Retire the US Treasury debt on the Federal Reserve’s balance sheet

An interesting idea floating around, most recently heard through Mark Grant, is that the US Treasury should retire the Treasury debt currently held on the Federal Reserve’s balance sheet.  Mark believes that the retirement of $1 trillion of the slightly more than $2 trillion in Treasury notes and Bonds on the balance sheet would eliminate near-term debt ceiling discussions and potentially reduce rates in the short-term.  We at Kamp Consulting Solutions like this idea very much.  Chuck DuBois, a former partner of mine while we were both at Invesco, has been touting this idea for a while, too.  We believe that the entire debt could be retired at once, but there are many investors who like the idea of holding US Treasury bonds and notes for investment purposes.

There are many market participants who fear that the retirement of the US debt would be inflationary, but in reality the swap of bonds with reserves actually reduces liquidity because the bonds are higher yielding.  Furthermore, many of the bonds are being used as longer-term investments, and it is likely that the reserves received in the swap would be reinvested in longer-dated securities and not used for short-term economic activity.

I’m tired of hearing about the debt ceiling, and the debates in DC as to whether this artificial ceiling should be raised.  I suspect that you may be, too.  Let’s retire some of the debt today, and eliminate this conversation from happening for a while.

Washington’s Folly

I have to be careful!  I find myself shaking my head so frequently at what is transpiring in Washington DC, that I might suffer permanent nerve damage.  It is scary how uninformed our politicians are regarding economics, and specifically the role of federal deficits in generating economic activity.

There are four primary sources of profits at the macro level of the US economy including, consumption (consumer spending), corporate investment (plant, equipment and inventory), net exports (exports minus imports) and net government spending (deficit spending minus tax receipts).  Since the great recession, it has really only been the federal spending that has kept corporate profits at all-time highs (averaging > 10% of GDP).  The consumer and corporations have kept spending and investment below normal historical levels, and our net exports are nearly -$500 billion. If it weren’t for the fact that the US fiscal deficit was as great as it has been, the economic recovery would have been far more muted, especially in 2010 and 2011.

Remember, the Federal deficit = private savings! Cut back too much on the federal deficit spending without a commensurate pick up in investment and consumption, and we could teeter on the brink of another recession.  With employment remaining weak, we need corporations to pick up the slack.  We may also benefit by becoming a bigger energy exporter, reducing the negative consequence of being a net importer nation, but that might take years.  Until then, we need Washington to stop focusing on the debt ceiling and expend their energy on creating an economic environment that creates jobs and stimulates demand for goods and services.