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into the future and could be paid gradually as the securities came due.
Other provisions of the American Monetary Act are discussed in
Chapter 41.




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Chapter 39
LIQUIDATING THE
FEDERAL DEBT WITHOUT
CAUSING INFLATION

The national debt . . . answers most of the purposes of money.
-- Alexander Hamilton, “Report on the Public Credit,”
January 14, 1790




T he idea that the federal debt could be liquidated by simply
printing up money and buying back the government™s bonds
with it is dismissed out of hand by economists and politicians, on the
ground that it would produce Weimar-style runaway inflation. But
would it? Inflation results when the money supply increases faster
than goods and services, and replacing government securities with cash
would not change the size of the money supply. Federal securities have
been traded as part of the money supply ever since Alexander Hamilton
made them the basis of the U.S. money supply in the late eighteenth
century. Federal securities are treated by the Fed and by the market
itself just as if they were money. They are traded daily in enormous
volume among banks and other financial institutions around the world
just as if they were money.1 If the government were to buy back its
own securities with cash, these instruments representing financial value
would merely be converted from interest-bearing into non-interest-
bearing financial assets. The funds would move from M2 and M3 into
M1 (cash and checks), but the total money supply would remain the
same.
That would be true if the government were to buy back its securities
with cash, but that is very different from what is happening today. When
the Federal Reserve uses newly-issued Federal Reserve Notes to buy
back federal bonds, it does not void out the bonds. Rather, they become

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the “reserves” for issuing many times their value in new loans; and
the new cash created to buy these securities is added to the money
supply as well. That highly inflationary result could be avoided if the
government were to buy back its own bonds and take them out of
circulation.

In Today™s Illusory Financial Scheme, Debt Is Money

“Money” has been variously defined as “a medium that can be
exchanged for goods and services,” and “assets and property
considered in terms of monetary value; wealth.” What falls under
those definitions, however, keeps changing. In a November 2005 article
titled “M3 Measure of Money Discontinued by the Fed,” Bud Conrad
observed:
Money used to mean the cash people carried in their pockets
and the checking and savings account balances they had in their
banks, because that is what they would use to buy goods. But
now they have money market funds, which function almost as
checking accounts. And behind many small-balance checking
accounts are large lines of credit. . . . [C]redit is what we use to
buy things so credit is a form of money. The broadest definition of
credit is all debt.2
“All debt” includes the federal debt, which is composed of securities
(bills, bonds and notes). If the government were to swap its securities
for cash and take them out of circulation, price inflation would not
result, because no one would have any more money to spend than before.
The government™s bond money would already have been spent -- it
wouldn™t get any more money out of the deal -- and the cashed-out
bondholders would not be any richer either. Consider this hypothetical:
You have $20,000 that you want to save for a rainy day. You
deposit the money in an account with your broker, who recommends
putting $10,000 into the stock market and $10,000 into corporate
bonds, and you agree. How much do you think you have saved in the
account? $20,000. A short time later, your broker notifies you that
your bonds have been unexpectedly called, or turned into cash. You
check your account on the Internet and see that where before it
contained $10,000 in corporate bonds, it now contains $10,000 in cash.
How much do you now think you have saved in the account? $20,000
(plus or minus some growth in interest and fluctuations in stock values).

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Web of Debt

Paying off the bonds did not give you an additional $10,000, making
you feel richer than before, prompting you to rush out to buy shoes or
real estate you did not think you could afford before, increasing demand
and driving up prices.
This result is particularly obvious when we look at the largest hold-
ers of federal securities, including Social Security and other institu-
tional investors . . . .

Solving the Social Security Crisis

In March 2005, the federal debt clocked in at $7.713 trillion. Of
that sum, $3.169 trillion, or 41 percent, was in “intragovernmental
holdings” “ government trust funds, revolving funds, and special funds.
Chief among them was the Social Security trust fund, which held
$1.705 trillion of the government™s debt. The 59 percent owned by the
public was also held largely by institutional investors “ U.S. and for-
eign banks, investment funds, and so forth.3
Dire warnings ensued that Social Security was going bankrupt,
since its holdings were invested in federal securities that the government
could not afford to redeem. Defenders of the system countered that
Social Security could not actually go bankrupt, because it is a pay-as-
you-go system. Today™s retirees are paid with withdrawals from the
paychecks of today™s working people. It is only the fund™s excess
holdings that are at risk; and it is the government, not Social Security,
that is teetering on bankruptcy, because it is the government that lacks
the money to pay off its bonds.4
The issue here, however, is what would happen if the Social
Security crisis were resolved by simply cashing out its federal bond
holdings with newly-issued U.S. Notes? Would dangerous inflation
result? The likely answer is that it would not, because the Social
Security fund would have no more money than it had before. The
government would just be returning to the fund what the taxpayers
thought was in it all along. The bonds would be turned into cash,
which would stay in the fund where it belonged, to be used for future
baby-boomer pay-outs as intended.




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Chapter 39 - Liquidating the Federal Debt

Cashing Out the Federal Securities of the Federal Reserve

Another institution holding a major chunk of the federal debt is
the Federal Reserve itself. The Fed owns about ten percent of the
government™s outstanding securities.5 If the government were to buy
back these securities with cash, that money too would no doubt stay
where it is, where it would continue to serve as the reserves against
which loans were made. The cash would just replace the bonds, which
would be liquidated and taken out of circulation. Again, consumer
prices would not go up, because there would be no more money in
circulation than there was before.
That is one way to deal with the Federal Reserve™s Treasury
securities, but an even neater solution has been proposed: the
government could just void out the bonds. Recall that the Federal
Reserve acquired its government securities without consideration, and
that a contract without consideration is void. (See Chapter 2.)
What would the Federal Reserve use in that case for reserves?
Article 30 of the Federal Reserve Act of 1913 gave Congress the right
to rescind or alter the Act at any time. If the Act were modified to
make the Federal Reserve a truly federal agency, it would not need to
keep reserves. It could issue “the full faith and credit of the United
States” directly, without having to back its dollars with government
bonds. (More on this in Chapter 41.)

