A Modest Proposal for Ending Debt Limit Gridlock

By L. Randall Wray

Washington’s deficit hysteria has morphed into gridlock over expansion of federal government debt limits. It is as if that stupid “debt clock” on Times Square had run out of electrons to keep the numbers racing ever higher. As we all know, the debt clock is actually tracking the growth of nongovernment net financial wealth—so if Washington really were able to stop the clock, it would also prevent private sector net financial wealth from growing. I presume that this is well-understood even inside the Washington Beltway, hence, the debate has more to do with politics than anything else. Still, it might be worthwhile to see how we can untie Uncle Sam’s purse strings while living with current debt limits. It is actually a relatively easy thing to do, requiring only a modest change of procedure.

First we need to see how things usually work. Congress (with the President’s signature) approves a budget that authorizes spending. Treasury then either cuts a check or directly credits a recipient’s bank account. While our Constitution vests in Congress the power to create money, in practice the Treasury uses our central bank, the Fed, to handle its payments. Current procedure is for the Treasury to hold deposits in its account at the Fed for the purposes of making payments. Hence, when it cuts a check or credits a private bank account, the Treasury’s deposit at the Fed is debited. The Treasury tries to maintain a deposit of $5 billion at the close of each day. Taxes paid to the Treasury are first held in deposit accounts it has with special private banks. When it wants to replenish its deposit at the Fed, Treasury moves deposits from these banks. Obviously there are two complications: first, tax receipts bunch around tax due dates; and, second, the Treasury normally runs an annual budget deficit—now amounting to a trillion dollars. That means Treasury’s account at the Fed is frequently short.

To obtain deposits, the Treasury sells bonds (of various maturities). The easiest thing to do would be to sell them directly to the Fed, which would credit the Treasury’s demand deposit at the Fed, offset on the Fed’s balance sheet by the Treasury’s debt. Effectively, that is what any bank does—it makes a loan to you by holding your IOU while crediting your demand deposit so that you can spend. But current procedures prohibit the Fed from buying treasuries from the Treasury (with some small exceptions); instead it must buy treasuries from anyone except the Treasury. That is a strange prohibition to put on a sovereign issuer of the currency, if you think about it, but it has a long history that we will not explore in detail. It is believed that this prevents the Fed from simply “printing money” to “finance” budget deficits so large as to cause high inflation–as if Congressional budget authority (and threatened Presidential veto) is not enough to constrain federal government spending sufficiently that it does not take the US down the path toward Zimbabwe and Weimar Republic hyperinflation.

So, instead, the Treasury sells the treasuries to private banks, which create deposits for the Treasury that it can then move over to its deposit at the Fed. And then “Helicopter Ben” buys treasuries from the private banks to replenish the reserves they lose when the Treasury moves the deposits. Got that? The Fed ends up with the treasuries, and the Treasury ends up with the demand deposits in its account at the Fed—which is what it wanted all along, but is prohibited from doing directly. The Treasury then cuts the checks and makes its payments. Deposits are credited to accounts at private banks, which simultaneously are credited with reserves by the Fed. And for any reader still following along, in normal times banks would find themselves with more reserves than desired so will offer them in the overnight Fed Funds market. This tends to push the Fed Funds rate below the Fed’s target, triggering an open market sale of treasuries to drain the excess reserves. The treasuries go back off the Fed’s balance sheet and into the banking sector.

And that is where the debt gridlock problem bites. Treasuries held by banks, households, firms, and foreigners are counted as government debt (and nongovernment wealth!) and thus subject to the imposed debt ceiling. Bank reserves, by contrast, are not counted as government debt. The last time we came up against the debt ceiling I proposed that we solve the problem by simply ordering Helicopter Ben to stop the open market sales of treasuries. Leave the reserves in the banking system. Enter QE2: Uncle Ben is buying hundreds of billions of treasuries to inject reserves back into banks—the reserves that were drained by selling the treasuries to banks in the first place. So we are getting treasuries back onto the Fed’s balance sheet where they belong, and yet gridlock remains because there are still too many treasuries off the Fed’s balance sheet.

