[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
MONETARY POLICY AND THE DEBT CEILING:
EXAMINING THE RELATIONSHIP BETWEEN THE
FEDERAL RESERVE AND GOVERNMENT DEBT
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
AND TECHNOLOGY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MAY 11, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-28
----------
U.S. GOVERNMENT PRINTING OFFICE
66-866 PDF WASHINGTON : 2011
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO R. CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
Larry C. Lavender, Chief of Staff
Subcommittee on Domestic Monetary Policy and Technology
RON PAUL, Texas, Chairman
WALTER B. JONES, North Carolina, WM. LACY CLAY, Missouri, Ranking
Vice Chairman Member
FRANK D. LUCAS, Oklahoma CAROLYN B. MALONEY, New York
PATRICK T. McHENRY, North Carolina GREGORY W. MEEKS, New York
BLAINE LUETKEMEYER, Missouri AL GREEN, Texas
BILL HUIZENGA, Michigan EMANUEL CLEAVER, Missouri
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
DAVID SCHWEIKERT, Arizona
C O N T E N T S
----------
Page
Hearing held on:
May 11, 2011................................................. 1
Appendix:
May 11, 2011................................................. 33
WITNESSES
Wednesday, May 11, 2011
Ebeling, Dr. Richard M., Professor of Economics, Northwood
University..................................................... 5
Ely, Bert, Ely & Company, Inc.................................... 7
Slaughter, Dr. Matthew J., Associate Dean, Tuck School of
Business, Dartmouth College.................................... 10
APPENDIX
Prepared statements:
Paul, Hon. Ron............................................... 34
Huizenga, Hon. Bill.......................................... 37
Ebeling, Dr. Richard M....................................... 38
Ely, Bert.................................................... 48
Slaughter, Dr. Matthew J..................................... 66
MONETARY POLICY AND THE
DEBT CEILING: EXAMINING
THE RELATIONSHIP BETWEEN
THE FEDERAL RESERVE AND
GOVERNMENT DEBT
----------
Wednesday, May 11, 2011
U.S. House of Representatives,
Subcommittee on Domestic Monetary
Policy and Technology,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:05 a.m., in
room 2128, Rayburn House Office Building, Hon. Ron Paul
[chairman of the subcommittee] presiding.
Members present: Representatives Paul, McHenry,
Luetkemeyer, Huizenga, Schweikert; Clay, Maloney, and Peters.
Ex officio present: Representative Frank.
Chairman Paul. This hearing will come to order. Without
objection, all members' opening statements will be made a part
of the record.
I would like to go ahead and start with our opening
statements and then get to our introductions.
Today's hearing deals with monetary policy and the debt
ceiling and examining the relationship between the Federal
Reserve and government debt. The government debt, the national
debt now is a big issue mainly because the debt limit has once
again been met, and the Congress has to go through the process
of raising the debt limit.
The question is whether or not monetary policy is in any
way related to the debt increase. Some say it is related; some
say it is not. And the statistics are available to us to study
that issue.
But to me, it looks like there is a relationship. It seems
like the Federal Reserve System provides a moral hazard, and
that as long as Congress knows that Treasury bills will be
bought and interest rates will not be allowed to rise,
therefore the Congress is more careless.
If we had no monetization of debt, which would annoy a lot
of people, I am sure, who think the world would come to an end
if that happened, the Congress would be self-regulated in many
ways, because if we in the Congress spent excessively and we
taxed excessively and borrowed excessively and we still didn't
have enough money to keep interest rates reasonably low,
interest rates would rise.
And it would be Congress that would have to respond and not
be bidding for so much capital out of the market, and therefore
wouldn't be tempted to say, ``Well, it really doesn't matter.
We have an emergency. We have a war going on. We must finance
the war. We have an entitlement system that depends on this, so
therefore if we print the money, this will take care of
things.''
It may well take care of things for a while, but
ultimately, this process will run up against a stone wall. And
I think that is where we are today.
We have raised the debt limit many times over the years,
and it has been generally a non-event. It used to be that when
you passed a budget resolution, the only part that was actual
law was raising the debt limit. It wasn't even debated. It was
just generally done.
But things have been moving along rather rapidly, and I
cannot believe that what we are doing is sustainable. Right
now, we are accumulating obligations. When you look at the
deficit plus what we borrow from our trust funds plus our
increase in our entitlement obligations, there are good
estimates made that this amounts to about $5 trillion a year.
And that, obviously, is unsustainable when we have a weak
economy, jobs are going overseas, we are not producing, and we
are in the midst of a slump.
The solution hardly seems to be just more debt and
depending on the Federal Reserve to come to our rescue while
devaluing the currency, which means that many people that some
of this deficit financing is supposed to help will actually be
hurt by it, because they are the ones who lose their jobs, and
then they end up with the prices going up because of the
debasement of the currency. So this deficit financing seems
like it can't last forever.
When the Fed was started, we didn't have the same type of
monetary statistics that we have today. But the base at that
time, the monetary base at that time, was probably around $4
billion. By 1971, at the time when we lost the last leak of our
dollar to gold, it was about $67 billion. But with the removal
of any restraint on the Fed to buy debt, the monetary base went
up to $616 billion.
Now, in this last decade, which has been a decade of
economic weakness, real income has not gone up. Good jobs have
not been added; they have been leaving our country because of
our economic problems. But in these last 10 years, the monetary
base has jumped from 616 billion to $2.5 trillion, so there is
a lot of activity going on there.
I also find that if you look at the debt during this period
of time, of course, in 1913 the debt was practically
irrelevant, a couple of billion dollars, but by 1971,
incrementally, on a weak economy, the debt went up to $398
billion. Ten years ago, it was $5.8 trillion, but in this
weakened economy, it has jumped up to $14 trillion.
And I think what is interesting is that if you still pay a
little bit of attention to M3, which we are not allowed to see
any more from the Fed, because it costs too much money to
produce those statistics, M3 is $14 trillion, and the national
debt is $14 trillion. I don't know how coincidental that is,
but I just think there is a relationship to that.
We have the statistics from the Fed that tell us about how
many Treasury bills they are buying, and they are buying
routinely. But what we don't know is whether or not--because we
don't have a full audit of the Fed--we extend loans to other
foreign banks with the quid pro quo for them to buy Treasury
bills, because foreigners are still buying a lot of our debt.
But, it is interesting to see how passionate this whole
argument about raising the debt limit is. It was a former
Secretary of the Treasury who just recently said that if we
don't bow down, immediately raise this level, it will be so
destructive that it would actually be equivalent to a terrorist
act. That is how serious it is.
The whole thing is they said, ``Well, we can't default.''
But we started our country by defaulting. I don't endorse this
idea, but we started it. We defaulted on the continental
dollar. We defaulted in the Civil War period. We refused to pay
what we promised to pay in gold. They just unleashed unlimited
spending.
We defaulted in the 1930s, took the gold from the people,
and didn't pay off the gold to the people. We took it from
them. And then in 1971, we defaulted again. We said to
foreigners, ``No.'' We said we would honor our dollar at $35 an
ounce, and we just quit.
So we have defaulted many times. Sure, there are going to
be problems if we don't raise our national debt, but I think if
we don't cut the spending, that kind of a default is going to
be much, much worse.
And now I yield to Mr. Clay, the ranking member.
Mr. Clay. Thank you, Chairman Paul. And thank you for
holding this hearing regarding the Federal Reserve's role in
United States monetary policy and the responsibility to address
the U.S. budget deficits.
To address this issue of the Federal Reserve's role in the
economy, we have to address the Federal Reserve's dual mandate
it has to maintain stable prices and full employment. And we
also have to have an adult conversation here in Washington
about this credit card mentality we have of putting big-ticket
items on a national credit card.
I think that has to stop, when you think about the last
decade, how we conducted two wars without having a way to
finance those wars. We had a prescription drug benefit
instituted without a way to pay for that.
Those are just two examples of what is wrong with the
Washington mentality, so I agree with you. We have to have an
adult conversation. Hopefully, this hearing can be the start of
it.
Mr. Chairman, I yield back.
Chairman Paul. I thank the gentleman.
I now yield 5 minutes to Congressman Huizenga.
Mr. Huizenga. Thank you, Mr. Chairman. I appreciate the
opportunity and I appreciate our panel of witnesses coming and
speaking to us today. And I, too, Mr. Chairman, appreciate your
willingness to hold this hearing and leading this conversation
in so many ways.
My constituents--I am from Michigan, the west side of
Michigan, so I am very familiar with our friends over on the
other side of the State at Northwood, but my constituents in
the 2nd District have made it very, very clear that the debt
and our spending is one of the most vital issues that is facing
not just this current Congress, the 112th Congress, but us as a
nation and to us as a people and our way of life.
And they are asking us to rein our spending in, reduce our
massive debt. And that is why I think it is so important that
we are holding this hearing.
The Federal Reserve Board of Governors is congressionally
mandated, as we all know, to maximize employment as well as to
hold down inflation. But after witnessing this massive debt
load that has been accumulated by other Administrations, but
has ramped up in this current Administration, it seems to me
that those are really failed fiscal policies.
And I am pleased that we are now spending some time
exploring the role of monetary policy and the national debt. I
am very concerned about the liquidity that has been put into
markets by the Fed. And through the purchase of those debts and
most recently through the fact that Federal funds rates sit at
basically zero, we have had to go through, or haven't had to go
through--the Fed made the decision to go through by purchasing
an additional $600 billion in Treasury securities with
utilizing the philosophy of quantitative easing.
And we have gone through QE1 and now QE2, and despite
purchasing $1.2 trillion previously in March of 2009, it seems
to me it has not proved to be an effective method of creating
jobs. And I would love to have your input on that.
Today, we will examine what effect the Fed's government
debt plays on the Federal Reserve's open market operations. In
addition, I look forward to inspecting how that role affects
our yearly deficits when compared to the more costly tax-and-
spend fiscal policies that we have had.
