflation. So far so good.

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    • #3
      Re: Solution to the Debt Ceiling Impasse

      I thought the fed was NOT an agency of the federal government. That it was owned by member banks, and has congressional oversight. Following Mr. Paul's plan a few lather-rinse-repeat cycles and all the federal debt problems are gone poof!

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      • #4
        Re: Solution to the Debt Ceiling Impasse

        isn't the long term solution to stop spending other people's money?

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        • #5
          Re: Solution to the Debt Ceiling Impasse

          Can iTuliperís come up with a plan that balances the US budget using market mechanisms?

          Here are some ideas to start with:

          1. Eliminate the US income tax for both individual and corporate. Replace it with a 5% VAT on all transactions including stock and bond purchases / trades.

          2. Eliminate all subsidies and taxes on business and individuals. Charge 5% on all funds returned to the US from abroad.

          3. Eliminate Medicare and Medicaid and replace it with a single payer health plan identical to Franceís single payer public/private system. (1/2 the cost of the US with #1 ranking in health outcomes).

          4. Make the dollar convertible to Gold reserves held by the US payable to international Central Banks on demand on a 40:1 basis (350,000 US Debt in (Metric Tons of Gold) / 8,965.6 Total US Gold Reserves (Metric Tons)

          5. Congress and the president can spend as much as they want each year however this would directly affect the Gold to US dollar convertibility ratio (which is floating).

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          • #6
            Re: Solution to the Debt Ceiling Impasse

            I want to change VAT to a national sales tax. The states can still have their own sales tax added of course.

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            • #7
              Re: Solution to the Debt Ceiling Impasse

              I agree with the national sales tax instead of a VAT. To the above I would add:

              Stop the banks being in charge of our money supply. Under our present system, every dollar created is created by the Fed and loaned to the government bearing interest. We need to stop this now. Money should be issued by the US Treasury in the form of debt-free, interest-free US Treasury Notes. We should use US Treasury Notes to pay off all debts.

              Be kinder than necessary because everyone you meet is fighting some kind of battle.

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              • #8
                Re: Solution to the Debt Ceiling Impasse

                Here is the response I received from C1ue:

                I posted this on another older thread but no response. Hat Tip to Bart's forum and iTuliper's charts on the debt to GDP in Gold.

                Can iTuliperís come up with a plan that balances the US budget using market mechanisms?

                Here are some ideas to start with:
                Frankly these are all completely gold bug/libertarian fantasies.

                The hint is in the requirement that the US balance its budget immediately. The issue isn't that the US' credit is already crap, the issue is that the current economic path that the US is on is bad and getting worse. Krugman isn't a moron for advocating more spending per se, he is a moron for advocating more spending without any coherent plan or objective.

                But let's look in more detail

                Originally Posted by ekemon
                1. Eliminate the US income tax for both individuals and corporations. Replace it with a 5% National Sales Tax on all transactions including stock and bond purchases / trades.

                The US federal budget is presently around $3.8 trillion. The entire US GDP is estimated to be around $14.7 trillion in 2010.

                If 5% were charged on every dollar of every transaction (GDP), you only get $0.735 trillion.

                So unless you're talking about cutting the federal budget over 50%, this proposal is completely nonsensical. (income taxes are roughly 1/3 of present federal revenues: $1.5 trillion. Of course spending is at a huge deficit at present).

                This also doesn't speak about the state, local, and city taxes/budgets.

                Originally Posted by ekemon

                2. Eliminate all subsidies and taxes on business and individuals. Charge 5% on all profits returned to the US from abroad.
                Given that the present tax system charges the normal corporate tax rate on income, whether from abroad or not, your proposal amounts to a gigantic tax break for corporations.

                To put this in perspective: the corporate repatriation one-time event being pushed now by Cisco and others is a tax rate of 5.25% - higher than what you're proposing.

                The last 'one time' offshore profit repatriation holiday in 2004 charged a similar amount as above (5.25%).

                Originally Posted by ekemon

                3. Eliminate Medicare and Medicaid and replace it with a single payer health plan identical to Franceís single payer public/private system. (1/2 the cost of the US with #1 ranking in health outcomes).
                Sounds nice. Who's going to hire all those doctors and hospitals in the public system (and pay them)? Do you nationalize all existing hospitals, nationalize some of them, or build new hospitals? Who sets the policy for what national health care does and does not provide? How will all this be paid for?

