What happens if... [trying to understand public debt in the age of fiat currency]

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lapuce
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What happens if... [trying to understand public debt in the age of fiat currency]

Post by lapuce » Thu Sep 21, 2017 10:01 pm

As a thought experiment, what would happen if the Federal Reserve sends tomorrow a check to the US government that covers all its present debts (it must be something around $20T) and the government in turns calls back all its bonds and pays off its creditors. Presumably, nobody would want to lend it anymore, but the government may not need to borrow either for a while (taxes keep going to the Treasury, no more debt to service and so no deficit, ...). Would it trigger runaway inflation somehow? The collapse of the World economy? Or maybe nothing so extreme, besides the Fed's balance sheet going from $4.5T to $24.5T?
(Let us consider this as an actionable topic in some general sense if it helps understanding modern economy -- I just don't know where else but on Bogleheads to ask such a question.)

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JoMoney
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by JoMoney » Thu Sep 21, 2017 10:14 pm

I don't think this is a actionable topic, all we can do is speculate, and I doubt the thread will remain...

In this scenario, where is the Fed getting the money to begin with? The treasury has to first 'borrow' the money before the bank/Fed can create it... so the debt owed by the treasury would go up by the amount the treasury is borrowing. :confused
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stlutz
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by stlutz » Thu Sep 21, 2017 10:20 pm

Google "trillion dollar coin".

av8r316
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by av8r316 » Fri Sep 22, 2017 12:05 am

JoMoney wrote:
Thu Sep 21, 2017 10:14 pm
In this scenario, where is the Fed getting the money to begin with? The treasury has to first 'borrow' the money before the bank/Fed can create it... so the debt owed by the treasury would go up by the amount the treasury is borrowing. :confused

It’s actually the other way around.

The Fed can literally create money that didn’t previously exist. They effectively have the ability to wire an unlimited amount of money, so when you hear about the Fed expanding its balance sheet, they’re buying bonds and giving the seller cash that they just created. This has the effect of increasing the Fed’s assets (for the bonds they purchased) and also increasing the Fed’s liabilities (for the cash they created), which is actually due to the US Treasury.

When the Fed contracts its balance sheet, it sells (or lets mature) its bond holdings, receiving cash from the buyer; except instead of keeping the cash, they retire it and effectively reduce the liability due to the US Treasury.

In this speculative scenario by the OP, the Fed would just be refinancing the Treasury’s debt. I doubt they have the authority to literally just gift the Treasury (or anybody) funds without getting a debt instrument/asset in return.

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JoMoney
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by JoMoney » Fri Sep 22, 2017 2:27 am

av8r316 wrote:
Fri Sep 22, 2017 12:05 am
... I doubt they have the authority to literally just gift the Treasury (or anybody) funds without getting a debt instrument/asset in return.
Exactly... That's what I said. The treasury (or someone like a Fed bank) would first have to 'borrow' the money (creating bonds for the Fed to hold on its balance sheet) in order for the Fed to create the funds, which just creates more debt rather than reducing it (although maybe the debt could be shifted to a fed bank or somewhere else in the economy that the Fed would lend to).

I think the other idea above, that the Treasury has the ability to mint coins, so the treasury (rather than the fed) minting coins declared by fiat to be worth enough to pay off the debt is probably closer to what OP is imagining... in which case I think inflation would follow as these coins would presumably not be made of sufficiently valued amount of precious metal, nor the promise to pay anything at some future date.
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AlohaJoe
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by AlohaJoe » Fri Sep 22, 2017 3:08 am

lapuce wrote:
Thu Sep 21, 2017 10:01 pm
the government in turns calls back all its bonds and pays off its creditors
They aren't callable. Why would you think they are? The Treasury hasn't issued callable bonds in over 3 decades.

I think discussions about US government debt -- especially when prefaced with phrases like "age of fiat currency" -- are unlikely to be enlightening or useful on Bogleheads. There are hundreds, probably thousands, of resources on the internet that explore how public debt works. That's a better place to learn, I reckon.

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LadyGeek
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Re: What happens if... [trying to understand public debt in the age of fiat currency]

Post by LadyGeek » Fri Sep 22, 2017 8:21 am

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