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MONETARY POLICY AND THE DEBT CEILING: 

EXAMINING THE RELATIONSHIP BETWEEN THE 

FEDERAL RESERVE AND GOVERNMENT DEBT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

DOMESTIC MONETARY POLICY 

AND TECHNOLOGY 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

MAY 11, 2011 

Printed for the use of the Committee on Financial Services 

Serial No. 112–28 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO R. CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

LARRY C. LAVENDER, Chief of Staff 

(III) 

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY AND TECHNOLOGY

RON PAUL, Texas, Chairman 

WALTER B. JONES, North Carolina, Vice 

Chairman 

FRANK D. LUCAS, Oklahoma 

PATRICK T. MCHENRY, North Carolina 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

NAN A. S. HAYWORTH, New York 

DAVID SCHWEIKERT, Arizona 

WM. LACY CLAY, Missouri, Ranking 

Member 

CAROLYN B. MALONEY, New York 

GREGORY W. MEEKS, New York 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GARY C. PETERS, Michigan 

(IV) 

C O N T E N T S 

Page 

Hearing held on: 

May 11, 2011 ..................................................................................................... 1 

Appendix: 

May 11, 2011 ..................................................................................................... 33 

WITNESSES 

WEDNESDAY, MAY 11, 2011 

Ebeling, Dr. Richard M., Professor of Economics, Northwood University .......... 5 

Ely, Bert, Ely & Company, Inc. .............................................................................. 7 

Slaughter, Dr. Matthew J., Associate Dean, Tuck School of Business, Dartmouth College ....................................................................................................... 10 

APPENDIX 

Prepared statements: 

Paul, Hon. Ron .................................................................................................. 34 

Huizenga, Hon. Bill .......................................................................................... 37 

Ebeling, Dr. Richard M. ................................................................................... 38 

Ely, Bert ............................................................................................................ 48 

Slaughter, Dr. Matthew J. ............................................................................... 66 

(1) 

MONETARY POLICY AND THE 

DEBT CEILING: EXAMINING 

THE RELATIONSHIP BETWEEN 

THE FEDERAL RESERVE AND 

GOVERNMENT DEBT 

Wednesday, May 11, 2011 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON DOMESTIC MONETARY

POLICY AND TECHNOLOGY, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:05 a.m., in room 

2128, Rayburn House Office Building, Hon. Ron Paul [chairman of 

the subcommittee] presiding. 

Members present: Representatives Paul, McHenry, Luetkemeyer, 

Huizenga, Schweikert; Clay, Maloney, and Peters. 

Ex officio present: Representative Frank. 

Chairman PAUL. This hearing will come to order. Without objection, all members’ opening statements will be made a part of the 

record. 

I would like to go ahead and start with our opening statements 

and then get to our introductions. 

Today’s hearing deals with monetary policy and the debt ceiling 

and examining the relationship between the Federal Reserve and 

government debt. The government debt, the national debt now is 

a big issue mainly because the debt limit has once again been met, 

and the Congress has to go through the process of raising the debt 

limit. 

The question is whether or not monetary policy is in any way related to the debt increase. Some say it is related; some say it is not. 

And the statistics are available to us to study that issue. 

But to me, it looks like there is a relationship. It seems like the 

Federal Reserve System provides a moral hazard, and that as long 

as Congress knows that Treasury bills will be bought and interest 

rates will not be allowed to rise, therefore the Congress is more 

careless. 

If we had no monetization of debt, which would annoy a lot of 

people, I am sure, who think the world would come to an end if 

that happened, the Congress would be self-regulated in many ways, 

because if we in the Congress spent excessively and we taxed excessively and borrowed excessively and we still didn’t have enough 

money to keep interest rates reasonably low, interest rates would 

rise. 

2 

And it would be Congress that would have to respond and not 

be bidding for so much capital out of the market, and therefore 

wouldn’t be tempted to say, ‘‘Well, it really doesn’t matter. We have 

an emergency. We have a war going on. We must finance the war. 

We have an entitlement system that depends on this, so therefore 

if we print the money, this will take care of things.’’ 

It may well take care of things for a while, but ultimately, this 

process will run up against a stone wall. And I think that is where 

we are today. 

We have raised the debt limit many times over the years, and 

it has been generally a non-event. It used to be that when you 

passed a budget resolution, the only part that was actual law was 

raising the debt limit. It wasn’t even debated. It was just generally 

done. 

But things have been moving along rather rapidly, and I cannot 

believe that what we are doing is sustainable. Right now, we are 

accumulating obligations. When you look at the deficit plus what 

we borrow from our trust funds plus our increase in our entitlement obligations, there are good estimates made that this amounts 

to about $5 trillion a year. And that, obviously, is unsustainable 

when we have a weak economy, jobs are going overseas, we are not 

producing, and we are in the midst of a slump. 

The solution hardly seems to be just more debt and depending 

on the Federal Reserve to come to our rescue while devaluing the 

currency, which means that many people that some of this deficit 

financing is supposed to help will actually be hurt by it, because 

they are the ones who lose their jobs, and then they end up with 

the prices going up because of the debasement of the currency. So 

this deficit financing seems like it can’t last forever. 

When the Fed was started, we didn’t have the same type of monetary statistics that we have today. But the base at that time, the 

monetary base at that time, was probably around $4 billion. By 

1971, at the time when we lost the last leak of our dollar to gold, 

it was about $67 billion. But with the removal of any restraint on 

the Fed to buy debt, the monetary base went up to $616 billion. 

Now, in this last decade, which has been a decade of economic 

weakness, real income has not gone up. Good jobs have not been 

added; they have been leaving our country because of our economic 

problems. But in these last 10 years, the monetary base has 

jumped from 616 billion to $2.5 trillion, so there is a lot of activity 

going on there. 

I also find that if you look at the debt during this period of time, 

of course, in 1913 the debt was practically irrelevant, a couple of 

billion dollars, but by 1971, incrementally, on a weak economy, the 

debt went up to $398 billion. Ten years ago, it was $5.8 trillion, 

but in this weakened economy, it has jumped up to $14 trillion. 

And I think what is interesting is that if you still pay a little bit 

of attention to M3, which we are not allowed to see any more from 

the Fed, because it costs too much money to produce those statistics, M3 is $14 trillion, and the national debt is $14 trillion. I don’t 

know how coincidental that is, but I just think there is a relationship to that. 

We have the statistics from the Fed that tell us about how many 

Treasury bills they are buying, and they are buying routinely. But 

3 

what we don’t know is whether or not—because we don’t have a 

full audit of the Fed—we extend loans to other foreign banks with 

the quid pro quo for them to buy Treasury bills, because foreigners 

are still buying a lot of our debt. 

But, it is interesting to see how passionate this whole argument 

about raising the debt limit is. It was a former Secretary of the 

Treasury who just recently said that if we don’t bow down, immediately raise this level, it will be so destructive that it would actually be equivalent to a terrorist act. That is how serious it is. 

The whole thing is they said, ‘‘Well, we can’t default.’’ But we 

started our country by defaulting. I don’t endorse this idea, but we 

started it. We defaulted on the continental dollar. We defaulted in 

the Civil War period. We refused to pay what we promised to pay 

in gold. They just unleashed unlimited spending. 

We defaulted in the 1930s, took the gold from the people, and 

didn’t pay off the gold to the people. We took it from them. And 

then in 1971, we defaulted again. We said to foreigners, ‘‘No.’’ We 

said we would honor our dollar at $35 an ounce, and we just quit. 

So we have defaulted many times. Sure, there are going to be 

problems if we don’t raise our national debt, but I think if we don’t 

cut the spending, that kind of a default is going to be much, much 

worse. 

And now I yield to Mr. Clay, the ranking member. 

Mr. CLAY. Thank you, Chairman Paul. And thank you for holding 

this hearing regarding the Federal Reserve’s role in United States 

monetary policy and the responsibility to address the U.S. budget 

deficits. 

To address this issue of the Federal Reserve’s role in the economy, we have to address the Federal Reserve’s dual mandate it has 

to maintain stable prices and full employment. And we also have 

to have an adult conversation here in Washington about this credit 

card mentality we have of putting big-ticket items on a national 

credit card. 

I think that has to stop, when you think about the last decade, 

how we conducted two wars without having a way to finance those 

wars. We had a prescription drug benefit instituted without a way 

to pay for that. 

Those are just two examples of what is wrong with the Washington mentality, so I agree with you. We have to have an adult 

conversation. Hopefully, this hearing can be the start of it. 