And I take my charge here as a Member, as a freshman Member
of this 112th Congress and as a member of this important
subcommittee, I take my responsibility for strict oversight of
taxpayer dollars with the utmost seriousness. And I know that
has to be done.
We have been irresponsible in the past, I believe, with the
trust that we have been given by the American people. And it is
time that we step up and take care of that.
I look forward to a robust conversation today. I am sure
that there are a number of differing opinions here. And as we
are exploring sort of the Fed's unparalleled intervention in
the markets, I am looking forward to hearing from you.
So again, Dr. Paul, Chairman Paul, I appreciate the
opportunity to be a part of this committee and a part of this
hearing and I look forward to that. Thank you.
Chairman Paul. I thank the gentleman.
Does anybody else care to make an opening statement?
Thank you.
Without objection, the written statements of our witnesses
will be made a part of the record, and each of you will be
granted 5 minutes to summarize what you have to say, and then
we will go into the questions. I will go ahead and introduce
the panel now.
The first panelist is Dr. Richard Ebeling, a professor of
economics at Northwood University in Midland, Michigan. He is
recognized as one of the leading members of the Austrian School
of Economics.
He is a former president of the Foundation of Economic
Education and author of, ``Political Economy, Public Policy and
Monetary Economics.'' Dr. Ebeling earned his Ph.D. in economics
from Middlesex University in London.
Also with us today is Mr. Bert Ely. He is the principal of
Ely & Company. He has consulted on banking issues since 1981
and has focused in recent years on banking problems, housing
finance, and the crisis in the entire U.S. financial system.
Mr. Ely frequently testifies before Congress on banking
issues and continuously monitors conditions in the banking
industry, as well as monetary policy. Mr. Ely received his MBA
from Harvard business school.
Also with us today is Dr. Matthew Slaughter. He is
associate dean of the MBA program at the Tuck School of
Business at Dartmouth. He is also a research associate at the
National Bureau of Economic Research and a member of the State
Department's Advisory Committee on International Economic
Policy.
During the George W. Bush Administration, he served as a
member of the President's Council of Economic Advisors. Dr.
Slaughter is co-author of, ``The Squam Lake Report: Fixing the
Financial System.'' Dr. Slaughter received his doctorate from
MIT.
And we will go ahead and recognize Dr. Ebeling at this
time.
STATEMENT OF RICHARD M. EBELING, PROFESSOR OF ECONOMICS,
NORTHWOOD UNIVERSITY
Mr. Ebeling. Mr. Chairman, I would like to thank you and
the other committee members for this opportunity to testify on
our current fiscal crisis and the issue of raising the
government's debt ceiling.
The current economic crisis through which the United States
is passing has given heightened awareness of the country's
national debt problem. Between 2001 and 2008, the national debt
doubled from $5.7 trillion to $10.7 trillion and has grown by
another $3.6 trillion in the last 3 years to a total of $14.3
trillion.
As I point out in my written testimony, this addition to
the national debt since 2008 represents a huge sum. It is 2
times as large as all private sector manufacturing expenditures
and nearly 5 times the amount spent on non-durable goods in
2009. The interest payments alone during the first 6 months of
the current fiscal year are equal to 40 percent of all private-
sector construction spending in 2009.
This highlights the social cost of government spending
above what it already collects in taxes from the American
public. Every dollar borrowed by the United States Government
and the real resources that dollar represents in the
marketplace is one dollar less that could have been available
for private sector investment, capital formation, consumer
spending, and other uses that could have been put to work to
improve the quality and the standard of living of the American
people.
The bottom line is that over the decades, the government,
under both Republicans and Democrats, has promised the American
people, through a wide range of redistributive and transfer
programs and other ongoing budgetary commitments, more than the
U.S. economy can successfully deliver without seriously
damaging the country's capacity to produce and grow for the
rest of the century.
To try to continue to borrow our way out of this dilemma
will be just more of the same on the road to ruin. The real
resources to pay for all the governmental largesse that has
been promised would have to come out of either significantly
higher taxes or crowding out more private sector access to
investment funds to cover continuing budget deficits.
Whether from domestic or foreign lenders, the cost of
borrowing will eventually and inescapably rise. There is only
so much savings in the world to finance both private investment
and government borrowing, particularly in a world in which
developing countries are intensely trying to catch up with the
industrialized nations.
Interest rates on government borrowing will rise, both
because of the scarcity of savings to go around and lenders'
concerns about America's ability to tax enough in the future to
pay back what has been borrowed. Default risk premiums need not
only apply to countries like Greece.
Reliance on the Federal Reserve to print our way out of
this dilemma through more monetary expansion is not and cannot
be the answer. Printing paper money or creating it on computer
screens at the Federal Reserve does not produce real resources.
It does not increase the supply of labor or capital, the
machines, tools and equipment out of which desired goods and
services can be manufactured or provided. That only comes from
work, savings, and investment, not from more green pieces of
paper with Presidents' faces on them.
As I point out in my written testimony, monetizing the debt
refers to the creation of new money to finance all or a portion
of the government's borrowing. Since 2007-2008, the Federal
Reserve, through either buying U.S. Treasuries or mortgage-
backed securities, has in fact increased through the money
multiplier of fractional reserve an amount already equal to
about two-thirds of all of the government's new deficit
spending over the last 3 years or so.
The fact is the Federal Reserve has more or less
monetized--that is, created paper money--to cover a good
portion of what the government has borrowed. The bottom line is
that government is too big. It spends too much, taxes too
heavily, and borrows too much.
For a long time, the country has been treading more and
more in the direction of increasing political paternalism. The
size and scope of the Federal Government has to and must be
reduced dramatically to a scale that is more consistent with
the limited government vision of our founding fathers, as is
outlined in the Declaration of Independence and formalized in
the Constitution of the United States.
The reform agenda for deficit and debt reduction,
therefore, must start with the promise of cutting government
spending and having a target downsizing of the government. As I
suggested in my remarks, the Federal budget should be cut 10 to
15 percent each year across-the-board to get government down to
a more manageable, traditional constitutional size.
As a first step in this fiscal reform, it is necessary to
not increase the national debt limit. The government should
begin now living within its means--that is, the taxes currently
collected by the Treasury.
In spite of much of the rhetoric in the media, the United
States need not run the risk of defaulting or losing its
international financial credit rating. Any and all interest
payments and maturing debt can be paid out of tax receipts.
What will have to be reduced are other expenditures of the
government.
The required reductions and cuts in various programs should
be viewed as a necessary wake-up call for everyone in America
that we have been living beyond our means. And as we begin
living within our means, priorities will have to be made and
trade-offs will have to be accepted as part of the transition
to a smaller and more constitutionally limited government.
In addition, we have to rein in the power of the Federal
Reserve. As I point out in my comments again, the power of
discretionary monetary policy must be removed from the hands of
the Fed.
They have too much authority to manipulate the supply of
money in the economy, to influence the purchasing power of the
monetary unit, and to distort interest rates, which influences
the savings and investments in the economy that easily set in
motion the boom and bust of the business cycle.
It is necessary first to think of seriously returning to a
monetary system as a transition that is a commodity-backed
system, such as a gold standard. And we should in the long run
seriously consider the possibility of even a monetary system
completely privatized and competitive without government
control and management.
In conclusion, the budgetary and fiscal crisis right now
has made many political issues far clearer in people's minds.
The debt dilemma is a challenge and an opportunity to set
America on a freer and potentially more prosperous track.
And in conclusion, Mr. Chairman, I would just like to give
the following quote from a former President of the United
States, with your permission:
``I place the economy among the first and most important
virtues and public debt as the greatest of dangers to be
feared. To preserve our independence, we must not let our
leaders load us with public debt. We must make our choice
between economy and liberty or confusion and servitude. If we
run such debts, we must be taxed in our meat and drink and our
necessities and comforts and our labor and in our amusements.
If we can prevent the government from wasting the labor of the
people under the pretense of caring for them, they will be
happy.''
Whose words are those, Mr. Chairman? Thomas Jefferson, the
third President of the United States. Thank you very much.
[The prepared statement of Dr. Ebeling can be found on page
38 of the appendix.]
Chairman Paul. I thank the gentleman.
And I will now recognize Mr. Ely.
STATEMENT OF BERT ELY, ELY & COMPANY, INC.
Mr. Ely. Chairman Paul, Ranking Member Clay, and members of
the subcommittee, I appreciate this opportunity to testify
today.
The first two charts attached to my written testimony show
the tremendous growth of the Fed balance sheet September 2008,
which reached an all-time high of $2.7 trillion in assets last
Wednesday. How much more will grow is anyone's guess.
As my testimony shows, almost all the growth in the Fed's
liabilities has occurred in deposits in the Treasury Department
and banks. Initially, the Treasury borrowed funds to lend to
the Fed that the Fed then lent and invested in the financial
markets. The later jump in bank deposits enabled the Treasury
to reduce its deposits and borrowing. Bank deposits at the Fed
rose to $1.54 trillion last month.
Exhibit 2 also has faced the steady growth of the Fed's
other major liability, currency. The Fed has no control over
the amount of currency outstanding, though. It is totally
demand-driven.
Turning to the Fed's income statement, the Fed has been
extremely profitable since 2008. Exhibit 6 shows how the Fed
earned a $52.9 billion profit for taxpayers last year. Over the
2008-2010 period, the Fed earned almost $90 billion, more than
all FDIC-insured institutions, and 2011 will be another
extremely profitable year for the Fed.
A key public policy question is whether the Federal
Government, through the Fed, should play such a substantial
role in the credit intermediation business.
Turning to the Fed's independence, that independence in
fact is a myth. The Fed is a creature of Congress, and it
operates with the full faith and credit backing of the Federal
Government. Key to understanding the linkage of the Fed to the
rest of the Federal Government is to consolidate the Fed and
Treasury Department's balance sheet. There are several merits
in viewing this balance sheet on a consolidated basis.
