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The National Debt: The Fed and Our Options

November 12th, 2013

The following is a guest post from Murray T. Holland. If you are interested in guest posting at Geek Politics, check out the guidelines here.

I wrote A Nation in the Red(aff) as a call to action for concerned citizens to save this country before we become inextricably caught in the debt trap that has shocked the economies of so many countries. Moms and dads, and especially moms and dads of children in their teens, twenties and thirties (this is the generation that will shoulder the burden of this debt), need to become informed of the problems that this much debt creates and make an issue out of it with all your friends, colleagues, schools and businesses. That is the action step that each concerned parent must take to save our country.

With regard to your specific question about the role of the Federal Reserve in helping the government out of the debt crisis, the Fed is now forced to walk a tightrope. Their primary job now is to grow the economy, but the traditional growth mechanisms are not working. The Fed has created more than sufficient reserves for banks to start lending, but consumers and governments have been de-leveraging since 2008 so there is no growth in the demand for consumer debt and hence slower economic activity. This has recently turned around but has not yet had much of an effect. Some economists argue the Fed should increase it purchases of Treasuries (to create inflation) while others think just the opposite (the normal mechanisms are not working).

Once the economy starts growing the problem becomes managing interest rates because the federal government has so much debt it cannot withstand large interest rate increases. This is the tightrope: if the economy grows, interest rates will increase due to increasing demand for debt. The Fed will be forced to maintain very low short-term rates so the federal government can pay interest expense without hurting other outlays. Then, what is the Fed going to do with the $3.6 trillion of Treasuries it already owns? A sale of even a portion of this amount would create a freefall in the debt markets. This is a problem. Unfortunately, the Fed is playing with “experimental” economics because no country has been here before so no one knows the exact outcome of Fed actions. Had the government not deficit spent, we would not have this problem and the recovery could be more straight-forward.

How does the U.S. get out of the debt trap? For countries that get to our debt levels, there are unfortunately only five methods out of the trap. The most used method is default and repudiation. Unfortunately for all of us, this method would devastate the world economy and needs to be avoided. The second method just recently created is a bailout, which of course is not available to us due to our size. The third method is pay the debt with newly printed money, but this has hyper-inflation side effects. The two remaining methods are grow the economy and balance the budget by spending cuts and tax increases. If we utilize the last two, my calculation is that we will be back to a 35% debt/GDP ratio in 36 years, assuming good economic growth and balanced budgets. This is where we were in 2008, five short years ago.

*Murray T. Holland is a 30-year veteran of the finance industry and managing director of Dallas-based MHT Partners. He is the author of A Nation in the Red(aff) (McGraw Hill, November 15, 2013). Readers are encouraged to visit ANationintheRed.com for more resources.

Author: Derek Clark Categories: Uncategorized Tags: