I know, what a radical statement considering the far-reaching implications that would happen to our capitalist system. This past week Steve Keen did a blog post (It’s not a debt, it’s a gift) about how we should allow direct purchases of bonds from the treasury.
Steve Keen

He addressed that we could just do away with government bonds and have the treasury account at the central bank go negative. Or the that there could still be government bonds sold directly to the CB and have the treasury account stay at a constant positive level. He suggests we continue to have government bonds so the treasury account at the CB remains positive.

Dirk Ehnts made a tweet that we should stop counting the amount of bond the CB holds and by default, the national debt would be lowered. As simplistic as that sounds it makes sense from a psychological perspective.

What about the market for these bonds? They do serve a purpose for many different investment vehicles, retirement packages, and so on. The simple mechanics of the treasury market goes like this, if the CB buys up a bunch of government bonds the value of the remaining bonds on the market goes up, the reverse happens when the CB sells bonds back to the private sector. This is just supply and demand.

What happens if we follow Steve Keen's suggestion and the CB buys a large portion of the bonds directly from the treasury? Does the market value of these bonds increase and by extension, the settlement balances of banks stay at a high level thus we have low interbank lending rates? Or does the market "bake in" that fact the CB is actually holding billions more of these bonds and the value of them drops?

The difference between the face value of a bond and its market price is its rate of interest. Bonds dropping in value increase their rate of interest. Now traditionally this would correspond to there being more settlement balances in the banking sector thus lower interbank lending rates. What if the market catches wind that the CB is buying up all the bonds directly from the treasury and prices at a lower value for bonds on the secondary market (higher rates on bonds)? At the same time, the bonds are used to offset treasury spending to keep the treasury account at the CB positive. This would mean there would be an increase in settlement balancing driving down interest rates in the interbank lending market.

We would have a situation where we had high-interest rates on bonds and low rates on settlement balances. What happens then? Logic would say there would be a reinforcing feedback loop, banks or primary dealers would stop buying bonds on the primary market as they would earn more lending settlement balances to other banks.

The idea that CBs paying interest on settlement balances can only take you so far in this situation, as soon as the market rejects that government bonds have no value it all blows up, and that's the end of the convoluted game.

We may already be at an inflection point where we should be evaluating a new vehicle for retirement funds to replace the "currently" very safe option of having government bonds as a part of the portfolio.

Should we just do away with government bonds? Moving forward are they a constraint even worth having?

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