First, the asset side of the balance sheet shows the extent
to which the Federal Government, through the Treasury and the
Fed, is supplying credit to the private sector, notably to
finance housing and higher education.
Second, the liability side of this consolidated balance
sheet shows that private sector funds, principally deposits by
banks in the Fed, currently provide substantial funding to the
Federal Government.
Third, the liability side of the consolidated balance sheet
shows at the end of March currency outstanding accounted for
10.4 percent of the total Federal debt held by the public. This
non-interest-bearing portion of the Federal debt has declined
as budget deficits have forced the issuance of substantial
amounts of interest-bearing debt
Given the magnitude of Federal budget deficits for the
foreseeable future, the currency portion of the Federal debt
will continue to decline. The printing press will not be a cure
for funding unseen future deficits.
In sum, the Fed could be folded into the Treasury
Department tomorrow. Doing so would permit a unified management
of the Federal Government's balance sheet. The Treasury could
also assume the role of lender of last resort. Since the Fed,
when acting as an emergency lender, is lending taxpayer
dollars, it is not doing anything that Treasury itself could
not do. Treasury's assumption as lender of last resort would
bring much greater political accountability to such lending.
Since folding the Fed into the Treasury will not occur any
time soon, Congress should mandate that the Treasury Department
periodically produce a consolidated balance sheet of the Fed
and the Treasury. This would present a more complete picture of
Federal finances and the impact of the Federal Government on
the U.S. economy.
Finally, the fundamental premise of central bank
independence is that monetary policy should be free of
political interference. Leaving aside the merits of that
premise, the key question is what constitutes monetary policy.
Today, it consists solely of the Fed trying to influence
interest rates through its open market operations, specifically
to hold the overnight Fed funds rate as close as practical to
the Federal Funds Rate Target, or FFRT, that is set by the
FOMC.
The Fed does not control the money supply. The amount of
currency in circulation is totally demand-driven. Money,
however defined, is merely that portion of the credit supply
which serves as media of exchange.
Inflation in the modern industrialized economy is to a
great extent a function of the price of credit. If credit is
underpriced, inflation may emerge as increased demand
stimulated by underpriced credit causes the economy to overheat
and asset prices to soar, as we saw in the recent years'
housing bubble. Overpriced credit has the opposite effect.
Given that monetary policy is all about interest rates, the
question is, who can better set interest rates: a committee of
government bureaucrats; the FOMC; or the financial market? The
experience of recent years certainly does not support the
notion that bureaucrats can do a better job than the financial
markets in pricing credit.
This question could be posed another way. What is it about
credit that makes it desirable for government to determine its
price? Somehow, either the central bank must provide a so-
called nominal anchor for the credit market, a pricing
benchmark, if you will. In the United States, that would be for
the Federal funds rate target.
In my opinion, a good case has never been made that the
financial markets cannot set interest rates across the entire
yield curve that will promote stable, non-inflationary economic
growth while minimizing the emergence of asset bubbles. More
specifically, there certainly is no reason why the interbank
lending market cannot establish and vary the overnight interest
rate, which the FOMC now establishes through its open market
operations.
I encourage the subcommittee to address the question of why
interest rates need a nominal anchor, why it is in the public
interest to have a government committee signaling what its
members consider to be the appropriate level of interest rate,
and why the Fed should try to enforce that signal through open
market operations.
If that case cannot be made, then the primary raison d'etre
for the Fed disappears, which would lead to folding the Fed
into the Treasury Department.
Mr. Chairman, thank you for this opportunity to testify. I
welcome the opportunity to answer questions.
[The prepared statement of Mr. Ely can be found on page 48
of the appendix.]
Chairman Paul. Thank you very much.
And finally, we will go on to Dr. Slaughter.
STATEMENT OF MATTHEW J. SLAUGHTER, ASSOCIATE DEAN, TUCK SCHOOL
OF BUSINESS, DARTMOUTH COLLEGE
Mr. Slaughter. Chairman Paul, Ranking Member Clay, and
members of the subcommittee, thank you very much for inviting
me to testify on these important and timely issues regarding
America's monetary and fiscal policies.
In my remarks, I will make two points regarding the
relationship between the Federal Reserve and Federal Government
debt. I will then make two broader points regarding the debt
ceiling.
First, it is important to emphasize that the Federal
Reserve purchases of Federal Government debt has for decades
been standard operating procedure for how the Fed conducts
monetary policy. In pursuit of its dual mandate of both price
stability and full employment, in the normal course of
operations the Fed has long bought or sold Treasury securities
to increase or decrease supply of what is commonly called high-
powered money, or the monetary base.
In turn, through rounds of lending in the private financial
system, these changes of the monetary base affect the broader
U.S. economy. Indeed, for many years before the world financial
crisis, the Fed executed monetary policy almost exclusively by
transacting Treasury Securities. There is nothing inherently
nefarious or worrisome about the Fed owning a large amount of
Federal Government debt.
Second, it is important to emphasize that the current
fiscal challenges facing America have not been caused or
abetted by the historic interventions the Federal Reserve
undertook amidst the world financial crisis. The Fed's efforts
to restore liquidity and stability to America's capital markets
required it to expand both the size and asset composition of
its balance sheet in unprecedented ways.
This historic expansion of Federal Reserve monetary policy
did not somehow cause the commensurate historic fiscal
expansion. Rather, massive Federal fiscal deficits were
triggered by a combination of sharp downfalls in Federal tax
receipts and especially sharp increases in Federal spending.
Thus, historically, monetary and fiscal expansion
coincided, but neither directly caused the other. Rather, both
have been directed at containing the damage to the real economy
of the world financial crisis.
Let me now turn to the broader issue of America's looming
debt ceiling. Here I would like to make two points, the
importance of which it is difficult for me to overstress.
First, the decision to lift the debt ceiling is a necessary
consequence of previous decisions on taxes and spending. If
America does not want to default, then raising the debt ceiling
is mandatory, not optional. Pick whatever deficit reduction
plan you like--that of the bipartisan deficit reduction panel,
that of Congressman Paul Ryan, that of President Obama. No
matter which plan you like, that plan will expand total Federal
debt outstanding by several trillion dollars over the next
decade.
This means that no matter which plan you like, to see it
become a reality without the United States defaulting, you must
support increasing the debt ceiling.
My second and final point is to implore you to understand
that America is tempting a crisis of unknowable proportions if
we default on our Federal Government debt. In many ways, global
capital markets today remain deeply impaired. Housing prices in
the United States continue to decline. Several sovereign
debtors in Europe are struggling to remain liquid and solvent.
Central banks continue to provide extensive support to the
global financial system.
At the same time, economic recovery remains tentative in
the United States and in many other countries, as Chairman Paul
indicated in his opening remarks. About 25 million Americans
remain unemployed or underemployed. Today's 108.9 million
private sector jobs is the same number that America had nearly
12 years ago.
Amidst all this fragility and uncertainty, the prospect of
a U.S. Government default is truly frightening. As the recent
past so painfully demonstrated, financial crises often arise
from unexpected sources and metastasize in unknowable ways. And
a default in U.S. Treasuries, rather than on some other debt
security in the world, would be especially worrisome for two
important reasons.
One is that U.S. Treasuries are the one asset that world
investors generally regarded to be free of default risk. But
there is no law of physics that states the world's risk-free
asset will always be U.S. Treasuries. Indeed, it was not always
so.
The other reason is that America's creditors are
increasingly foreign, not domestic. Thanks to ongoing low
saving rates by U.S. households, the foreign holdings of U.S.
Government debt are likely only to rise beyond the recently
crossed the 50 percent threshold.
History shows that deeply-in-debt sovereign powers are more
likely to encounter sudden loss of confidence, the larger is
the share of their outstanding debt held by foreign creditors.
These fiscal crises have often come sharply and with little
warning. All is okay, all is okay, all is okay. And then one
day, all is catastrophically not okay.
America's fiscal challenges are grave. We need the
understanding of our creditors to overcome these challenges. As
such, America should be doing everything in its power not to
cast doubt on the pledge to honor our debt. Time is running
short, and what America needs most of all is leaders, such as
those of you on this committee, to raise America's debt ceiling
as part of meeting our fiscal challenges.
Thank you again for your time and interest in my testimony.
And I look forward to answering any questions that you may
have.
[The prepared statement of Dr. Slaughter can be found on
page 66 of the appendix.]
Chairman Paul. Thank you.
I will start the session for questioning. I want to follow
up on Dr. Slaughter's position, on what would happen if we
don't raise the national debt.
I concede it will be a problem and there would be some
consequences, but the reason I come down on the side of saying
that we shouldn't continue to do this is that we have embarked
on a course that will lead us to such a consequence that will
be much worse than not facing up to the fact that we just can't
continue to do this constantly. There has to be some pressure
put on the system that we can't depend on the creation of new
money to accommodate the deficits that we come up to.
And I would like to ask Dr. Ebeling and Mr. Ely and let Dr.
Slaughter respond, if he would like to, how bad is that if this
debt limit is raised? And is there an argument made that it
might not be nearly as bad as they suggest? They were panicking
us now and saying that anybody who would suggest this is the
equivalent to a terrorist suggesting that. And that came from a
Republican.
So can you comment on that, Dr. Ebeling?
Mr. Ebeling. Yes. I don't think that it has the danger that
has been suggested. As I said in my comments, both in my
opening remarks and in my written remarks, the U.S. Government
certainly takes in enough tax revenue far and above the tax
revenue necessary to meet interest and rollover costs of
existing debt.
What would be required, if one is going to maintain one's
international creditworthiness in that manner, is to start
cutting back on other domestic spending other than one's debt
obligation.