Here is the modest proposal. When Uncle Sam needs to spend and finds his cupboard bare, he can replenish his demand deposit at the Fed by issuing a nonmarketable, nonbond, nontreasury warrant to be held by the Fed as an asset. With the full faith and credit of Uncle Sam standing behind it, the warrant is a risk-free asset to balance the Fed’s accounts. If desired, Congress can mandate a low, fixed interest rate to be earned by the Fed on its holdings of these warrants (to be deducted against the excess profits it normally turns over to the Treasury at the end of each year). In return, the Fed would credit the Treasury’s deposit account to enable government to spend. When the Treasury spends, its account is debited, and the private bank that receives a deposit would have its reserves at the Fed credited.

So, from the Fed’s perspective it ends up with the Treasury’s warrant as an asset and bank reserves as its liability. The Treasury is able to spend as authorized by Congress, and its deficit is matched by warrants issued to the Fed. Congress would mandate that these warrants would be excluded from debt limits since they are nothing but a record of one branch of government (the Fed) owning claims on another branch (the Treasury). The Fed’s asset is matched by the Treasury’s warrant—so they net out. (The same can be said about Social Security Trust Fund holdings of nonmarketable treasuries, which also should be excluded from debt ceilings—a topic for another day.)

Unlike Swift’s modest proposal, no children get eaten. Instead, they get fed because with gridlock removed and spending released, school lunch programs are reinstated.

L. Randall Wray is a Professor of Economics at the University of Missouri-Kansas City and Research Director with the Center for Full Employment and Price Stability as well as a Senior Research Scholar at The Levy Economics Institute and author of Understanding Modern Money.

Professor Wray also blogs at New Economic Perspectives, and at New Deal 2.0.

This article originally appeared at Benzinga.com.

16 Comments
  1. Douglas says

    Randall Wray’s article represents the kind of slippery morality that ails the US today.

    Who cares about the intention of the debt ceiling and that these limits are supposed to be worked out via a specifically political process? Instead, let’s game the system to produce the result that we are so sure are in everyone’s interests.

    1. Friedrich says

      Douglas, I like Professor Wray’s idea so much that I decided to apply it to Missouri’s budget and wrote the following to the governor and all state senators:

      Governor Nixon,
      I ran across an article written by Professor Wray of the University of Missouri Kansas City on how to solve the federal debt ceiling. Here is a link: http://www.benzinga.com/markets/bonds/11/03/950670/a-modest-proposal-for-ending-debt-limit-gridlock-feed-the-children-dont-e
      I propose that you use this brilliant idea to solve Missouri’s budget problems.

      A Modest Proposal To Fix Missouri’s Budget
      Professor Wray pointed out in his article that the debt clock is actually tracking the growth of nongovernment net financial wealth. He is referring to the national debt clock and is simply stating that government debt = nongovernment net financial worth. Interesting financial alchemy to say the least and I think that this economic black magic should be used by Missouri state government.
      Professor Wray’s solution to the debt ceiling is for the Treasury to issue nonmarketable warrants to the Federal Reserve and then the Federal Reserve will issue credits to allow the government to continue its out of control spending spree. And he proposes that this accounting witchcraft be not count toward the debt ceiling. He does not have a maturity date for the warrants, but since the creation of these warrants will increase nongovernment net financial worth, I assume that he wants these warrants to continue in perpetuity. Brilliant!
      Now let’s apply this economic sorcery to Missouri’s budget. Since this is complex stuff, only to be understood by brilliant university educators, I recommend that the following solution only be implemented for the budget of the Department of Higher Education. That’s approximately $1.3 billion. So instead of sending money, just pay the entirety of House Bill 3 in Missouri Warrants. And don’t count these warrants toward Missouri’s debt, just as Professor Wray suggested that the Federal Government do with their warrants. Why count them? The warrants will exist in perpetuity, increasing nongovernment net financial worth! I’m sure that these intellectual giants will be ecstatic in that their net financial worth will increase by $1.3 billion.
      I think it’s important that Professor Wray’s net financial worth be increased since this is his idea. I propose that the University of Missouri pay Professor Wray’s entire $106,630 salary (according to public records) in these same nonmarketable warrants. He so richly deserves to be paid not in currency, but in nonmarketable warrants.
      This is clearly a win-win thanks to the brilliant Professor. I request that you give this idea the widest dissemination – just make sure that you give full credit to Professor Wray.

