Can the U.S. pay off the national debt without printing more money?
By mid-August, 2011, the Federal Reserve will hold over $1 trillion of the $13.6 trillion U.S. national debt, making it the largest holder in the entire world, greater than Japan or China. Right now it holds over $821 billion worth of treasuries, roughly equal to Japan’s stake in July.
Since August 19th, the Fed has bought on average $4.625 billion more treasuries a week, a pace that will bring it over the $1 trillion milestone in about 38 weeks. That’s if nothing changes with the Fed’s current plans to sell off more than $1 trillion of its mortgage-backed securities holdings and reinvest them in treasuries.
Making matters worse, in a speech on October 15th, Fed Chairman Ben Bernanke set the table for further treasuries purchases on top of what the Fed already holds.
Bernanke said “there would appear — all else being equal — to be a case for further action… [A] means of providing additional monetary stimulus, if warranted, would be to expand the Federal Reserve’s holdings of longer-term securities.” If it does that, it will come atop its current holdings, and without a doubt be difficult to undo.
Bernanke added, “substantial further expansion of the balance sheet could reduce public confidence in the Fed’s ability to execute a smooth exit from its accommodative policies at the appropriate time.” Gee, you think?
If the Fed props up the national debt to the point of being the Treasury’s lender of first and last resort, confidence will shaken — that the U.S. can even honor its obligations. Printing money to pay debts will be the “pretended payment” Adam Smith warned against in his final chapter of The Wealth of Nations.
There already is good reason to be concerned. According to Strategas Research Partners’ Jason Desena Trennert: “$5.2 trillion of U.S debt comes due in the next three years…” On top of that, the White House Office of Management and Budget projects that in the next three fiscal years the national debt will grow by $3.6 trillion to $17.453 trillion.
So, in the next three years, the Treasury will have to sell $8.8 trillion more treasuries: $5.2 trillion to roll over the existing debt, and another $3.6 trillion that will be added atop it. That means each year it will have to sell $2.93 trillion of more debt, $630 billion more than it has ever sold in a single year.
In that context, the true rationale for “QE2” comes into perspective. Of course, the shortfall of needed treasuries sales to prevent a default only being $630 billion is entirely dependent on current demand for U.S. debt remaining at peak levels. If other nations can increase their purchases, the gap will be less.
Unfortunately, the rest of the world may not be able to fill in that gap. China, for example, is about to watch a tremendous real estate bubble pop, and meanwhile needs to transition from its export-driven economy. It is already reducing its share of treasuries, so the nation will likely buy less debt this fiscal year than it bought last year. Japan remains stagnant after it went through the same problem twenty years ago.
Assuming demand for treasuries remains the same or goes down, the Fed would have little choice but to step in just to prevent the U.S. from defaulting on its debts.
The only alternative appears to be if Congress managed to drastically slash spending and balance the budget next year. If balanced for fiscal years 2012 and 2013, that would reduce the need to borrow by $2.4 trillion, reducing the Treasury’s needed sales of treasuries to $2.13 trillion every year for the next three years. But how?
According to the White House Office of Budget and Management, by the end of Fiscal Year 2011, if nothing changes, the national debt will be approximately $15.144 trillion. One option House Republicans might propose if they win in November is capping the debt there. No more debt ceiling increases after that.
The Treasury can only sell treasuries subject to the statutory limitation of the debt ceiling. So, with the debt legally capped, the budgets for 2012 and 2013 would have to be balanced, or else the nation would default. The Senate and White House, which would otherwise be reluctant parties to balancing the budget, would instead be forced to work with the House.
Under that scenario, Republicans could propose paying for defense, current entitlements, and a few other things, but the rest of the budget would have to essentially be slashed and the federal bureaucracy dismantled.
That may seem drastic, but even that will not prevent the Fed from becoming the number one holder of the debt next year (if not sooner). What it would do, however, is offer the much-needed confidence that the U.S. can honor its obligations without Bernanke and Co. firing up the printing press. And it would give the American people the opportunity to at long last begin paying off the mountain of debt it has accumulated.
Robert Romano is the Senior Editor of Americans for Limited Government (ALG) News Bureau.