Will that necessarily require trimming, cutting, reducing a
variety of current expenditures that the U.S. Government is
committed to? Yes. But the fact is that the same thing applies
to households.
If a household finds itself in the situation where it
cannot afford, because it has reached its credit card limit, to
add to this debt without serious problems, and is threatened
with default if you can't meet its minimum payment, it then
tightens its belt, and to decide maybe not to buy the flat
screen TV for the extra bedroom for a while, maybe not to go
out to the restaurant 2 or 3 times a month, and maybe to watch
more on Netflix for the $14 a month as opposed to going to the
movie theater for $15 a ticket.
And that is how it will have to be managed. Now, as I say,
this is an important--
Chairman Paul. Excuse me. I want to follow up, because you
have emphasized the need to cut back, and you suggested where
it would have to be.
Mr. Ebeling. Right.
Chairman Paul. And it would not be all that much comfort
for the people who have to cut back. But can't you include in
there how rapidly could we cut some of the spending that we do
overseas and some of this foreign policy adventurism? Wouldn't
that be a place that we could save some money as well?
Mr. Ebeling. I totally agree with you. The fact is that
even in the post-Cold War era, the United States has dozens
upon dozens of military bases and facilities around the world.
Tens of thousands of American servicemen--Army, Navy, Air
Force, Marine Corps--are stationed in various numbers in many,
many countries around the world.
I see no reason why we could not significantly cut back on
this overreach in our foreign policy and bring those soldiers
home, reduce our expenditures for those bases, and make the
countries that have for decades had this umbrella of military
security from the United States shoulder these expenses
themselves.
The fact is the United States still provides a huge
military umbrella for the European Union, which they have had a
free ride on practically since the beginning of NATO. I see no
reason why we couldn't cut back and expect them to defend
themselves more effectively. And the same thing applies to
Korea or Japan.
Chairman Paul. Let me get Mr. Ely's comments, too.
Mr. Ely. Mr. Chairman, I am clearly concerned by what the
present trajectory of spending is and, more importantly, what
this means in terms of the ratio of Federal debt to GDP. It is
reaching astronomical heights.
And the challenge that Congress faces is basically not only
trimming the spending, but getting the economic growth we need
to help bring down the relationship of Federal debt to the
current GDP. And, of course, as everybody knows, entitlements
are a key aspect of that problem.
I am one who draws Social Security and is a beneficiary of
the Medicare program, which, of course, are tow of the really
serious long-term problems facing the Federal Government. And
they have to be addressed.
As much as I am--as I say, I am a beneficiary of those two
programs. I fully appreciate, and I think even many of my
fellow seniors do, that this cannot continue indefinitely. I do
not envy the 30-year-olds and the 25-year-olds and so forth
just now coming into the workforce because of the accumulation
of these debts.
So it is going to have to be addressed, but it has to be
more than cutting at the margin. It has to be some really
fundamental changes and trimming back of the basic entitlement
program.
Chairman Paul. My 5 minutes is up, but I hope to be able to
give you a chance to respond as well in time, so I am going to
move on and recognize Congressman Frank.
Mr. Frank. I agree on the need to cut back America's
overcommitment internationally. I would say to Mr. Ebeling
that, one, you said NATO has been getting a free ride
practically since the beginning. No, not practically, no--since
the very beginning.
Look, in 1949 we had countries in Western and Central
Europe that were poor and devastated--enabled by his method to
mobilize it all into military. And so the United States stepped
in.
Two of those elements have changed. Western and Central
Europe is no longer poor and weak and defenseless. There is no
more Soviet Union menacing them. The only thing that hasn't
changed is the American military protection. So, yes, there is
a lot that could be done to shave that.
But--and I think this is true elsewhere in the world--
Afghanistan. We are being told by some we should stay in Iraq
another year to be the political and religious referee for
Iraqi--but that is one of the points I want to make first of
all.
The way this debt limit issue has been framed, I have had
people acting--frankly, some of my Republican colleagues--as if
they would be doing me a favor by raising the debt limit. The
Federal Government doesn't owe me any money. I am not involved
here.
I didn't vote for the war in Iraq. I didn't vote for the
tax cuts of 2001 and for their renewal. I didn't vote for an
unfunded prescription drug program. If everybody voted the way
I did, we would have another couple of years before we would
have to raise the debt limit.
Now, I lost. We incurred those debts. So that doesn't mean
they don't pay them. But this notion that somehow I am
responsible, that people on our side are responsible, no, there
was a joint responsibility.
Let me just ask, though, Mr. Ely, in your response, the
chairman had asked, and Mr. Ebeling responded, about what the
consequences would be of not raising the debt limit. You didn't
get to that. Would you tell me what is your view? Should we
raise the debt limit? What if we are unable to come to a
formula and don't raise the debt limit and run into the problem
of not being able to--what do you think the consequences of
that are?
Mr. Ely. I think it depends on how long things would go on
before there was either resumption of the payment of the debt
or at least the interest on the debt. If it is something that
lasted a couple of days, I think--
Mr. Frank. Okay. But if it is a couple of weeks or longer?
Mr. Ely. A couple of weeks or longer, I think could create
some very serious longer-term negative consequences for the
Federal Government in terms of leading to higher interest rates
on Treasury debt. Again, I think it comes back to how does the
financial--
Mr. Frank. Yes, I am sorry, but I only have 5 minutes. I
appreciate, but you--so you do think an indefinite problem. I
agree that 1 or 2 days is never much of a problem. But if there
is real uncertainty about how we are going to do that and it
goes on for a while, there are negative consequences.
Mr. Ely. Oh, there is no question that there will be. And
those negative consequences will mean higher interest rates on
the Federal debt, and that will add to the budget deficit, if
it goes on for a long time. A couple of days--
Mr. Frank. Yes, if you don't have a resolution, yes, again,
nobody thinks 1 or 2 days is a problem. We can do anything
around here for 1 day except maybe hold our breath. But if you
start getting into a deadlock, it is a different story.
Mr. Slaughter, you served in a very important position
during the previous Administration, the Bush Administration.
Again, on the debt limit, I appreciate your coming here and
sharing your view.
What was the general view in the Bush Administration of the
President and other high financial officials at Treasury and
elsewhere, about the consequences if we were unable to come to
an agreement on raising the debt limit?
Mr. Slaughter. I think there was a variety of views, but I
think almost everyone recognized that the unique position the
United States has in global capital markets where Treasuries
are regarded as the risk-free asset, everyone reasonably knew
to have the humility to not know what would happen if we
jeopardized that.
If we were to breach the debt ceiling and not have a
resolution for some period of time, it is really difficult to
know what is going to happen to demand for Treasuries around
the world. We have never lived in that world. And again, today,
now of the roughly $10 trillion in U.S. Federal debt that is in
public hands, slightly over half of it is foreign-held.
Mr. Frank. Let me just a quick question, because you have
been to business school. What about American businesses that
operate internationally? Is there some negative impact for
them, the multinationals that have to operate across national--
Mr. Slaughter. There absolutely is. The global
corporations, they have long time horizons, and when they
discuss seeking certainty for the key investment and job
creation decisions they make, the kind of uncertainty that we
create in not resolving the debt issue makes them look outside
of the United States to create those jobs.
Mr. Frank. Mr. Paul and I can persuade our colleagues that
we are spending hundreds of billions over time unnecessarily.
By the way, we are defending wealthy nations against
nonexistent threats. If we just started to bring some of that
home, we can do some good work.
I thank you, Mr. Chairman.
Chairman Paul. I thank the gentleman.
And I now recognize Mr. Huizenga for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. And I wanted to
continue your line of questioning.
Dr. Slaughter, if you care to comment briefly on what
Chairman Paul was asking before he ran out of time.
Mr. Slaughter. Sure, I would add just a little bit of data.
Again, there is about $5 trillion of the $10 trillion in U.S.
debt outstanding in public hands that is now held by foreign
entities. We don't have great data on who is holding U.S.
Treasuries and what the source of their demand is. That is the
reality of how data is collected globally.
Most people think that the People's Bank of China, which is
the Chinese central bank, is the single largest entity holding
U.S. Treasuries outside of the United States at about $1.5
trillion. A lot of both the private and public institutions are
holding Treasuries, we think, because of the perceived safety
of that asset.
And safety is not something you can measure like you can
measure things in the physics laboratory. What is saved in the
eyes of these international investors is up to them, in large
part. And so whether it is a 2-day breach, whether it is a 2-
week breach of the debt ceiling, what is sort of mandated or
chosen liquidations of holding U.S. Treasuries, it is hard to
predict.
And it is hard to predict, then, as Bert said, what is
going to be the impact on interest rates in the United States
and that stress more generally on world capital markets that in
many ways remain quite strained. And frankly, I think it is
important to keep in mind financial crises are almost by
definition hard to predict what would be the exact causes of
them and hard to predict how they will evolve through time.
Mr. Huizenga. I appreciate that. And I wish our former
chairman hadn't left. I was scarily going to say that we might
be coming from a similar spot here. I am a freshman. I haven't
been involved here on the run-up on our debt either, as his
claim was, but we certainly have a position here--I have a
position here of my desire to stop spending.
And that, I think, is how, if we hear from some of our
friends on the other side of the aisle, who argue, ``I wasn't
part of that problem, because I didn't vote for this or that,''
I am here now, and I believe that part of that solution,
exactly as Dr. Ebeling is talking about, is stopping our
spending.
So it seems to me that is a fiscally responsible thing to
do, as we are moving ahead, because I have a fear that, too,
also, Dr. Slaughter, if we are going to put our currency as the
reserve currency of the world at risk and we are going to be
looking at much of what has happened to many of our
constituents, where they have had issues with their own
personal credit and then had to go back and try to borrow more
money, what has happened?
They are a greater credit risk, and they have had greater
interest rates. We have seen this in Portugal recently. But I
think our first and foremost focus needs to be on the stop-
spending part. And I am curious to hear a comment there.
