Wednesday, October 31, 2012

How To Eliminate $4.5 Trillion of Debt


Note: It’s dark north of NYC. Only those with generators have lights, heat and the ability to communicate. I counted 27 trees down on my property; the costs to make the damage right will be about $10k. Insurance will not pay a dime. I got off easy.


 You’ve seen the pictures by now, big trees hanging on downed wires. What you miss from the pictures is the scope of the devastation; it’s massive. Whatever your estimate for the cost of Sandy, and how long it will take to get back to “normal”, double or triple it. And it’s getting cold. Anyway, allow me a (lengthy) ramble on a somewhat bizarre idea that has been floating around.



 Tear Up the Paper


Total global debt is around $200Tn. World GDP is less than $70Tn (300% global debt to global GDP). Advanced economies have a higher percent of total Debt/GDP than developing countries. So the crux of the problem lies with Japan, most of the EU and the USA.


The question of what to do with all this debt has become a topic of discussion of late. The catalyst was (surprisingly) the IMF. Some deep thinkers at the IMF have resurfaced an old idea. Just cancel the debt; make it disappear. FTAlphaville, Ambrose Pritchard, and Zero Hedge have had articles that discussed the IMF paper.





This sounds beautiful. According to the IMF, the mechanism for debt cancellation is already in place. The proposal is to simply eliminate all of the US Treasury debt that is purchased by the Fed (QE). At the end of the day, the citizens “own” both the Treasury and the Fed, so the loss to the Fed from cancellation is the gain of the Treasury. One pocket is full of Assets; the other pocket is full of Debts. Both pockets are emptied; no one is richer or poorer as a result.


Hmmm. What’s wrong with this?


-The Fed would have a loss. Does this matter? I’m not sure. The most important Central Bank in the world would have a negative net worth. But the Fed would still have the Full Faith and Credit of the USA behind it, so the paper loss is irrelevant.


-If the Fed wanted to tighten monetary conditions at some point in the future it would normally sell the bonds that it had purchased. But if the bonds had been cancelled, the Fed would have nothing to sell, and therefore could not reduce reserves.


Ideas like this scare the crap out of worriers like me. The result of debt cancellation (ala the IMF)is a permanent increase in money outstanding (signorage). But the reality is, the bonds purchased by the Fed ARE permanent. The Fed will never be able to sell the trillion or two of Treasury bonds that it owns, so we might as well just recognize that fact, and cancel the bonds.


-The problem that I see is one of scale. How much additional Treasury debt could the Fed buy and then cancel? They currently have approximately $1Tn that is eligible for cancellation. There is a limit to the purchases that could be accomplished. I don’t think the Fed could buy an additional $3Tn without serious consequence to the government bond market.


-This is a goofy concept. Arbitrarily cancelling publicly issued debt has a bad ring to it.  This has the appearance of a desperate act. Destabilizing the Fed might have negative consequences.


The IMF’s objective is to reduce debt by a meaningful percentage, and to accomplish that without consequence. If that is the case, I have a an alternative proposal. America could eliminate $4.5Tn of IOUs with the stroke of a pen. Debt to GDP would fall from today’s perilous level of 102%, to a much more comfortable 70%.


That also sounds nice, BUT, I  hope to show that there ain’t no free lunch when it comes to tearing up IOUs.


 The Plan

The Social Security Trust Fund (SSTF), the Federal Workers Retirement Fund (FERF) and the Military Retirement Fund (MRF) are sitting on a whopping $4.6Tn of Special Issue Treasury Securities. This category of debt is referred to as intergovernmental debt.  What would happen if all of this debt was erased? Not a damn thing. That may sound impossible; follow the money.


SSTF, FERF and MERF all have the same operating profile:


-They take in real cash money.


-They pay benefits.


-They have assets in the form of those Special Issue securities.


-They earn interest on their assets. Importantly, interest is not paid in cash, it is paid with more paper.


-The Funds are running annual cash deficits. (Tax receipts are less than benefits paid).