Cashing Out the Holdings of Foreign Central Banks

Other major institutional holders of U.S. government debt are
foreign central banks. At the end of 2004, foreign holdings of U.S.
Treasury debt came to about $1.9 trillion, roughly comparable to the
$1.7 trillion held in the Social Security trust fund. Of that sum, foreign
central banks owned 64 percent, or $1.2 trillion.6
What would cashing out those securities do to the money supply?
Again, probably not much. Foreign central banks have no use for
consumer goods, and they do not invest in real estate. They keep U.S.
dollars in reserve to support their own currencies in global markets
and to have the dollars available to buy oil as required under a 1974
agreement with OPEC. They keep dollars in reserve either as cash or
as U.S. securities. Holding U.S. securities is considered to be the
equivalent of holding dollars that pay interest.7 If these securities were
turned into cash, the banks would probably just keep the cash in

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Web of Debt

reserve in place of the bonds “ and count themselves lucky to have
their dollars back, on what is turning out to be a rather risky investment.
Fears have been voiced that the U.S. government may soon be unable
to pay even the interest on the federal debt. When that happens, the
U.S. can either declare bankruptcy and walk away, or it can buy back
the bonds with newly-issued fiat money. Given the choice, foreign
investors would probably be happy to accept the fiat money, which
they could spend on real goods and services in the economy. And if
they complained, the U.S. government could argue that turnabout is
fair play. John Succo is a hedge fund manager who writes on the
Internet as “Mr. Practical.” He estimates that as much as 90 percent
of foreign money used to buy U.S. securities comes from foreign central
banks, which print their own local currencies, buy U.S. dollars with
them, and then use the dollars to buy U.S. securities.8 The U.S.
government would just be giving them their fiat currency back.
Market commentators worry that as foreign central banks cash in
their U.S. securities, U.S. dollars will come flooding back into U.S.
markets, hyperinflating the money supply and driving up consumer
prices. But we™ve seen that this predicted result has not materialized
in China, although foreign money has been flooding its economy for
thousands of years. American factories and industries are now laying
off workers because they lack customers. A return of U.S. dollars to
U.S. shores could prime the pump, giving lagging American industries
the boost they need to again become competitive with the rest of the
world. We are continually being urged to “shop” for the good of the
economy. What would be so bad about having our dollars returned
to us by some foreigners who wanted to do a little shopping? The
American economy may particularly need a boost after the housing
bubble collapses. In the boom years, home refinancings have been a
major source of consumer spending dollars. If the money supply
shrinks by $2 trillion in the next housing correction, as some analysts
have predicted, a supply of spending dollars from abroad could be
just the quick fix the economy needs to ward off a deflationary crisis.
There is the concern that U.S. assets could wind up in the hands of
foreign owners, but there is not much we can do about that short of
imposing high tariffs or making foreign ownership illegal. We sold
them the bonds and we owe them the cash. But that is a completely
different issue from the effects of cashing out foreign-held bonds with
fiat dollars, which would give foreigners no more claim to our assets
than they have with the bonds. In the long run, they would have less
claim to U.S. assets, since their dollar investments would no longer be

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Chapter 39 - Liquidating the Federal Debt

accruing additional dollars in interest.
Foreign central banks are reducing their reserves of U.S. securities
whether we like it or not. The tide is rolling out, and U.S. bonds will
be flooding back to U.S. shores. The question for the U.S. government
is simply who will take up the slack when foreign creditors quit rolling
over U.S. debt. Today, when no one else wants the bonds sold at
auction, the Fed and its affiliated banks step in and buy them with
dollars created for the occasion, creating two sets of securities (the
bonds and the cash) where before there was only one. This inflationary
duplication could be avoided if the Treasury were to buy back the
bonds itself and just void them out. Congress could then avoid the
debt problem in the future by following the lead of the Guernsey
islanders and simply refusing to go into debt. Rather than issuing
bonds to meet its costs, it could issue dollars directly.

Prelude to a Dangerous Stock Market Bubble?

Even if cashing out the government™s bonds did not inflate
consumer prices, would it not trigger dangerous inflation in the stock
market, the bond market and the real estate market, the likely targets
of the freed-up money? Let™s see . . . .
In December 2005, the market value of all publicly traded
companies in the United States was reported at $15.8 trillion.9 Assume
that fully half the $8 trillion then invested in government securities
got reinvested in the stock market. If the government™s securities were
paid off gradually as they came due, new money would enter those
markets only gradually, moderating any inflationary effects; but
eventually, the level of stock market investment would have increased
by 25 percent. Too much?
Not really. The S&P 500 (a stock index tracking 500 companies in
leading industries) actually tripled from 1995 to 2000, and no great
disaster resulted.10 Much of that rise was due to the technology bubble,
which later broke; but by 2006, the S&P had gained back most of its
losses. High stock prices are actually good for investors, who make
money across the board. Stocks are not household necessities that
shoot out of reach for ordinary consumers when prices go up. The
stock market is the casino of people with money to invest. Anyone
with any amount of money can jump in at any time, at any level. If
the market continues to go up, investors will make money on resale.
Although this may look like a Ponzi scheme, it really isn™t so long as

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the stocks are bought with cash

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