Why Scott Sumner should love the debt ceiling

Suppose that the debt ceiling is never raised. Never ever. It remains in perpetuity at its current level of $16.7 trillion dollars.

Suppose also that the Treasury chooses to (and is operationally able to) prioritize payments on formal Treasury securities so that there is never a default on a US bond or bill. At or near the statutory debt limit, Treasury suspends other payments to build up a cash buffer sufficient to cover any spikes in payments due net of taxes. Once that is accomplished, Treasury securities can resume their role as the nearly default-risk-free asset at the center of the global financial system.

The question, then, is how are the other obligations of the US Treasury to be discharged? If the US government cannot (formally) increase its borrowings, then it is in theory subject to a cash-in-hand constraint. It can only spend the money it has, primarily in the form of funds on deposit at the Federal Reserve. (Yes, my chartalist friends, this is stupid, since the consolidated government/central-bank need never be bound by a financing constraint in a currency it issues. But in this case, the political system chooses, however bizarrely or foolishly, to constrain itself. C’est la vie!)

Humans, when ostensibly subject to a cash-in-hand constraint, do not in fact always live within their means. In particular, humans sometimes surreptitiously borrow money by writing checks against funds they don’t actually have. If I write a check for goods and services you provide today, you are lending me money. Usually that is mere transactional credit — an advance of convenience against funds I already have. But not always. If I write a check against funds I hope I’ll have in my account before it clears, you’re lending me money, whether you know it or not.

This is usually an expensive borrowing strategy for humans, because if I fail to assure an inflow of funds before my bank is ordered to pay the check, I will be hit by all kinds of costs — overdraft fees, returned-check fees, perhaps even fines or jail time if the “bad check” (defaulted loan) is deemed to be fraudulently arranged.

However, the government has a much cozier relationship with its bank than your typical check-kiter. Suppose the government, in response to the insoluble problem presented by congressional spending mandates and a debt limit, simply decides to pay all its bills as old-fashioned paper checks. It then asks the Federal Reserve not to “bounce” checks presented for payment against insufficient funds, but simply to hold them and make payments on a first-in, first-out basis as funds become available. Everyone who deposits a US Treasury simply finds that the funds don’t appear in their account until weeks or even months later. (Banks, in order to protect their own cash flows, would revise their “hold period” policies with respect to checks from the US Treasury, making funds available only when the checks actually clear, like they might with deposit of a large personal check.)

Suddenly, the debt ceiling is moot. Every check issued by the US Treasury is basically a credit line that does not count towards the debt limit. The Treasury pays its bills, on time and as usual, in the form of paper checks. It’s just that those checks clear a bit sluggishly.

Of course, recipients of US Treasury checks may not be happy to wait some indeterminate period before actually spendable funds appear in their bank accounts. There would quickly arise a liquid market discounting endorsed Treasury checks. Suppose “the market” expects payment of checks two months following a deposit, and the current short-term Treasury bill rate is about 1%. then you should be able to sell an endorsed $100 check from the Treasury for $99.83. Let’s call it $99.80, because the purchaser would want to be compensated for the uncertainty surrounding the exact time of payment. Of course, 1% is much higher than current T-bill rates. At a more realistic yield of 0.02%, you’d pay about a nickel per $1000 to redeem a two-month delayed check today, including some compensation for buyers’ uncertainty.

But this would be a very large market, and banks would quickly find themselves accumulating and trading billions of dollars of endorsed Treasury checks every day, with each day’s cohort trading at slightly different prices. The delay would initially be short, but it would expand for a while, then slow and eventually become pretty stable, somewhere (I am guessing!) between several months and two years. More precisely, the delay would be (total_debt - traditional_debt) / (tax_receipts - interest_on_traditional_debt). Traditional US Treasuries would remain actively traded in a $16.7T market, providing us with full risk-free yield curves. So we’d have good market predictions of the interest cost of traditional debt, and know the appropriate risk-free rate to discount for any length of delay. The only real unknowns relevant to pricing endorsed Treasury checks would be 1) the rate of future tax receipts and 2) a risk premium surrounding date-of-payment uncertainty. Date-of-payment uncertainty would itself be mostly a function of tax-receipt uncertainty. To a first, pretty good, approximation, the price of these these securities would just reflect a market estimate of the rate of future tax receipts relative to the known current stock of debt. One would have to adjust a little bit for illiquidity and uncertainty premia, but on these ultimately very low-risk securities, the adjustments would probably be quite small.