Consider what happens with SSTF. In 2012 they will have an operating cash shortfall of $50Bn. It must have cash in hand to pay the benefits, so it must sell (redeem) an amount of its portfolio of SI bonds to cover the shortfall. It redeems the necessary amount with the Treasury. The Treasury has no cash lying around so it must issue more Debt to the Public. The result:


Pre-SSTF cash shortfall


Debt to Public = 12.0Tn

IG Debt = 4.5Tn

Total = 16.5Tn



Pro-forma a $100Bn SSTF cash shortfall:


Debt to Public = 12.1Tn

IG debt = 4.4Tn

Total = 16.5Tn


Note that Debt to Public (DTP) increases, IG goes down, total debt is unchanged. Now consider what happens when IG debt is eliminated:


Pre-SSTF cash shortfall


Debt to Public = 12.0Tn

IG debt = 0

Total = 12.0Tn


Pro-forma a $100Bn SSTF cash shortfall:


Debt to Public = 12.1Tn

IG debt = 0

Total = 12.1Tn


So there you have it. It doesn’t matter at all if the Intergovernmental Account is eliminated and all those Special Issue Treasuries are ripped up. $4.5Trillion of US debt is just a fiction.


I know that there will be some who look at this and say, “But the bonds held by the SSTF are my security that SS will continue to pay monthly checks”. There is not one shred of truth to that line of thinking. Congress can alter the benefits paid by SS anytime it chooses. The existence of the SS Trust Fund has nothing to do with that promise to pay.


When you peel back the onion that is the Intergovernmental Account, you find that there are no real assets, just paper and accounting gimmicks.

If the objective is reduce debt, there are cosmetic ways to do it. But eliminating the debt does not eliminate the underlying problem. As long as the SSTF, FERF and MRF run annual cash deficits (they will for the next 75 years) the real debt that America has, will have to rise.

The result of eliminating the IG debt is not unlike the consequences of the IMF’s Chicago Plan. It looks like something is being achieved. The result is an immediate reduction in debt. But really that is just a charade. The liability just pops up someplace else. The pain of debt is not eliminated, just hidden so we feel better about it. Sorry IMF, it won’t work.






  1. The debt is gone but the money the treasury raised and spent is still out there.

    Would that be the straw that broke the camel’s back and cause the public to finally wise up to the cold hard fact that the fiat money they have been assured by the gov’t to be safe is nothing but one giant con?

  2. Bruce:
    What you are suggesting has already been occurring with the cash deficits in the SS trust fund since 2010. When the SS trust fund interest is redeemed, additional debt held by the public is issued, due to the budget deficit. (If a budget surplus, general revenuers would be used to redeem the interest).
    While intragovernmental debt goes down due to the redemption, debt held by the public increases by the same amount, thus leaving total debt the same.
    As you suggest with a stroke of a pen, we could wipe out intragovernmental debt, increasing debt held by the public by the same amount, and still keeping total debt the same.
    This is the problem I have with intragovernmental debt. The asset part was used immediately by the Treasury over the years to pay real expenses and lower real deficits.
    The liability part did not materialize until the cash flow shortfall in 2010 necessitated the redemption of Treasury interest, 27 years after the trust fund surplus started to grow.
    All of this is occurring without any impact on the budget, from a cash perspective. Deficits are lowered, interest in the trust fund is accrued, and total debt remains the same.
    Then, when the interest (and eventually trust principal) is redeemed, there is still no cash flow impact on the budget, for debt held by the public is issued, not general revenues spent, which would impact the budget – and the total deficit remains the same.
    The asset part of the debt (from a cash perspective) has been used immediately, while the liability part (from a cash perspective) has been continuously postponed.
    Wouldn’t it be great if American citizens could do the same with their debt?
    Don Levit

  3. But What Do I Know? says:

    Yes, now you’re getting it, Bruce! Tear up the Treasury debt owned by the Fed–it’s not real anyway. Neither is the debt owned by the SSTF or the other governmental trust funds–excluding what is specifically owned by employees in their retirement funds. The SSTF is simply a bunch of IOMe’s stuck in a drawer, which the government “pays” interest on by adding more IOMe’s to.

    The Treasury can either issue bonds or cash. If the Fed wishes to exchange cash for some bonds, it’s only changing the composition of the choice the Treasury made in the first place.

    The national debt “crisis” is a complete red herring, pushed by those who either don’t understand the nature of our monetary system or do understand but are faking it for their own purposes.

