ed dolan is a senior fellow at the Washington-based Niskanen Center. This post represents his own views and not necessarily those of the Center.
Published September 10, 2021
Harvard-trained attorney Michael Ginsberg’s new novel, Debt Bomb (BQB Publishing, 2021), is a warning to America of a coming fiscal catastrophe written in the style of an international espionage thriller. Now I make no claims to be a literary critic, so don’t think you’re about to read a conventional book review. There is enough action to make it good beach reading, and in any case, I doubt that many readers pick up a tome of this genre in search of subtle character development or memorable dialog.
To me, though, the interesting thing about Debt Bomb is what it reveals about the mindset of the fiscal hawks who see America’s thirteen-figure deficits and fourteen-figure national debt as looming threats to the nation’s prosperity. If public finance actually worked as they think it does, I would be scared, too. Let me explain why I am not — or at least not scared of the same things.
Can the Government Spend Without Borrowing?
The central character of Debt Bomb is Andrea Gartner, an accountant who becomes director of the White House Office of Management and Budget and chief economic adviser to the president. Early in the book, in an appearance before a congressional committee, Gartner says this:
The United States is utterly dependent on members of the public and foreign countries to buy our debt. If they decide they don’t want to loan us money and we can’t finance our debt, the country goes broke. We won’t have a dime to spend.
It is worth parsing this statement in detail, since the same ideas are repeated time and again, and the whole of the plot of the novel turns on them.
Start by tracing what happens when someone pays $1,000 for a newly issued Treasury bond. To be specific, suppose, as is more often than not the case, that the buyer is a bank or big securities broker that is registered as a primary securities dealer with the New York Federal Reserve Bank. The buyer in question pays for the bond by drawing down its reserve account at the Fed. The Fed, in turn, credits the proceeds to the Treasury General Account, which appears on the liability side of the Fed’s balance sheet and the asset side of the Treasury’s. Netting out the intermediate steps, the end result is to reduce one form of government liability — private deposits with the Fed — and increase another: the Treasury bond that must eventually be repaid.
Next, suppose that the Treasury decides to spend $1,000 to buy a whiteboard for one of its conference rooms from an office supply company. That will trigger a similar process, but in reverse. The Treasury issues a payment order to the whiteboard seller’s bank to credit the office supply company’s checking account with $1,000 and simultaneously orders the Fed to credit that bank’s reserve account with $1,000. To complete the transaction, the Fed debits the Treasury General Account by $1,000.
But what if the Treasury runs the balance in its General Account down to zero? Can it still spend?
One way to do so would be to arrange an overdraft agreement with the Fed, much as you or I might arrange with our local bank so as not to worry about overdrawing our checking accounts. However, in the Treasury’s case, a legal technicality would stand in the way: any overdraft would be considered a loan by the Fed, and the Federal Reserve Act of 1913 forbids the Fed from lending directly to the Treasury.
Fortunately, there is an easy workaround. The Treasury can sell a newly issued bond to a private securities dealer, depositing the proceeds in the TGA, and the Fed can simultaneously buy a previously issued Treasury bond that the securities dealer already owned. There would be no change in debt held by the private sector, so these paired transactions would allow the Treasury to spend without engaging in any new net borrowing. It is all perfectly legal, and it is done routinely to keep the TGA from running low.
The only thing that might stand in the way is a Treasury borrowing limit imposed by Congress. But in practice, this ceiling is a weak impediment. After a little grandstanding, Congress has always raised the limit as needed. In 2019, Congress went even further, granting a two-year suspension of the debt limit, which expired at the end of July.
In any event, this was not a hard deadline, since the Treasury has some tricks up its sleeve to keep spending for a few more months. Smart money says that the ceiling will either be reinstated at a higher level or the suspension will be extended. As Bruce Bartlett, a former deputy assistant secretary of the Treasury, put it, “In practice, [the debt limit] does nothing whatsoever to restrain the growth of debt and only enables demagoguery and insincerity.”
The bottom line: yes, aside from some easily evaded technicalities, the government can indeed spend without any new net borrowing. The fictional Andrea Gartner seems to be one of the few insiders who does not know that.
As long as the Treasury is sure to pay off all securities as they mature, there will always be some interest rate — even if an abnormally high one — that will tempt buyers to come forward.
Can Treasury Auctions Fail?
At another point in Debt Bomb, government finances are thrown into crisis when the Treasury tries to sell some bonds, but no one is willing to buy them. Could that actually happen?
Theoretically, yes, but there are good reasons to think it very unlikely. Newly issued Treasury securities are sold at auction, with no specific reserve price. Normally bids exceed the quantity of bonds offered for sale by several times over. And the worst that happens is that the prices bid are a little lower than expected so that the interest yield ends up being a little higher. On the rare occasion when there is a major lack of interest in a new bond issue, the aforementioned primary dealers, who are required to enter bids, can be made to pick up the slack. Something like that happened with an auction of seven-year Treasury notes on February 23, 2021. Interest rates briefly spiked, but the market soon calmed down again.
As long as the Treasury is sure to pay off all securities as they mature, there will always be some interest rate — even if an abnormally high one — that will tempt buyers to come forward. Almost the only thing that might cause investors to stay away altogether would be if the Treasury were to flat out default on obligations to pay interest or return principal on previously issued debt. Conceivably, a refusal of Congress to raise the debt ceiling might force such a default, but that is exactly the reason Congress has never failed to raise it.
What About China?
At one point in Debt Bomb, all hell breaks loose when the Chinese government announces that it not only will stop buying newly issued U.S. debt but also will insist on repayment of what it already holds. Is that a realistic threat?