Holding tax law and the character of economic activity constant, tax receipts are pretty proportional to… nominal GDP. Of course, tax law and the character of economic activity are never constant. But periods of real uncertainty surrounding near-future tax law are infrequent, and the character of economic activity changes slowly. So a “futures market” in Federal tax receipts would not be a bad approximation of a futures market in nominal GDP!

I think Scott Sumner is the Svengali behind all of Ted Cruz’s antics. He must be. It’s the only sensible explanation.

I can’t quite wrap my head around what Treasury will actually do when the debt ceiling binds, if they won’t “mint the coin” or issue super-premium bonds, or invoke the “constitutional option”. Obviously the scenario described here is very speculative. But prioritizing Treasuries and slowing payments to everyone else doesn’t sound totally wacko. And if they do that, even if it’s not via paper checks, financial markets will try to figure out ways to discount and trade the loans implicit in delayed Treasury obligations. Maybe that will turn out to be a good thing!


p.s. i’ve been interested for a while in the possibility securities that pay-out fixed, predetermined sums on uncertain, revenue-dependent schedules. they strike me as a nice sort of debt-equity hybrid, offering some of the certainty of debt but much less hazard to issuers that payments will come due when they cannot easily be met. prices of such securities would be informative and easy to interpret. i’ve primarily thought about these with respect to small business finance. they seem an odd fit for a government that can in theory issue currency at will. such a government would pay for insurance it does not need because investors would on average demand a higher-rate of return than for fixed-term debt. but the informative prices might be worth the extra cost! and, in the debt-ceiling-forced scenario described here, the cost would be borne at least in part by recipients of government checks, who face an implicit tax.

 
 

41 Responses to “Why Scott Sumner should love the debt ceiling”

  1. vbounded writes:

    I can’t quite wrap my head around what Treasury will actually do when the debt ceiling binds … But prioritizing Treasuries and slowing payments to everyone else doesn’t sound totally wacko. And if they do that, even if it’s not via paper checks, financial markets will try to figure out ways to discount and trade the loans implicit in delayed Treasury obligations.

    ————

    Per bob woodward obama said he has “no stomach for crazy shit,” so if you’ve got to bet, bet on prioritization. It’s been blessed by GAO and sounds kitchen table.

  2. Michael Byrnes writes:

    Would US Treasury checks with delayed payment be either a new form of US debt instrument or a new medium of exchange (but not a new medium of account)?

  3. This is an interesting twist on my own theory of what’s going to happen if the debt ceiling doesn’t get raised, which is that the Treasury will go ahead and issue checks, and that the Fed (with no other alternative than to bounce them) will go ahead and pay them, letting the Treasury run an overdraft.

    If the Treasury is being honest about not having any mechanism for picking and choosing among payments—and that’s the sort of major software revision that you’d have to test extensively if you wanted it to work—just paying everything is really the only option the Treasury has. Add to that the fact that the Anti-Impound Act requires the Treasury to make the payments, going ahead and issuing the checks seems like the obvious thing to do, putting the hot potato in the Fed’s hands.

  4. Steve Roth writes:

    Just to say, having run into business cash-flow crunches: when you have to start picking and choosing which payments to delay, it’s a very human-judgement-based exercise. All the automated systems you have in place to pay your bills on time go out the window. There are dozens or hundreds of these type of systems in the government, none of them set up to automatically delay certain types or classes of payments. It will be a total crap-shoot hodge-podge. Mistakes will be made, and cleaning them up will be a long and arduous process.

  5. Morgan Warstler writes:

    Well done dear boy, well done!

    Now let’s get into the actuality of what it all means – what truly happens, not there on the paper.

    First off, the end result is the same with NGDPLT. The public sector labor force shrinks. Nothing else happens. And you know it. Please tell everyone I’m right.

    When those checks TAKE LONGER to clear, the truly viable option for entitlement recipients is to reduce the current account balance.

    Sure, cut some military spending, but the TRUE FAT CALF to gore is the $1.7T paid out to 22M public employees.

    INTERFLUIDITY FACT: Public sector compensation is $500B MORE per year what it would be if we only grew it at inflation since 1998. ($1.2T instead of $1.7T).

    Yep, since the Internet, we gave them a giant unearned pay raise, while nobody else got one.

    And it is morally unethical for economists of any stripe not to note this when discussing deficits and debt.

    So back to our held checks, grandma and US contractors know if govt. is automated, if the Government is turned into an online platform, if their are less labor force checks cut, the time delay on their checks decreases rapidly.

    NGDPLT is the same thing, it is just MUCH NICER about it.