      Very respectfully,
      iflyjetzzz

      1. Anonymous says

        Prof Wray describes the monetary/fiscal realities of a sovereign nation (USA) that can issue fiat money with legal tender laws mandating use of money for all debts private and public AND has the power to tax and enforce these laws. Said differently, license to print money. Sorry, no state or local government or in your satirical case University has this capability.

        for a great reference see:
        http://neweconomicperspectives.blogspot.com/2011/03/modern-monetary-theory-and-mr-paul.html

    2. Barry says

      Douglas – the morality that needs to be questioned is that of the austerity brigade seeking to put the burden of deficit reduciton entirely on workers and the most vulnerable.

      Wray is pointing out that the deficit hysteria promulgated by the austerity brigade is groundless.

  2. Douglas says

    Randall Wray’s article represents the kind of slippery morality that ails the US today.

    Who cares about the intention of the debt ceiling and that these limits are supposed to be worked out via a specifically political process? Instead, let’s game the system to produce the result that we are so sure are in everyone’s interests.

    1. Friedrich says

      Douglas, I like Professor Wray’s idea so much that I decided to apply it to Missouri’s budget and wrote the following to the governor and all state senators:

      Governor Nixon,
      I ran across an article written by Professor Wray of the University of Missouri Kansas City on how to solve the federal debt ceiling. Here is a link: http://www.benzinga.com/markets/bonds/11/03/950670/a-modest-proposal-for-ending-debt-limit-gridlock-feed-the-children-dont-e
      I propose that you use this brilliant idea to solve Missouri’s budget problems.

      A Modest Proposal To Fix Missouri’s Budget
      Professor Wray pointed out in his article that the debt clock is actually tracking the growth of nongovernment net financial wealth. He is referring to the national debt clock and is simply stating that government debt = nongovernment net financial worth. Interesting financial alchemy to say the least and I think that this economic black magic should be used by Missouri state government.
      Professor Wray’s solution to the debt ceiling is for the Treasury to issue nonmarketable warrants to the Federal Reserve and then the Federal Reserve will issue credits to allow the government to continue its out of control spending spree. And he proposes that this accounting witchcraft be not count toward the debt ceiling. He does not have a maturity date for the warrants, but since the creation of these warrants will increase nongovernment net financial worth, I assume that he wants these warrants to continue in perpetuity. Brilliant!
      Now let’s apply this economic sorcery to Missouri’s budget. Since this is complex stuff, only to be understood by brilliant university educators, I recommend that the following solution only be implemented for the budget of the Department of Higher Education. That’s approximately $1.3 billion. So instead of sending money, just pay the entirety of House Bill 3 in Missouri Warrants. And don’t count these warrants toward Missouri’s debt, just as Professor Wray suggested that the Federal Government do with their warrants. Why count them? The warrants will exist in perpetuity, increasing nongovernment net financial worth! I’m sure that these intellectual giants will be ecstatic in that their net financial worth will increase by $1.3 billion.
      I think it’s important that Professor Wray’s net financial worth be increased since this is his idea. I propose that the University of Missouri pay Professor Wray’s entire $106,630 salary (according to public records) in these same nonmarketable warrants. He so richly deserves to be paid not in currency, but in nonmarketable warrants.
      This is clearly a win-win thanks to the brilliant Professor. I request that you give this idea the widest dissemination – just make sure that you give full credit to Professor Wray.

