Donald Trump inherited nearly $20 trillion in debt when he became president. He also inherited a financial puzzle that, if pieced together in his favor, could make that debt decline appreciably.
Or, in the worst case scenario, it could make the finances of the US look like those of a developing-world country whose currency isn’t worth the paper it is printed on.
In the minutes of its March meeting on Wednesday, the Federal Reserve indicated that most of its members want to later this year stop reinvesting the maturing principal and the dividends it gets from the bonds it purchased during the quantitative easing (QE) phase of its financial bailout plan.
The only problem: If that money isn’t put back into the purchase of new government bonds, where should it go?
The Fed has about $4.5 trillion in government bonds that it accumulated mostly during the many QE policy actions. I’ll leave it to someone else to figure out how much interest those bonds earn annually. Someone else will also have to tell you how many of those $4.5 trillion in bonds will mature this year.
The big question that hasn’t yet been answered: If that interest and the maturing bonds aren’t used to purchase more bonds, should they be monetized — meaning, should the money be given to the Treasury Department to be spent or pay down some of the $20 trillion in debt?
The answer would appear to be obvious: Hell, yes, it should be.
Ah, but there’s a problem with doing that. That $4.5 trillion in bonds wasn’t purchased with real money. Those bonds were bought with currency that was created artificially for the sole purpose of buying government bonds in an effort to keep interest rates low.
It was extra currency that didn’t show up in the US money supply. Fake money!
So, the interest income on the bonds purchased with that fake money is also fake — or artificially created outside the usual money supply. And the maturing bonds? They, too, are the spawn of fake money.
So the Treasury Department would be turning fake money into real money — or monetizing it — if the Fed were to hand over those bonds and interest payments.
There seems to be no other alternative for the Treasury Department. The Fed already turns trading profits over to Treasury each year. So why wouldn’t it do the same with the benefits of QE?
Quantitative easing was unprecedented. The solution regarding what to do with the remnants of it will also be unprecedented.
The main problem with giving the money to the Treasury Department is that such action would be considered highly inflationary. Essentially, the fake money would give people and the government more money to spend, causing prices to rise.
There’s something else going on. Remember, the Fed was using that interest income from the bonds to buy more government bonds. And when old bonds matured, it was buying new ones.
Without the Fed in the market as a bond buyer, interest rates will probably rise. And they might even rise quickly, which would hurt economic growth.
So those two additional rate hikes expected this year will be more like three — or even four — when the Fed starts unwinding QE.
The financial markets understand this. A nice rise in stock prices Tuesday turned into a loss when Wall Street digested the effects of the Fed’s move (along with disappointment over a new health care package).
President Trump should ask the Fed for those dividends right away and see what happens. It’ll be fun watching Fed chief Janet Yellen collapse to the floor in horror.