2011-07-04tnr.com

Representative Ron Paul has hit upon a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds... Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn't have its bonds.

What Baker doesn't seem to realize is that the Fed isn't actually an "agency of the government" -- it's a private bank (albeit with some ad hoc connections to the federal government at the Board of Governors level). Telling them to destroy $1.6 trillion of their "assets" is not likely to go over well.

Even if they did do it, think about what is happening here. The Fed bought those $1.6 trillion in bonds because the Treasury couldn't find enough buyers (at the low interest rates needed). Simply destroying them is the same as outright printing the money, because the bonds aren't going to be sold off later, "sterilizing" the market.

Baker suggests that the Fed can compensate by simply raising reserve requirements, but the Fed doesn't like doing this either. Baker's analysis misses that the Fed essentially hasn't used reserve requirements (at all) since the early 90s. And when the Fed raised reserve requirements in the latter years of the Great Depression, it caused the economy to crash anew in 1937.

What Baker is missing is that Paul is once again calling the Fed and the government's bluff. The Fed should simply tear up those bonds. But in doing so, it would be forced to admit that its recent actions are no more than outright printing, and there is really no other "solution" to the mess we've gotten ourselves in.


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