The Secretary of the US Treasury has stated that the consequences of US debt default might prove catastrophic, and could cause credit markets to freeze, the dollar to plummet and interest rates to rise precipitously. These outcomes could bring on a new global financial crisis.
One might have thought that the McClintock-Toomey bill could have provided some comfort, and a possible way forward, but it gives priority to credit rating over domestic constituency needs, and appears to have proven unacceptable.
While a political resolution may still be possible, one would be foolish to assume it. And the debt ceiling bullet must be avoided at all costs.
Let us, therefore, consider other options available to the President if the Senate fails to reach a satisfactory outcome on the budget, and the possibility of debt default becomes a reality.
The President could be advised along the following lines:
- As Keynes advised Roosevelt in an open letter in December 1933, there are basically three ways to finance on-going budget deficits:
- Option 1: by issuing new government bonds;
- Option 2: by taxation; and
- Option 3: by printing new money.
- In relation to Option 1, it is instructive to note that general government primary net borrowing in the United States increased by 40 per cent of GDP between 2008 and 2012. This increase accounted for the entire increase in general government net debt over this period.
- Put another way, had new government bonds not been issued by the government to finance budget deficits over this period then the net public debt would have been only 48 per cent of GDP rather than 88 per cent at 2012.
- Option 1 adds directly to public debt, and so, going forward, option 1) would need to be avoided if the debt ceiling cannot be raised.
- Option 2 could weaken demand and activity and would be unwise in an economy suffering from a pro-longed, substantial deficiency in aggregate demand.
- Option 3 would result in no increase in public debt, and hence the debt ceiling bullet could be avoided.
Creating new money to finance the budget deficit has been proposed for consideration by many economists including Abba Lerner (1943), Milton Friedman (1948), Ben Bernanke (2002), Richard Wood (2011), Biagio Bossone (2012), Willem Buiter (2012), McCulley and Pozar (2013), Lord Adair Turner (2013), and others. Detailed references can be found in Richard Wood, ‘Overt Money Financing and Public Debt’, EconoMonitor, 3 September 2013.
Creating new money to finance to budget deficit is far superior to creating new money to finance banks and speculators under quantitative easing (QE). Under the former approach — overt money financing — the new money reaches the unemployed and the disadvantaged (with relatively high marginal propensities to consume) in the real economy, whereas under QE the new money merely finances asset price bubbles, benefits speculators, creates currency wars or sits in unproductive reserve accounts held by commercial banks at the central bank.
QE inflates base money but not the effective money supply. Under overt money financing the new money flows into real domestic activities and increases the effective money supply.
Further, QE is of doubtful value, distorts risk-taking and has other serious adverse side-effects, and needs to be shut down and replaced.
Overt money financing represents the most powerful fiscal and monetary policy combination to simultaneously provide fiscal stimulus without increasing public debt.
To give effect to new money financing of on-going budget deficits, the Government could, inter alia, take back control of all currency issuance from the central bank; or create Federal government currency notes to circulate alongside Federal reserve bank currency notes; or issue a high value Federal government coin to the central bank in exchange for central bank currency notes.