From Dan Ferris in The 12% Letter:
... There's another solution to the debt ceiling problem that would instantly eliminate $1.6 trillion in government debt.
In other words, it would instantly reduce the national debt to approximately $1.6 trillion below the debt ceiling. That would give the President and Congress at least a year to hash out an agreement on spending cuts and tax increases.
The plan is elegantly simple and radical.
The largest holder of U.S. Treasury debt is the Federal Reserve Bank of the United States, the central bank of the United States. Texas Congressman Ron Paul has proposed the Federal Reserve simply cancel the $1.6 trillion in Treasury debt it holds. The Federal Reserve owns the bonds, so the Treasury is paying the Fed interest. The Fed in turn refunds the interest back to the Treasury. This is theatre of the absurd.
Though the Fed is technically a privately owned bank, it's really the hand maiden of the government. It was created by a government act and is overseen by a government-appointed board of governors. For practical intents and purposes, the government owns the Fed's Treasury debt holdings. In other words, the government is borrowing from itself and manufacturing an enormous liability on which it must make interest payments – to itself!
I hope you're starting to get the feeling the government is playing games and inventing a phony crisis. That's much closer to the truth. But the government's shell game of lending to itself could turn genuinely ugly.
You see, the Fed plans to sell the bonds eventually. That would be bad. It would turn a phony liability the government owes itself into a real liability the government owes to real investors outside itself. The government would owe the interest payments to the individuals and corporations who buy the bonds from the Fed. Such a sale would take a piece of government monetary voodoo that could easily be undone and turn it into a real problem. Canceling the debt is a much better idea.
Congressman Paul's ingenious solution will never fly politically. It would reveal too much about the flimsy nature of our monetary system. It would also shrink the Fed's balance sheet... meaning it would shrink the country's monetary base. Economists would line up around the block to scream about how that would cause a deflationary collapse. I don't see how. Everyone would still get paid. Nobody would get fired. No jobs would be lost. We just wouldn't have $1.6 trillion of phony obligations the government owes to itself.
But like I said, don't hold your breath. The debt won't be canceled. I just want you to understand how silly the whole system is and how any intelligent person could quickly fix it.
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