  6. Tom Hickey writes:

    SRW: “Suppose also that the Treasury chooses to (and is operationally able to) prioritize payments on formal Treasury securities so that there is never a default on a US bond or bill.”

    Completely unrealistic assumption? See Cardiff Garcia at FT Alphaville a couple of days ago. I link to it at MNE. See also my comment on this post at MNE today.

  7. Neil Wilson writes:

    They will do what any other business does when it runs up against cash flow issues. They will push the problem onto their suppliers by running up credit. A simple unilateral increase in credit terms to 180 days, or 360 days would do the trick.

    That credit can then be sold to factoring companies, owned unsurprisingly by the commercial banks. And you’ll get a good price for them.

    You don’t even need to issue checks. If the state starts issuing different forms of liability, then those forms of liability will become a form of money pretty much automatically.

  8. Philippe writes:

    “the US government cannot (formally) increase its borrowings, then it is in theory subject to a cash-in-hand constraint. It can only spend the money it has, primarily in the form of funds on deposit at the Federal Reserve”.

    Federal Reserve deposits are liabilities of the US government.

    Please explain to me how your own liability can constitute “funds” that you can then “use” to spend.

    If you write “IOU 1 trillion dollars” on a piece of paper, and then stash that piece of paper in a box under your bed, do you then have 1 trillion dollars of extra “funds”? No, of course not. So why do you think that when the government does this it then has extra “funds”?

  9. Mark A. Sadowski writes:

    Philippe,
    Steve’s probably referring to the U.S. Treasury General Account, which as of last week held just under $38 billion:

    http://research.stlouisfed.org/fred2/series/WTREGEN

  10. Philippe writes:

    Mark,

    the TGA deposit ($38 billion) is a liability of the Fed and a liability of the US government. It’s a US government IOU.

  11. Samuel Conner writes:

    Paper checks issued by Treasury are debt instruments which do not
    count against the statutory limit. Are there other such instruments?
    It has been suggested that “consols”, non-maturing interest-bearing
    bonds redeemable at the issuer’s pleasure, would also evade the
    limit. And they would be much easier for Treasury to issue than a
    blizzard of paper checks. And if they were ultimately monetized by
    the Fed, as so much conventional Treasury debt has been in recent
    years, the net cost to Treasury would be inconsequential, since the Fed
    pays most of its income back to Treasury. And since they don’t
    mature, they would not raise concerns about the “solvency of the
    Fed’s balance sheet”. This looks to me like the least craziest sh*t
    available.

  12. Handle writes:

    Very clever indeed! Well done.

    But somehow I think the Fed would vacuum up all the delayed checks and pay them at par, retiring / sterilizing them in order as accounts receivable from the Treasury arrive.

    Which would technically overcome the political reluctance to issue new currency to fund the deficit.

    Wait a minute, not just Sumner, but a lot of folks would like that a lot.

    I’ll calling dibs. Call it ‘The Handle Strategy’.

  13. DanH writes:

    Philippe,

    Can you cite the specific law stating that bank reserve deposits are liabilities of the US government? I know Fed bank notes are stated explicitly as such, but I don’t believe there’s a law stating that Fed Reserve deposits are liabilities of the US government.

  14. Alex Godofsky writes:

    re: Philippe’s assertion, does it even matter? It’s a bank account, they can write checks against it, no amount of metaphysical angst over what constitutes a “liability” will change that mechanical reality.

  15. DanH writes:

    @Alex – does it matter who’s responsible for specific liabilities? Only if you care about accounting and understanding banks, central banking and stuff like that. Which Scott Sumner doesn’t.

  16. Peter K. writes:

    “So a “futures market” in Federal tax receipts would not be a bad approximation of a futures market in nominal GDP! I think Scott Sumner is the Svengali behind all of Ted Cruz’s antics. He must be. It’s the only sensible explanation.”

    Either that or he’s a Calgarian Candidate created by the Democrats. My belief is that Republicans are going suffer next year at the polls because of Cruz et al. and maybe lose the House. If they don’t raise the debt ceiling, it could destroy the Republican party. The wealthy’s Frankenstein monster got away from them.

    The futures market for nominal GDP is an idea born by logic, evidence, historical data and the collective, democratic quest for economic policies which would better society. Praxis. Cruz and those threatening to not raise the debt ceiling are engaged in Orwellian fabrications and the abuse of language and reason in which they insist Obama has not compromised or negotiated; they are not extorting the President and Senate; and that forcing these unprecedented decisions on the Treasury is not a big deal.

