Ron Paul Suggests Using Fed to End Debt Ceiling Impasse

The only reason to think Republicans are serious about their threat to have the Federal government default rather than raise the debt ceiling is that they have an undue fondness for apocalyptic outcomes. I suppose I should actually favor this sort of thing; I’ve long thought the only hope for getting the US freed from rule by financiers was another financial crisis, provided it came soon enough and it was big enough. This one might fit the bill on those scores.

However, with the immediate trigger being pigheaded Congressmen, the banks might look like innocent victims, when the ballooning of public debt around the world was the direct result of their recklessness and the resultant global economy near-death experience. So a debt-ceiling-row-induced great big financial dislocation would probably not produce the opportunity to break the power of banks that yours truly and many others are looking for.

As the hour of reckoning approaches, more and more creative ideas to disarm the Republican weapon are being put forward, and an intriguing one comes from, of all places, a Republican, Ron Paul. As described by Dean Baker in the New Republic last week, Paul’s plan is simple – have the Fed cancel some or all of the Treasuries it got via its quantitative easing programs:

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.

Baker points out a second benefit. Canceling the bonds The only use the Fed had for those bonds was to eventually sell them back to the public to soak up liquidity when it started worrying about inflation. But the Fed can achieve that end the old fashioned way, by raising reserve requirements.
So getting rid of the bonds formally in one stroke really would reduce the debt level, because it saves the interest payments that would have been made to investors after the Fed’s Treasury bonds were sold back in the open market.

The Baker discussion says Congress would have to approve this maneuver, and that would seem to put everything back at square zero. But perhaps not. I’m not terribly conversant with the fault lines within the Republican camp, but Ron Paul has a great deal of appeal with voters. The fact that he’s willing to put out a clean, viable third option may suggest that he is not alone in recognizing that his fellow party members are playing Russian roulette with all chambers loaded. And as one of the Fed’s longest-standing critics, for him to say, effectively, that some of the Federal debt has effectively been monetized, why not quit pretending otherwise, is close to a Nixon comes to China moment.

Paul’s gambit is also a clever way to hoist the banks on their own petard. The deficit hysteria has in no small measure been driven by the banks as part of a desire to enforce their new program of insulating bondholders from losses, including those of inflation. State support for policies like that amounts to socialism for rentiers, since the reason bonds pay more interest that Treasury bills is interest rate risk and credit risk. If investors want a premium yield, they should expect to bear the hazards which go with them.

I hope Paul prevails. When a Congressman who has often been depicted as a wingnut has the best idea in the room, you know a serious house cleaning is in order.

This post originally appeared at naked capitalism and is reproduced here with permission.