National Debt Monetization

Largely lost in yesterday’s media coverage of the national debt eclipsing the $15 trillion mark was the fact that the Federal Reserve has officially become the largest holder of public debt in the United States.  I suppose we no longer have to fret about China being the number one debt holder now that the Fed accounts for $1.665 trillion in treasury securities – more than double the amount of national debt it held on its balance sheet just a year ago.

As I have mentioned in other posts, the troubling thing about debt monetization is that unlike other cases where countries or private entities purchase treasury bonds with already existing money that has a specific purchasing worth, the Federal Reserve typically orders new monies printed to facilitate these transfers.  This practice is incredibly inflationary to the money supply which generally causes prices of goods and services to rise.  Unfortunately, retirement investments like 401(k)s are harmed dramatically because the invested money’s buying power shrinks along with the increase in supply, and salaries historically do not keep up with this inflation to balance the growth.

Some argue that debt monetization actually reduces the real debt because it is a means of financing the government without actually borrowing, as the money is literally printed on demand.  That may very well be true but it will only be so if and when the government decides to write off these “obligations” to repay the Federal Reserve.  In the meantime, however, the inflated and thus weaker money created by the infusion of the new money is very real and hits those in society who receive it last the hardest – the poor and lower middle-class.  This inflation reduces consumers’ real ability to purchase the same goods in the same quantities they could before the new money entered the supply, and as prices rise as a result of this government finance it has the very real effect of taxation while circumventing constitutional legislative process to legitimately do so.  Additionally, absent paying the money back directly the only way to deflate the national money supply and thereby strengthen its purchasing power is to recoup it through higher credit interest rates, something that would be doubly impactful given the weakened state of the dollar due to its inflation in the first place.

The Federal Reserve has no legal constraints on how much debt can be monetized in this country and given the debasing nature of the effects this practice has it is ironic to consider that the Coinage Act of 1792 (also known as the Mint Act) – the first legislative act passed under the Constitution regulating monetary policy – made it a capital offense for any officer or employee of the Mint who debased the coinage.  For my part I agree with Congressman Ron Paul (TX), who states that “short of intentional war, inflation is the most immoral act political leaders can commit.”


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