Mr. Chairman, I yield back. 

Chairman PAUL. I thank the gentleman. 

I now yield 5 minutes to Congressman Huizenga. 

Mr. HUIZENGA. Thank you, Mr. Chairman. I appreciate the opportunity and I appreciate our panel of witnesses coming and 

speaking to us today. And I, too, Mr. Chairman, appreciate your 

willingness to hold this hearing and leading this conversation in so 

many ways. 

My constituents—I am from Michigan, the west side of Michigan, 

so I am very familiar with our friends over on the other side of the 

State at Northwood, but my constituents in the 2nd District have 

made it very, very clear that the debt and our spending is one of 

the most vital issues that is facing not just this current Congress, 

4 

the 112th Congress, but us as a nation and to us as a people and 

our way of life. 

And they are asking us to rein our spending in, reduce our massive debt. And that is why I think it is so important that we are 

holding this hearing. 

The Federal Reserve Board of Governors is congressionally mandated, as we all know, to maximize employment as well as to hold 

down inflation. But after witnessing this massive debt load that 

has been accumulated by other Administrations, but has ramped 

up in this current Administration, it seems to me that those are 

really failed fiscal policies. 

And I am pleased that we are now spending some time exploring 

the role of monetary policy and the national debt. I am very concerned about the liquidity that has been put into markets by the 

Fed. And through the purchase of those debts and most recently 

through the fact that Federal funds rates sit at basically zero, we 

have had to go through, or haven’t had to go through—the Fed 

made the decision to go through by purchasing an additional $600 

billion in Treasury securities with utilizing the philosophy of quantitative easing. 

And we have gone through QE1 and now QE2, and despite pur- chasing $1.2 trillion previously in March of 2009, it seems to me 

it has not proved to be an effective method of creating jobs. And 

I would love to have your input on that. 

Today, we will examine what effect the Fed’s government debt 

plays on the Federal Reserve’s open market operations. In addition, 

I look forward to inspecting how that role affects our yearly deficits 

when compared to the more costly tax-and-spend fiscal policies that 

we have had. 

And I take my charge here as a Member, as a freshman Member 

of this 112th Congress and as a member of this important subcommittee, I take my responsibility for strict oversight of taxpayer 

dollars with the utmost seriousness. And I know that has to be 

done. 

We have been irresponsible in the past, I believe, with the trust 

that we have been given by the American people. And it is time 

that we step up and take care of that. 

I look forward to a robust conversation today. I am sure that 

there are a number of differing opinions here. And as we are exploring sort of the Fed’s unparalleled intervention in the markets, 

I am looking forward to hearing from you. 

So again, Dr. Paul, Chairman Paul, I appreciate the opportunity 

to be a part of this committee and a part of this hearing and I look 

forward to that. Thank you. 

Chairman PAUL. I thank the gentleman. 

Does anybody else care to make an opening statement? 

Thank you. 

Without objection, the written statements of our witnesses will 

be made a part of the record, and each of you will be granted 5 

minutes to summarize what you have to say, and then we will go 

into the questions. I will go ahead and introduce the panel now. 

The first panelist is Dr. Richard Ebeling, a professor of economics 

at Northwood University in Midland, Michigan. He is recognized as 

one of the leading members of the Austrian School of Economics. 

5 

He is a former president of the Foundation of Economic Education and author of, ‘‘Political Economy, Public Policy and Monetary Economics.’’ Dr. Ebeling earned his Ph.D. in economics from 

Middlesex University in London. 

Also with us today is Mr. Bert Ely. He is the principal of Ely & 

Company. He has consulted on banking issues since 1981 and has 

focused in recent years on banking problems, housing finance, and 

the crisis in the entire U.S. financial system. 

Mr. Ely frequently testifies before Congress on banking issues 

and continuously monitors conditions in the banking industry, as 

well as monetary policy. Mr. Ely received his MBA from Harvard 

business school. 

Also with us today is Dr. Matthew Slaughter. He is associate 

dean of the MBA program at the Tuck School of Business at Dartmouth. He is also a research associate at the National Bureau of 

Economic Research and a member of the State Department’s Advisory Committee on International Economic Policy. 

During the George W. Bush Administration, he served as a member of the President’s Council of Economic Advisors. Dr. Slaughter 

is co-author of, ‘‘The Squam Lake Report: Fixing the Financial System.’’ Dr. Slaughter received his doctorate from MIT. 

And we will go ahead and recognize Dr. Ebeling at this time. 

STATEMENT OF RICHARD M. EBELING, PROFESSOR OF 

ECONOMICS, NORTHWOOD UNIVERSITY 

Mr. EBELING. Mr. Chairman, I would like to thank you and the 

other committee members for this opportunity to testify on our current fiscal crisis and the issue of raising the government’s debt ceiling. 

The current economic crisis through which the United States is 

passing has given heightened awareness of the country’s national 

debt problem. Between 2001 and 2008, the national debt doubled 

from $5.7 trillion to $10.7 trillion and has grown by another $3.6 

trillion in the last 3 years to a total of $14.3 trillion. 

As I point out in my written testimony, this addition to the national debt since 2008 represents a huge sum. It is 2 times as large 

as all private sector manufacturing expenditures and nearly 5 

times the amount spent on non-durable goods in 2009. The interest 

payments alone during the first 6 months of the current fiscal year 

are equal to 40 percent of all private-sector construction spending 

in 2009. 

This highlights the social cost of government spending above 

what it already collects in taxes from the American public. Every 

dollar borrowed by the United States Government and the real resources that dollar represents in the marketplace is one dollar less 

that could have been available for private sector investment, capital formation, consumer spending, and other uses that could have 

been put to work to improve the quality and the standard of living 

of the American people. 

The bottom line is that over the decades, the government, under 

both Republicans and Democrats, has promised the American people, through a wide range of redistributive and transfer programs 

and other ongoing budgetary commitments, more than the U.S. 

6 

economy can successfully deliver without seriously damaging the 

country’s capacity to produce and grow for the rest of the century. 

To try to continue to borrow our way out of this dilemma will be 

just more of the same on the road to ruin. The real resources to 

pay for all the governmental largesse that has been promised 

would have to come out of either significantly higher taxes or 

crowding out more private sector access to investment funds to 

cover continuing budget deficits. 

Whether from domestic or foreign lenders, the cost of borrowing 

will eventually and inescapably rise. There is only so much savings 

in the world to finance both private investment and government 

borrowing, particularly in a world in which developing countries 

are intensely trying to catch up with the industrialized nations. 

Interest rates on government borrowing will rise, both because of 

the scarcity of savings to go around and lenders’ concerns about 

America’s ability to tax enough in the future to pay back what has 

been borrowed. Default risk premiums need not only apply to countries like Greece. 

Reliance on the Federal Reserve to print our way out of this dilemma through more monetary expansion is not and cannot be the 

answer. Printing paper money or creating it on computer screens 

at the Federal Reserve does not produce real resources. 

It does not increase the supply of labor or capital, the machines, 

tools and equipment out of which desired goods and services can 

be manufactured or provided. That only comes from work, savings, 

and investment, not from more green pieces of paper with Presidents’ faces on them. 

As I point out in my written testimony, monetizing the debt refers to the creation of new money to finance all or a portion of the 

government’s borrowing. Since 2007–2008, the Federal Reserve, 

through either buying U.S. Treasuries or mortgage-backed securities, has in fact increased through the money multiplier of fractional reserve an amount already equal to about two-thirds of all 

of the government’s new deficit spending over the last 3 years or 

so. 

The fact is the Federal Reserve has more or less monetized—that 

is, created paper money—to cover a good portion of what the government has borrowed. The bottom line is that government is too 

big. It spends too much, taxes too heavily, and borrows too much. 

For a long time, the country has been treading more and more 

in the direction of increasing political paternalism. The size and 

scope of the Federal Government has to and must be reduced dramatically to a scale that is more consistent with the limited government vision of our founding fathers, as is outlined in the Declaration of Independence and formalized in the Constitution of the 

United States. 

The reform agenda for deficit and debt reduction, therefore, must 

start with the promise of cutting government spending and having 

a target downsizing of the government. As I suggested in my remarks, the Federal budget should be cut 10 to 15 percent each year 

across-the-board to get government down to a more manageable, 

traditional constitutional size. 

As a first step in this fiscal reform, it is necessary to not increase 

the national debt limit. The government should begin now living 

7 

within its means—that is, the taxes currently collected by the 

Treasury. 

