The New Fed Plan – Same as the Old Fed Plan?“The People’s Option” Not on the Table

We’d like to acknowledge the summary by Clearly Finance who provided much of the content of this article that supplements the video which can be found at this link. https://youtu.be/qXHy4ZefO8c?si=ErDMWJrMddD_3Qcd 

(CL) If given the choice, how many Americans would choose to have their retirement accounts, their social security benefits, their welfare benefits, and even their salaries reduced every year in favor of more government spending through monetary inflation? Let’s look at it in terms of democracy, another word that gets tossed around by the Politburo. If a vote was given to the people of the United States, how many would pull the lever for increased costs of living? Well, no worries as they say. The Federal Reserve and the Federal Government are going to make that decision for you. After all, this is why we have a representative government right...so the experts can make the really important decisions for the uninformed masses.

(CF) The United States government is paying close to $1 trillion dollars a year on government debt. It’s not paying it down just perpetuating it and it’s rising.

(CL) This is not a new process it’s just at a level that is, well unfathomable in a world with accountability. Since 1863 and the passage of the National Banking Act that enabled debt-based currency through government bonds, the government has been operating in the same way. As debt increased, government officials – usually Congress – would write “refunding” bills. Of course, when people heard the word “refunding” they thought they were getting something back, and at that time they were. Refunding bills, often re-established lower interest rates for the debt but protracted (extended the time to pay it off) it at the same time. The Financial coup d’ état, that all of the so-called experts apply to current events only, miss the fact that the initial takeover was done by a Republican congress ex parte, that is, while the Democrats had seceded prior to the Civil War.

(CL) In the 1860s however, these refunding bills bought time. That time gave the country the opportunity to pay off its debt with real productions. As we know now, debt was never to be paid off because that’s how the ruling class (bondholders, bureaucrats, and bankers) maintain their status and try to continue to control the political economy, agenda, and by consequence, our lives.

(CF) One of President Trump’s goals is to have the Federal Reserve cut short term rates hard. He has had pushback from the current Chairman Jerome Powell in perhaps a true attempt at fiscal conservation. The new Fed Chair, Kevin Warsh, knows he has been appointed to deliver. But cutting short term rates can reignite inflation. And when inflation rises, investors demand higher long term yields to fund the government. That's when the debt spiral starts.

The current Fed solves this by buying long term bonds, absorbing supply and keeping rates capped. So contrary to what has been advertised as a “lender of last resort” to other banks, the Fed is a buyer of last resort enabling the expansion in federal budgets. Warsh called that a disaster. So, the new Fed chair has to cut rates without letting inflation push long term rates higher and without the Fed printing money to buy bonds. That sounds impossible, but he has a plan and you're not going to like it.

According to officials and state economists, there are only four exits, and three of them are either impossible or catastrophic. The last one is just very unpleasant. The US debt to gross domestic product (GDP) ratio is sitting at over 120%. That means the government owes more than the entire economy produces in a year. The last time it was this high was right after World War 2 and what the government did to solve it back then is the same playbook being dusted off right now.

Option 1 is running a surplus, cut spending, stop borrowing, pay the debt down. Officials say this is “not happening.”

(CL) To the initial question: Why is this not happening? This seems like a viable plan, and it should appeal to conservatives. We know it’s possible because Bill Clinton was the last president to actually balance the budget and pay down the debt. Apparently this did more than raise some eyebrows and in the 21^st century political economy this is no longer an option. This is a clear indication that we are now living under a command economy. As I have written about command economies in other articles and books, these are typically the economies of socialist and fascist countries. So be wary when politicians tout the free market. There’s a market, but it’s a mixed market with a heavy hand and a disappearing invisible one. Another term to be wary of is “conservative.” Fiscal and monetary conservatives would choose option one. The fact that they don’t proves that they are actually neo-conservatives, which disregard the fiscal and monetary part of that characterization. A neocon is now a wealthy individual who has attained that wealth through liberal monetary and fiscal means. Time will determine whether these modern liberals can maintain their position. Time may even prove much of the machinations in government are actually criminal, but the average American is not ready to face that notion.  

(CF) Option 2 is default on the debt. Just refuse to pay. The debt disappears overnight. So does the global financial system. Not realistic.

(CL)  Part of the reason we can’t have a jubilee per se, is that the debt, the bonds and treasury securities under gird many pensions and are found in many investment portfolios. Although option 2 may not be totally realistic, there is 30% of foreign owned debt that could be reduced or attenuated. It is possible that what we are witnessing right now is a changing of the guard, that is, the end of the petro dollar as the global reserve currency. Yes Americans would have to adjust. Will our governments adjust? History says “no.”

(CF) Option 3 is growing #86C6E5the economy faster than the debt grows. This is the hope, AI, automation, productivity revolutions possible, but hope is not a strategy.

