The U.S. federal debt has more than doubled since the 2008 financial crisis, shooting up from $9.4 trillion in mid-2008 to over $21 trillion in mid-2018 and in excess of $22 trillion in April 2019. This debt is never paid off. The government just keeps paying the interest on it, and interest rates are rising.
The Fed has announced plans to raise rates by 2020 to “normal” levels — a fed funds target of 3.5 percent — and to sell about $1.5 trillion in federal securities at the rate of $50 billion monthly. This will further grow the mountain of federal debt on the market; and unlike the Fed, which rebates the interest to the government after deducting its costs, the new buyers of these securities will be pocketing the interest, adding to the taxpayers’ bill.
If the Fed follows through with its plans, projections are that by 2027, U.S. taxpayers will owe $1 trillion annually just in interest on the federal debt. That is enough to fund President Donald Trump’s trillion-dollar infrastructure plan every year, and it is a direct transfer of wealth from the middle class to the wealthy investors holding most of the bonds.
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Where will this money come from? Crippling taxes, wholesale privatization of public assets, and elimination of social services will not be sufficient to cover the bill.
Bondholder Debt Is Unnecessary
The irony is that the United States does not need to carry a debt to bondholders at all. It has been financially sovereign ever since President Franklin D. Roosevelt took the dollar off the gold standard domestically in 1933. This was recognized by Beardsley Ruml, Chairman of the Federal Reserve Bank of New York, in a 1945 presentation before the American Bar Association titled, “Taxes for Revenue Are Obsolete.”
“The necessity for government to tax in order to maintain both its independence and its solvency is true for state and local governments,” he said, “but it is not true for a national government.” The government was now at liberty to spend as needed to meet its budget, drawing on credit issued by its own central bank. It could do this until price inflation indicated a weakened purchasing power of the currency.
Then, and only then, would the government need to levy taxes — not to fund the budget but to counteract inflation by contracting the money supply. The principal purpose of taxes, said Ruml, was “the maintenance of a dollar which has stable purchasing power over the years. Sometimes this purpose is stated as ‘the avoidance of inflation.’”
The government could be funded without taxes by drawing on credit from its own central bank; and since there was no longer a need for gold to cover the loan, the central bank would not have to borrow. It could just create the money on its books. This insight is a basic tenet of Modern Monetary Theory: the government does not need to borrow or tax, at least until prices shoot up. It can just create the money it needs by writing an overdraft on its account at the Fed.
The Bankers’ “Power Revolution”
It could do that in theory, but some laws would need to be changed. Currently the federal government is required to have the money in its account before spending it. After the dollar went off the gold standard in 1933, Congress could have had the Fed just print money and lend it to the government, cutting the banks out. But Wall Street lobbied for an amendment to the Federal Reserve Act, forbidding the Fed to buy bonds directly from the Treasury as it had done in the past.
The Treasury can borrow from itself by transferring money from “intragovernmental accounts” — Social Security and other trust funds that are under the auspices of the Treasury and have a surplus. But these funds do not include the Federal Reserve, which can lend to the government only by buying federal securities from bond dealers. The Fed’s website states, “The Federal Reserve’s holdings of Treasury securities are categorized as ‘held by the public,’ because they are not in government accounts,” further evidence that the Fed is considered independent of the government.
According to Marriner Eccles, chairman of the Federal Reserve from 1934 to 1948, the prohibition against allowing the government to borrow from its own central bank was written into the Banking Act of 1935 at the behest of the securities dealers. A historical review on the website of the New York Federal Reserve quotes Eccles as stating, “I think the real reasons for writing the prohibition into the [Banking Act] … can be traced to certain Government bond dealers who quite naturally had their eyes on business that might be lost to them if direct purchasing were permitted.”
The government was required to sell bonds through Wall Street middlemen, which the Fed could buy only through “open market operations” conducted by the Open Market Committee. Rep. Wright Patman, Chairman of the House Committee on Banking and Currency from 1963 to 1975, called the official sanctioning of the Federal Open Market Committee in the banking laws of 1933 and 1935 “the power revolution” — the transfer of the “money power” to the banks. The FOMC established a mechanism by which money was created through bond sales in what was essentially a rigged market. Patman said, “The ‘open market’ is in reality a tightly closed market.” Only a selected few bond dealers were entitled to bid on the bonds the Treasury made available for auction each week. The practical effect, he said, was to take money from the taxpayer and give it to these dealers.
Feeding Off the Real Economy
That massive Wall Street subsidy was the subject of testimony by Eccles to the House Committee on Banking and Currency on March 3-5, 1947. Patman asked Eccles, “Now, since 1935, in order for the Federal Reserve banks to buy Government bonds, they had to go through a middleman, is that correct?” Eccles replied in the affirmative. Patman then launched into a prophetic warning, stating, “I am opposed to the United States Government, which possesses the sovereign and exclusive privilege of creating money, paying private bankers for the use of its own money. … I insist it is absolutely wrong for this committee to permit this condition to continue and saddle the taxpayers of this Nation with a burden of debt that they will not be able to liquidate in a hundred years or two hundred years.”
The truth of that statement is painfully evident today, when we have a $21 trillion debt that cannot possibly be repaid. The government just keeps rolling it over and paying the interest to banks and bondholders, feeding the “financialized” economy in which money makes money without producing new goods and services. The financialized economy has become a parasite feeding off the real economy, driving producers and workers further and further into debt.
In the 1960s, Patman attempted to have the Fed nationalized. The effort failed, but his committee did succeed in forcing the central bank to rebate its profits to the Treasury after deducting its costs. The prohibition against direct lending by the central bank to the government, however, remains in force. The money power is still with the FOMC and the banks.
A Model We Can No Longer Afford
Today, the debt-growth model has reached its limits, as even the Bank for International Settlements, the “central bankers’ bank” in Switzerland, acknowledges. In its June 2016 annual report, the BIS said that debt levels were too high, productivity growth was too low, and the room for policy maneuver was too narrow. “The global economy cannot afford to rely any longer on the debt-fueled growth model that has brought it to the current juncture,” the BIS warned.
But the solutions it proposed would continue the austerity policies long imposed on countries that cannot pay their debts. It prescribed “prudential, fiscal and, above all, structural policies” — “structural readjustment.” That means privatizing public assets, slashing services, and raising taxes, choking off the very productivity needed to pay the nations’ debts. That approach has repeatedly been tried and has failed, as witnessed most recently in the devastated economy of Greece.
Meanwhile, according to Minneapolis Fed president Neel Kashkari, financial regulation since 2008 has reduced the chances of another government bailout only modestly, from 84 percent to 67 percent. That means there is still a 67 percent chance of another major systemwide crisis, and this one could be worse than the last. The biggest banks are bigger, local banks are fewer, and global debt levels are higher. The economy has farther to fall. The regulators’ models are obsolete, aimed at a form of “old-fashioned banking” that has long since been abandoned.
We need a new model, one designed to serve the needs of the public and the economy rather than to maximize shareholder profits at their expense.