In spite of much of the rhetoric in the media, the United States 

need not run the risk of defaulting or losing its international financial credit rating. Any and all interest payments and maturing debt 

can be paid out of tax receipts. What will have to be reduced are 

other expenditures of the government. 

The required reductions and cuts in various programs should be 

viewed as a necessary wake-up call for everyone in America that 

we have been living beyond our means. And as we begin living 

within our means, priorities will have to be made and trade-offs 

will have to be accepted as part of the transition to a smaller and 

more constitutionally limited government. 

In addition, we have to rein in the power of the Federal Reserve. 

As I point out in my comments again, the power of discretionary 

monetary policy must be removed from the hands of the Fed. 

They have too much authority to manipulate the supply of money 

in the economy, to influence the purchasing power of the monetary 

unit, and to distort interest rates, which influences the savings and 

investments in the economy that easily set in motion the boom and 

bust of the business cycle. 

It is necessary first to think of seriously returning to a monetary 

system as a transition that is a commodity-backed system, such as 

a gold standard. And we should in the long run seriously consider 

the possibility of even a monetary system completely privatized and 

competitive without government control and management. 

In conclusion, the budgetary and fiscal crisis right now has made 

many political issues far clearer in people’s minds. The debt dilemma is a challenge and an opportunity to set America on a freer 

and potentially more prosperous track. 

And in conclusion, Mr. Chairman, I would just like to give the 

following quote from a former President of the United States, with 

your permission: 

‘‘I place the economy among the first and most important virtues 

and public debt as the greatest of dangers to be feared. To preserve 

our independence, we must not let our leaders load us with public 

debt. We must make our choice between economy and liberty or 

confusion and servitude. If we run such debts, we must be taxed 

in our meat and drink and our necessities and comforts and our 

labor and in our amusements. If we can prevent the government 

from wasting the labor of the people under the pretense of caring 

for them, they will be happy.’’ 

Whose words are those, Mr. Chairman? Thomas Jefferson, the 

third President of the United States. Thank you very much. 

[The prepared statement of Dr. Ebeling can be found on page 38 

of the appendix.] 

Chairman PAUL. I thank the gentleman. 

And I will now recognize Mr. Ely. 

STATEMENT OF BERT ELY, ELY & COMPANY, INC. 

Mr. ELY. Chairman Paul, Ranking Member Clay, and members 

of the subcommittee, I appreciate this opportunity to testify today. 

The first two charts attached to my written testimony show the 

tremendous growth of the Fed balance sheet September 2008, 

8 

which reached an all-time high of $2.7 trillion in assets last 

Wednesday. How much more will grow is anyone’s guess. 

As my testimony shows, almost all the growth in the Fed’s liabilities has occurred in deposits in the Treasury Department and 

banks. Initially, the Treasury borrowed funds to lend to the Fed 

that the Fed then lent and invested in the financial markets. The 

later jump in bank deposits enabled the Treasury to reduce its deposits and borrowing. Bank deposits at the Fed rose to $1.54 trillion last month. 

Exhibit 2 also has faced the steady growth of the Fed’s other 

major liability, currency. The Fed has no control over the amount 

of currency outstanding, though. It is totally demand-driven. 

Turning to the Fed’s income statement, the Fed has been extremely profitable since 2008. Exhibit 6 shows how the Fed earned 

a $52.9 billion profit for taxpayers last year. Over the 2008–2010 

period, the Fed earned almost $90 billion, more than all FDIC-insured institutions, and 2011 will be another extremely profitable 

year for the Fed. 

A key public policy question is whether the Federal Government, 

through the Fed, should play such a substantial role in the credit 

intermediation business. 

Turning to the Fed’s independence, that independence in fact is 

a myth. The Fed is a creature of Congress, and it operates with the 

full faith and credit backing of the Federal Government. Key to understanding the linkage of the Fed to the rest of the Federal Government is to consolidate the Fed and Treasury Department’s balance sheet. There are several merits in viewing this balance sheet 

on a consolidated basis. 

First, the asset side of the balance sheet shows the extent to 

which the Federal Government, through the Treasury and the Fed, 

is supplying credit to the private sector, notably to finance housing 

and higher education. 

Second, the liability side of this consolidated balance sheet shows 

that private sector funds, principally deposits by banks in the Fed, 

currently provide substantial funding to the Federal Government. 

Third, the liability side of the consolidated balance sheet shows 

at the end of March currency outstanding accounted for 10.4 percent of the total Federal debt held by the public. This non-interestbearing portion of the Federal debt has declined as budget deficits 

have forced the issuance of substantial amounts of interest-bearing 

debt 

Given the magnitude of Federal budget deficits for the foreseeable future, the currency portion of the Federal debt will continue 

to decline. The printing press will not be a cure for funding unseen 

future deficits. 

In sum, the Fed could be folded into the Treasury Department 

tomorrow. Doing so would permit a unified management of the 

Federal Government’s balance sheet. The Treasury could also assume the role of lender of last resort. Since the Fed, when acting 

as an emergency lender, is lending taxpayer dollars, it is not doing 

anything that Treasury itself could not do. Treasury’s assumption 

as lender of last resort would bring much greater political accountability to such lending. 

9 

Since folding the Fed into the Treasury will not occur any time 

soon, Congress should mandate that the Treasury Department periodically produce a consolidated balance sheet of the Fed and the 

Treasury. This would present a more complete picture of Federal 

finances and the impact of the Federal Government on the U.S. 

economy. 

Finally, the fundamental premise of central bank independence 

is that monetary policy should be free of political interference. 

Leaving aside the merits of that premise, the key question is what 

constitutes monetary policy. 

Today, it consists solely of the Fed trying to influence interest 

rates through its open market operations, specifically to hold the 

overnight Fed funds rate as close as practical to the Federal Funds 

Rate Target, or FFRT, that is set by the FOMC. 

The Fed does not control the money supply. The amount of currency in circulation is totally demand-driven. Money, however defined, is merely that portion of the credit supply which serves as 

media of exchange. 

Inflation in the modern industrialized economy is to a great extent a function of the price of credit. If credit is underpriced, inflation may emerge as increased demand stimulated by underpriced 

credit causes the economy to overheat and asset prices to soar, as 

we saw in the recent years’ housing bubble. Overpriced credit has 

the opposite effect. 

Given that monetary policy is all about interest rates, the question is, who can better set interest rates: a committee of government bureaucrats; the FOMC; or the financial market? The experience of recent years certainly does not support the notion that bureaucrats can do a better job than the financial markets in pricing 

credit. 

This question could be posed another way. What is it about credit 

that makes it desirable for government to determine its price? 

Somehow, either the central bank must provide a so-called nominal 

anchor for the credit market, a pricing benchmark, if you will. In 

the United States, that would be for the Federal funds rate target. 

In my opinion, a good case has never been made that the financial markets cannot set interest rates across the entire yield curve 

that will promote stable, non-inflationary economic growth while 

minimizing the emergence of asset bubbles. More specifically, there 

certainly is no reason why the interbank lending market cannot establish and vary the overnight interest rate, which the FOMC now 

establishes through its open market operations. 

I encourage the subcommittee to address the question of why interest rates need a nominal anchor, why it is in the public interest 

to have a government committee signaling what its members consider to be the appropriate level of interest rate, and why the Fed 

should try to enforce that signal through open market operations. 

If that case cannot be made, then the primary raison d’etre for 

the Fed disappears, which would lead to folding the Fed into the 

Treasury Department. 

Mr. Chairman, thank you for this opportunity to testify. I welcome the opportunity to answer questions. 

[The prepared statement of Mr. Ely can be found on page 48 of 

the appendix.] 

10 

Chairman PAUL. Thank you very much. 

And finally, we will go on to Dr. Slaughter. 

STATEMENT OF MATTHEW J. SLAUGHTER, ASSOCIATE DEAN, 

TUCK SCHOOL OF BUSINESS, DARTMOUTH COLLEGE 

Mr. SLAUGHTER. Chairman Paul, Ranking Member Clay, and 

members of the subcommittee, thank you very much for inviting 

me to testify on these important and timely issues regarding America’s monetary and fiscal policies. 

In my remarks, I will make two points regarding the relationship 

between the Federal Reserve and Federal Government debt. I will 

then make two broader points regarding the debt ceiling. 

