Fed decides to not start tapering…
The FOMC statement has just come out…
They have decided to not change the policy of buying $85 billion in bonds per month.
“The bigger they are, the harder they fall.” … The next recession will be interesting.
The FOMC statement has just come out…
They have decided to not change the policy of buying $85 billion in bonds per month.
“The bigger they are, the harder they fall.” … The next recession will be interesting.
Considering they are buying 85 billion of a 4 trillion dollar market, I see little care for this.
merrill and goldman guessed they might taper to $75 billion / mo at this meeting..
so if they wait til next month’s FOMC, the balance sheet will be 0.25% higher as a result..
Well since I just know enough to be dangerous let me put some things in the form of assertions that lead to questions that more informed and so hopefully less dangerous folk can address.
The two single biggest holders of U.S. Treasuries are the Federal Reserve and the Social Security Trust Fund(s), one in regular Treasuries the other in Special Issue Treasuries but both being components of the $17 trillion or so of Public Debt, and which is much the same thing Debt Subject to the Limit. While I don’t know if there is a precise metric of total Fed holdings of Treasuries and still less some metric of holdings by the Fed itself as opposed to those of Member Banks serving as mandated reserves, but it is safe to say that it is close to the $2.6 trillion being held by Social Security and probably to the upside. We could ball park it and say that just these two semi-independent Federal (or federal-ish) entities hold something like 40% of all Public Debt. Which by the way does NOT include federally backed debt of other types but which also make up a big part of the Feds portfolio. And growing at some substantial part of that $85 billion in QE3 purchases monthly.
But this is the key point on which I have been begging for answers in many fora to little avail. Nothing in the normal course of events can force either the Fed or Social Security into a forced sale of Treasuries. In fact Social Security Special Issues are explicitly non-marketable and as such are ALWAYS held to maturity. And while the Fed is a market maker it also can never be forced (it seems to me) into a Sell position against its will. Because both its profits on market transactions AND any gains from simple interest on instruments effectively withdrawn from the market are remitted to Treasury anyway. That is unlike most other participants in the Treasury market, neither the Fed nor the Social Security Trustees are particularly concerned about price. Or really very much about yield. Because Social Security always must and the Fed at will can simply hold Treasuries to maturity.
And this has all kinds of implications for our notions of ‘indebtedness’. For example I have often made the case that under conditions of Social Security ‘solvency’ as defined, Trust Fund principal never would or should be redeemed on net. As such it is hard to see that it should really be considered ‘debt’ at all. Except that it requires debt service. But even that only in part. Because the defintion of ‘solvency’ as relating to Social Security means that a large portion of accruing interest ends up retained as never redeemed principal leaving no one in any real sense on the hook. Similarly it seems to me that any portion of the Feds portfolio of Treasuries destined to be held to maturity is not really ‘debt’ as that is normally defined – as a future liability to be paid. Or in this case because portfolio earnings by the Fed are to my understanding simply remitted to Treasury that equally applies to the ‘debt service’.
The conclusion seems to be that neither the holder or issuer of these Treasuries is particularly concerned about interest rates on the existing and future portfolio because in a real sense they are mostly not liabilities. Which isn’t to say that they are insignificant. Because what the Fed has been doing in all its rounds of QE is directly reducing the Real burden of debt service on Public Debt by sucking up higher yielding long bonds and replacing them with lower yielding short bonds. That is quite apart from the effect of QE3 on money supply it is also serving to directly reduce the cost of debt service.
But no one smarter than me, or at least better informed, seems willing to comment directly on this reduction not of Debt as a Percentage of GDP (because I am maybe the only one nutty enough to argue that those holdings are not REALLY debt) but on Debt Service as a Percentage of GDP. Which now that the Spectre of RR has been buried with an Excel stake through its heart seems to be the operationally important number. Do we really care if the total public debt is $8 trillion or $17 trillion if debt service is say a third of the rate that it was before? Because it seems to me that the net effect of all the rounds of QE is a massive refinance of Public Debt to lower interest rates. Which has its own implications for generational equity and everything else. But no one is talking about this. At least in a form that tells me that they ARE talking about it.
Does any of this make sense? Or do I just need a stern talking to? (Or talking DOWN to?)
And let me add a pure question.
What happens if the Fed simply holds a given existing Treasury long bond to maturity? How is it redeemed? In a Treasury check redeemeable in Federal Reserve Notes? In the form of new Ten Year notes with face yields at the current zero rate? And how would that differ from just having the Fed write off the principal and directly reduce its portfolio?
Is QE3 and its predecessors in effect just a back door retirement of Public Debt first by taking huge chunks of the real cost of debt service away and maybe second by converting principal into zero coupon bonds?
Please someone school me here. Or School me if that feels better. Because I am honestly baffled and will take a well meaning beating in a good cause.