      Very respectfully,
      iflyjetzzz

      1. Anonymous says

        Prof Wray describes the monetary/fiscal realities of a sovereign nation (USA) that can issue fiat money with legal tender laws mandating use of money for all debts private and public AND has the power to tax and enforce these laws. Said differently, license to print money. Sorry, no state or local government or in your satirical case University has this capability.

        for a great reference see:
        http://neweconomicperspectives.blogspot.com/2011/03/modern-monetary-theory-and-mr-paul.html

    2. Barry says

      Douglas – the morality that needs to be questioned is that of the austerity brigade seeking to put the burden of deficit reduciton entirely on workers and the most vulnerable.

      Wray is pointing out that the deficit hysteria promulgated by the austerity brigade is groundless.

  3. Karen says

    “While our Constitution vests in Congress the power to create money…”

    That’s not actually true. Congress was given the power to make coins out of gold or silver, for purposes only of standardization.

    Article I, Section 8 of our Constitution says
    “The Congress shall have the power….5. To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.”

    To understand what is meant by that, you have to understand that at that time coins were made of gold and silver, and it was universally understood that a given coin’s value was determined by how much gold or silver it contained. The reasoning behind the power of Congress to coin money is explained in Federalist Paper #44:

    “The right of coining money, which is here taken from the States, was left in their hands by the Confederation, as a concurrent right with that of Congress, under an exception in favor of the exclusive right of Congress to regulate the alloy and value. In this instance, also, the new provision is an improvement on the old. Whilst the alloy and value depended on the general authority, a right of coinage in the particular States could have no other effect than to multiply expensive mints and diversify the forms and weights of the circulating pieces. The latter inconveniency defeats one purpose for which the power was originally submitted to the federal head; and as far as the former might prevent an inconvenient remittance of gold and silver to the central mint for recoinage, the end can be as well attained by local mints established under the general authority.”

    (source: http://avalon.law.yale.edu/18th_century/fed44.asp )

    1. Anonymous says

      so turn the clock forward to today:

      Congress did worse in 1913 by turning the monopoly to create money over to the central banking cartel – the FED. Time to reclaim the power to “coin” money, which today is the authorization to create of an asset in an bank account or print a real piece of paper money. Give US Treasury money issue responsibility with congressional oversight and public transparency. It is time to end the incestuous relationship between the UST and the secret and corruptible nature FED manipulations.

  4. Karen says

    “While our Constitution vests in Congress the power to create money…”

    That’s not quite true. Congress was given the power to make coins out of gold or silver, for purposes only of standardization.

    Article I, Section 8 of our Constitution says
    “The Congress shall have the power….5. To coin money, regulate the value thereof, and of foreign coin, and fix the standard of weights and measures.”

    To understand what is meant by that, you have to understand that at that time coins were made of gold and silver, and it was universally understood that a given coin’s value was determined by how much gold or silver it contained. The reasoning behind the power of Congress to coin money is explained in Federalist Paper #44:

    “The right of coining money, which is here taken from the States, was left in their hands by the Confederation, as a concurrent right with that of Congress, under an exception in favor of the exclusive right of Congress to regulate the alloy and value. In this instance, also, the new provision is an improvement on the old. Whilst the alloy and value depended on the general authority, a right of coinage in the particular States could have no other effect than to multiply expensive mints and diversify the forms and weights of the circulating pieces. The latter inconveniency defeats one purpose for which the power was originally submitted to the federal head; and as far as the former might prevent an inconvenient remittance of gold and silver to the central mint for recoinage, the end can be as well attained by local mints established under the general authority.”