And then also, if anybody cares to comment on the value of
the U.S. dollar, as opposed to the other currencies of the
world and what we have seen in the rise of those other
currencies or maybe more accurately a fall of our value.
Mr. Ely. If I could jump in here, again, I think a key
aspect of the attack on spending has to be on the entitlements,
has to be on money that people my age and older and even
younger now are getting under Social Security and Medicare. And
particularly, as the boomers come onto Social Security and
Medicare, the problem is going to grow. And I think that is a
very tough political issue that you have to deal with.
There is also the question that I know came up before, and
that is about the savings rate. America is the world's largest
debtor nation, somewhere in the range of $3 trillion. And I
think a key aspect of our poor financial situation isn't just
the Federal debt, but it is the overall position of the United
States with the rest of the world.
I know there are folks in the Pentagon who are concerned
about our net debtor position, because the key reason why
foreign interests hold so much in Treasury is because as a
country, as a whole, we are so deeply in hock to the rest of
the world.
So domestic savings and trying to encourage a greater level
of domestic savings is, I think, a very important element of
dealing with our global situation.
Mr. Huizenga. Dr. Ebeling?
Mr. Ebeling. Yes, if I can just make a couple of comments,
the concern has been expressed, and I don't disagree that if
the United States were to default on its debt, its interest
payment, this would have significant ramifications for our
creditworthiness, interest rates at which the Treasury could
borrow and so on.
But let us think of the alternative. If, as the Secretary
of the Treasury has recommended, the debt limit is increased by
$2 trillion, then that will mean that between now and the
beginning of 2013, the United States is likely, given the
current trajectory, to need to borrow additional $2 trillion.
Now, it is very hard to believe that if the Federal Reserve
does not increase the money supply, that will not eventually
have an effect of rising interest rates anyway because of the
amount of money that is going to be sucked into the
government's deficit spending either domestically or from the
international financial market.
There is also the fact that if the Fed monetizes it, as
could happen as well, and as I was suggesting it has already
done to a great extent, that will start having even more
inflationary effects as the money starts percolating through
the economy. And eventually, as people develop inflationary
expectations, interest rates will rise anyway as they put an
inflation premium on the rate of interest. So the fact is that
it is between a rock and a hard place.
Mr. Huizenga. It is inevitable, is what you are saying?
Mr. Ebeling. But in the long run, the important thing is
that the government's budget has to be put under control. And
the starting point, in my view, is that we do not raise the
debt limit. We get our financial house in order now and start
cutting and trimming spending so as to meet our financial
obligations, but start taking our medicine to get on a sound
financial course.
Mr. Huizenga. Dr. Slaughter, would you like to comment on
that?
Mr. Slaughter. I agree with many of the previous comments
on the need for the United States to address both its medium-
and long-term fiscal challenges. Our fiscal trajectory is
completely unsustainable. I don't anticipate getting any Social
Security, quite frankly.
Mr. Huizenga. I am 42, and I will be shocked if I get any.
Mr. Slaughter. I am also 42, and my wife is the house
accountant. I am the household trash recycling guy, but that is
how we do it.
But that said, with no disrespect to anyone here or the
broader U.S. Congress, I just don't see how these deep
challenges of spending and savings choices both for America
overall and for the Federal Government can be addressed,
frankly, in the next few days or few weeks without having major
damage done to the creditworthiness of the United States if it
breaches--
Mr. Huizenga. Are you implying that maybe we don't have the
political will to go out and do some of the things that we need
to do?
Mr. Slaughter. I am saying it is a really complicated set
of issues and trade-offs that our country faces about what--
Mr. Huizenga. Because I would say I don't believe we have
the political will to go out and do what probably most people
believe we need to do.
Mr. Slaughter. In which case, I am just very concerned
about how the policy conversation proceeds and what happens in
global capital markets. That timetable of global capital
markets is not one that anyone in the United States controls.
Mr. Huizenga. Would anybody care to comment?
My time has expired. So thank you, Mr. Chairman.
Chairman Paul. The gentleman's time has expired. And if you
hang around, we might be able to get some more questions later.
Now, I recognize the ranking member, Mr. Clay.
Mr. Clay. Thank you, Chairman Paul.
Dr. Ebeling, the President's deficit reduction commission
recommended numerous items of reining in spending. Also, they
addressed a fair tax proposal. You have mentioned several times
that we need to reduce spending. Should some type of tax reform
be a part of that equation also?
Mr. Ebeling. With all due respect, Congressman Clay, I
think there needs to be tax reform, but the reform has to be
taking the longer view--cutting taxes, not raising them. I
believe that all across the income spectrum, Americans are
paying more than enough taxes for what government does.
The fact is, it is not a taxing problem. True, the taxes
have fallen because of the recession, but it is not a taxing
problem. It is a spending problem.
The Congress, the President, too many special interest
groups, and the general environment of the country have become
addicted to the idea that the U.S. Government can afford and
has the ability to hand out more and more largesse to society
in general, to various special interest groups, for which the
money and the resources are not there.
It is a spending problem, not a taxing problem. You don't
want to raise taxes--
Mr. Clay. Right. We have--
Mr. Ebeling. --and create disincentives for work, savings,
and investment, which in the long run doesn't make the economic
pie get bigger. If you raise taxes, you slow down the pie's
growth potential.
Mr. Clay. You have mentioned the accumulation of U.S. debt
over the past 3 years. What was the accumulation of the U.S.
debt over the past decade?
Mr. Ebeling. I am here at one level as someone who is not
wearing a political hat. I am an academic economist. That means
I try to look at the truth. And the Republicans were
unbelievably irresponsible.
As I mentioned in my written testimony, between 2001 and
2008, our national debt doubled from approximately $5 trillion
to $10 trillion. And therefore, they were as responsible, as I
think the present situation is, with an unwillingness to cut
government spending to bring this danger to a close.
Mr. Clay. Okay.
Mr. Ebeling. So, no. Both hands have a little bit of dirt
on them.
Mr. Clay. There are no clean hands. You are correct.
Dr. Slaughter, has the Fed policy of quantitative easing
helped to improve the economy over the past 18 months?
Mr. Slaughter. Yes, I think it has. I think both phase one
and phase two were an attempt to continue to stabilize U.S. and
global capital markets. I think they largely succeeded in that.
In particular, quantitative easing two was put into place
at a time in mid- to late 2010 when there were a number of
signs that the U.S. economy's rate of growth was slowing and
that the general level of prices was coming close to being flat
to falling, and so the need to try to avoid deflation, which
can be very corrosive and as the Japanese experience over the
past many years has demonstrated can be very difficult to
overcome, it was important to avoid that outcome.
That said, as Chairman Bernanke himself said in his press
conference recently, the Fed can't solve all the systematic
challenges that face the United States, and in particular
trying to get economic growth going again and get the job
creation and income growth that America needs.
The Fed, simply over the medium- and long-term, can't
create those jobs and can't create those rising incomes. That
largely comes from the private sector. And so the policy
conversations we need to have, I think, need to focus on what
it is to incite job creation in the private sector.
Mr. Clay. Earlier this week, Speaker John Boehner offered
up a $2 trillion cut in exchange for raising the debt ceiling.
And with the conditions being as they are on Capitol Hill, with
a split Senate and a House, what is the likelihood of actually
resolving this, if we have a protracted battle over this, over
raising the debt ceiling? Or what would be the consequences of
it?
Mr. Slaughter. Again, part of the challenge I would stress
is I don't exactly know how and where the consequences will
arise. But if we miss an interest payment or we miss a
principal repayment because the United States is not able to
re-channel some of the incoming tax revenue away from current
spending obligations to making good on interest and/or
principal payment, it is difficult to say how credit rating
agencies will respond.
It is difficult to know what both domestic and foreign
creditors to the United States, how that might cut back on
their demand for U.S. Treasuries.
I would stress again that financial crises by definition
are hard to know how they arise and hard to know how they
develop, so I think it is incumbent on people to realize as
fragile as the world's financial system and the U.S. economy
remain today, going in that direction carries great risk.
Mr. Clay. Thank you for your responses.
Mr. Chairman, I am out of time.
Chairman Paul. I thank the gentleman.
I recognize Mr. Luetkemeyer for his 5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
I would like to ask a question of Mr. Ebeling, probably,
with regards to interest rates and the end of QE2 this summer.
What do you think is going to happen when we quit absorbing all
of our debt? Do you think that the rest of the world has enough
liquidity in it to purchase our debt? And if so, at what
interest rate do you think would be able to have that done?
Mr. Ebeling. I am not sure if there is enough liquidity in
the global economy to make up the difference of what the Fed
has been doing in increasing the money supply to help finance
the government borrowing. I think that inevitably when the Fed
ends its QE2, as it is saying in June formally, that means we
are going to be relying upon what the financial markets--what
the fixed amount of funds in the financial markets can do at
home and any money that might be lent to us from abroad.
I will be surprised if looking over the next year, the
Federal Reserve does not go on a monetary expansionary policy
again if we don't start seeing interest rates rise.
Of course, there could be political crises in other parts
of the world where everyone runs to the United States as a
traditional shelter to park their money. But presuming that
does not occur, I would be very surprised if the Fed does not
become accommodative again, if interest rates don't start
nudging up.
It was pointed out earlier by Mr. Slaughter, and I agree
with him--or I believe it was Mr. Ely--that savings rates have
been very low in the United States. The fact is, according to
the St. Louis Federal Reserve in their monthly monetary trend
publication, since the last quarter of 2009, when adjusted for
inflation, the Federal Reserve has pushed interest rates so
low, such as the 1-year Treasuries and the Federal funds rate,
that real interest rates are in the negative range, -2 percent.
It is not surprising, then, that when interest rates in
whole are so low that you don't create much of an incentive for
people to save. The fact is we have to allow the financial
markets to tell us how much real savings is in the domestic
economy and how much of the world economy has savings to share
with us. And then on that basis, we can know what real interest
rates should be.
