Ron Paul Proposes Destroying the Debt to (temporarily) Solve Crisis

Posted: Jul 06, 2011 3:45 PM

While his son leads the charge against dodging debate on the debt in the Senate, Ron Paul recently offered his own opinion on how to solve the debt crisis, one that has a lot of people talking.

His solution? Destroy the debt.

That's right. Just get rid of it. Or at least some of it. No, this is not out of the Onion. His plan is serious, and will spare lawmakers from having to make a last minute compromise, and help ensure that Republicans do not give in to pressures to raise taxes revenues. The plan is politically viable, even attractive, if negotiations continue to hit a wall in the coming days.

But how does this work, you say? Economist Dean Baker explains:

The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself.

Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations.

Thus, having the Fed essentially burn the bonds amounts to nothing more than eliminating a liability that the government has to itself, while still taking us $1.6 trillion further from hitting the debt ceiling. Also, Stephen Gandel pointed out yesterday:

What's more, under the current scenario, the Federal Reserve would eventually have to sell that debt back into the market. That could cause interest rates to rise. Rip up the debt and you don't have to worry about what the added selling pressure of the Fed would do to the market.

Yes, there are a number of catches to this plan, not the least of which is the message such a default would send to the rest of the world. And as Paul has said, it is only a temporary relief, and should not take the place of real spending cuts. But is waiting around 'til the last minute, only to once again raise the debt ceiling without securing anything more than miniscule spending cuts really any better? There aren't many options at this point, as we face huge deficits for the next two years and a Congress that can't agree on anything more specific than generic "spending cuts".

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