Congressman and presidential candidate Ron Paul recently introduced legislation calling for the federal government to cancel the $1.6 trillion debt held by the Federal Reserve. Such a move creates legal challenges, one of which would be that the Fed would openly acknowledge that it is a private entity and that fedgov has no authority confiscate its assets. (Fedgov had no “authority” to call in gold in 1933, but legal tests to that stood up.)
Yet the $1.6 trillion in Treasury debt was obtained via the Fed creating money “out of thin air,” to use an old and established description of what the Fed does when it buys debt (or other securities that it now owns). Banks do the same when they make loans to consumers via fractional-reserve banking.
Another argument that can be expected: if the Fed has no debt to sell, it cannot shrink the money supply if it deems it appropriate. This would be a smoke screen; it is highly unlikely we will ever again see the Fed decrease the money supply. QE3 is right around the corner.
On the surface this looks like a good idea to reduce the national debt. However, the results maybe disastrous:
1. The credit rating of the U.S. may reflect an equivalent to bankruptcy or a lower rating below AAA.
2. The Federal Reserve may increase the interest rates that banks charge for loans. This may result in hyper-inflation.
3. Savings banks rather than commercial banks may lose their float or the money they may barrow from. Commercial banks may have their own money supply.
4. With foreclosures that are caused by devalued property with mortgage rates above the value of the property, if interest rates are raised above the current levels that banks loan at, this would stagnate the housing market, since loans would be at a higher premium, whereas the value of the properties would be lower.
Stan’s objections to Ron Paul’s bill callling for cancellation of $1.6 trillion in US debt held by the Fed are addressed below.
1. The credit rating of the U.S. may reflect an equivalent to bankruptcy or a lower rating below AAA.
Answer: If $1.6 trillion in US debt disappeared, that would most likely increase the US debt rating.
2. The Federal Reserve may increase the interest rates that banks charge for loans. This may result in hyper-inflation.
Answer: Fed increases in interest rates have been used in the past to contain price inflation. Fairly recent example: Paul Volcker’s containment of price inflation in the early 1980s.
3. Savings banks rather than commercial banks may lose their float or the money they may barrow (sic) from. Commercial banks may have their own money supply.
Answer: Cancelling US debt should have no impact on saving banks except to make them stronger as the US debt is reduced.
4. With foreclosures that are caused by devalued property with mortgage rates above the value of the property, if interest rates are raised above the current levels that banks loan at, this would stagnate the housing market, since loans would be at a higher premium, whereas the value of the properties would be lower.
Answer: It appears that Stan fears that any increase in interest rates by the Fed will negatively impact the housing market. Maybe so, but an increase in interest rates would reward savers, which would cause more savings, which builds funds for capital investments, which would be very positive for the economy.
If the $1.6T debt to the Fed were “cancelled,” surely the Obama administration would shamelessly declare that it had just successfully reduced the national debt by $1.6T. And then, wouldn’t Obama and the Democrats — with the full support/acclaim of the of the left-wing media, academia, labor unions, etc — then use this same insane claim to justify further increasing our out-of-control government spending by yet another $1.6T? And thus, wouldn’t this action amount to, in effect, raising the debt limit by another $1.6T? Why would Ron Paul support that?