(CL) AI, like and as part of the technology industry, would require inflation, more money and credit since it doesn’t produce anything organic, at least not at this point in the product cycle. The reality is that the United States must reduce its trade deficit by producing products that the rest of the world may want, especially if we can’t export our money and bonds any longer.

(CF) That leaves option 4. Option 4 inflate the debt away.

Think about buying a house with a $500,000 mortgage. On day one, your debt is 100% of the home's value. Now inflation rises to 4%. Dollars lose value or get weaker. You still owe $500,000 plus interest, but you're paying it back with dollars that are worth less than the ones you borrowed on your house. Inflation pushes it to $520,000. Now that $500,000 debt is about 96% of what you own, the burden feels smaller not because you paid it off, but because the measuring stick changed.

(CL) This isn’t entirely true. Using this analogy, when a homeowner builds equity through inflation, some if not all of that value is lost, especially in states like New Jersey where property taxes are constantly on the rise and mandated for frequent re-evaluations. So, the state steps in and raises property taxes on top of the inflation that is causing higher costs of living. The value is not fully realized by the homeowner and talking from experience, whether short term or long term, the profits from selling are significantly reduced when aggregate amounts of insurance and taxes are included in the overall calculation. Of course, the timing between purchasing and selling a home has a huge impact on the outcome.

(CF) The government does the same thing, except the house is the entire U.S. economy or GDP. The national debt is measured in dollars, but inflation makes those dollars worth less while it pushes GDP higher in dollar terms. So, the debt to GDP ratio shrinks. The burden eases, not because the debt disappeared, but because every dollar is worth a little less. But there's no free lunch, the government is deleveraging through inflation, and you're paying through higher prices. Groceries, rent, everything. A quiet bill every day. The phrase “hidden tax” has been used by economists originally opposed to the state’s fiscal policy.

(CL) There are several cautions here but specifically when state economists refer to GDP. In the 21^st century, and I am not aware of when the calculation changed, GDP includes consumption and transactions. This is an adulteration of true production and obfuscates the true depths of our debt.

(CF) Here's where history gets uncomfortably relevant after World War II. U.S. debt to GDP ratio was around 120%. Very close to today. The government had the same problem. Too much debt and can't tax enough to cover it. It also can't let long term rates rise because the interest costs would be crushing. But from 1942 through 1951, the Federal Reserve and the Treasury worked together. The Fed pegged short term rates near 0 and capped long term yields at 2.5%. If inflation caused the bond market to push rates higher, the Fed printed money and bought bonds as needed until rates came back down, whatever it took. It's called yield curve control. It's what they do when the debt gets too big. And it worked. The government borrowed cheaply to finance the war and the early post war years and that along with an increase in post-World War II productivity allowed the debt burden to shrink relative to the economy. But inflation also hit 17% in 1946. By 1951, it was over 20%.*

*The 1951 figure may represent the cumulative inflation rate. Data doesn’t support an annual inflation rate that high. However, the calculations for these figures have changed over the years in order to accommodate policy.

In 1951, the Federal Reserve allegedly severed its relationship with the Treasury. (CF) They broke from Treasury control and regained their independence. That agreement the Fed reasserting its right to set monetary policy without Treasury direction, was called the Treasury Fed Accord of 1951. During this period total circulation remained relatively stable. Here's what almost nobody gets about that history. The 1951 accord wasn't the Fed agreeing to help the government. It was the Fed escaping the government. It was the Fed saying we will no longer take orders on what bonds to buy and at what price. Now the new Fed chair is calling for a new accord. Same name, different outcome.

What Warsh is signaling isn’t independence from the Treasury. It's coordination with the Treasury, A framework where the Feds balance sheet activities are aligned with the government's debt plans, where the Treasury has meaningful input. Into how the Fed manages its portfolio. That's not a return to 1951, that's a return to what 1951 was supposed to end. And we know this coordination will involve lower rates, which can cause inflation, which can push up long term borrowing costs. But the new Fed chair doesn't want the Fed to print money and buy long term bonds to keep the government's borrowing costs low. So when inflation hits, what’s his plan. Two mechanisms. The first is technical, but the second is the one you need to watch. It changes who pays. The 1st is a rebalancing of the Fed's own portfolio. Right now the Fed holds large amounts of mortgage-backed securities and long term bonds. The Fed could sell those and replace them with short term treasury bills. That restructuring alone gives the government a fresh source of demand for its short term debt without expanding the balance sheet. It's subtle. It doesn't look like money printing, but it has the same effect on the government's borrowing costs.

The second mechanism is bank deregulation. This one is hiding in plain sight. There's a rule called the Supplementary Leverage Ratio, the SLR. It caps how many U.S. Treasury bonds a bank can hold relative to its capital. The rule exists to prevent banks from loading up on government debt to dangerous levels of 2020 that rule was temporarily suspended. What happened? Banks went on the Treasury buying spree. Demand surged. Long-term yields fell. The government borrowed cheaply, but the suspension ended in 2021.

