Repudiating Government Debt Owed to the Federal Reserve

Ron Paul has suggested that one way Congress could avoid raising the debt ceiling is to repudiate the debt owed to the Federal Reserve.  Since the Fed "owns" approximately $1.6 trillion in government debt, this could simply be wiped away and it would give the federal government more breathing room without raising the debt limit.

Robert Murphy wrote an interesting analysis on this subject.  Lew Rockwell responded.  Robert Murphy then responded to these comments by Rockwell.  It is interesting to see the varying opinions from two of my favorite libertarians.  These are two of the biggest heavyweights you can get when it comes to libertarianism and Austrian economics.

It is very difficult for me to disagree with Ron Paul and Lew Rockwell because I have so much respect for them.  But with this issue, I am having a hard time being convinced.  I question my own opinion because it is not something that the mainstream media and the establishment favor, so how bad can the idea be?

I completely understand Ron Paul's point on this.  He is saying that the Fed will not sell off this debt anyway, so why act like it is debt.  But there are a couple of reasons that I am skeptical of this plan.

First, it actually gives an "out" for the Congress and Obama.  It would essentially kick the can down the road some more.  It would give up to $1.6 trillion in breathing room without having to raise the debt limit.  Personally, I am going to sit back and enjoy the next couple of weeks.  I am hoping that they fail to raise the ceiling and that government will actually have to be cut, although I am not counting on it.

Second, I question if this strategy would be inflationary.  Regardless of whether raising the reserve requirement is "stealing" from the banks (see the discussions on the links above), it is still not the same thing as withdrawing the money.

If the Fed creates new money to buy government debt, it is still inflating even if the money goes as excess reserves to the banks.  The effects are far less because it is not being exponentially grown through the fractional reserve process.  But the money is still there and available, even if not for loans.

The best thing to happen with this $1.6 trillion would be for the Fed to sell it and reduce the money supply by that amount.  This would have a far greater effect on our economy as it would help to keep prices down and it would help liquidate all of the malinvestment.

This whole discussion just shows all of the accounting gimmicks that take place regarding monetary policy and I think that is part of Ron Paul's point.  He is probably suggesting this just to bring attention to the issue, especially when he knows that it is not likely to happen.

With that said, I am a skeptical libertarian on this strategy.  It would let the Congress of the hook.  I would rather see no increase in the debt limit and watch the federal government be forced into making massive cuts in spending.  If we are going to suggest repudiating government debt, I would start with all of the other debt first as it would most certainly not be inflationary.