John C: “Considering they are buying 85 billion of a 4 trillion dollar market, I see little care for this.”
$85 billion x 12 = $1.02 trillion. Times 2 years = $2.04 trillion. Which even given an expanded market pool still has the Fed on a pace to hold 50% of more of that particular market in a remarkably brief period of time.
Call me naive but having a single player being a practical non-entity in the government backed mortage market to being not only the number one holder but at some point the majority holder of that market would seem to have some signficance. I mean look at how people freak out about the Chinese and the U.S. Public Debt market even though their holdings currently are maybe 8% of the total. Enough that there is plenty of hysterical talk about the U.S. being owned by the CCB.
What does it mean that the Fed is on track to be the largest holder by far of both categories of federal debt and guarantee obligations and so dwarfing either the Chinese or the Japanese separately and certainly rivalling them put together?
At a minimum it would seem to be red meat for Randites and LaRouchies both. Forget the Queen of England, the Rothschilds and the Bilderbergs, all bow down to the Board of Governors. The real Trillionaires in our midst.
Bruce:
Allow me to play the pseudo-protagonist in this scenario as often times the media message and Libertarian / Teabagger bleating is one of a growing debt shackling the future generations with taxes and a lck of growth. What say you to their point?
Well first I would say it was totally responsive to any of the issues I raised in my comments here. In particular because it totally ignores the question “when is a debt not really a debt” and the related question “why are we focused on debt as a percentage of GDP and not debt service as such a percentage”.
Then I would ask them to provide actual data and logical argumentation that current and projected levels of debt are or would actually having the crowding out effect that their argument assumes (because it boils right down to debt service crowding out investment or what is the same thing increasing shares of tax revenue having to be devoted to debt service). Because given the total implosion of R-R combined with actual decreases in the debt to GDP ratio that R-R deplored plus the seemingly unexamined results of several rounds of QE actually reducing the yield curve in ways that reduce debt service as a ratio of either debt or GDP there is little substance left to their argument. Or at least it could take some explicit defense rather than simply positing it (even as a Devil’s Advocate).
Plus I would take the Libertarian/Teabagger bleating a little more seriously if they were not all the time conflating ‘debt’ and so-called ‘unfunded liability’. That is most of the multi trillions of dollars of ‘growing debt’ we are ‘shackling’ future generations with is not actually ‘debt’. And in important respects is not ‘growing’. For example a couple of years ago the Medicare Annual Report returned numbers showing that a full 75% of Part A’s ‘unfunded liability’ or some $30 trillion in so-called ‘debt’ had simply vanished from the books at the result of ACA. Which if we took such measures as ‘unfunded liability’ as really representing the proper metric for intergeneration accounting would make Obama the greatest debt reducer in human history. On his watch and at his initiative an amount of ‘debt’ equal to twice the total amount of Public Debt actually extant simply vanished. Overnight. Literally at the stroke of a pen (plus some CBO scoring).
Which should have made Obama the Man of the Century/Millennium/Infinite Future by the whole CRFB, Fixing the Debt, Kick the Can, Generational Equity crowd. Yet crickets. Because the savings had the effect of preserving Medicare in more or less its current form. Which is to say the least not the preferred policy solution of all these ‘non-partisan’ Peterson funded and/or Kock brother funded groups.
So what I would say to ‘their point’ is: “What point? Given honest accounting?” As in “Lets start with numbers and not talking points and knee jerk sloganizing”.
“Well first I would say it was totally responsive—”
and then for seconds correct that to “non-responsive”.
Back in 1997 I noticed a peculiar thing in regards to Social Security reporting. That is if we simply accepted the outcomes of the Low Cost Alternative (and as Barkley Rosser and I argued at the time that was not outlandish) the end result would have been a Social Security Trust Fund at the end of the 75 year actuarial projection period sitting at $100 trillion. Every single dollar of which would be counted as ‘Public Debt’ and making up a significant share of then U.S. GDP. Yet under those conditions not a single dollar of it would ever be projected to be re-paid, instead Social Security would in continuing to be ‘over-funded’ equally be piling up ever increasing amounts of ‘Public Debt’.
This paradoxical outcome led me to write a whole series of Thought Experiments up as blog posts over at the now moribund The Bruce Web back in 2005. Because for a brief shining moment it looked like the real solution to ‘Social Security Crisis’ was to plan a series of FICA CUTS in the outyears. But ‘luckily????’ first the Bush tax cuts and then the worldwide economic implosion starting around 2006 (not then noticed by most anyone not named ‘Baker’ or ‘Shiller’) put paid to that outsized surplus/debt projected for Social Security.
But even after it left the question of “is debt that is never projected to be repaid, and only serviced in part really ‘Debt’?” Which as I argued above applies not only to the reserve component of the Social Security Trust Fund but arguably to the Feds entire holdings of Treasuries.