(CL) This is one of the several reasons some of us felt that COVID-19 was a sham. Colleagues and others argued that the government had to do something. Again, there was another option; budget cuts while the private sector got eviscerated.

(CF) Now imagine making that suspension permanent if the SLR is lifted. Banks can buy as much government debt as they want. the Fed doesn't have to buy long term bonds. The new Fed chair gets to say he never engaged in the kind of quantitative easing he criticized for years. But the effect is similar. Long-term yields get capped because there's a massive new buyer absorbing every dollar of supply, and money that's been sitting on the sidelines floods the economy. The buyer is just the banking system, instead of the Fed, and the banking system is sitting on your deposits. This requires coordination. The SLR is a regulatory mechanism that sits between the Fed and the Treasury. Lifting it needs both Scott Bessent and Kevin Warsh aligned on the same outcome.

(CL)  This is the same circular policy employed since the 1863, only worse because the banks are all part of the Federal Reserve system. Lower rates means cheaper credit and more malinvestment like Hayek and others posited.

That alignment, that coordination, is exactly what the new Accord provides the framework for. So here's what this actually means. They reduce the debt burden by making your dollars less valuable. Not with a new tax but with prices. The Fed cuts rates, short term borrowing gets cheaper. Inflation starts to build. Long term bond investors push yields up.

But banks, now freed from the SLR, absorb that supply and keep rates from spiraling. Inflation rises. The government borrows at rates below the inflation rate, the debt burden slowly shrinks in real terms, the debt to GDP ratio falls. Success for them. Watch what happens over the next 12 months and you pay through purchasing power erosion. Every dollar you saved, every paycheck you earned, every fixed income investment you hold, it all buys less, quietly, gradually, in a way that never shows up as a tax in a way that never requires a vote. This is called financial repression. It's not new. It's the oldest trick in the government debt playbook, and it worked last time.

After World War II, the debt to GDP ratio fell from around 120% to around 30%. Over the next three decades, the government deleveraged successfully. The people who held cash and bonds during that period saw their purchasing power quietly destroyed. The people who held real assets, land, commodities, equities with pricing power saw those assets rise with inflation. The new Fed chair isn't riding in to save your savings. He's been handed an equation and he found a solution. It's just not one where you come out ahead by doing nothing. The question worth asking right now isn't whether this plan works. It probably will on paper for the government. The question is what you're holding while it plays out.

(CL) Option 5 – The People’s Option that “They” refuse to even mention.

Throughout our 250 years, economic historians have mentioned “the people’s money.” In a nutshell, this is the money that circulates without the characteristic of debt-based commercial paper. It existed in different media like gold, silver, certificates that represented both metals, treasury notes, and other forms. As capital became consolidated by monopolists in banking, politics, and industry, they contracted or vitiated some of those other forms. That is why we are not hearing any mention of option 5.

The Treasury could truly divorce itself from the Federal Reserve, not the other way around. The Treasury has a steady flow of tax revenue, it’s just never enough to fulfil the avarice of power hungry politicians and their donors. The government could print treasury notes that are legal tender for all payments and debts, public and private. They would not be based on debt but on a portion of real GDP. The government could use them to pay down the debt, especially the foreign debt. The challenge would still be inflation but if the t-notes were based on tax revenue and GDP it would provide a ceiling on the federal budget.

Treasury notes could provide competition to the Federal Reserve notes. Competition usually garners efficiency. In this case it could be a sounder currency through values in the market, not dictated or inflated by the Treasury or the Federal Reserve. In turn the people may tolerate a fair bond market, i.e., where the Federal Reserve and its banks are either not permitted to buy bonds as a quasi-customer to manipulate the rate, or to be very limited in its purchases of both long term or short term bonds.  

The fact of life in America is that the U.S. Government has put itself in a primary position above the prosperity of most people. You may agree with this position. But that’s not what the founders, at least some of them, intended. As a matter of fact, Lenin coined the phrase “commanding heights” to emphasize this power structure in centrally planned economies.

As we celebrate our 250^th anniversary, the media will continue to bang us over the head with the Declaration of Independence and the Constitution, but we are a far cry from that republic. Without dispensing of those tropes, it’s delusion. On the other hand, if you feel that the United States is the greatest empire ever established, this may not be arguable. We are the latest iteration. Great Britain was the  former from whom we once revolted. There is a key word here called rapprochement, used at the end of the 19^th century by objective historians to characterize the relationship and to show how similar America became to Great Britain.

A republic may choose to keep the people as the primary benefactor of its policy. This requires the government to take a secondary or tertiary role and position in the civil economy but is there just in case of an emergency. Tyrants take the primary position and maintain it through chaos and favorable financial law.