Ron Popeil is the late-night marketer who brought us cool things like the Veg-O-Matic and the Pocket Fisherman. He also marketed a hairspray that would help to cover bald spots.
In the commercial for that one, Mr. Popeil would walk up to people with bald spots in airports and offer to spray on some of the hairy glue. Now that was entertainment!
But it was his more mainstream product that came to mind when I read the latest McKinsey & Company report on global debt. As I flipped through the pages, I kept hearing Ron as he hawked the Showtime Rotisserie: “Just set it, and forget it!”
The gist of the report is that since the financial crisis few countries have managed to reduce their overall outstanding debt, even though there’s been widespread reduction in the amount of credit offered or used by businesses and consumers. In developed countries, there’s been some deleveraging on the private side, but this has been dwarfed by the amount of debt issued by governments.
The authors note that rising government debt can be a drag on policy and growth, so they outline possible ways of reducing the burden.
Governments could adjust their budgets (raise taxes and cut spending) so as to run surpluses which could be used to pay down their debt, or they could count on GDP to grow faster than their debt. Considering the position of most governments and their aging populations, there is little chance that either of these will occur…
Governments could restructure their debt, which is a euphemism for defaulting on some of what they owe. This is considered bad form (unless you are Greece or Argentina) and is not a likely solution.
But the report does mention one more path to decreasing government debt, although it’s not very prominent in the document. This approach calls for central banks to write off all the government debt they own. As radical as this might sound, I think the step is unnecessary.
Once a central bank buys the debt of its government, effectively the debt has already been forgiven. To paraphrase Ron Popeil, they can just set it… and forget it.
Central banks buy bonds with newly printed money. They don’t use credit or existing assets; they simply create money out of thin air and ship it to the seller of the bonds. In return, the banks receive in assets like government bonds. What happens after that is where we find the magic of debt forgiveness.
Central banks can rid themselves of assets in one of two ways — either sell the securities in the public market, or wait for fixed income products to mature. Either way, the banks end up with cash on the books.
Keep in mind that this cash came from selling securities or being paid on securities that were originally purchased with newly printed money. Once the central banks have the liquid cash in their accounts, they hand it over to their respective government treasury departments.
Reread that last sentence.
This is the step that most people find incomprehensible… when a central bank ends up with cash, it hands the money over to the government, even though the money originated by printing it out of thin air to buy securities.
This is why, from my point of view, taking the step of “forgiving” government debt that resides on the books of central banks is unnecessary. In essence, once the purchase of the bonds is complete, the whole affair from printing new money to transmitting the funds to the government is nothing but an operational sideshow.
And it doesn’t stop with government bonds. Effectively, any asset purchased by a central bank will eventually provide cash to the government, because the process remains the same — money is created, used for purchasing securities, and when those assets are disposed of, the funds are sent to the government.
The McKinsey & Company report shows that if central bank holdings of government debt were forgiven or simply not considered, then U.S. debt outstanding as a percentage of GDP would fall by 20%, whereas the Japanese government’s debt would fall by 140%.
These are not trivial amounts, but they don’t tell the whole story.
The Federal Reserve owns more than $1 trillion of mortgage-backed bonds in addition to its holdings of U.S. government bonds, and the Bank of Japan regularly buys corporate bonds and even ETFs on the Japanese stock market. When these additional assets are considered, the amount of “forgiveness” is even larger.
All of this might sound like bookkeeping mumbo jumbo, but remember one thing — when the central bank first prints a new dollar, they are effectively stealing value from everyone who currently holds dollars. This means that when the Fed creates new cash and uses it to buy anything, the theft of value happens to all of us… in that instance.
Everything else… selling the securities, remitting funds to the government, etc…. is all just noise.
It would be nice if, after stealing the money from us in the first place, the Fed would give us the money back at the end, instead of shipping it to the U.S. Treasury as a gift.
By the way… last year’s gift was a whopping $98.7 billion.
P.S. Adam takes on another issue today… what’s fueling the commodity market. Supply or demand? Find out in today’s Ahead of the Curve.