[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

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                 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.]




















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                              May 11, 2011

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