A question that never seems to get addressed. Even to be ridiculed. Which for all I know it should be. Except that the non-response seems to be telling. Because maybe, just might be, kinda sorta the question is uncomfortable for the Henny Penny ‘Debt Sky is Falling!! Just look at the National Debt Clock!!” crowd.
Bruce,
You bring up so many interesting thoughts and questions. And you ask if it makes any sense. Your thoughts do make sense. Bringing down the burden of servicing the “debt” is undoubtedly a primary concern of the Fed and Treasury. In that sense, interest rates must be kept low. The Fed is seeing to that.
But you ask a deeper question… “And how would that differ from just having the Fed write off the principal and directly reduce its portfolio?”
The Fed can reduce reserves at a push of a button. But I don’t think they will do that quickly because of the huge amount of derivatives in the financial sector. I think the Fed is facing a new world where its balance sheet has to be large.
At the same time, the government does not want interest rates to increase as that would increase debt servicing. Look how the Treasury came down on the European Central Bank in 2011 when it tried to raise their interest rate.
There is a game being played right now among government, bankers and elite capitalists. They are establishing a new system that not only keeps the interest rate low, but maintains liquidity and substantial profit rates for capital.
It is almost as if the bankers said… “OK, if you are going to keep interest rates low for a long time, we need concessions and abundant liquidity.”
Bankers are just becoming more powerful from the situation. and like you say, the board of governors are “the real trillionaires in our midst”.
I think the point you are making is that the important concern is not debt, but the cost of debt, who controls that cost and who benefits from that cost. Am I interpreting you correctly?
Ed thanks for taking the time to answer.
First I would say that the ‘cost of debt’ is AN important concern and AT LEAST an EQUAL concern to ‘debt’ rather than THE important concern. But that is maybe just a linguistic quibble.
I don’t know what the weighted average of interest rates on government debt back in the Reagan years. But given prime rates in the high teens it was clearly in double digits somewhere. Equally I don’t know where the actual weighted average is today between long and short bonds and notes but obviously it is in single digits. Assuming for the moment that debt as a percentage of GDP stabiizes at any level where there are still buyers for newly issued Treasuries or to put it another way to say that all principal can just be rolled over indefinitely then clearly ‘debt service’ trumps ‘debt’. And the more so as we consider the difference in weighted average rates on existing debt.
This is particularly true when we turn to fiscal policy where the argument has always been (though not always stated as such) that the danger of handing on so much debt to our grandchildren is precisely in the crowding out effect of debt service on other vital spending. This is even more true when we turn to Social Security and the ‘Phony IOU’ argument where the more legitimate version is not that the Special Issues are themselves ‘Phony’ but instead that the promises of paying the interest and redeeming the principal are unrealistic precisely because the ultimate effect will be crowding out spending on everything else.
But you don’t get much crowding out at the lower bound, not in a situation where actual principal never gets redeemed on net. (Or to flip it around you can afford about five times the house on an interest only loan at 2% real than 10% real. Because truth be told most people get their principal back out when they sell a house, and certainly expect to. In fact a whole lot of the smart boys got rich convincing America right up to late 2006 that home equity could never actually decline on average.)
So debt service is important in that the current $17.5 trillion in debt at a ballbark 6% average interest represents the same financing challenge as $8.75 trillion at an average 12%.. That is just simple math. But the implications are not simple at alll.
And everything gets more messy when you exercise the thought experiment that would have the Fed never directly deleverage their balance sheet by reselling the long terms in reexchange for short terms but instead just holds them to maturity. Which in effect withdraws them from the market . Which does not seem to me just the same thing as reducing reserve requierments ‘at the push of a button’.
It just seems to me that Debt Hawk/Scaremongers always build in scenarios that would have major holders of Treasury Debt someday and somehow become sellers and in so doing spike interest rates on new Treasuries. But for a variety of reasons this is fanciful even in the case of the normal bete noire of the Chinese Central Bank. Because the CCB holds dollar instruments for all kinds of reasons that have nothing to do with investment yield or price. And it holds still less (for different reasons) for the even larger holders of such debt the Fed and the Social Security Trustees. Who are not going to sell. In the latter case because they literally can’t (Special Treasuries are not marketable) and in the former because in the final analysis the Fed is in a fiduciary relation to Treasury.
As usual this has gotten too long and meandered too far. Maybe I could sum it up by saying that not only has to little attention been paid to debt service and the actions of the Fed in reducing it across the board for all holders but equally too little has been paid to the effect of the ‘debt that is not ‘debt’ because it will never be redeemed on net’. Which it seems to me might be a good description of much of the Feds current balance sheet. Even though it is explicitly counted (like the Social Security Trust Funds) as a portion of total Public Debt.