Should Central Banks Cancel Government Debt?
Peter Tenebraurum of Acting-Man Blog
Ron Paul's Foray Into Monetary Education
Readers may recall that Ron Paul once surprised everyone with a seemingly very elegant proposal to bring the debt ceiling wrangle to a close. If you're all so worried about the federal deficit and the debt ceiling, so Paul asked, then why doesn't the treasury simply cancel the treasury bonds held by the Fed? After all, the Fed is a government organization as well, so it could well be argued that the government literally owes the money to itself. He even introduced a bill  which if adopted, would have led to the cancellation of $1.6 trillion in federal debt held by the Fed.
Paul argued that given the fact that the Fed had simply created the money to buy the bonds from thin air, no-one would be hurt by this selective default. Moreover, he reckoned that this would likely neuter the Fed and make it less likely to manipulate the money supply in the future – if it could no longer rely on the treasury honoring its debt, there would be no point in buying more of it. He also considered the Fed's 'exit' talk to be spurious: the inflation of the money supply its bond buying had inaugurated would likely never be reversed anyway (we agree on this point).
Of course the proposal was not really meant to be taken serious: rather, it was meant to highlight the absurdities of the modern-day monetary system. Paul himself pointed out in subsequent interviews that the proposal would naturally never be adopted. In short, it was essentially an educational foray on his part - he wanted to encourage people to think. Ron Paul has always been an exception among politicians – he regarded educating people about monetary policy matters as part of his remit.
We live in an age where a pure credit money is used – a fiat money, that has been created by stripping money substitutes of their backing by money proper and imposing 'legal tender' laws. This means that certain conventions have to be followed by the official engines of inflation, the central banks, if they want to be successful in their vain (and dangerous) endeavor to create what they term a 'stable money' (in reality, 'stability' is held to be an arbitrarily chosen decline in money's purchasing power of 2% per year. This neither represents 'stability', nor is it even possible to realize such a plan. The purchasing power of money certainly exists, but it cannot be measured).
These conventions need to be adhered to in order to hold 'inflation expectations' in check. As long as a critical mass of individual actors in the economy remains convinced that the central bank is indeed capable of guaranteeing a fairly 'stable value of money', it is unlikely that they will react to inflationary policy by trying to quickly get rid of their cash balances in the expectation that its purchasing power will rapidly decline. As a rule, it takes a long time for people to abandon this misguided faith, but when they finally do, we often get to observe a discontinuous, sudden change in the money relation.
Anyway, it is one thing for Ron Paul to employ the idea of canceling the Fed's bond holdings as a means of educating people, it is quite another when modern day mainstream economic observers and even policymakers begin to discuss the possibility in earnest.