First, it is important to emphasize that the Federal Reserve purchases of Federal Government debt has for decades been standard 

operating procedure for how the Fed conducts monetary policy. In 

pursuit of its dual mandate of both price stability and full employment, in the normal course of operations the Fed has long bought 

or sold Treasury securities to increase or decrease supply of what 

is commonly called high-powered money, or the monetary base. 

In turn, through rounds of lending in the private financial system, these changes of the monetary base affect the broader U.S. 

economy. Indeed, for many years before the world financial crisis, 

the Fed executed monetary policy almost exclusively by transacting 

Treasury Securities. There is nothing inherently nefarious or worrisome about the Fed owning a large amount of Federal Government 

debt. 

Second, it is important to emphasize that the current fiscal challenges facing America have not been caused or abetted by the historic interventions the Federal Reserve undertook amidst the world 

financial crisis. The Fed’s efforts to restore liquidity and stability 

to America’s capital markets required it to expand both the size 

and asset composition of its balance sheet in unprecedented ways. 

This historic expansion of Federal Reserve monetary policy did 

not somehow cause the commensurate historic fiscal expansion. 

Rather, massive Federal fiscal deficits were triggered by a combination of sharp downfalls in Federal tax receipts and especially 

sharp increases in Federal spending. 

Thus, historically, monetary and fiscal expansion coincided, but 

neither directly caused the other. Rather, both have been directed 

at containing the damage to the real economy of the world financial 

crisis. 

Let me now turn to the broader issue of America’s looming debt 

ceiling. Here I would like to make two points, the importance of 

which it is difficult for me to overstress. 

First, the decision to lift the debt ceiling is a necessary consequence of previous decisions on taxes and spending. If America 

does not want to default, then raising the debt ceiling is mandatory, not optional. Pick whatever deficit reduction plan you like— 

that of the bipartisan deficit reduction panel, that of Congressman 

Paul Ryan, that of President Obama. No matter which plan you 

like, that plan will expand total Federal debt outstanding by several trillion dollars over the next decade. 

11 

This means that no matter which plan you like, to see it become 

a reality without the United States defaulting, you must support 

increasing the debt ceiling. 

My second and final point is to implore you to understand that 

America is tempting a crisis of unknowable proportions if we default on our Federal Government debt. In many ways, global capital markets today remain deeply impaired. Housing prices in the 

United States continue to decline. Several sovereign debtors in Europe are struggling to remain liquid and solvent. Central banks 

continue to provide extensive support to the global financial system. 

At the same time, economic recovery remains tentative in the 

United States and in many other countries, as Chairman Paul indicated in his opening remarks. About 25 million Americans remain 

unemployed or underemployed. Today’s 108.9 million private sector 

jobs is the same number that America had nearly 12 years ago. 

Amidst all this fragility and uncertainty, the prospect of a U.S. 

Government default is truly frightening. As the recent past so painfully demonstrated, financial crises often arise from unexpected 

sources and metastasize in unknowable ways. And a default in U.S. 

Treasuries, rather than on some other debt security in the world, 

would be especially worrisome for two important reasons. 

One is that U.S. Treasuries are the one asset that world investors generally regarded to be free of default risk. But there is no 

law of physics that states the world’s risk-free asset will always be 

U.S. Treasuries. Indeed, it was not always so. 

The other reason is that America’s creditors are increasingly foreign, not domestic. Thanks to ongoing low saving rates by U.S. 

households, the foreign holdings of U.S. Government debt are likely 

only to rise beyond the recently crossed the 50 percent threshold. 

History shows that deeply-in-debt sovereign powers are more 

likely to encounter sudden loss of confidence, the larger is the 

share of their outstanding debt held by foreign creditors. These fiscal crises have often come sharply and with little warning. All is 

okay, all is okay, all is okay. And then one day, all is catastrophically not okay. 

America’s fiscal challenges are grave. We need the understanding 

of our creditors to overcome these challenges. As such, America 

should be doing everything in its power not to cast doubt on the 

pledge to honor our debt. Time is running short, and what America 

needs most of all is leaders, such as those of you on this committee, 

to raise America’s debt ceiling as part of meeting our fiscal challenges. 

Thank you again for your time and interest in my testimony. 

And I look forward to answering any questions that you may have. 

[The prepared statement of Dr. Slaughter can be found on page 

66 of the appendix.] 

Chairman PAUL. Thank you. 

I will start the session for questioning. I want to follow up on Dr. 

Slaughter’s position, on what would happen if we don’t raise the 

national debt. 

I concede it will be a problem and there would be some consequences, but the reason I come down on the side of saying that 

we shouldn’t continue to do this is that we have embarked on a 

12 

course that will lead us to such a consequence that will be much 

worse than not facing up to the fact that we just can’t continue to 

do this constantly. There has to be some pressure put on the system that we can’t depend on the creation of new money to accommodate the deficits that we come up to. 

And I would like to ask Dr. Ebeling and Mr. Ely and let Dr. 

Slaughter respond, if he would like to, how bad is that if this debt 

limit is raised? And is there an argument made that it might not 

be nearly as bad as they suggest? They were panicking us now and 

saying that anybody who would suggest this is the equivalent to a 

terrorist suggesting that. And that came from a Republican. 

So can you comment on that, Dr. Ebeling? 

Mr. EBELING. Yes. I don’t think that it has the danger that has 

been suggested. As I said in my comments, both in my opening remarks and in my written remarks, the U.S. Government certainly 

takes in enough tax revenue far and above the tax revenue necessary to meet interest and rollover costs of existing debt. 

What would be required, if one is going to maintain one’s international creditworthiness in that manner, is to start cutting back 

on other domestic spending other than one’s debt obligation. 

Will that necessarily require trimming, cutting, reducing a variety of current expenditures that the U.S. Government is committed 

to? Yes. But the fact is that the same thing applies to households. 

If a household finds itself in the situation where it cannot afford, 

because it has reached its credit card limit, to add to this debt 

without serious problems, and is threatened with default if you 

can’t meet its minimum payment, it then tightens its belt, and to 

decide maybe not to buy the flat screen TV for the extra bedroom 

for a while, maybe not to go out to the restaurant 2 or 3 times a 

month, and maybe to watch more on Netflix for the $14 a month 

as opposed to going to the movie theater for $15 a ticket. 

And that is how it will have to be managed. Now, as I say, this 

is an important— 

Chairman PAUL. Excuse me. I want to follow up, because you 

have emphasized the need to cut back, and you suggested where 

it would have to be. 

Mr. EBELING. Right. 

Chairman PAUL. And it would not be all that much comfort for 

the people who have to cut back. But can’t you include in there 

how rapidly could we cut some of the spending that we do overseas 

and some of this foreign policy adventurism? Wouldn’t that be a 

place that we could save some money as well? 

Mr. EBELING. I totally agree with you. The fact is that even in 

the post-Cold War era, the United States has dozens upon dozens 

of military bases and facilities around the world. Tens of thousands 

of American servicemen—Army, Navy, Air Force, Marine Corps— 

are stationed in various numbers in many, many countries around 

the world. 

I see no reason why we could not significantly cut back on this 

overreach in our foreign policy and bring those soldiers home, reduce our expenditures for those bases, and make the countries that 

have for decades had this umbrella of military security from the 

United States shoulder these expenses themselves. 

13 

The fact is the United States still provides a huge military umbrella for the European Union, which they have had a free ride on 

practically since the beginning of NATO. I see no reason why we 

couldn’t cut back and expect them to defend themselves more effectively. And the same thing applies to Korea or Japan. 

Chairman PAUL. Let me get Mr. Ely’s comments, too. 

Mr. ELY. Mr. Chairman, I am clearly concerned by what the 

present trajectory of spending is and, more importantly, what this 

means in terms of the ratio of Federal debt to GDP. It is reaching 

astronomical heights. 

And the challenge that Congress faces is basically not only trimming the spending, but getting the economic growth we need to 

help bring down the relationship of Federal debt to the current 

GDP. And, of course, as everybody knows, entitlements are a key 

aspect of that problem. 

I am one who draws Social Security and is a beneficiary of the 

Medicare program, which, of course, are tow of the really serious 

long-term problems facing the Federal Government. And they have 

to be addressed. 

As much as I am—as I say, I am a beneficiary of those two programs. I fully appreciate, and I think even many of my fellow seniors do, that this cannot continue indefinitely. I do not envy the 30- 

year-olds and the 25-year-olds and so forth just now coming into 

the workforce because of the accumulation of these debts. 

So it is going to have to be addressed, but it has to be more than 

cutting at the margin. It has to be some really fundamental 

changes and trimming back of the basic entitlement program. 