And the United States, as I say, should cut back, eliminate
its deficit spending so that the savings that is available,
either domestically or from foreign sources, can help the
recovery in the United States.
Mr. Luetkemeyer. Okay. So it is your contention that the
Fed, in order for us to continue to spend at a deficit level,
will have to have a QE3?
Mr. Ebeling. Whether they call it that or not, I don't see
how $2 trillion more of borrowing over what amounts to the next
year-and-a-half is going to be successfully provided by the
global or the domestic economy alone.
Mr. Luetkemeyer. And if it is provided, it would definitely
be at a higher interest rate, I would assume. Would you agree
with that?
Mr. Ebeling. If it is accommodated by the Fed, interest
rates may temporarily stay low. But as I was suggesting in
response to an earlier question, the fact is that inflation
will start nudging up even further, and inflation premium will
go on the rate of interest, and we will not get away from it.
And in addition, the value of the dollar will continue to fall
on foreign exchange markets.
Mr. Luetkemeyer. And there is another problem here as well.
As interest rates go up, the cost of our monies go up, the
deficit that we have is going to go up, which means all of the
cuts that we make, all those stays we make in our budget are
going to be eaten up by increased interest rates.
Mr. Ebeling. Correct. This is the dilemma that is facing
those peripheral European countries, as they are called, such
as Greece and Portugal. On the one hand, they are trying to
carry out what they call austerity programs, but the
international creditors don't have confidence in them, so it is
time for them to rollover or pay off debt, and the new interest
rates are even higher, which immediately reverses or cuts into
the attempt to get their budget under control.
Mr. Luetkemeyer. Okay. Let us leave it at--
Mr. Ebeling. It has to be believable.
Mr. Luetkemeyer. I agree with you.
Mr. Ely. If I could just interject in here--
Mr. Luetkemeyer. Yes, sir.
Mr. Ely. --there are many, myself included, who are
concerned that interest rates, that nominal interest rates are
too low and that what may happen is that before we know it, we
will start to see asset bubbles emerge again and that the Fed
will not respond quickly enough. And so what we will do is we
will get an overshoot in terms of rising asset prices.
Now, that doesn't seem like much of a concern today,
particularly when we look at where housing prices are, but in
fact the Fed can't turn on a dime, in part because we don't
know in a real-time basis what is happening out there in the
market. So I--
Mr. Luetkemeyer. I have one more quick question, if I can
interrupt.
Mr. Ely. Okay.
Mr. Luetkemeyer. Just with regards--I see my time is up.
Okay. Thank you, Mr. Chairman.
Chairman Paul. I thank the gentleman.
And I recognize the gentlelady from New York, Mrs. Maloney.
Mrs. Maloney. Thank you.
And welcome. I would like to ask each of your perspectives
on this question: Isn't it true that the real drivers of U.S.
debt are not the Federal Reserve's monetary policy, but fiscal
policy decisions that we have to face about congressional
policy on entitlements, taxes, and spending?
I recognize that there has been controversy surrounding
monetary policy decisions like the QE2 program, keeping the
Federal funds rate at nearly zero percent to access to the
Federal Reserve's lending window. But all of these programs are
really temporary. And once the economy turns around, the Fed
will exit from them.
And so I would like your comment on it. The title of the
hearing, of course, is about the Federal Reserve policies and
the debt ceiling, but I am asking whether you see it as Federal
Reserve policies or really congressional decisions on spending
and fiscal policy.
Mr. Ely. If I could jump in here, I think it is basically
focused on fiscal policies. I am not going to blame the Fed for
the situation that we are in. But this is going to be that
tough issue of what do we do about fiscal policy.
I am not in favor of raising taxes. I think the
entitlements have to be addressed, although I think in the
context of tax reform, there should be greater incentives in
place to not only save, but also not to borrow.
One of the problems we have in the economy is that the
Federal Government, through the Tax Code, effectively
subsidizes borrowing, and borrowing in the private sector did a
lot to get us in the mess we are in now. But I think the key
longer-term focus has to be on the spending side, and
particularly on entitlements.
Mrs. Maloney. Any other comments?
Mr. Slaughter. I would agree with Mr. Ely. Yes, the debt
problem we face today with the debt ceiling has been driven by
fiscal policy choices, not by monetary policy choices. And
again, as they go to the medium- and long-term, it is the
projected increases in Social Security, Medicare, and Medicaid
spending that are going to present the largest charges to the
United States.
On the tax side, the one thing I would say is I agree
raising tax rates is not great. When you are raising tax rates
on income, that creates disincentives for work and effort. But
there are a lot of inefficiencies in our Tax Code today. We
could raise tax revenues without raising tax rates with
simplifying the Tax Code in a lot of ways.
One example is the mortgage interest deduction. Another
example is the tax advantage that is given currently to health
care spending. The cost of both of those tax advantages in our
current Tax Code are currently estimated to be north of $200
billion per year.
So as we think about innovative solutions to address these
challenges, I think that is one thing to keep in mind is tax
reform can be a great way to try to incent job creation and a
lot of great things in the private sector, while also helping
address the tax revenue challenge.
Mr. Ebeling. It is a fiscal problem fundamentally. In this
process, the Federal Reserve has been an accomplice during the
fact in the sense that it has supplied the money to fund a lot
of what the government has been borrowing.
But the bottom line is the burden is here in the House of
Representatives, in the Senate, and in the White House. You are
the ones who have the authority to tax. You are the ones who
also have, more importantly, the authority to spend. And it is
the spending side more than anything else that has to be
handled.
This gap between revenues and expenditures, this deficit
each year, has to do with the fact that you are promising the
American people, in entitlements or other current annual
expenditures, more than the economy is generating in the tax
revenues, given the code that you have, and the economy's
ability to generate wealth in the long run.
So the fact is it is a fiscal problem. And as I have
suggested, the bottom line is--there is nothing wrong with,
obviously, introducing efficiencies in the Tax Code in
principle, depending upon the content and the specific
character of it--but the bottom line is it is the spending that
is out of control, not the taxing.
Chairman Paul. I thank the gentlelady.
I recognize Mr. Schweikert, from Arizona.
Mr. Schweikert. Thank you, Mr. Chairman.
A slightly different question and what I have been trying
to watch, as we go through this summer, and let us assume that
we will call it quantitative easing goes into an unwind. Japan,
being what, they hold about 20 percent of our foreign-held U.S.
sovereign debt, has to do some unwind there to pay for
infrastructure. Some of the tells coming out of China are true
that they intend to do more moving of foreign reserves into
commodity or commodity-based currency.
What happens at the end of the summer if we were to go just
raise the debt ceiling, not having a series of triggers and
mechanics and tells to the market that we are serious about
this explosion of U.S. sovereign debt, and at the same time the
very people who have been buying and financing our debt are not
as big a participant in the market?
First, am I being realistic? Am I just being a ``Chicken
Little?'' And if there is any truth in that scenario, what
happens to interest rates on our debt? Anyone who wants to
answer?
Mr. Slaughter. That kind of scenario is eminently
plausible. Again, there are a lot of investors around the world
that hold U.S. Treasuries today for a lot of complicated
reasons, but they have a lot of other assets that they can
choose from. That is true for the government-related entities,
the central banks, and some fiscal authorities, but also the
private savers in other countries as well, sovereign wealth
funds, individual pension funds, things like that.
So their demand for Treasuries would depend, as you rightly
say, a lot on whether they perceive the United States
leadership as credibly addressing the fiscal challenges we
face. So the sooner that we can credibly signal to our
creditors that we are on that, the less likely it is that bond
rates in the United States will go up with damages to the
United States.
And the one thing I would add is I am struck at the
heterogeneity in opinions that you see out there from a lot of
the key investors in asset markets. To single out one
particular gentleman, Bill Gross, head of PIMCO, publicly
announced in the past couple of months that a lot of their key
bond funds have totally divested of U.S. Treasuries.
Mr. Schweikert. And just a little bit of trivia on that, if
you noticed their latest disclosure, they have actually
increased their hedge again. They are basically hedging on the
downturn.
Mr. Slaughter. Yes, so that uncertainty, I think, is
symptomatic of why I would urge caution and prudence on all
these fiscal things, but especially get on not breaking the
debt ceiling.
Mr. Ely. The key thing is that what you are suggesting and
what is implied in your question is that there will be reduced
demand for Treasuries from outside the United States. That has
to have an upward effect on Treasury rates. And given the fact
that we have so much in the way of short-term and medium-term
Treasury debt outstanding, that starts to bite pretty quickly
in terms of higher interest costs. So we are in a very dicey
situation.
Mr. Schweikert. Mr., is it pronounced ``Ely?''
Mr. Ely. ``Ely.''
Mr. Schweikert. ``Ely,'' like the coffee?
Mr. Ely. Yes.
Mr. Schweikert. Okay. Are we also under a common
understanding that our WAM is what, about 4.25 years?
Mr. Ely. I am not sure what it is right now. It has
shortened up, I know, and, of course, the shorter the weighted
average maturity of the debt, the sooner an increase in rates
is going to whack the Federal budget.
Mr. Schweikert. It makes us very interest rate sensitive,
which is--
Mr. Ely. Yes, it is. It is increasingly interest rate
sensitive because of the shortening up. In fact, it is a very
significant question as whether or not Treasury has properly
managed debt, our Federal debt, so it is actually extend the
maturity during this time of historically low interest rates.
Mr. Schweikert. You are actually hitting one of the things
I was going to pitch at the end is maybe we should also in this
environment, even though the outer end of the curve is a little
bit steeper, but maybe we really need to start pushing out our
maturities to insulate ourselves from shock.
Mr. Ely. I would agree, and actually we have gone the wrong
way.
