Could The US Default Due To A Complexity Catastrophe?
Could The US Default Due To A Complexity Catastrophe?
Front page story in today’s Washington Post by Damien Paletta reports that “Treasury chief hurtles toward fiasco,” the fiasco being a failure to raise the US debt ceiling in time to avoid a default. Trump has declared that Sec Mnuchin is responsible for this matter, which he should be, but somehow has not made a sufficiently definitive statement to keep his former Freedom Caucus big cheese OMB director, Mulvaney, from opining that Mnuchin is an out of it New York finance guy (Goldman Sachs even) who is not well connected in Washington, and he, Mulvaney, thinks that the dumb games he played as a Congressman threatening to default are appropriate for somebody in charge of all this.
The deadline is approaching, although it might be somewhere between early September and mid-October, but at some point if the debt ceiling is not raised, the US will seriously default, something we have not seen, and I doubt that any deal Mulvaney might propose would get through this dysfunctional Congress. And the article reports that while Mnuchin wants a “clean raise” before the Congress really shuts down in August, well, according to WaPo, he does not have the “stature in Washington to press through a vote on a measure” supported by all previous Treasury Secretaries. Indeed, the article is right that he may not be able to do so, and the US may well seriously default on its debt for the first time, something the gang that Mulvaney has belonged to has declared is no big deal. We may be about to find out if that is correct or not.
In thinking about this I have come to realize that part of the problem is that this is a very complicated issue, one that few people understand, and that this lack of understanding is self-propagating: that few understand it means that there are few who can teach those who do not understand it what it is about. The upshot is that an incredibly miniscule proportion of the US population has any remote idea what all this is about, so are not putting any pressure on these loud mouthed Congresspeople to behave resonably. If in fact there is a default and it leads to a global financial crisis that puts the world economy back into a serious recession, well, who could have known that, and who will be to blame?
So let me get personal on how severe the lack of knowledge about this is, which is exacerbated by the fact that few media talk about it at all, or if they do so, it is with massive ignorance. So, over the Fourth of July weekend I was with extended family. A niece is a prominent journalist in Washington. Her brother, a nephew, was the top performer in high school on a statewide math test in California. He is now a wealthy high level computer game programmer in Silicon Valley. They asked me if there was a threat of recession, as some other family members were claiming, and I said the most serious near term threat for such would be a default by the US failing to raise its debt ceiling, leading to a global financial crisis. It became clear that both of these very smart and well-informed people knew nearly nothing about this issue. If they do not, well, probably less than 1% of the US population does, which makes it all the more likely that full-of-themselves ignorami in the House Freedom Caucus will be all too happy to put Secy Mnuchin in his place when he comes calling for a “clean debt ceiling increase.”
Why is this so hard? Well, one thing is that few Americans know, and neither my very well-informed and super smart relatives did, that the US is the only nation in the world to have such a stupid thing as a debt ceiling. The vast majority of professional economists think it should be eliminated. Congress effectively decides on this when it passes a budget, and this is just an extra nonsensical conundrum. It is a historical arttfact from a century ago, when right after the 1913 passage of the amendment allowing the personal income tax, the US went into WW I, which was not supported by many in the Congress, the Congress imposed this idiotic debt ceiling to retain control over the budget during wartime. When the war ended, it was not repealed, and we have been stuck with it since, with the vast majority of both the Congress and the public thinking it is something sacred and important and stuck in marble, when in fact it was an unfortunate mistake that should have been repealed a century ago.
Regarding what will happen if we default, I do not know, as that could follow many paths. But a serious catastrophe cannot be ruled out, and if it comes to pass it may be at least partly due to how complicated this whole thing has become, with neither the public nor most of the Congress at all aware of what is involved here. So, we could indeed end up with a complexity catastrophe, and if we do, let us hope that it is not too severe.
Fed staff just responded to Q/A that ‘monies’ paid to redeem the principal of bonds are not subject to the remittance rule related to sums in excess of operational needs of the Fed.