Chairman PAUL. My 5 minutes is up, but I hope to be able to 

give you a chance to respond as well in time, so I am going to move 

on and recognize Congressman Frank. 

Mr. FRANK. I agree on the need to cut back America’s overcommitment internationally. I would say to Mr. Ebeling that, one, 

you said NATO has been getting a free ride practically since the 

beginning. No, not practically, no—since the very beginning. 

Look, in 1949 we had countries in Western and Central Europe 

that were poor and devastated—enabled by his method to mobilize 

it all into military. And so the United States stepped in. 

Two of those elements have changed. Western and Central Europe is no longer poor and weak and defenseless. There is no more 

Soviet Union menacing them. The only thing that hasn’t changed 

is the American military protection. So, yes, there is a lot that 

could be done to shave that. 

But—and I think this is true elsewhere in the world—Afghanistan. We are being told by some we should stay in Iraq another 

year to be the political and religious referee for Iraqi—but that is 

one of the points I want to make first of all. 

The way this debt limit issue has been framed, I have had people 

acting—frankly, some of my Republican colleagues—as if they 

would be doing me a favor by raising the debt limit. The Federal 

Government doesn’t owe me any money. I am not involved here. 

I didn’t vote for the war in Iraq. I didn’t vote for the tax cuts of 

2001 and for their renewal. I didn’t vote for an unfunded prescription drug program. If everybody voted the way I did, we would 

14 

have another couple of years before we would have to raise the 

debt limit. 

Now, I lost. We incurred those debts. So that doesn’t mean they 

don’t pay them. But this notion that somehow I am responsible, 

that people on our side are responsible, no, there was a joint responsibility. 

Let me just ask, though, Mr. Ely, in your response, the chairman 

had asked, and Mr. Ebeling responded, about what the consequences would be of not raising the debt limit. You didn’t get to 

that. Would you tell me what is your view? Should we raise the 

debt limit? What if we are unable to come to a formula and don’t 

raise the debt limit and run into the problem of not being able to— 

what do you think the consequences of that are? 

Mr. ELY. I think it depends on how long things would go on before there was either resumption of the payment of the debt or at 

least the interest on the debt. If it is something that lasted a couple of days, I think— 

Mr. FRANK. Okay. But if it is a couple of weeks or longer? 

Mr. ELY. A couple of weeks or longer, I think could create some 

very serious longer-term negative consequences for the Federal 

Government in terms of leading to higher interest rates on Treasury debt. Again, I think it comes back to how does the financial— 

Mr. FRANK. Yes, I am sorry, but I only have 5 minutes. I appreciate, but you—so you do think an indefinite problem. I agree that 

1 or 2 days is never much of a problem. But if there is real uncertainty about how we are going to do that and it goes on for a while, 

there are negative consequences. 

Mr. ELY. Oh, there is no question that there will be. And those 

negative consequences will mean higher interest rates on the Federal debt, and that will add to the budget deficit, if it goes on for 

a long time. A couple of days— 

Mr. FRANK. Yes, if you don’t have a resolution, yes, again, nobody 

thinks 1 or 2 days is a problem. We can do anything around here 

for 1 day except maybe hold our breath. But if you start getting 

into a deadlock, it is a different story. 

Mr. Slaughter, you served in a very important position during 

the previous Administration, the Bush Administration. Again, on 

the debt limit, I appreciate your coming here and sharing your 

view. 

What was the general view in the Bush Administration of the 

President and other high financial officials at Treasury and elsewhere, about the consequences if we were unable to come to an 

agreement on raising the debt limit? 

Mr. SLAUGHTER. I think there was a variety of views, but I think 

almost everyone recognized that the unique position the United 

States has in global capital markets where Treasuries are regarded 

as the risk-free asset, everyone reasonably knew to have the humility to not know what would happen if we jeopardized that. 

If we were to breach the debt ceiling and not have a resolution 

for some period of time, it is really difficult to know what is going 

to happen to demand for Treasuries around the world. We have 

never lived in that world. And again, today, now of the roughly $10 

trillion in U.S. Federal debt that is in public hands, slightly over 

half of it is foreign-held. 

15 

Mr. FRANK. Let me just a quick question, because you have been 

to business school. What about American businesses that operate 

internationally? Is there some negative impact for them, the multinationals that have to operate across national— 

Mr. SLAUGHTER. There absolutely is. The global corporations, 

they have long time horizons, and when they discuss seeking certainty for the key investment and job creation decisions they make, 

the kind of uncertainty that we create in not resolving the debt 

issue makes them look outside of the United States to create those 

jobs. 

Mr. FRANK. Mr. Paul and I can persuade our colleagues that we 

are spending hundreds of billions over time unnecessarily. By the 

way, we are defending wealthy nations against nonexistent threats. 

If we just started to bring some of that home, we can do some good 

work. 

I thank you, Mr. Chairman. 

Chairman PAUL. I thank the gentleman. 

And I now recognize Mr. Huizenga for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. And I wanted to continue your line of questioning. 

Dr. Slaughter, if you care to comment briefly on what Chairman 

Paul was asking before he ran out of time. 

Mr. SLAUGHTER. Sure, I would add just a little bit of data. Again, there is about $5 trillion of the $10 trillion in U.S. debt outstanding in public hands that is now held by foreign entities. We 

don’t have great data on who is holding U.S. Treasuries and what 

the source of their demand is. That is the reality of how data is 

collected globally. 

Most people think that the People’s Bank of China, which is the 

Chinese central bank, is the single largest entity holding U.S. 

Treasuries outside of the United States at about $1.5 trillion. A lot 

of both the private and public institutions are holding Treasuries, 

we think, because of the perceived safety of that asset. 

And safety is not something you can measure like you can measure things in the physics laboratory. What is saved in the eyes of 

these international investors is up to them, in large part. And so 

whether it is a 2-day breach, whether it is a 2-week breach of the 

debt ceiling, what is sort of mandated or chosen liquidations of 

holding U.S. Treasuries, it is hard to predict. 

And it is hard to predict, then, as Bert said, what is going to be 

the impact on interest rates in the United States and that stress 

more generally on world capital markets that in many ways remain 

quite strained. And frankly, I think it is important to keep in mind 

financial crises are almost by definition hard to predict what would 

be the exact causes of them and hard to predict how they will 

evolve through time. 

Mr. HUIZENGA. I appreciate that. And I wish our former chairman hadn’t left. I was scarily going to say that we might be coming 

from a similar spot here. I am a freshman. I haven’t been involved 

here on the run-up on our debt either, as his claim was, but we 

certainly have a position here—I have a position here of my desire 

to stop spending. 

And that, I think, is how, if we hear from some of our friends 

on the other side of the aisle, who argue, ‘‘I wasn’t part of that 

16 

problem, because I didn’t vote for this or that,’’ I am here now, and 

I believe that part of that solution, exactly as Dr. Ebeling is talking 

about, is stopping our spending. 

So it seems to me that is a fiscally responsible thing to do, as 

we are moving ahead, because I have a fear that, too, also, Dr. 

Slaughter, if we are going to put our currency as the reserve currency of the world at risk and we are going to be looking at much 

of what has happened to many of our constituents, where they 

have had issues with their own personal credit and then had to go 

back and try to borrow more money, what has happened? 

They are a greater credit risk, and they have had greater interest rates. We have seen this in Portugal recently. But I think our 

first and foremost focus needs to be on the stop-spending part. And 

I am curious to hear a comment there. 

And then also, if anybody cares to comment on the value of the 

U.S. dollar, as opposed to the other currencies of the world and 

what we have seen in the rise of those other currencies or maybe 

more accurately a fall of our value. 

Mr. ELY. If I could jump in here, again, I think a key aspect of 

the attack on spending has to be on the entitlements, has to be on 

money that people my age and older and even younger now are getting under Social Security and Medicare. And particularly, as the 

boomers come onto Social Security and Medicare, the problem is 

going to grow. And I think that is a very tough political issue that 

you have to deal with. 

There is also the question that I know came up before, and that 

is about the savings rate. America is the world’s largest debtor nation, somewhere in the range of $3 trillion. And I think a key aspect of our poor financial situation isn’t just the Federal debt, but 

it is the overall position of the United States with the rest of the 

world. 

I know there are folks in the Pentagon who are concerned about 

our net debtor position, because the key reason why foreign interests hold so much in Treasury is because as a country, as a whole, 

we are so deeply in hock to the rest of the world. 

