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The Art of Monetizing Debt

Timothy Geithner wants the debt ceiling raised. Feeling more confident about the U.S. economy?

Timothy Geithner wants the debt ceiling raised. Makes you feel more confident about the U.S. economy, huh?

The public debt soared to $1.27 trillion in July, for fiscal year 2009. The current ceiling for the total public debt is set at $12.1 trillion, a figure the Treasury projects will be eclipsed by mid-October. This has Treasury Secretary Tim Geithner urging Congress to raise the debt ceiling, and raise it fast.

One would think if hundreds of billions of dollars in Treasury bills were being bought up by the Federal Reserve, that the administration would publicly address it, and revisit it, as more T-bills were being purchased. I’ve yet to hear one peep from the president about it. The reality is, such actions leave us at risk to high inflation, once the newly printed money picks up velocity of circulation in the economy. But let’s back up, and explain monetization of debt.

The federal government auctions off Treasury bills to the open market; this is another way of saying the government is borrowing money from individuals, organizations and countries, to pay for budget shortfalls. The U.S. government must borrow money to cover all government spending, that tax revenues do not. Due to the fact the government runs budget deficits virtually every year, interest payments on past debt issuance (Treasury bills) become increasingly more onerous. Imagine what an interest payment on $12.1 trillion amounts to? If you’re having trouble, here are a couple charts to assist you:

Click on chart for a larger, viewable version





Total interest expense for debt in 2009 sits at $340 billion, through July. In 2008, total interest expense cost taxpayers $412 billion. Onerous indeed. Combine this with a contracting economy, and therefore less tax revenue, and unprecedented government spending in 2009, one can see why people are nervous to loan Americans money.

Whether or not demand exists for American debt is an important issue. Do people believe in the American economy enough to become a creditor? Are creditors willing to expose themselves to risk over a short period of time, like 3 months, maybe a year, or over the long haul, like 7, 10 or 30 years? Will the U.S. credit rating take a hit, increasing interest rates on future Treasury debt? The level of demand for Treasuries really matters as long as government continues to run budget deficits and make interest payments on $12.1 trillion of existing debt. The government must have the ability to auction off Treasuries at will, for simple cash flow purposes.

However, there is another way to pay for budget shortfalls: printing new money. This works pretty much how it sounds. The Treasury prints additional money to pay for government spending. Because most of the money supply is electronic, it isn’t so much printing physical money, as it is fiddling with numbers on a computer screen. Money obtains its value from the relationship between the total amount of money circulating in the economy, with respect to demand for goods and services. If you increase the amount of money in an economy, and demand for goods and services remains the same, one type of inflation will occur.

Congratulations! You’ve taken the introductory course on debt monetization. The upper division course is known as The Art of Monetizing Debt. The process is, if not a secretive ordeal, then a tactical one. The art of monetizing debt begins with the same Treasury auction; the Treasury auctions off T-bills to primary buyers. After the dust of the auction settles, and demand levels are reported for each Treasury note, the Federal Reserve steps in and buys the Treasuries back from the primary buyer, on a secondary market. The Federal Reserve uses newly printed money to complete the transaction. Demand levels for U.S. debt are reported after the auction, which are not quite accurate, if the primary buyers plan to sell back the debt. Perhaps the artificially high demand is reported to help overall investor psychology in future auctions.

It’s difficult to believe that legitimate demand exists for Treasuries, if the Fed is buying a portion of them back within two weeks of an auction. And if U.S. government debt is being financed by the American central bank, well, we’re selling our own debt to ourselves. Monetizing debt in a straight-forward fashion would have the Federal Reserve purchasing Treasuries directly, without the facade of an auction to primary buyers, and later repurchase. The Federal Reserve’s plan to buy Treasuries and mortgage-backed securities is well-documented by the financial press. However, the president himself should discuss the risks of such a strategy with all of us, and his rationale for implementing it. This backdoor approach, a more artistic way, is misleading.

The Federal Reserve has bought $252.8 billion of longer-term Treasuries this year, and plans to make good on their promise of $300 billion in 2009 Treasury bill purchases. The program is supposed to end in October; ironically, the same time the public debt ceiling will be proven to be glass. (1)

The Fed’s balance sheet has expanded $1 trillion during the financial crisis to backstop organizations, buy up debt securities and lend to private firms.


(1) – Fed Treasury Buying to Slow Before Ending in October

(2) – Interest Expense on the Debt Outstanding


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