That is an opinion about the law and I am not sure it is lawful. It is an expression of ‘independence’ and power though as it tells the public that they must continue to borrow these sums to transfer them to Fed accounts (as long as we have less revenues than outlay claims during a fiscal period). The Fed will have mounting cash amounts on their books and in other statements they say that they will not use this money in the economy, leaving it horded on their books.
This strikes me as unseemly results especially in light of the fact that the public’s sovereignty was used by the Fed to create these sums out of whole cloth in the first place.
But the odd thing is that the Fed and Treasury could agree to redeem all this public agency or public debt, and because they are shuffling among their own accounts, they normally could use offset accounting to erase their positions — erasing any need to borrow in the first place.
Rather than default on the public agency debt, common sense tells me they have many coordination options instead.
As I have noted in other comments, the world of finance, fiscal affairs and monetary theory is turned on its head by these massive central bank purchases, seen best when considering what happens at redemption time.
Not sure that there is a complexity catastrophe in the works with Sec Mnuchin and OMB director, Mulvaney involved.
Oh , I hope others also noted that Treasury in the last two months moved to increase it cash holdings in the Treasury Account (TGA) from its $80 Billion amounts they have had for years and years up to around $250 Billion now (note, the Fed manages all this tyoe accounting for Treasury and for their own books too), a huge swing in a short time.
I assume they have over borrowed recently, though that would move some debt-ceiling closer the way this is seen now by most, but I am actually concerned that the added cash, during a time of lower revenues they also reported, means that the Trump Administration is not paying claims or creating obligations in the execution of the law ( resulting in less cash outlays). GAO needs to look closely at this as this huge swing in the TGA as it may be evidence if unlawful Impoundments by this Administration.
I have to say, if we had a Congress that could think clearly, there would be common sense in fiscal affairs so we could sort this not-normal finance situation out. This Congress cannot be trusted in this regard, imo.
Government default is not a financial problem for digital currencies that are auto traded. The techies have nailed the theory, they have auto trade pits in which defaults can be dropped opportunistically.
Complexity in government is the problem. Government defaults result in direct inflation and all the government accounts are COLAed or price fixed or price restricted by contract. In order for the Senate to default orderly it has to put all its major programs under a cash flow accounting system and give each their own active accounts so they can bet even money on default. The new system is multi-currency so the tax dollar will gain and lose market share as trading completes.
On your first remark, this is the first I have heard of anybody suggesting that somehow the Fed could just either take it over or somehow make some declaration that will just get everybody off the hook. This is Treasury debt, and they must pay the bills of the government, and they must borrow to do so. When they cannot, well, there is a big problem. One of the weirder possible outs mentioned in the past that most said “noo!” is the possibility of minting a $1 trillion coin, apparently technically legal, maybe.
As for your second, I think you are observing that the deadline has already passed, I think it was in May, but the Treasury does have a lot of tricks that it uses and has in the past. and is using now. The question becomes how long and far can these be used. There are differences of opinion out there, with some saying the game is up somewhere in September, but at least one source (forget which one) claiming it can be stretched out to mid-October. But the hard fact is that there is a point where all that runs out, and either something unheard of is pulled with the Fed or there is high value coin minted or the debt ceiling is raised (or, preferably, abolished0, or there is some sort of default, although how that would play out is unclear, although without guidance from Congress it would involve the Treasury having to arbitrarily decide which bills not to pay. Will it be interest on the debt, which would trigger a defaulit, not paying SS checks, or maybe just stringing out a bunch of government contracgtors. We do not know at this point, and I hope we do not have to find out. But with this gang of incompetents, we may yet find out.
Currency is not directly affected by a default, so that cryptocurrencies are unaffected is a nothing burger of no use or interest.
It is “government complexity” onliy in the sense that indeed many in the admin and Congress do not understand what is involved here, although the bigger problem I raised is that the public is especially misinformed and thus not a source of any pressure on Congress to do the right thing.