So domestic savings and trying to encourage a greater level of 

domestic savings is, I think, a very important element of dealing 

with our global situation. 

Mr. HUIZENGA. Dr. Ebeling? 

Mr. EBELING. Yes, if I can just make a couple of comments, the 

concern has been expressed, and I don’t disagree that if the United 

States were to default on its debt, its interest payment, this would 

have significant ramifications for our creditworthiness, interest 

rates at which the Treasury could borrow and so on. 

But let us think of the alternative. If, as the Secretary of the 

Treasury has recommended, the debt limit is increased by $2 trillion, then that will mean that between now and the beginning of 

2013, the United States is likely, given the current trajectory, to 

need to borrow additional $2 trillion. 

Now, it is very hard to believe that if the Federal Reserve does 

not increase the money supply, that will not eventually have an effect of rising interest rates anyway because of the amount of money 

that is going to be sucked into the government’s deficit spending 

either domestically or from the international financial market. 

17 

There is also the fact that if the Fed monetizes it, as could happen as well, and as I was suggesting it has already done to a great 

extent, that will start having even more inflationary effects as the 

money starts percolating through the economy. And eventually, as 

people develop inflationary expectations, interest rates will rise 

anyway as they put an inflation premium on the rate of interest. 

So the fact is that it is between a rock and a hard place. 

Mr. HUIZENGA. It is inevitable, is what you are saying? 

Mr. EBELING. But in the long run, the important thing is that 

the government’s budget has to be put under control. And the 

starting point, in my view, is that we do not raise the debt limit. 

We get our financial house in order now and start cutting and 

trimming spending so as to meet our financial obligations, but start 

taking our medicine to get on a sound financial course. 

Mr. HUIZENGA. Dr. Slaughter, would you like to comment on 

that? 

Mr. SLAUGHTER. I agree with many of the previous comments on 

the need for the United States to address both its medium- and 

long-term fiscal challenges. Our fiscal trajectory is completely 

unsustainable. I don’t anticipate getting any Social Security, quite 

frankly. 

Mr. HUIZENGA. I am 42, and I will be shocked if I get any. 

Mr. SLAUGHTER. I am also 42, and my wife is the house accountant. I am the household trash recycling guy, but that is how we 

do it. 

But that said, with no disrespect to anyone here or the broader 

U.S. Congress, I just don’t see how these deep challenges of spending and savings choices both for America overall and for the Federal Government can be addressed, frankly, in the next few days 

or few weeks without having major damage done to the creditworthiness of the United States if it breaches— 

Mr. HUIZENGA. Are you implying that maybe we don’t have the 

political will to go out and do some of the things that we need to 

do? 

Mr. SLAUGHTER. I am saying it is a really complicated set of 

issues and trade-offs that our country faces about what— 

Mr. HUIZENGA. Because I would say I don’t believe we have the 

political will to go out and do what probably most people believe 

we need to do. 

Mr. SLAUGHTER. In which case, I am just very concerned about 

how the policy conversation proceeds and what happens in global 

capital markets. That timetable of global capital markets is not one 

that anyone in the United States controls. 

Mr. HUIZENGA. Would anybody care to comment? 

My time has expired. So thank you, Mr. Chairman. 

Chairman PAUL. The gentleman’s time has expired. And if you 

hang around, we might be able to get some more questions later. 

Now, I recognize the ranking member, Mr. Clay. 

Mr. CLAY. Thank you, Chairman Paul. 

Dr. Ebeling, the President’s deficit reduction commission recommended numerous items of reining in spending. Also, they addressed a fair tax proposal. You have mentioned several times that 

we need to reduce spending. Should some type of tax reform be a 

part of that equation also? 

18 

Mr. EBELING. With all due respect, Congressman Clay, I think 

there needs to be tax reform, but the reform has to be taking the 

longer view—cutting taxes, not raising them. I believe that all 

across the income spectrum, Americans are paying more than 

enough taxes for what government does. 

The fact is, it is not a taxing problem. True, the taxes have fallen 

because of the recession, but it is not a taxing problem. It is a 

spending problem. 

The Congress, the President, too many special interest groups, 

and the general environment of the country have become addicted 

to the idea that the U.S. Government can afford and has the ability 

to hand out more and more largesse to society in general, to various special interest groups, for which the money and the resources 

are not there. 

It is a spending problem, not a taxing problem. You don’t want 

to raise taxes— 

Mr. CLAY. Right. We have— 

Mr. EBELING. —and create disincentives for work, savings, and 

investment, which in the long run doesn’t make the economic pie 

get bigger. If you raise taxes, you slow down the pie’s growth potential. 

Mr. CLAY. You have mentioned the accumulation of U.S. debt 

over the past 3 years. What was the accumulation of the U.S. debt 

over the past decade? 

Mr. EBELING. I am here at one level as someone who is not wearing a political hat. I am an academic economist. That means I try 

to look at the truth. And the Republicans were unbelievably irresponsible. 

As I mentioned in my written testimony, between 2001 and 2008, our national debt doubled from approximately $5 trillion to $10 

trillion. And therefore, they were as responsible, as I think the 

present situation is, with an unwillingness to cut government 

spending to bring this danger to a close. 

Mr. CLAY. Okay. 

Mr. EBELING. So, no. Both hands have a little bit of dirt on them. 

Mr. CLAY. There are no clean hands. You are correct. 

Dr. Slaughter, has the Fed policy of quantitative easing helped 

to improve the economy over the past 18 months? 

Mr. SLAUGHTER. Yes, I think it has. I think both phase one and 

phase two were an attempt to continue to stabilize U.S. and global 

capital markets. I think they largely succeeded in that. 

In particular, quantitative easing two was put into place at a 

time in mid- to late 2010 when there were a number of signs that 

the U.S. economy’s rate of growth was slowing and that the general 

level of prices was coming close to being flat to falling, and so the 

need to try to avoid deflation, which can be very corrosive and as 

the Japanese experience over the past many years has demonstrated can be very difficult to overcome, it was important to 

avoid that outcome. 

That said, as Chairman Bernanke himself said in his press conference recently, the Fed can’t solve all the systematic challenges 

that face the United States, and in particular trying to get economic growth going again and get the job creation and income 

growth that America needs. 

19 

The Fed, simply over the medium- and long-term, can’t create 

those jobs and can’t create those rising incomes. That largely comes 

from the private sector. And so the policy conversations we need to 

have, I think, need to focus on what it is to incite job creation in 

the private sector. 

Mr. CLAY. Earlier this week, Speaker John Boehner offered up 

a $2 trillion cut in exchange for raising the debt ceiling. And with 

the conditions being as they are on Capitol Hill, with a split Senate 

and a House, what is the likelihood of actually resolving this, if we 

have a protracted battle over this, over raising the debt ceiling? Or 

what would be the consequences of it? 

Mr. SLAUGHTER. Again, part of the challenge I would stress is I 

don’t exactly know how and where the consequences will arise. But 

if we miss an interest payment or we miss a principal repayment 

because the United States is not able to re-channel some of the incoming tax revenue away from current spending obligations to 

making good on interest and/or principal payment, it is difficult to 

say how credit rating agencies will respond. 

It is difficult to know what both domestic and foreign creditors 

to the United States, how that might cut back on their demand for 

U.S. Treasuries. 

I would stress again that financial crises by definition are hard 

to know how they arise and hard to know how they develop, so I 

think it is incumbent on people to realize as fragile as the world’s 

financial system and the U.S. economy remain today, going in that 

direction carries great risk. 

Mr. CLAY. Thank you for your responses. 

Mr. Chairman, I am out of time. 

Chairman PAUL. I thank the gentleman. 

I recognize Mr. Luetkemeyer for his 5 minutes. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

I would like to ask a question of Mr. Ebeling, probably, with regards to interest rates and the end of QE2 this summer. What do 

you think is going to happen when we quit absorbing all of our 

debt? Do you think that the rest of the world has enough liquidity 

in it to purchase our debt? And if so, at what interest rate do you 

think would be able to have that done? 

Mr. EBELING. I am not sure if there is enough liquidity in the 

global economy to make up the difference of what the Fed has been 

doing in increasing the money supply to help finance the government borrowing. I think that inevitably when the Fed ends its 

QE2, as it is saying in June formally, that means we are going to 

be relying upon what the financial markets—what the fixed 

amount of funds in the financial markets can do at home and any 

money that might be lent to us from abroad. 

I will be surprised if looking over the next year, the Federal Reserve does not go on a monetary expansionary policy again if we 

don’t start seeing interest rates rise. 