    So it would be ironic if we got a NGDP futures market out of it.

  17. Morgan Warstler writes:

    Peter,

    The NGDPLT futures market, NGDPLT, and MM in general is PRO-CRUZ.

    Cruz might not yet believe it, but believe me I’m telling him.

    The point here is that when the Fed runs a stable level target – just hits that number month-by-month, nearly like a metronome, NGDPLT reduces EVEN MORE the effects of shutdowns and defaults.

    That’s not me, that’s Scott Sumner.

    There’s more there for Cruz as well, namely NDGPLT shrinks govt. and truly teaches the normals that increased govt. spending = inflation, it never =’s growth.

    You think Cruz doesn’t want people all knowing that fact?

  18. Steve,

    I’m not clear what you mean by “debt-equity hybrid” here. The securities you describe still meet the definition of the (quite abstract) Standard Debt Contract (apologies for referencing theoretical corporate finance). I don’t see–and have never heard–that uncertainty in the timing of payments was a fundamental, necessary, or required feature of equity, nor have I heard that debt couldn’t have such uncertainty. The key theoretical distinction to me has always been equity’s call option-like payoffs, whereas the amounts of cash flows from holding debt are known (hence the term “fixed income”).

    Aside from that, I think it’s an interesting idea, and a straightforward way to create another debt contract that doesn’t “count”.

  19. Philippe writes:

    DanH,

    Federal Reserve deposits are just Federal Reserve notes in electronic form. The Treasury could swap its deposit at the Fed for notes, and then swap them back again, what would that change? Nothing.

  20. DanH writes:

    Philippe,

    That’s not right. I can swap my bank deposit for a cash note. That doesn’t mean the bank’s liability is the government’s liability. They’re two different things. Reserve deposits, coins and cash are all different and serve different functions.

    As far as I know, there is no law explicitly stating that all Fed liabilities are government liabilities.

  21. Philippe writes:

    “I can swap my bank deposit for a cash note”

    yeah but that note isn’t your liability is it.

  22. DanH writes:

    A bank deposit isn’t my liability either so what’s your point?

  23. Philippe writes:

    If a bank swaps its reserve balances at the Fed for notes, it swaps one type of asset for another type of asset. If you withdraw cash from your bank, you swap one type of asset (bank deposit) for another type of asset (cash). If the government were to swap the Treasury’s deposit at the Fed for notes (i.e. withdraw cash) it would then be holding its own liability in the form of notes.

  24. DanH writes:

    The US Treasury does not have an ATM machine that it accesses at the Fed so I don’t know what that has to do with anything. You seem to be making things up as you go along.

  25. Philippe writes:

    I don’t know why you think ATM machines have anything to do with it. Given that you appear to be a fan of “MR”, here’s JKH on the subject:

    “US central bank is an operational currency issuer. It issues central bank notes, as well as liabilities in the form of bank reserves and US Treasury deposits, which are electronic variations of currency notes”.

    http://monetaryrealism.com/treasury-and-the-central-bank-a-contingent-institutional-approach/

  26. Alex Godofsky writes:

    @DanH:

    No, it doesn’t matter, not in this case. If IN REAL LIFE I can write a check and another bank will cash that check, then no invocation of accounting identities or anything will actually prevent that physical reality from occuring. Philippe can yell until he’s blue in the face that that shouldn’t be happening, but he’ll just be a random hippie with a sign.

  27. Philippe writes:

    Alex, I never said “that shouldn’t be happening”. I was making a more general point. Not sure why you feel it necessary to call me a hippie for it.

  28. JP Koning writes:

    Steve, interesting scheme. You may be interested to read about Ireland’s experience with the use of circulating cheques during a 1970 bank strike. Though the cheque settlement mechanism no longer functioned, the use of unsettled cheques as money and short-term credit was based on the probability that settlement would occur at some point in the future, once the strike had been resolved. Antoin Murphy wrote a great paper on the incident.

  29. Alex Godofsky writes:

    Philippe, here was your original question:

    Please explain to me how your own liability can constitute “funds” that you can then “use” to spend.

    The answer is that it doesn’t matter even a tiny bit whether or not the money is “their liability” or not. It’s money in a bank account. You can spend it. That’s how money works.

  30. [...] Why Scott Sumner Should Love the Debt Ceiling (Steve Randy Waldman at his blog) . [...]

  31. Anders writes:

    @Philippe: ‘Please explain to me how your own liability can constitute “funds” that you can then “use” to spend’

    You’re thinking about stock, not flow. It’s not that the US govt takes some of its stock of existing liabilities and uses them to pay for things. Rather, the US govt spends whilst simultaneously creating an IOU (‘ex nihilo’), which increases the stock of liabilities.