Mr. Schweikert. I want to pounce on just my scenario. Am I
pitching a doomsday scenario? Am I pitching just a realist's on
what essentially will drive up our interest rate?
Mr. Ely. In my opinion, your scenario is very realistic.
Mr. Ebeling. I don't think it is unrealistic. I think the
very points that you raise--the Japanese are going to have a
huge financial cost to rebuild the destruction from the
earthquake and the tsunami. The Chinese might very well lose
their taste or their desire for U.S. Government securities.
There is the question of the amount of savings to come into the
United States to fund U.S. Treasuries, given the financial
crisis in the European Union.
All of these things are creating serious problems looking
over this year. But I think that this concern about what is the
signal or the message that foreign creditors, either the
private sector or others, sovereign wealth funds, for example,
will read from this.
What will they read from it if you raise the debt limit by,
for example, Secretary Geithner's request of $2 trillion, and
this basically puts aside virtually any debate, discussion or
decision about what to do for the budget between now and the
next election cycle--that is, to 2013--and the uncertainty, to
be honest, who is going to be the next President of the United
States? Will it be the continuing current President or someone
else?
Mr. Schweikert. Doctor--
Mr. Ebeling. That will create a huge amount of further
uncertainty on the financial markets and hesitancy about
maintaining the value of the dollar in those markets.
Mr. Schweikert. Thank you.
And, Mr. Chairman, I know I am out of time, but one
interesting conversation, I spent a couple of days in New
York--actually, Monday and Tuesday--and I had a couple of folks
who are huge buyers, are marketers in U.S. sovereign debt
issues. And they said, ``Look, we are going to punish you if
you go and raise the debt ceiling and don't communicate to the
markets that you are taking this seriously.''
And every single point is what, $100+ billion bleeding. So
even just moving back to normalized interest rates is
devastatingly ugly to this budget. Thank you, Mr. Chairman.
Chairman Paul. I thank the gentleman. And we will have a
chance for a follow-up, if you care to stay.
I have a follow-up. I want to talk a little bit more about
the consequences of not raising the debt limit. And I think
even Dr. Slaughter admitted that he is not exactly sure--it
wouldn't be good, but not precisely sure exactly what will
happen, because it is unknown territory.
The question I have, Dr. Slaughter, is how do you answer
the argument that others say why don't we, Treasury, just use
priorities, pay the most important bills, pay the debt? Does
that raise a lot of questions about our credit rating, if we
always honored the commitment to pay the interest?
And, of course, we would still have a problem. We would
have to pay our other bills slower. But wouldn't that protect
the integrity of the credit?
Mr. Slaughter. So that has a couple of costs, I think. One
important cost is you are implicitly turning into creditors,
involuntarily, Social Security recipients or government
contractors. They are being made unwanted creditors to the U.S.
Government to make good on outstanding--
Chairman Paul. Maybe farm subsidies.
Mr. Slaughter. Whatever it is, but the principle that I
think a lot of holders of Treasuries look at is a sudden, on-
the-fly change in priority of payments by the U.S. Government.
That is going to introduce uncertainty and risk.
And I am not a legislative expert, but I just don't know.
My understanding from what I have read up to learn about this
is we simply don't have a set of rules and laws or executive
orders in place to prioritize payments coming out of the U.S.
Treasury when there isn't any existing law or regulatory
structure in place to make those priorities--
Chairman Paul. But okay, let us assume they can do it and
they always honored the commitment to pay it. Would that mean
that it would be less drastic than you anticipate? Wouldn't
that soften the concern, if you knew that they put it into a
form of a law and they said that you could do it? Would that
soften your concern?
Mr. Slaughter. No, not necessarily. The other issue I want
to raise is the economic concern--again, the fragility of the
recovery right now.
If we are talking about truly not raising the debt ceiling
at all, the implied fiscal contraction that would come in the
coming months from that, without offsetting policy support for
economic growth of the private sector, so things like trade
liberalization and other things, would have a very bad impact
on jobs and the labor market in the broader U.S. economy.
Chairman Paul. A concern I have sometimes is the crisis is
very often overblown. In 2008, it was a major crisis. We didn't
do it. We are going to have a grand depression.
But what we did was we had TARP funds and we had the
Federal Reserve pumping trillions, and everybody said, ``See?
We saved ourselves from a depression.'' Maybe Wall Street
didn't get their depression, but the people got the depression.
They lost their jobs and they lost their houses.
So I can't see how ringing the alarm bells and doing it
just because something terrible might happen--maybe doing it
will make things worse. And I think what we are doing will
eventually make it worse. You had another comment on it?
Mr. Slaughter. I guess my concern is I would express again
the unknowability of how capital markets are going to react to
a breach of our debt ceiling.
And I would stress again part of the challenge in the fall
of 2008 was how quickly the crisis with Lehman Brothers and AIG
and capital markets metastasized to the General Electrics and
other firms that were not able to rollover their commercial
paper. And we were looking at layoffs several million more
potentially than what we actually saw.
Chairman Paul. But we don't know. It might even boost
confidence to say, ``Hey, they are going to get their house in
order.'' It might even give more integrity to the dollar, and
then we wouldn't have the crashing dollar.
Bert?
Mr. Ely. If I could just add something to that, there has
been this discussion of we will pay the interest, but not repay
the principal. In effect, what that is is a forced rollover of
the debt.
Now, if you take Treasury bills, bills get paid off because
the government sells new bills. If you say, ``Okay, we are not
going to pay off the bills as they are maturing,'' effectively,
that has the same cash flow effect for the Federal Government
as paying them off and rolling them over. So nothing is gained,
in my opinion, by delaying the payment of maturing debt.
But the effect of paying on the markets, of not paying off
maturing debt I think would be catastrophic, because people,
particularly institutional investors, have cash flow programs
that are based on known maturity dates for their debt.
If they don't get it, it may actually cause severe
financial problems in some circumstances, but certainly really
rattle the market. So I think one option that is, as a
practical matter, not on the table is not paying debt as it
matures.
Chairman Paul. Of course, the other side of the argument is
what we are looking at is something even more catastrophic with
an inflationary blow-off, and that can be very, very tragic.
Dr. Ebeling, did you want to make a comment on that?
Mr. Ebeling. I do. I think that the soundest policy, the
one that would send the right signals to our international
creditors, to set a tone in the United States, is precisely to
say we will meet our financial obligations as interest and
securities become due and that we are going to adjust our
domestic spending to assure that.
The fact is, obviously, nobody wants their ox to be gored
while others don't. But it seems to me that if we had the
political will, which means the Members of the Congress make
these decisions, to say that we are going to meet our financial
obligations on the debt as they come due, but we are going to
be reducing spending across the board by 5, 10 percent to see
that it is covered without getting an increase in the debt
limit, certainly, that sends the right signals internationally.
And it makes every American realize that nobody is getting
a cut that they are not--well, that another person is, and that
everyone has to bear the burden of this precisely because the
promises have been greater than the tax structure and the
economy can sustain.
I think that if it is across-the-board, it is very
difficult to say that someone is getting something of a deeper
cut or burden compared to someone else.
That requires political commitment and willingness to do it
as well, but what else are you going to do? Do you want to be
in this situation, maybe not today? You could raise the debt
limit. You could put it off 2, 3, 4 years. But do you want to
be put in the position in our own circumstances of a Greece or
a Portugal? Eventually, you cannot keep this going.
Chairman Paul. Right. My time has expired.
Now I am going to recognize the gentleman, Mr. Luetkemeyer,
from Missouri.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
The reason for my question a while ago was we had a
discussion with Chairman Bernanke in this committee at one
point, and, obviously, you gentleman answered the question the
opposite of the way he did, which is not surprising.
Another question for you with regards to the discussion we
had with him with regards to the Fed and their policy, he made
the point during the discussion that with QE2, look at how
great the stock market is. It has all gone up.
And my concern is, I am not sure you can use the stock
market as an indication of the strength of the economy, when
you are looking at 9 percent unemployment.
Can you tell me the relationship between the stock market
and our economy, the jobs, Fed policy? Can you kind of put it
into--that is a broad thing to talk about in just a 30-second
sound bite, but it would seem to me that I think the stock
market is an institute unto itself. It is a daily reaction to
what is going on in the world versus a long-term thought
process or process on long-term thinking about really where our
economy is going.
Would you care to comment or give me some thoughts on it?
And we will go right down the line. I would like to have
everybody's comment.
Mr. Ebeling. I think that what we have seen for the last
2\1/2\ years with this huge run-up in the stock market has
basically been due to Fed policy. It is not due to anything of
a natural and normal recovery in the economy, which has been
delayed by, as I also mentioned in my written remarks, regime
uncertainty.
The fact is the economy was thrown out of the severe
imbalance due to the monetary expansion and interest rate
manipulations of the bubble years from 2002 to 2007. And it is
necessary for these misallocations of resources, investment
mistakes, to sort themselves out.
But the fact is that instead of allowing the market to
properly correct, the Fed bought up these mortgage-backed
securities and distorted the housing market. What are houses
worth? Nobody knows. We think they are at the bottom. But what
do we know about the real supply and demand?
So there is uncertainty in the housing market. This has
affected the construction industry. The fact is the ones who
have benefited are some people in the stock market and in the
financial market.
If you break down the government statistics that have been
coming out every month about GDP and employment figures to
sectors of the economy, as 2008 and 2009 rolled on, you saw
falling employment in virtually every sector of the economy
except the one. If you look at the little sectoral breakdowns,
that was the financial market.
It seems that no one from the top to the teller in the
retail bank office lost their job. And that is because the Fed
basically bolstered the financial market for their bad
decisions, which they felt confident would be bolstered because
of expected bailouts. And it has fallen upon the rest of the
economy while the economy has not been left alone to properly
adjust.
Mr. Luetkemeyer. Thank you.
Mr. Ely?