Of course, there could be political crises in other parts of the 

world where everyone runs to the United States as a traditional 

shelter to park their money. But presuming that does not occur, I 

would be very surprised if the Fed does not become accommodative 

again, if interest rates don’t start nudging up. 

20 

It was pointed out earlier by Mr. Slaughter, and I agree with 

him—or I believe it was Mr. Ely—that savings rates have been 

very low in the United States. The fact is, according to the St. 

Louis Federal Reserve in their monthly monetary trend publication, since the last quarter of 2009, when adjusted for inflation, the 

Federal Reserve has pushed interest rates so low, such as the 1- 

year Treasuries and the Federal funds rate, that real interest rates 

are in the negative range, –2 percent. 

It is not surprising, then, that when interest rates in whole are 

so low that you don’t create much of an incentive for people to save. 

The fact is we have to allow the financial markets to tell us how 

much real savings is in the domestic economy and how much of the 

world economy has savings to share with us. And then on that 

basis, we can know what real interest rates should be. 

And the United States, as I say, should cut back, eliminate its 

deficit spending so that the savings that is available, either domestically or from foreign sources, can help the recovery in the United 

States. 

Mr. LUETKEMEYER. Okay. So it is your contention that the Fed, 

in order for us to continue to spend at a deficit level, will have to 

have a QE3? 

Mr. EBELING. Whether they call it that or not, I don’t see how $2 trillion more of borrowing over what amounts to the next yearand-a-half is going to be successfully provided by the global or the 

domestic economy alone. 

Mr. LUETKEMEYER. And if it is provided, it would definitely be 

at a higher interest rate, I would assume. Would you agree with 

that? 

Mr. EBELING. If it is accommodated by the Fed, interest rates 

may temporarily stay low. But as I was suggesting in response to 

an earlier question, the fact is that inflation will start nudging up 

even further, and inflation premium will go on the rate of interest, 

and we will not get away from it. And in addition, the value of the 

dollar will continue to fall on foreign exchange markets. 

Mr. LUETKEMEYER. And there is another problem here as well. 

As interest rates go up, the cost of our monies go up, the deficit 

that we have is going to go up, which means all of the cuts that 

we make, all those stays we make in our budget are going to be 

eaten up by increased interest rates. 

Mr. EBELING. Correct. This is the dilemma that is facing those 

peripheral European countries, as they are called, such as Greece 

and Portugal. On the one hand, they are trying to carry out what 

they call austerity programs, but the international creditors don’t 

have confidence in them, so it is time for them to rollover or pay 

off debt, and the new interest rates are even higher, which immediately reverses or cuts into the attempt to get their budget under 

control. 

Mr. LUETKEMEYER. Okay. Let us leave it at— 

Mr. EBELING. It has to be believable. 

Mr. LUETKEMEYER. I agree with you. 

Mr. ELY. If I could just interject in here— 

Mr. LUETKEMEYER. Yes, sir. 

Mr. ELY. —there are many, myself included, who are concerned 

that interest rates, that nominal interest rates are too low and that 

21 

what may happen is that before we know it, we will start to see 

asset bubbles emerge again and that the Fed will not respond 

quickly enough. And so what we will do is we will get an overshoot 

in terms of rising asset prices. 

Now, that doesn’t seem like much of a concern today, particularly 

when we look at where housing prices are, but in fact the Fed can’t 

turn on a dime, in part because we don’t know in a real-time basis 

what is happening out there in the market. So I— 

Mr. LUETKEMEYER. I have one more quick question, if I can interrupt. 

Mr. ELY. Okay. 

Mr. LUETKEMEYER. Just with regards—I see my time is up. 

Okay. Thank you, Mr. Chairman. 

Chairman PAUL. I thank the gentleman. 

And I recognize the gentlelady from New York, Mrs. Maloney. 

Mrs. MALONEY. Thank you. 

And welcome. I would like to ask each of your perspectives on 

this question: Isn’t it true that the real drivers of U.S. debt are not 

the Federal Reserve’s monetary policy, but fiscal policy decisions 

that we have to face about congressional policy on entitlements, 

taxes, and spending? 

I recognize that there has been controversy surrounding monetary policy decisions like the QE2 program, keeping the Federal 

funds rate at nearly zero percent to access to the Federal Reserve’s 

lending window. But all of these programs are really temporary. 

And once the economy turns around, the Fed will exit from them. 

And so I would like your comment on it. The title of the hearing, 

of course, is about the Federal Reserve policies and the debt ceiling, but I am asking whether you see it as Federal Reserve policies 

or really congressional decisions on spending and fiscal policy. 

Mr. ELY. If I could jump in here, I think it is basically focused 

on fiscal policies. I am not going to blame the Fed for the situation 

that we are in. But this is going to be that tough issue of what do 

we do about fiscal policy. 

I am not in favor of raising taxes. I think the entitlements have 

to be addressed, although I think in the context of tax reform, 

there should be greater incentives in place to not only save, but 

also not to borrow. 

One of the problems we have in the economy is that the Federal 

Government, through the Tax Code, effectively subsidizes borrowing, and borrowing in the private sector did a lot to get us in 

the mess we are in now. But I think the key longer-term focus has 

to be on the spending side, and particularly on entitlements. 

Mrs. MALONEY. Any other comments? 

Mr. SLAUGHTER. I would agree with Mr. Ely. Yes, the debt problem we face today with the debt ceiling has been driven by fiscal 

policy choices, not by monetary policy choices. And again, as they 

go to the medium- and long-term, it is the projected increases in 

Social Security, Medicare, and Medicaid spending that are going to 

present the largest charges to the United States. 

On the tax side, the one thing I would say is I agree raising tax 

rates is not great. When you are raising tax rates on income, that 

creates disincentives for work and effort. But there are a lot of inefficiencies in our Tax Code today. We could raise tax revenues withVerDate Nov 24 2008 17:49 Jun 29, 2011 Jkt 066866 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 K:\DOCS\66866.TXT TERRIE
22 

out raising tax rates with simplifying the Tax Code in a lot of 

ways. 

One example is the mortgage interest deduction. Another example is the tax advantage that is given currently to health care 

spending. The cost of both of those tax advantages in our current 

Tax Code are currently estimated to be north of $200 billion per 

year. 

So as we think about innovative solutions to address these challenges, I think that is one thing to keep in mind is tax reform can 

be a great way to try to incent job creation and a lot of great things 

in the private sector, while also helping address the tax revenue 

challenge. 

Mr. EBELING. It is a fiscal problem fundamentally. In this process, the Federal Reserve has been an accomplice during the fact in 

the sense that it has supplied the money to fund a lot of what the 

government has been borrowing. 

But the bottom line is the burden is here in the House of Representatives, in the Senate, and in the White House. You are the 

ones who have the authority to tax. You are the ones who also 

have, more importantly, the authority to spend. And it is the 

spending side more than anything else that has to be handled. 

This gap between revenues and expenditures, this deficit each 

year, has to do with the fact that you are promising the American 

people, in entitlements or other current annual expenditures, more 

than the economy is generating in the tax revenues, given the code 

that you have, and the economy’s ability to generate wealth in the 

long run. 

So the fact is it is a fiscal problem. And as I have suggested, the 

bottom line is—there is nothing wrong with, obviously, introducing 

efficiencies in the Tax Code in principle, depending upon the content and the specific character of it—but the bottom line is it is the 

spending that is out of control, not the taxing. 

Chairman PAUL. I thank the gentlelady. 

I recognize Mr. Schweikert, from Arizona. 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. 

A slightly different question and what I have been trying to 

watch, as we go through this summer, and let us assume that we 

will call it quantitative easing goes into an unwind. Japan, being 

what, they hold about 20 percent of our foreign-held U.S. sovereign 

debt, has to do some unwind there to pay for infrastructure. Some 

of the tells coming out of China are true that they intend to do 

more moving of foreign reserves into commodity or commoditybased currency. 

What happens at the end of the summer if we were to go just 

raise the debt ceiling, not having a series of triggers and mechanics 

and tells to the market that we are serious about this explosion of 

U.S. sovereign debt, and at the same time the very people who 

have been buying and financing our debt are not as big a participant in the market? 

First, am I being realistic? Am I just being a ‘‘Chicken Little?’’ 

And if there is any truth in that scenario, what happens to interest 

rates on our debt? Anyone who wants to answer? 

Mr. SLAUGHTER. That kind of scenario is eminently plausible. 