As for the outcome of a default, I think you are making nonsense statements that cannot be easily defended.b
Prof Rosser, Thanks for the response above. I have been noting for some time that the remittance rule would in practice mean that the Treasury woukd borrow, transfer the amounts to the Fed who would just remit it back to them as they are already in excess positions. So it makes no practical sense to borrow and then just move the funds around. Accounting simply allows the parties to recognize this and offset, making the need to borrow unnecessary. Once they declared that they do not need to remit these amounts then the borrowing becomes necessary.
Have people lost sight of the fact that the Fed is an instrumentality of the public and that its ‘assets’ are owned by the public????
What does the Finance law say, Title 31 USC and the implementing regulations and rules? If they are required to remit, then how do they agree to coordinate?
So no one else has pointed this out to you before. We should learn the law, and learn the wiser approaches here. But I have no doubt that the Fed’s assets are owned by the public. Do you?
That has been what Matt Young has done for over a decade. He lives in a world with which I am not familiar.
Take the 2.4T the Fed holds. over the next five years the Fed could engineer defaults during periods of low inflation. The asset is wiped out, a direct grant to government. Not all at once, but only when distracted moments arrive in the markets. The small, but accumulating, defaults directly cause inflation, they are direct losses by the Fed. Absolutely doable and more than one CEO in the finance industry has agreed with the idea from time to time.
The problem are the COLAs. Congress can directly create inflation, but then it directly suffers the consequences when everything is COLAed up.
My problem with America’s unending deficits is that they allow us to wage bomb and destroy other countries and maintain an overseas empire of around 1,000 military bases without any direct cost being borne by the public. If it takes America defaulting to end the endless wars, I say bring it on. Whatever pain we suffer as a result is nothing less than we deserve.
Fom the Fed’s website the organizing statute appears (codified in title 12 USC) contains the fillowing reference to excess funds:
“Transfer To The General Fund. Any amounts of the surplus funds of the Federal reserve banks that exceed, or would exceed, the limitation under subparagraph (A) shall be transferred to the Board of Governors of the Federal Reserve System for transfer to the Secretary of the Treasury for deposit in the general fund of the Treasury.”
Note – this statute refers to Any amounts, no distinction about how the sums arrive — so the Fed’s view that principal payments do not create surplus funds that are to be remitted to Treasury would be incorrect unde this statute. This law says they should be remitted, actually, it “shall” be remitted, no Fed discretion at all.
Perhaps there is another authorizing law to make such an assertion lawful, perhaps in the authorization of their roll over discretion.
What you are reading about is that the Fed remits to the Treasury any profits it makes on its operations as a bank. Because of the runup of the Fed assets in recent years during the Quantitative Easing, it is making a lot of money, nearly $50 billion a year, on it assets. That all goes to Treasury, and has nothing to do with what Treasury does or defaults or anything else. It just happens automatically. What is currently an issue about that is that the Fed is talking about reducing its large pile of assets, which would reduce that flow of profits to the Treasury, thus making the deficit situation of the Treasury worse and thus making a default more likely.
It is not the Fed that is responsible for defaults. It is the Congress, pure and simple. It is simply rank and ignorant and nonsense to talk of the Fed “engineering defaults” in any pattern at all. Sorry, but the fact that people like you believe such ridiculous things is an example of the “complexity” I was talking about in terms of the extreme lack of public knowledge out there that lies behind this impending crisis.
You are simply a left-wing version of all those dingeberries in the right wing Freedom Caucus who want a shutdown so as to end all those nasty government payments like to social security recipients. I suspect that if indeed there is a default and the Treasury decides arbitrarily what bills to pay, those for warmaking will be among the last ones to be cut, with a lot of things you probably support being higher on the list for not being paid for. You are in lala land. Sorry. This is delusional thinking. Get real.
I assume you meant assets . . .
Matt Young has been kind to you so far with his claims. Wait until he starts telling you about the hospital built in the middle of nowhere in northern California that was constructed solely for the purpose of joint replacement surgery for retired state workers.
And it can get worse.
