Debt jubilee is debt forgiveness, and it’s already happening at a staggering rate for public sector debt. Sovereign debt is fundamentally different from private debt in that the sovereign makes the rules and never has to repay its debt. When the Fed purchases a Treasury, and then continues to roll over that Treasury forever, then that debt is effectively cancelled. That is why public sector debt is not deflationary, nor a drag on growth. This post walks through the mechanics of our modern day debt jubilee, and how it can help deleverage private sector debt.
What Happens when the Fed Buys a Treasury?
Deficit spending financed by the Fed is effectively free money being minted and deposited into the accounts of the private sector. The spending doesn’t have to be in stimulus checks; it can be any form of spending. The Fed creates new money, sends it to Treasury, who then spends it into the real economy. (For those who need a refresher on how reserves and bank deposits interact, see this post for a primer on our two-tiered monetary system.)
Traditional economic textbooks may mumble something about a potential for higher future tax rates or interest rates under large deficit spending, but that is just nonsense. All major central banks have been financing their governments to the tune of trillions for over a decade with no end in sight. Government debt never has to be (and in practice never is) repaid. When the sovereign can print its own currency, there can be no ‘bond vigilantes’ and there is no need for taxes (crazy things will happen when the public and Congress fully realizes this). The risks in Fed financed deficit spending arise in the form of a weaker currency and inflation, both of which are just beginning to materialize.
What Happens when the Treasury debt purchased matures?
When the Treasury debt purchased matures, the Fed simply takes the maturing principle and re-invests it in newly issued Treasury securities. When the Fed receives interest payments it takes those interest payments and pays them right back to Treasury. If all the mortgage payments you made on your house were returned right back to you – do you really have mortgage debt? Does that debt burden reduce your income?
Treasuries purchased by the Fed are effectively interest free and never have to be paid back, provided the Fed keeps re-investing maturing securities. This is the modern day debt jubilee. (Note the same logic applies to other assets the Fed buys and keeps rolling over, such as Agency MBS)
The the Fed attempted to shrink its QE portfolio in late 2017 by reducing the amount of maturing Treasury principal that would be re-invested (the redemptions in the graph above), but that experiment only lasted a couple years. Looking across the world, the BOJ and ECB have never been able to shrink their QE portfolio. Their QE portfolio has only gotten larger. Fed communication hasn’t suggested that they are eager to slow down their current pace of asset purchases, so reducing reinvestments is even further into the future.
Public Debt Jubilee is an Indirect Private Debt Jubilee
Government spending never has to be paid back (and probably never will), so it is effectively new money that remains in the financial system and can be used to extinguish private debts. When the government is spending massively (as it is now) with Fed financing (as it is now, at $90 billion a month), then that is $90 billion in new money injected into the private sector. That money can be used to help repay private debt, as seen in the example below.
However, given that household balance sheets are solid and interest rates are low, there probably isn’t much of a need for the private sector to deleverage. That new money pumped into the system is probably just going into TSLA/housing/crypto/stonks.