To bring a little humor into an otherwise tense narrative, Ginsberg depicts the Chinese government not only refusing to roll over its Treasury holdings but also demanding payment in kind. It sends teams to America who start carting off U.S. government property, right down to furniture and paintings from the Oval Office.
In reality, though, this absolutely, positively cannot happen: Treasury borrowing is unsecured and uncollateralized. Neither China nor anyone else has legal standing to demand payment in any form other than in U.S. dollars. And that is exactly why most observers think it unlikely that China would want to suddenly unload its liquid dollar-denominated reserves held in the form of Treasury securities.
The key to understanding the issue is that the whole reason China accumulated its vast holdings of U.S. securities in the first place was to weaken the exchange rate of the yuan relative to the dollar and thus make Chinese goods cheaper to foreign buyers. (See this article in Investopedia for details and charts.) Doing so has enabled the highly successful Chinese strategy of export-led development.
The most rapid period of increase in China’s reserves ended in 2011. Their reserve holdings have been fairly steady since that time at just above $1 trillion. Any rapid reduction of those reserves would have the effect of causing the yuan to appreciate sharply relative to the dollar. That would make it harder for Chinese firms to export and harder for Americans to import Chinese goods. At the same time, imported goods would become cheaper in China and domestic firms there would face stiffer import competition. China’s whole development strategy (to which Chinese industry is thoroughly addicted) would be thrown off course, while American exporters and import-competing firms would rejoice.
In short, although an abrupt sell-off of dollar reserves by China would indeed cause turmoil in financial markets (which is their objective in Debt Bomb), such a move would have both winners and losers. Many of the losers would be in China and many of the winners in the United States.
The economic crisis in Debt Bomb is purely demand-side, brought on by brutal cuts to government spending. The supply capacity of the economy is untouched. What is lacking is the purchasing power to buy the output that businesses are itching to produce and sell.
As the financial crisis intensifies, Gartner reacts by imposing a swingeing austerity budget. Government spending is slashed. Government employees are laid off by the tens of thousands. Social Security and Medicare are cut. People lose their medications, get evicted from their homes and die “by the hundreds of thousands.”
“Did I really do everything I could?” Gartner asks herself.
“Print money,” suggests a general whose troops are running out of ammunition to hold off the Chinese military.
“We’ve already killed Social Security,” answers Gartner. “You want to kill peoples’ retirement accounts too? You want people to pay for food with truckloads of dollars? Why don’t you go online and search ‘Weimar’ and ‘wheelbarrows’ sometime?”
Pretty dramatic stuff. So, with hundreds of thousands dying and the U.S. Army out of howitzer shells, would Weimar-scale hyperinflation really be the only alternative?
Probably not. In Germany’s Weimar Republic of the 1920s, Yugoslavia in the 1990s, Zimbabwe in the early 2000s and Venezuela today, hyperinflation was preceded by a supply-side collapse of the economy. It was then fed when those countries’ governments reacted to the collapse of supply by feeding demand with ever larger increases in the money supply. But that is not the scenario portrayed in Debt Bomb.
No, the economic crisis in Debt Bomb is purely demand-side, brought on by brutal cuts to government spending. The supply capacity of the economy is untouched. The labor force is still there and the factory buildings still stand. What is lacking is the purchasing power to buy the output that businesses are itching to produce and sell.
Under those circumstances, expansionary monetary policy and fiscal policy are just the ticket. Rather than driving people to bid up prices for goods that the economy is physically incapable of producing, fiscal and monetary expansion would put idle workers and factories back to work.
Of course, in the modern world, “printing money” would not mean literally printing wheelbarrows full of banknotes with insane numbers of zeros tacked on, as it did in Weimar Germany. It would mean the sequence of spending-without-borrowing practices that were described above. The result of those practices is not mountains of paper currency, but mostly an increase in the monetary base held as private bank reserve deposits at the Fed.
We do not have to speculate to know that increases in the monetary base in today’s United States would not have the same inflationary effect as printing paper currency did in Weimar Germany. We have already performed that experiment. Between 2008 and 2021, the Fed’s policy of “quantitative easing” to counter the Great Recession increased the monetary base by about 500 percent! Over those 13 years, the consumer price index rose by a cumulative 26 percent — a rate of inflation that did not even meet the Fed’s announced target.
In short, as long as there is excess capacity in the economy, as there was in the real United States of 2008 to 2021, and as there is in Ginsberg’s fictional United States of the Debt Bomb, expansionary monetary policy will speed the process of getting people back to work without stimulating inflation. So, Gartner did not do everything she could.
Does That Mean We Have Nothing to Worry About?
Time to pop a Xanax and chill? Are steady economic growth and crisis-free prosperity just a matter of not being afraid to push the right monetary and fiscal buttons? That would be overstating the case.
For one thing, there really are weak points in our economy that a hostile power could use to bring about an economic crisis — especially if it was willing to absorb some blow-back damage to its own economy. But if I were to write a novel about it, the vulnerabilities I would highlight would not be those featured in Debt Bomb. I would focus instead on some more realistic fragility in the markets for cryptocurrencies or stable coins or SPACs, or even something as prosaic as the market for private short-term debt. Or I might invent a ransomware attack that did the same thing to Citibank or the New York Stock Exchange as was done earlier this year to Colonial Pipeline.
Hmmm … maybe I should give it a try. The novel, that is; not the ransomware attack.
But thrillers aside, the most realistic worry is that some future president might appoint someone to run the Treasury, the OMB or the Fed who has as poor an understanding of basic finance and economics as Ginsberg’s fictional Andrea Gartner.