                Originally Posted by ekemon

                4. Make the dollar convertible to Gold reserves held by the US payable to international Central Banks on demand on a 40:1 (to start) market determined floating basis (350,000 US Debt in (Metric Tons of Gold) / 8,965.6 Total US Gold Reserves (Metric Tons)

                So is gold redeemable for dollars then? freely by anyone or just central banks? What about deficit spending - guaranteed necessary due to the ramping up of a brand new medical system noted above? What about the money held by private people - apparently it doesn't count in your conversion scheme as having any value? What about state, local, and city debts/assets - equally not accounted for in this scheme?

                Originally Posted by ekemon

                5. Congress and the president can spend as much as they want each year on any infrastructure, social or military programs however this would directly affect the Gold to US dollar convertibility ratio (which would be floating).

                So you're saying the US will pay its debts in gold. Are you ready to get your gold nationalized? Because that's the immediate next impact as the government scratches for gold in order to make ends meet.
                Last edited by c1ue; 07-29-11 at 02:16 PM.

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                • #9
                  Re: Solution to the Debt Ceiling Impasse

                  Hi Shiny!

                  Excellent suggestion lets add it to the solution.

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                  • #10
                    Re: Solution to the Debt Ceiling Impasse

                    #1 objection from C1ue is that we would have to reduce Federal expenditures by 50% using a 5% NST. Eliminating the military budget would do that ;-) However, reducing the military budget by 50% would put it back to non wartime levels. A very good thing I would suspect.

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                    • #11
                      Re: Solution to the Debt Ceiling Impasse

                      Regarding C1ue's #2 objection it seems to me I heard recently GE and several other corporations paid ZERO in taxes. Charging them 5% with no tax breaks is quite an improvement.

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                      • #12
                        Re: Solution to the Debt Ceiling Impasse

                        Regarding C1ue's #3 objection France is a Private/non-profit/public hospital mixed system. By converting to a system like theirs the US having a single payer system does not require it to purchase anything or run anything. However, they do have to set Information Technology interface standards for exchanging patient, drug, lab and hospital data like France does. Not a big deal but there is a cost to implement across all providers. Similar to having a Visa and Mastercard account and terminal device in your place of business. Imaging iPads with a standardized reporting program hooked to the Internet. Not too difficult with lots of vendors wanting a doctor or hospital's business. See excellent discussion on healthcare link http://www.itulip.com/forums/showthr...care-in-France
                        Last edited by ekemon; 08-16-11, 05:51 AM. Reason: Added link to another post

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                        • #13
                          Re: Solution to the Debt Ceiling Impasse

                          ******* corporations have everybody by the balls. They can just leave. And they do.

                          I just read that Microsoft gets some huge state tax breaks (including possibly a billion dollars they owe the state). This is ridiculous. But, what do you do? Turn the screws on them?

                          They own the governments.
                          -------------

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                          • #14
                            Re: Solution to the Debt Ceiling Impasse

                            aaron you are right of course. I was hoping a small 5% tax would not cause them to locate to the islands.
                            Last edited by ekemon; 10-13-11, 08:28 PM.

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                            • #15
                              Re: Solution to the Debt Ceiling Impasse

                              Originally posted by ekemon View Post
                              Can iTuliperís come up with a plan that balances the US budget using market mechanisms?
                              My two cents worth. Balancing the budget can be given a huge push in the right direction through a no give-aways tax policy and not getting involved in unnecessary, expensive wars.

                              In another post, I'd written something on how to encourage corporations to hire Americans instead of off-shoring. Being that much of government revenue comes from income taxes, the ideas espoused in that post should reduce unemployment, thus reducing the need for unemployment benefits, while enabling the government to tax the now-employed workers. A corporate tax rate 5.25% is unacceptable: why should a corporation be taxed at a lower rate than a working person? The corporation receives benefits (I would argue moreso than individuals in aggregate) from being in this country and yet they don't want to pay the taxes that make those benefits possible?

                              The government should also do away with the various giveaways related to real estate that have been enacted over the years. For example, allowing the depreciation of the full value of real estate just because the property changes hands even though the previous owner has already fully depreciated the property, the mortgage interest rate deduction, and the elimination of capital gains on one's residence. While eliminating these giveaways may not generate revenue for the government, it will most certainly reduce the price of real estate and make housing more affordable in this country and thus make it easier for corporations to hire Americans instead of off-shoring.

                              As for the issue of wars, a few trillion dollars can easily be saved by simply not waging them.

                              I'm less certain about closing the military bases the U.S. has. While it would help tremendously to balance the budget, it's not clear to me what the side effects would be on the U.S. and the rest of the world.

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