Tuesday, August 2, 2011

National Debt: Short Version

On the eve of the Debt Ceiling vote in the House of Representatives, I submitted the following Letter to the Editor of the Albuquerque Journal. It is a short recap of my post here on July 22. As a friend told me, "Few people will understand or believe it, but you have to keep trying." So, here goes...

"Few people concerned about the national debt know what it is. Certainly, nobody in Washington, DC seems to know or the discussions would be much more intelligent and beneficial to the nation. 

The national debt is not like a loan one gets from a bank to buy a house or car. Such a loan has to be paid back in a certain time or default with some consequences.

Treasury securities (Notes, Bonds, and Bills) are savings accounts at the Federal Reserve Bank (Fed). Those saving accounts are owned by entities, including people, mostly in the non-government sector. So, why not call the national debt clock a savings clock?

Commercial banks have checking accounts at the Fed. These are called reserve accounts and are maintained at a level to promptly clear checks written on each of the many banks in the banking system. These checking accounts earn very little interest, so banks like to keep their reserve accounts at a minimum. To accomplish this, banks loan to one another in the overnight funds market. Those banks with excess reserves can loan to those with too little. The Fed tries to set the loan rate for these transactions.

Deficit spending by the government tends to increase reserves as recipients of government checks deposit them and draw upon their deposits. When the banking system as a whole has excess reserves, no amount of interbank trading will reduce them. The forces of supply and demand will drive the interbank lending rate down.

To decrease the level of excess reserves in the banking system the Fed sells Treasuries  to the banks. That is, they transfer funds from bank checking accounts to savings accounts. When the Treasuries mature, the funds plus interest are transferred back to the checking (reserve) accounts. There would be no need to sell Treasuries, if the Fed just paid interest on the reserves.

There are two points to realize about these operations. They are accomplished within the US banking system not the international bond market, and there are no grandchildren involved.

We are having an unnecessary crisis over an anachronism in our government accounting system." 

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