  4. One fly in the ointment, the FED is not a government agency. It is a cartel of banks owned by the banks.

    • But What Do I Know? says:

      True, but irrelevant under the present arrangement whereby the Fed turns its interest earnings over to the Treasury. If you pay interest to yourself, you’re not really paying interest; if you’re not paying interest, it’s not really debt. . .

  5. Bruce,
    God bless you man. You keep trying but even the ZH comments are rough. I support your effor to inform and educate but remember this Atlas Shrugged D’anconia quote: “Money will not serve the mind that can not match it.” You and I both know what is going to happen and trying to save this ship at this point is futile…..as mentioned before.
    Take care and be safe.

  6. Bruce: doesn’t this come down to whether we pull the black swan forward or kick it down the road? We know that when it comes time to print for real, it will be because the number is an order of magnitude larger than $1T. Why not kick off a modern Jubilee by putting (say) $1T of helicopter money in people’s bank accounts–every year until inflation hits 2% or we get spanked by the currency or bond markets–and let higher tax receipts bring down the deficit? No more congressional pork fests, no more QE-induced famines, fewer excuses to coddle the bankers, and so on. Your worries about the ring of desperation and the Fed’s credibility suggest to me you’re hesitant to accept the narrow range of endgames suggested by your own work. My view is that US households cannot delever fast enough for the retirement of the baby boomers, and that financial repression and other redistributionary efforts will fall short.

  7. Bruce,

    Why won’t your insurance company cover the damages? … oh…. nevermind…. I had a mental lapse there for a few seconds, I actually thought for a moment that insurance companies are business to insure their policy holders against loss. hahahahaha. hahahahaha. hahahahaha. Silly me! What a ridiculous notion, eh? I momentarily forgot that insurance companies are in business to take your money and then to do everything they can to prevent you from getting anything in return.

    PS Glad to hear you are safe!

    • Most of the cost is downed trees. My insurance co. does not cover cleanup. Who’s does?

      I gambled and lost. I have damage to a pool house. Not too bad. Maybe 5k. That’s insured, but I also have a 5k deductible….

      • But What Do I Know? says:

        BTW, I’m glad to hear the damage wasn’t life-threatening. Hope the power comes back on soon and things return to normal for you.

  8. Before tearing up the paper, cut every citizen a check for what, $50k, $100k, $250K, then tear up the paper

    • Addendum: Treasury cuts the check, Ben buys the debt, then paper is torn up. Maybe on CNBC, Fast Money or at 4 pm as wide ride squels, “It’s 4 o clock, do you know where your money is?”

  9. Sounds good to me. Can I tear up my mortgage and credit card bills at the same time? Didn’t think so.

  10. Years ago in Econ101 I tried to make sense of the textbook statement–‘the Fed is supremely unconcerned about the price it pays to buy and sell the governments’ bonds”. No one can be ‘unconcerned’ about the price they pay. But now I realize that if I was a perfect counterfeiter and everything I did was legal, I wouldn’t be concerned about the price of anything either. I used to think the Fed was a responsible steward. They managed the fairness and justice of the monetary system by not playing favorites. The moral problem with counterfeiters is the private benefit. That’s what we have now–$40b for GM, $180bfor AIG–nothing for you or me. So now the ‘responsible steward’ is the counterfeiter. The reason that I don’t have any money is that the government hasn’t given it to me. I have to find it from someone else the government has given it to and then give them a percentage of what I find. Aren’t we all donkeys chasing a carrot on a stick, turning the money wheel for the lifestyles of the rich and famous (and connected to the money tree?) So where does the idea of free men come in? Is it, we in government are free–the rest of you wogs, do what you’re told.

  11. I would agree but on a much simpler level. If cancelling the debt were to occur, why wouldn’t every government on the planet rush to issue as much debt as possible with the future expectations of just cancelling that debt. Makes no sense … not that anything does make sense anymore, which is why we are in the dodo we are in.

  12. If the trees that fell are large and straight (and not rotten) the lumber can be sold, there are a number of sawmills in New Jersey:


    Here’s one:


    Depending on type, size and condition you could make some long-green on yr long-green. Make sure to replant fallen trees: 2 or 3 new trees for each you remove.

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    penny? I’m not very web savvy so I’m not 100% positive. Any tips or advice would be greatly appreciated. Cheers