How long can we "borrow from ourselves"?

By DAVID MOON, Moon Capital Management, LLC
November 4, 2012

In the past several years, officials have told us that one of the reasons our increased national debt is less worrisome than might otherwise appear is that we are “borrowing from ourselves.”

In the past seven years, the US Treasury has accumulated $9 trillion in new debt. Fannie Mae and Freddie Mac have added another $3.5 trillion in debt – all of which is now fully backed by the US government. That is a total of $12.5 trillion in new sovereign debt in seven years.

In those same seven years, the GDP of the entire US economy grew only a total of $3.2 trillion.

How is the US “borrowing from ourselves?”

The Federal Reserve is buying almost all of the new long-term Treasury debt and mortgage-backed bonds of Freddie Mac and Fannie Mae. At best, it is a stretch to call that “borrowing from ourselves,” since the Fed effectively prints the money it uses to pay for the bonds it purchases. In the past five years it has created $2 trillion, using all of it to fund US government deficit spending.

How long can this last? And more importantly, what happens when it ends?

With that in mind, a couple of weeks ago I asked Austan Goolsbee, the former Chairman of the Council of Economic Advisers to President Barack Obama and current economics professor at the University of Chicago, if there was a limit to the Federal Reserve’s ability to expand its balance sheet. Could it simply create an increasingly larger amount of money into perpetuity, funding an exponentially growing deficit with paper money and keeping interest rates at zero forever? Is there either a theoretical or political limit on the Fed’s ability to grow?

Based on his reaction, I'm not sure anyone had ever asked him that question.

Goolsbee is a brilliant economist. He has degrees from both the Massachusetts Institute of Technology and Yale, where he was a member of the exclusive and mysterious Skull and Bones Society. He answers questions with analogies about things like negative 14-year-old children. Now that's smart. That’s over-my-head smart. But he stumbled around when trying to respond to whether or not the Fed could quantitatively ease until the end of time.

Finally, Goolsbee acknowledged that political pressure might prevent the Fed from perpetually increasing its balance sheet and buying every asset in sight.

Common sense, however, suggests the opposite. (Economists do not become famous for common anything.) Politicians would likely prefer that the Fed never end quantitative easing. It is like free money, or at least so it appears. Politicians love free money.

And that was the crux of my question. How and when might quantitative easing end? Will the Fed eventually sell all of the long-term assets it has purchased, or simply hold them to maturity?

I have an opinion about these matters, but it is only an opinion. I can’t base my opinion on empirical evidence, because there is none. That’s why I asked a guy who has been at the big boy table. He uses long words, Greek letters and talks about negative 14-year-old children; he would know the answer.

He didn’t even pretend to know.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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