QE Can Solve the Debt Ceiling Problem: Treasury Securities Held by the Federal Reserve Are Only Virtual Debt, Not Real Debt, and Can Be Cancelled at Any Time by the Fed.

It’s important to understand that all Treasury bills, notes, and bonds held by the Federal Reserve, as opposed to those held by investors, are only virtual debt, not real debt which must be repaid by citizens through taxes. The Fed is an agency of the federal government, and at any time before maturity or upon maturity the Fed can cancel those Treasuries and not require the Treasury to redeem them using tax payer dollars. There would be no negative side effects. The result would only be a reduction in the federal debt, at no cost. That’s true, not too good to be true.

All Fed funding of our enormous budget deficits since 2009 was done with QE (Quantitative Easing), which consists of the Fed purchasing Treasury securities (Treasury bills, notes, and bonds) with essentially newly “printed” money (through electronically crediting the Treasury’s account with the Fed). It’s important to always keep in mind that the trillions of QE between 2009 and 2019 did not cause inflation; they only saved the economy from a severe recession if not a severe depression. In fact, inflation between 2009 and 2019 averaged under 3%, practically a record low. It only started to rise during the Covid crisis in 2020–2021 which caused severe supply chain disruptions. Inflation then accelerated in 2022 due to Russia’s invasion of Ukraine which drove up the cost of oil, natural gas, and grains. Again, the inflation from 2020 up till the present was not due to QE, since it did not create excess aggregate demand. The inflation starting in 2020 has only been caused by Covid supply chain disruptions and Russia’s invasion of Ukraine.

Importantly, all Treasury debt held by the Fed can be eliminated at will. President Biden can order the Fed to cancel an amount of its Treasury securities sufficient to remain under the debt ceiling. Biden’s executive order would be justified as a national emergency measure to avoid the United States defaulting on its debts, which could have disastrous economic and national security consequences.

Canceling Treasury debt held by the Fed would not be inflationary since it would not increase the money supply, which would remain unchanged. Whereas the money supply would be reduced and weaken the economy if the Fed were to require the Treasury to redeem maturing debt. In fact, the Fed’s incipient QT (Quantitative Tightening, intended to reverse its previous QE) is a big mistake since the economy is not overheating.

The upshot: we have no federal debt problem thanks to QE, which means we do not depend on foreign capital to finance our budget deficits, as mistakenly believed by mainstream economists since the 1980’s. QE can also avoid reaching and breaching the debt ceiling, which by the way is only a provision of a Congressional law which is actually in violation of the Constitution’s 14th Amendment, Section 4 (“The validity of the public debt of the United States… shall not be questioned.”) President Biden has sworn to uphold the Constitution, therefore he must prevent any default on repayment of the nation’s debts.

© Edward Sonnino 2023

May 9, 2023