BR, agree that earnings paid on a declining book of financial instruments result in a declining flow back to Treasury when looked at from the Fed’s view of the flow. If indeed the Fed simply hordes the monies as these instruments redeem (we should see the composition of their book change as the cash-held accounts mount) when they start the process of lowering the magnitude of these type assets.
The Fed staff reports indicate that an estimated $580 Billion of these instruments will redeem in 2018, they plan on purchasing US public debt in a continuation of their roll over practices using some if these monies, and they plan on keeping the cash for another portion of the amount (so it is Treasury borrowing that draws excess reserves down, even though the Treasury actually turnstiles it out to pay lawful claims, which is why they borrow, and this should find itself into reserve bank accounts).
So as we watch the cash horde on the Fed’s book mount it will be interesting to see the rate of shrinkage in excess reserves within the banking system. Perhaps it will rise as monies held outside the US now but used to purchase new Treasuries gets funneled back out to mainly domestic recipients (salaries, contractors and suppliers, healthcare providers, social security program outlays, grant payments, most end up within the US).
We are learning, as this has never been done before.
But please focus some attention on the stock side of things that dwarfs the annual flow side.
And even on the flow side, the Fed conveys its surplus but please do not lose sight of the fact that the Fed gets the actual monies from Treasury, so let us not count it twice, or forget that the Treasury is borrowing this amount. Treasury may indeed prefer that it does not need to borrow the $90 Billion when looking from their view they see that they just get it back in remittance.
Interesting stuff, but scary too, as we don’t yet know what we will learn. But $4 Trillion is not a small number.
Perhaps you should explain to all the Dumbo’s out there in la-la land why it is that the debt default threat has only occurred since the tea-party activists (read hard right anti-federalists) installed their hard-right picks in Congress in 201l and not ever before that despite the same budget rules having been in place.
In fact perhaps you should also explain why a debt default threat was never made before 2011, since it’s always been an option open to congress in using it to force the opposition party to cave since the debt ceiling law was installed.
Since the general public has no awareness of what it means then what changed… certainly not the general public lack of awareness, so there me some other reason than that? I mean they were just as clueless before as now and yet until 2011’s new congress was seated there was never a threat to default before that. So how can you blame the public’s lack of understanding?.
Also if the debt ceiling is just an “unfortunate mistake” then why hasn’t it been repealed long since? I mean doesn’t congress in all those years since 2017 know how to repeal dumb mistakes? Perhaps you can also explain that to the dumbos out there in la-la land that don’t understand the implications.
Of course there’s also a possibility that all those dumbos out there in your described la-la land do understand the implications and half of them may actually like the debt ceiling law and it’s implications if it’s used to default on the debt…. and like it that way. Do you think that’s a possibility?
Correction: “since 1917”.
I think you are making too much of this. They are always rolling over assets when due to keep their balance at what they want. Sometimes the composition of those changes, as it did after 2008. Prior to then it was all pretty much just straight Treasury bills, notes, and bonds. Since then it has become heavily a lot of mortgage-backed securities. The big news is that they are planning to, maybe this fall, start lowering the total amount, which got more than tripled after 2008. That would mean simply not renewing them or even selling them off without them reaching maturity. But details of how and what have not been announced, and they may not do so if things go blooey, which they will if there is a default.
Also, you have to be careful about talking about “cash.” The proper definition of “cash” is coins and currency, but lots of people in banks, incluidng the Fed, use it to refer to those Treasury securities: bills, notes, and bonds, and I suspect that is what is meant here.
I think I answered all your questions in the original post, if you read it carefully enough. The only thing I shall add is that I am not able to communicate to the entire US public what they should know about this. As I did with this post, I have been regularly posting on Econospeak on this issue, but not all that many people read what I post. I do not think I can get on Sean Hannity to explain all this. As it is, I think a majority of professional economists agree that the debt ceiling should simply be eliminated, but even the weight of all of us is not sufficient to overcome the entrenched political biases and mythologies backed up by the massive level of public ignorance that keeps this monstrosity going.