There has been much commentary about the furore in Washington, DC. The US Treasury is running out of credit because it has reached the maximum it is allowed to borrow (the “debt ceiling”). Congress can fix that by raising the debt ceiling. However this would require cooperation between both houses and the President. And this is not happening. As I write this, the wrangling continues with no end in sight.
For the past week or so, the big “D” word has been bandied about. Is the US Treasury going to default? Is it going to miss interest payments on bonds? Or is it going to do something else? Or is it simply going to be business as usual because Congress raises the debt ceiling?
First, let’s consider if the debt ceiling is raised. That will obviously stave off immediate consequences. However, unless spending comes under control, the whole drama will repeat itself in a few years. The US nation debt will continue to grow at an alarming pace and that growth will likely accelerate as the US population continues to age. So raising the debt ceiling is a temporary measure at best. At least one commentator has suggested that by 2015, things will be looking quite bleak, even in this scenario.
Now, suppose the US Treasury defaults on its obligations, or part of them. This would, of course, have far reaching consequences. The precise magnitude and reach of those consequences is difficult to predict, however. It will certainly cause a major shakeup in the world financial markets as the lemmings who have bought into the USD as a reserve currency flock to another currency to use as such (the Euro? Something else?). It could even touch off another round of “depression” (the other “D” word).
So, it seems that defaulting is not a good option in the short term though it might turn out better in the very long term. It also seems that raising the debt ceiling without changing the status quo is only a very short term solution. Is there another option?
Well, there is. The US Treasury could actually issue more money. That’s right. I said “print money”. Now I can hear everyone screaming at me. That’s bad. It will lead to runaway inflation leading to bread costing $25000 per loaf. There is no way printing more money is going to help! But if you will bear with me long enough to explain, you may find the result interesting.
What is the purpose of the US Treasury borrowing money? You may think it is to meat its obligations when it is short. And, on the surface, that would be correct. However, the net effect of the Treasury borrowing money is to increase the amount of money in circulation. This happens through the magic of fractional reserve lending, which I will not explain in detail here as there are many sites which expend a great deal of effort explaining it. Think about what I just said. The US Treasury is actually adding money to circulation by borrowing money. (See www.positivemoney.org.uk for an explanation of the mechanics and why this is a bad idea.)
Now that we’ve established that the US Treasury borrowing money is actually increasing the circulating money supply, let’s consider the option. Printing money also increases the money supply, but it does so directly. No magic is required. No fractional reserve lending. And, best of all, no hidden interest costs to cover later. (Borrowing to create money using fractional reserve magic requires continual inflation to simply stave off collapse.) And here’s the best part. There is no need to increase the debt ceiling because this new money would not be borrowed from anywhere.
To answer the runaway inflation concerns, this is easily handled by limiting government spending to something reasonable. If the current level of spending is not causing runaway inflation, then financing it by printing money instead of borrowing money will not either. And printing money instead of issuing bonds will have the net beneficial effect of reducing annual operation costs by eliminating interest payments over time. While these interest payments may be a fairly small fraction of the overall budget, when you are facing a debt crisis, every cut matters. You do not solve personal financial woes by eliminating your biggest expense (housing probably), but by cutting a bit here and a bit there until it adds up to enough to balance the books. The same applies to a government. Reduce debt service costs as part of an overall strategy to reduce the deficit. Every dollar saved by reducing debt servicing is one less dollar that needs to be cut from social security or health care or which has to be raised through additional taxes.
I’ll leave with one final note about printing money as a solution. It is critical that printing money not become the primary mechanism by which governments fund operation for that way leads to runaway inflation. Instead, the government must fund its operations at a level that keeps new money creation at a level that maintains inflation at an approximately neutral level. That is, enough to keep the economy liquid and no more. Thus, balanced budgets are still needed and are, in fact, critical.
The positive money site I mentioned above talks about much of this from the perspective of the United Kingdom, and without reference to debt ceilings. However, the basic concepts still apply, regardless of the specific implementation referenced. In this particular case, the United States and the United Kingdom have similar enough structures that the same problems and solutions generally apply.