Let's Stop Paying Interest on our Debt

Yesterday, I posted up a comment in Columnist Conversations saying that I think the U.S. should default on the interest portion of its debt. Paying interest on the money that the US government issues freely -- the dollar -- is nonsensical. Interest payments are just another fiscal transfer, but they go mainly to wealthy individuals or institutions that don't need the money.

Even Warren Buffet agrees. He, personally, is a big recipient of interest income. The government (the taxpayers) pay him about $1.2 billion annually in interest on the $40 billion in government securities that he owns. In contrast, we are cutting food stamps to needy families by about $40 billion. How is that rational or just?

In the fiscal year just concluded the government paid out $225 billion in interest on Treasury securities and that's just a part of the total amount of interest the government pays out for use of its own money. The actual figure is more like $400 billion and that doesn't even include what the Fed pays in interest on reserve balances.

It seems to me that this money could be better spent elsewhere, like in rebuilding our infrastructure or for education or health care or science and research or any one of a number of things.

Paying interest is a device left over from the days of the gold standard. Under a gold standard a country's ability to issue money was limited by the amount of gold it had. If it didn't have enough money to meet liabilities, it would have to borrow (either gold or get credit from banks) and like any other non-currency-issuing borrower, it had to pay interest on its loans.

Often the way the nation would borrow would be to issue bonds, otherwise called gold certificates, to acquire gold from people. Gold certificates were the precursors of modern day Treasuries. They required the government to pay interest on those gold loans.

The problem is we are no longer on the gold standard. The government can issue its own money without the constraint of needing gold or having some fixed exchange rate or convertibility issue. After we went off the gold standard (1933 domestically, 1971 internationally) the issuance of Treasuries continued mainly as a tool to manage the level of reserves in the banking system. That was necessary in order for the central bank to keep its rate target where it wanted. Nowadays, with the Fed paying interest on reserves directly, it is really no longer necessary to issue Treasuries at all and it's certainly not necessary for the government to issue anything longer than a 30-day T-Bill.

The practice goes on giving us the impression that the government is borrowing. But if you are the monopoly issuer of the currency, why do you need to borrow it from someone and why in heavens do you pay for that? Talk about government waste. This takes the cake.

So what would happen if the government said it was not paying interest on Treasuries? Well, investors would probably panic and sell. but that would cause rates to move beyond the Fed's targets (or negatively impact its dual mandate) and then the central bank would be in there buying as it must do as the rate setter and also to fulfill its Congressional mandate of maintaining stable prices and low unemployment. In other words, the Fed would keep the rates steady and it has the power to do that. Always.

As for the total outstanding amount of U.S. debt, that is just the total net amount of dollars issued in the past 234 years, since the birth of the Republic. That means all the dollars spent by government minus all the dollars taken away through taxation. That comes to $16.7 trillion dollars, which is our current debt. But it's not really debt, it's just dollars that are held in the form of a Treasury security. We can't default on that because those are dollars already in the hands of the people.