Yes, We can Pay off the National Debt without Spending Cuts, New Taxes or Inflation



Is it even a problem? It doesn't appear that way.

The National Debt is a football in American politics. Republicans constantly complain about it, calling it a “burden” on families and our children. These complaints are usually limited to situations when Democrats are in the White House, when federal social spending is at stake (the debt is never a problem when it comes to deficit spending on the military), but never when tax cuts are on the table. They even concocted a fairy tale about how lowering taxes increases revenue, which has been disproved multiple times over the last thirty five years.

However, even Democrats can’t resist the temptation to blame the Republicans for growing the national debt. How many of us have heard indignant liberals talk about Bush taking over from Bill Clinton a budget surplus only to turn it into a one trillion plus yearly deficit, and wars paid with bonds instead of tax revenue? As our national debt crosses an eye popping $20 trillion threshold, a number most of us simply cannot fathom, it’s time to discuss it in more rational terms and ask whether this is a real problem, and if so, what needs to be sacrificed. Should we cut spending? Raise taxes? It turns out, we may not need to do either.



In its simplest terms, when the federal government spends more in a year than it takes in tax revenue, it creates a “deficit.” The shortfall is covered by issuing a series of Treasury Bonds, or T-bills, for the difference, where the Federal Government invites individuals and institutional investors to lend them the shortfall, which the US government promises to pay back with interest over a number of years. As deficit spending piles on year after year, it accumulates into the “national debt,” the total amount of outstanding obligations by the US government to bond holders. In addition to the total principal of the debt, the US government owes interest payments on this principal which it must budget each year.

Japan, whose debt to GDP ratio is more than double that of the United States, decided to tackle it this problem recently in a very creative way. According to Truthdig:

While the US government is busy driving up its “sovereign” debt and the interest owed on it, Japan has been canceling its debt at the rate of $720 billion (¥80tn) per year. How? By selling the debt to its own central bank, which returns the interest to the government. While most central banks have ended their quantitative easing programs and are planning to sell their federal securities, the Bank of Japan continues to aggressively buy its government’s debt. An interest-free debt owed to oneself that is rolled over from year to year is effectively void – a debt “jubilee.”

In effect, the Central Bank of Japan, which issues the Japanese currency and is buying back the bonds from private bond holders and issuing additional currency with which to buy them.  They are not raising taxes to finance these buy backs, nor are they cutting other spending from Japan’s government budget.

This is not all too dissimilar from something which America’s own Central bank, the Federal Reserve, did over the last few years to solve the subprime crisis. Instead of issuing bonds for government debt, the Federal Reserve merely issued dollars to purchase toxic mortgages with high default rates. The purpose behind it was to relieve distressed banks which had these “non performing assets” (mortgages which people simply weren’t paying). The Federal Reserve would take away these unfavorable loans from private banks, issue dollars to the banks, and leave the banks free to re-lend other, hopefully more sound loans. Meanwhile, the bad loans appeared on the federal reserve’s balance sheet including the losses. This was a process called “quantitative easing” and at the time it was incredibly controversial.



WHAT ABOUT INFLATION?

Shouldn’t the creation of free money create staggering amounts of inflation? After all, the Central Bank pressing a few keys on a keyboard and creating money out of thin air to buy real debt increases the money supply. Conventional Wisdom states that it should. Japan tried this precisely because it wanted to create inflation – it has had a multi decade problem with “deflation“, inflation’s polar opposite where prices are falling year over year, causing consumers to not spend because they expect that new car, appliance, or house to be cheaper the following year, which in turn causes the economy to stagnate.

Turns out inflation didn’t rise from this maneuver by the Bank of Japan, much to the disappointment of Japanese government officials. In the US’ program of quantitative easing, many conservative economists were predicting hyperinflation, which also did not materialize. Does this not mean that the Federal Reserve can simply do another round of quantitative easing except instead of buying back bad mortgages from banks, it can simply buy Treasury bills from bond holders and start retiring our national debt.



 

Why is this possible without inflation still remains an open question among economists, but one school of thought seeking to answer it is Modern Monetary Theory (MMT). It argues, among other things, that the nature of money has changed since the US went off the gold standard in 1971 and that governments such as the US and Japan, which issue its own fiat currency, borrow exclusively in its own currency, and have economies which denominate major expenses in the same are monetary sovereign systems with far more freedom to conduct monetary policies that other governments simply couldn’t. In the future, we plan to be doing other articles on MMT, but for those who want more information should check out the link provided above.

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2 Comments

  1. One more thing. Even if there could be some inflationary pressure from creating the money to buy the debt, couldn’t the Fed in the U.S. just compensate by increasing the reserve requirements in the private system, so the new reserves will not cause the multiplicative expansion of the money supply outside of desired targets? We could do this and not be paying interest on the debt to whoever owns this debt.

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