    (source: http://avalon.law.yale.edu/18th_century/fed44.asp )

    I concede that the power to regulate the value of coined money was always possible for Congress to abuse, even though the Federalist Paper makes it clear that the idea is to avoid abuses.

    1. Anonymous says

      so turn the clock forward to today:

      Congress did worse in 1913 by turning the monopoly to create money over to the central banking cartel – the FED. Time to reclaim the power to “coin” money, which today is the authorization to create of an asset in an bank account or print a real piece of paper money. Give US Treasury money issue responsibility with congressional oversight and public transparency. It is time to end the incestuous relationship between the UST and the secret and corruptible nature FED manipulations.

  5. Anonymous says

    Prof Wray,

    I like the proposal, but why not go one step further by simplifying the structure to eliminate debt based “money” which carries with it the “borrow to spend” methodology. Instead move directly to a “Spend into existence” system. Use accounting to track the dollars created with an account at the US Treasury, e.g. “Taxes Due” which ultimately accounts for accumulated deficits (to day know as National Debt).

    In the context of FED QE, how about a QE3 strawman:

    QE should really stand for Questionable Ethics

    QE I was really Bank Back Door Bailout I (BBDB I) – FED buys toxic MBS assets that the private market would not touch at price levels that would keep the banks solvent. The FED did the toxic asset purchase that TARP was supposed to do, but without congressional approval and under the guise of Monetary Policy (QE).

    QE II – Wizard of OZ II – Pay no attention to the wizards (BB & Timmy) behind the curtain. Creates continuous distraction and debate while gaming the system.

    * enables record deficits by effectively circumventing the law that the UST can’t have an overdraft at the FED
    * keeps interest rates low as FED will meet all bond demand (essentially infinite demand)
    * effective interest rate on bonds held on FED balance sheet – zero, as FED remits profits back to UST, these profits come from UST paying interest on bonds (and through the fog of deception the FED has the gull to claim that record profits are returned to the UST).
    * Provide backdoor gift from the FED/govt to the banks/PD for ‘laundering’ the bonds between UST and FED – front running for the xx basis point spread.
    * Provide backdoor gift from the FED/govt to banks by paying 25 basis point Interest on Excess Reserves (IOER)
    * QE does nothing to provide liquidity for bank loans – banks loan on the capital base, they can convert bonds and other collateral to loan deposits and access reserve requirements via repo, interbank borrowing and the FED window if necessary. It is not capital or liquidity that prevent banks from loaning money, it is lack of loan demand, tighter lending standards and delevering (either through payback or default) that is occuring.

    On the bright side, if folks would understand what is really going on. The more the FED buys bonds and held on the FED balance sheet the less effective interest rate is on the national debt. This could be considered a dry run for eliminating the bond market and FED. This perverse QE activity is validating that fact the gov’t spends independent of the bond market. This is shattering the facade that the US Bond market is an open market process to set interest rates and control gov’t spending. We are seeing that the FED sets the rates through systemic manipulation and gov’t spends unconstrained by either the “bond market” and “virtual” debt cap.

    Proposal for QE III — Quick End III: The New Beginning

    * End debt based money regime, change from Federal Reserve Notes (FRNs) to US Dollar
    * US Dollar spent into existence by the gov’t, issued by the UST
    * Shut down the US Bond market – Interest on outstanding bonds paid in US Dollar, as bonds mature the principal paid in US Dollar
    * All inter government trust funds, convert bonds to US Dollar. Trust fund managers invest in private market investments and/or State, Muni, etc.
    * Convert all reserves to US dollar
    * Replace existing FRNs with US Dollars as they flow into the system or UST
    * Repeal the FRA 1913 and all subsequent laws – End the FED; absorb operational, economic monitoring, research and statistics into the UST
    * End TBTF doctrine – return to competitive free market principles of failure = bankruptcy – No gov’t bailouts.
    * Establish a neutral inflation/deflation policy for fiscal budgets (target balance) and tax policy
    * Repeal 16th amendment to eliminate corp and personal income taxes, replace with consumption tax and capital gains tax on speculative gains
    – consumption tax (e..g fairtax.org) provides built in stabilizer tied to GDP dynamics – economy heats up, higher taxes and vice versa
    – capture capital gain when realized