Mr. Ely. The stock market is based on--and values in the
stock market are based, as much as anything else, on
expectations. What are future earnings going to be and future
dividend levels? And so the market tends to be a leading
indicator in a crude way of where the economy is going.
But the market doesn't always get it right. It tends to
undershoot and overshoot. And the real question is, how has the
market gotten ahead of itself, given some of the factors that
you pointed out, such as the very high unemployment rate?
Ultimately, the stock market has to reflect the real
economy, and the fact is we have a weak economy. The
unemployment rate is still at very high levels. We are running
these huge deficits, as we have been talking about here. So it
may be a situation where the market is ahead of itself, and
that is why I don't think we ought to place too much emphasis
on where the market is and focus more on what is happening in
the real economy.
Mr. Slaughter. That is a great question. There is a
positive effect from stock market valuations to the broader
economic performance, but it is not lockstep, and it is not
what drives economic performance overall.
You can look at the balance sheets of households. Only
about half of households own any equities directly or
indirectly. And for the median household, the single biggest
asset on its balance sheet is the equity it may have in its
home. The home prices matter a lot more for the typical family.
And for income statements for most households, it is to have a
job and what is their earnings for that job.
If you look at the recovery, a lot of the publicly traded
companies, a lot of them, the revenue growth such as they are
realizing, if any, is coming from outside the United States. It
is the Caterpillars and the Deeres and companies like that
reporting huge revenue growth around the world, especially in
emerging markets.
So I think the challenge that you rightly point to is how
can we get job creation in America? We need it from all kinds
of companies now, U.S.-based and foreign-based. We need it from
big and little companies, but creating jobs linked especially
to exports and investment opportunities around the world, not
as much as we have been discussing, the things like consumption
spending in the United States.
But if you look at--that comes back to, in part, the fiscal
conversations we are having in this hearing. If you look at
recent surveys of small business owners in the NFIB, the single
biggest problem that a lot of these firms cite is there is some
combination of poor sales, but also government uncertainty,
uncertainty over tax rates and government regulation.
Mr. Luetkemeyer. Okay. I see my time is up, but I want to
thank you gentlemen for being here.
It seems as though there is an underlying theme through all
of this, and it is confidence in the ability to get our economy
going. It is confidence in the ability of the Fed to manage. It
is confidence in the ability of financial institutions to work
back and forth and believe that they are going to be able to
get their money back when invested.
As somebody in the financial industry, the whole thing is
held together by confidence, believing that we can do business
with each other and be able to get our money back. I think we
have a huge confidence problem right now.
Thank you, gentlemen.
Thank you, Mr. Chairman.
Chairman Paul. Thank you.
I now recognize the gentleman from Arizona, Mr. Schweikert.
Mr. Schweikert. I love this, where I can get another
question this quickly, Mr. Chairman.
Back in sort of the circle I was trying to--and I
appreciate you indulging me, because I have been trying to get
my head wrapped around some of this--how much of a benefit do
you believe we have had? Because I am looking at the short end
of our interest rate curve right now and we basically have free
money. And if you look at also throw a little inflation on top
of that, it is almost people are giving us money and almost
taking a hit on it.
How much of that, though, is because of the world situation
around us? With turmoil in the Middle East, is there a flight
of capital? I read stories about how much capital is actually
leaving countries like Russia, even the things we have seen in
the EU. Are we just really lucky right now? Let us start from
Doctor--yes, no?
Mr. Ebeling. I think there has been a degree of luck. You
might have read in the press like I did that the Russian
government is thinking of imposing more export controls on
capital leaving the country, precisely because people earn
money in the Russian economy from resources and raw materials,
etc., and then they also want to park their money outside of
Russia. That is very much the case, yes.
Mr. Ely. But I, whether or not it is lucky is a matter of
where you sit. If you are a saver, if you are a senior citizen,
you are getting killed from an income standpoint by these very
low interest rates. And for people in their working years, what
is the incentive to save when you go to a bank and maybe it was
75 basis points or a percent on your CDs?
So for the debtor, these low rates are a great idea and a
great benefit, but for the creditors, who are as much owed as
is owned, they are really taking a beating on this. And it
looks like it is going to continue for a while. So again, a
matter of whether we are lucky depends so much on where you
sit.
Mr. Schweikert. Understood. When I ask that question, I am
actually asking for a series of my concerns of what happens
when we start to get real pricing of risk.
Mr. Slaughter?
Mr. Slaughter. You are definitely right that if you look at
the fall of 2008, despite the crisis that we are having here in
America, demand for Treasuries surged in part because of the
fear and uncertainty about some of the other countries at the
financial crisis there and what was happening to their
sovereign debtors.
And so I think you hit upon an important point, which is
our fiscal conversations we need to increasingly see in a
global context. It is not just what we do here. There is a
limited pool of savings in the global economy, and where those
savers choose to allocate what assets they want to buy of U.S.
Treasuries relative to other assets in the world, it is not
just what we do, it is what other countries are doing.
And to the extent that if they can continue to make
progress--the U.K. is having some serious fiscal conversations
today and how that plays out, I think, will be very instructive
for our country--the more other countries are able to address
their fiscal challenges and we aren't, that compounds the
problems that we have been talking about today.
Mr. Schweikert. Okay. And, Mr. Chairman, Dr. Slaughter, my
understanding, and you shared with me over the last 12 months,
or 11 months as it may be, the Fed has consumed what percentage
and how much of U.S. sovereign debt issue?
Mr. Slaughter. Meaning of the United States?
Mr. Schweikert. Yes.
Mr. Slaughter. One of my fellow panelists may know the
numbers better than me, but it is a pretty high fraction of the
net new debt that Treasury has issued--has a net been bought by
the Fed.
Mr. Schweikert. Is it close to 80? What percentage of new
issuances have been financed through the Fed?
Mr. Ebeling. The figure that I found was that just U.S.
Treasuries, they have bought about $1.2 trillion.
Mr. Schweikert. Okay. What percentage of all issuance is
that?
Mr. Ebeling. The total issuance of debt, let us say, since
2007-2008, has been an additional 3.6--
Mr. Schweikert. I am just trying to do the QE2 math in my
head.
Mr. Ely. Can I interject something here? When you talk
about how much the Fed's Treasury holdings have increased, that
is only looking at one side of the equation. The other side is,
where did the Fed get the funds to buy those Treasuries?
And where they have come from is basically a tremendous
increase in the funds, up to now roughly $1.5 trillion, that
banks have on deposit in the Fed. So then, arguably, it is the
banking industry through the Fed that has financed much of the
increase that we have seen in outstanding Federal debt. The Fed
is just kind of a middleman.
Mr. Schweikert. Mr. Chairman, Mr. Slaughter, isn't this
sort of right, because in many ways you just closed the circle,
because I was going to make the argument that the Fed is a
huge, huge buyer of new issuances. They are not as interest
rate sensitive, where your banks may say, ``Look, I am not
going to buy this. I am going to buy an agency product.'' And
is that one of the things that has helped push down these
interest rates in the short term of the curve?
Mr. Slaughter. So, again, I had stressed for many, many
years, the Fed on its balance sheet, a sizable fraction of its
total assets have been Treasury securities at different
maturities. That has been in part because of the liquidity and
transparency of Treasury markets. They value being able to
conduct monetary policy in their open market operation.
So I think the larger challenge for the United States you
have hit upon, which is it is the demand from other savers in
the United States and, importantly, demand from the rest of the
world for U.S. Treasuries that increasingly will shape what
happens with interest rates that we have to pay as a country.
Mr. Ely. And if I could add to that, and the reason that
will be the case that other foreign countries, foreign
investors become more important is because the United States
continues to get deeper into debt to the rest of the world. And
so as an economy as a whole, we are sucking in more and more of
the world's savings.
Just imagine that the United States was not in that debtor
position. In effect, we would owe the money to ourselves in
terms of the economy as a whole. But we are in hock to the rest
of the world, ultimately, because of our low savings rate in
this country that has led to this $3 trillion-plus net debtor
position that we have.
Mr. Ebeling. If I can add just one more point here, there
is a bit of a musical chairs situation here. The Fed goes in
and buys up all of these Treasury securities and mortgage-
backed securities out of bank portfolios. Then they pay these
banks an interest rate higher than market rates to park the
money that they have created with the Federal Reserve.
It still ends up being money that the Federal Reserve
created out of thin air. It may have this appearance on the
ledger book, assets and liabilities--
Mr. Schweikert. It is a three-legged--
Mr. Ebeling. It is still funny money.
Mr. Schweikert. It is a three-legged stool, where there is
a premium paid within it, Mr. Slaughter.
And thank you for tolerating my rambling, Mr. Chairman.
Mr. Slaughter. I was just going to echo Mr. Ely's insight.
Japan is a good example. Japan's debt outstanding as a share of
GDP is now approaching 200 percent. A major reason we have not
had an international financial crisis related to the yen is
because the large majority of that debt outstanding is held by
Japanese households due to their high savings rate.
Mr. Schweikert. The internal, yes.
My last statement, and I will share this with you, Mr.
Chairman, because you and I have had this conversation on the
side, is one of my great, great fears is with the Fed
intervention in U.S. sovereign debt and some of the other
mechanics out there, we have no real pricing for risk.
We are approaching a debt ceiling. We are approaching a lot
of these untenable numbers, but yet the old days when we used
to look at bond futures and say, ``The market is starting to
price risk,'' in many ways the Fed's actions now, it is hard to
know what is reality in the market anymore. Thank you, Mr.
Chairman.
Chairman Paul. And I thank the gentleman.
This hearing is now finished. The Chair notes that some
members may have additional questions for this panel, which
they may wish to submit in writing. Without objection, the
hearing record will remain open for 30 days for members to
submit written questions to these witnesses and to place their
responses in the record.
[Whereupon, at 11:40 a.m., the hearing was adjourned.]
A P P E N D I X
May 11, 2011
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]