    This was SRW’s point, I think.

    Incidentally, when the US govt holds some dollar bills, those have no economic value since they are both assets and liabilities. But if the US govt uses a stack of dollar bills to pay for something, that is the same as creating a liability.

  32. Mercury writes:

    In other words:
    Better to officially grant the government unlimited spending authority because they are just going to spend as much as they want anyway.

    Under a best case scenario entropy alone will ensure that the economic benefits of keeping a bloated and overextended government running with such a scheme will be outweighed by the detrimental effects which will result from the Treasury paying its bills “a bit sluggishly”.

    Sure, the government can pull all kinds of financial tricks to nominally avoid insolvency but ultimately wealth destruction is the impetus behind all of them.

    Why not just go full-Mugabe right now and get it over with?

  33. Justin Cidertrades writes:


    asks the Federal Reserve not to “bounce” checks presented for payment against insufficient funds, but simply to hold them and make payments on a first-in, first-out basis as funds become available. Everyone who deposits a US Treasury simply finds that the funds don’t appear in their account until

    Zounds like a quote from Henry Paulson TV Interview! No! Not even HP. Sounds more like brunch conversation with Bernie Madoff.


    You can easily distinguish between fiction and truth. Truth is usually much stranger.

    Did Sherlock Holmes truly say that? Both quote and Holmes are merely fiction, but less strange than the strange-quark.

  34. Greg writes:

    “In other words: Better to officially grant the government unlimited spending authority because they are just going to spend as much as they want anyway.

    Why not just go full-Mugabe right now and get it over with?”

    Mercury @32

    There seems so much wrong with this thinking. Its similar to the religious types who claim if there is no God behind morality then we might as well just do whatever we want and never worry about consequences. As if this imaginary guy watching from above is a larger deterrent than real people actually watching and judging what you do.

    The removal of an artificial debt ceiling would not change the fact that all govt spending would be appropriated via the same process we always have, by Congress debating and deciding what to spend on. What it would remove is any idiot hiding behind the idea that we “dont have the money to do it” We have the money to do anything we want its just a matter of prioritizing. We could have Merlot flowing through all public water fountains so long as we have the grapes and the fermentation chambers, it has NOTHING to do with dollar availability.

  35. stone writes:

    SRW, “securities that pay-out fixed, predetermined sums on uncertain, revenue-dependent schedules. they strike me as a nice sort of debt-equity hybrid, offering some of the certainty of debt but much less hazard to issuers that payments will come due when they cannot easily be met. prices of such securities would be informative and easy to interpret. i’ve primarily thought about these with respect to small business finance.”

    Isn’t this a bit like cumulative preferred stock? http://en.wikipedia.org/wiki/Preferred_stock

  36. Nick Bradley writes:

    This seems preferable to traditional ggovernment financing, and approaches MMT ideals.

    If the deficit is 1/12th of expenditures, then the IOU would be paid after a Month. The Fed can convert these IOUs into commercial paper pretty easily. All IOUs would be paid on the order they were issued.

    Over time, the payment delay would grow, but very slowly. It would take 12 or 13 years to reach a 1-year maturity, based on CBO projections. It would take well over a century to reach 10 years.

  37. Philippe writes:

    Anders,

    “Incidentally, when the US govt holds some dollar bills, those have no economic value since they are both assets and liabilities. But if the US govt uses a stack of dollar bills to pay for something, that is the same as creating a liability.”

    Yes, that was what I was getting at.

  38. Mercury writes:

    @Greg #34

    It’s hard to believe that without an artificial debt ceiling we’d be more aware of the real debt ceiling or have less of a preference for gratification now at the expense of (often someone else’s) gratification later.

    Having the money to do anything we want isn’t the same thing as having the money to do everything we want.

  39. [...] is my second post trying to think through the consequences of such a regime. In the first, I pointed out that claims to future delayed payments would be securitized, and that prices of those securities [...]

  40. Matthew writes:

    In principle, there’s no need for the Fed to be involved. The government could open a checkable account at an investment bank, write deposit all revenues into that accounts and write checks against it. The bank would be free to issue bonds as it pleases, and since these are not guaranteed by the US treasury, they’d be totally legal. And in principle, there is no reason for the borrowing capacity of this investment bank would differ at all from the US treasury unless 1) the bank is taking on significant risks elsewhere, or 2)markets think the treasury will eventually revoke this system.