  6. Anonymous says

    Prof Wray,

    I like the proposal, but why not go one step further by simplifying the structure to eliminate debt based “money” which carries with it the “borrow to spend” methodology. Instead move directly to a “Spend into existence” system. Use accounting to track the dollars created with an account at the US Treasury, e.g. “Taxes Due” which ultimately accounts for accumulated deficits (to day know as National Debt).

    In the context of FED QE, how about a QE3 strawman:

    QE should really stand for Questionable Ethics

    QE I was really Bank Back Door Bailout I (BBDB I) – FED buys toxic MBS assets that the private market would not touch at price levels that would keep the banks solvent. The FED did the toxic asset purchase that TARP was supposed to do, but without congressional approval and under the guise of Monetary Policy (QE).

    QE II – Wizard of OZ II – Pay no attention to the wizards (BB & Timmy) behind the curtain. Creates continuous distraction and debate while gaming the system.

    * enables record deficits by effectively circumventing the law that the UST can’t have an overdraft at the FED
    * keeps interest rates low as FED will meet all bond demand (essentially infinite demand)
    * effective interest rate on bonds held on FED balance sheet – zero, as FED remits profits back to UST, these profits come from UST paying interest on bonds (and through the fog of deception the FED has the gull to claim that record profits are returned to the UST).
    * Provide backdoor gift from the FED/govt to the banks/PD for ‘laundering’ the bonds between UST and FED – front running for the xx basis point spread.
    * Provide backdoor gift from the FED/govt to banks by paying 25 basis point Interest on Excess Reserves (IOER)
    * QE does nothing to provide liquidity for bank loans – banks loan on the capital base, they can convert bonds and other collateral to loan deposits and access reserve requirements via repo, interbank borrowing and the FED window if necessary. It is not capital or liquidity that prevent banks from loaning money, it is lack of loan demand, tighter lending standards and delevering (either through payback or default) that is occuring.

    On the bright side, if folks would understand what is really going on. The more the FED buys bonds and held on the FED balance sheet the less effective interest rate is on the national debt. This could be considered a dry run for eliminating the bond market and FED. This perverse QE activity is validating that fact the gov’t spends independent of the bond market. This is shattering the facade that the US Bond market is an open market process to set interest rates and control gov’t spending. We are seeing that the FED sets the rates through systemic manipulation and gov’t spends unconstrained by either the “bond market” and “virtual” debt cap.

    Proposal for QE III — Quick End III: The New Beginning

    * End debt based money regime, change from Federal Reserve Notes (FRNs) to US Dollar
    * US Dollar spent into existence by the gov’t, issued by the UST
    * Shut down the US Bond market – Interest on outstanding bonds paid in US Dollar, as bonds mature the principal paid in US Dollar
    * All inter government trust funds, convert bonds to US Dollar. Trust fund managers invest in private market investments and/or State, Muni, etc.
    * Convert all reserves to US dollar
    * Replace existing FRNs with US Dollars as they flow into the system or UST
    * Repeal the FRA 1913 and all subsequent laws – End the FED; absorb operational, economic monitoring, research and statistics into the UST
    * End TBTF doctrine – return to competitive free market principles of failure = bankruptcy – No gov’t bailouts.
    * Establish a neutral inflation/deflation policy for fiscal budgets (target balance) and tax policy
    * Repeal 16th amendment to eliminate corp and personal income taxes, replace with consumption tax and capital gains tax on speculative gains
    – consumption tax (e..g fairtax.org) provides built in stabilizer tied to GDP dynamics – economy heats up, higher taxes and vice versa
    – capture capital gain when realized

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