Again, there are a lot of investors around the world that hold U.S. 

23 

Treasuries today for a lot of complicated reasons, but they have a 

lot of other assets that they can choose from. That is true for the 

government-related entities, the central banks, and some fiscal authorities, but also the private savers in other countries as well, sovereign wealth funds, individual pension funds, things like that. 

So their demand for Treasuries would depend, as you rightly say, 

a lot on whether they perceive the United States leadership as 

credibly addressing the fiscal challenges we face. So the sooner that 

we can credibly signal to our creditors that we are on that, the less 

likely it is that bond rates in the United States will go up with 

damages to the United States. 

And the one thing I would add is I am struck at the heterogeneity in opinions that you see out there from a lot of the key investors in asset markets. To single out one particular gentleman, 

Bill Gross, head of PIMCO, publicly announced in the past couple 

of months that a lot of their key bond funds have totally divested 

of U.S. Treasuries. 

Mr. SCHWEIKERT. And just a little bit of trivia on that, if you noticed their latest disclosure, they have actually increased their 

hedge again. They are basically hedging on the downturn. 

Mr. SLAUGHTER. Yes, so that uncertainty, I think, is symptomatic 

of why I would urge caution and prudence on all these fiscal 

things, but especially get on not breaking the debt ceiling. 

Mr. ELY. The key thing is that what you are suggesting and 

what is implied in your question is that there will be reduced demand for Treasuries from outside the United States. That has to 

have an upward effect on Treasury rates. And given the fact that 

we have so much in the way of short-term and medium-term Treasury debt outstanding, that starts to bite pretty quickly in terms of 

higher interest costs. So we are in a very dicey situation. 

Mr. SCHWEIKERT. Mr., is it pronounced ‘‘Ely?’’ 

Mr. ELY. ‘‘Ely.’’ 

Mr. SCHWEIKERT. ‘‘Ely,’’ like the coffee? 

Mr. ELY. Yes. 

Mr. SCHWEIKERT. Okay. Are we also under a common understanding that our WAM is what, about 4.25 years? 

Mr. ELY. I am not sure what it is right now. It has shortened 

up, I know, and, of course, the shorter the weighted average maturity of the debt, the sooner an increase in rates is going to whack 

the Federal budget. 

Mr. SCHWEIKERT. It makes us very interest rate sensitive, which 

is— 

Mr. ELY. Yes, it is. It is increasingly interest rate sensitive because of the shortening up. In fact, it is a very significant question 

as whether or not Treasury has properly managed debt, our Federal debt, so it is actually extend the maturity during this time of 

historically low interest rates. 

Mr. SCHWEIKERT. You are actually hitting one of the things I was 

going to pitch at the end is maybe we should also in this environment, even though the outer end of the curve is a little bit steeper, 

but maybe we really need to start pushing out our maturities to 

insulate ourselves from shock. 

Mr. ELY. I would agree, and actually we have gone the wrong 

way. 

24 

Mr. SCHWEIKERT. I want to pounce on just my scenario. Am I 

pitching a doomsday scenario? Am I pitching just a realist’s on 

what essentially will drive up our interest rate? 

Mr. ELY. In my opinion, your scenario is very realistic. 

Mr. EBELING. I don’t think it is unrealistic. I think the very 

points that you raise—the Japanese are going to have a huge financial cost to rebuild the destruction from the earthquake and the 

tsunami. The Chinese might very well lose their taste or their desire for U.S. Government securities. There is the question of the 

amount of savings to come into the United States to fund U.S. 

Treasuries, given the financial crisis in the European Union. 

All of these things are creating serious problems looking over 

this year. But I think that this concern about what is the signal 

or the message that foreign creditors, either the private sector or 

others, sovereign wealth funds, for example, will read from this. 

What will they read from it if you raise the debt limit by, for ex- ample, Secretary Geithner’s request of $2 trillion, and this basically puts aside virtually any debate, discussion or decision about 

what to do for the budget between now and the next election 

cycle—that is, to 2013—and the uncertainty, to be honest, who is 

going to be the next President of the United States? Will it be the 

continuing current President or someone else? 

Mr. SCHWEIKERT. Doctor— 

Mr. EBELING. That will create a huge amount of further uncertainty on the financial markets and hesitancy about maintaining 

the value of the dollar in those markets. 

Mr. SCHWEIKERT. Thank you. 

And, Mr. Chairman, I know I am out of time, but one interesting 

conversation, I spent a couple of days in New York—actually, Monday and Tuesday—and I had a couple of folks who are huge buyers, 

are marketers in U.S. sovereign debt issues. And they said, ‘‘Look, 

we are going to punish you if you go and raise the debt ceiling and 

don’t communicate to the markets that you are taking this seriously.’’ 

And every single point is what, $100+ billion bleeding. So even 

just moving back to normalized interest rates is devastatingly ugly 

to this budget. Thank you, Mr. Chairman. 

Chairman PAUL. I thank the gentleman. And we will have a 

chance for a follow-up, if you care to stay. 

I have a follow-up. I want to talk a little bit more about the consequences of not raising the debt limit. And I think even Dr. 

Slaughter admitted that he is not exactly sure—it wouldn’t be 

good, but not precisely sure exactly what will happen, because it 

is unknown territory. 

The question I have, Dr. Slaughter, is how do you answer the argument that others say why don’t we, Treasury, just use priorities, 

pay the most important bills, pay the debt? Does that raise a lot 

of questions about our credit rating, if we always honored the commitment to pay the interest? 

And, of course, we would still have a problem. We would have 

to pay our other bills slower. But wouldn’t that protect the integrity of the credit? 

Mr. SLAUGHTER. So that has a couple of costs, I think. One important cost is you are implicitly turning into creditors, involunVerDate Nov 24 2008 17:49 Jun 29, 2011 Jkt 066866 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 K:\DOCS\66866.TXT TERRIE
25 

tarily, Social Security recipients or government contractors. They 

are being made unwanted creditors to the U.S. Government to 

make good on outstanding— 

Chairman PAUL. Maybe farm subsidies. 

Mr. SLAUGHTER. Whatever it is, but the principle that I think a 

lot of holders of Treasuries look at is a sudden, on-the-fly change 

in priority of payments by the U.S. Government. That is going to 

introduce uncertainty and risk. 

And I am not a legislative expert, but I just don’t know. My understanding from what I have read up to learn about this is we 

simply don’t have a set of rules and laws or executive orders in 

place to prioritize payments coming out of the U.S. Treasury when 

there isn’t any existing law or regulatory structure in place to 

make those priorities— 

Chairman PAUL. But okay, let us assume they can do it and they 

always honored the commitment to pay it. Would that mean that 

it would be less drastic than you anticipate? Wouldn’t that soften 

the concern, if you knew that they put it into a form of a law and 

they said that you could do it? Would that soften your concern? 

Mr. SLAUGHTER. No, not necessarily. The other issue I want to 

raise is the economic concern—again, the fragility of the recovery 

right now. 

If we are talking about truly not raising the debt ceiling at all, 

the implied fiscal contraction that would come in the coming 

months from that, without offsetting policy support for economic 

growth of the private sector, so things like trade liberalization and 

other things, would have a very bad impact on jobs and the labor 

market in the broader U.S. economy. 

Chairman PAUL. A concern I have sometimes is the crisis is very 

often overblown. In 2008, it was a major crisis. We didn’t do it. We 

are going to have a grand depression. 

But what we did was we had TARP funds and we had the Federal Reserve pumping trillions, and everybody said, ‘‘See? We saved 

ourselves from a depression.’’ Maybe Wall Street didn’t get their 

depression, but the people got the depression. They lost their jobs 

and they lost their houses. 

So I can’t see how ringing the alarm bells and doing it just because something terrible might happen—maybe doing it will make 

things worse. And I think what we are doing will eventually make 

it worse. You had another comment on it? 

Mr. SLAUGHTER. I guess my concern is I would express again the 

unknowability of how capital markets are going to react to a breach 

of our debt ceiling. 

And I would stress again part of the challenge in the fall of 2008 

was how quickly the crisis with Lehman Brothers and AIG and 

capital markets metastasized to the General Electrics and other 

firms that were not able to rollover their commercial paper. And 

we were looking at layoffs several million more potentially than 

what we actually saw. 

Chairman PAUL. But we don’t know. It might even boost confidence to say, ‘‘Hey, they are going to get their house in order.’’ 

It might even give more integrity to the dollar, and then we 

wouldn’t have the crashing dollar. 

Bert? 

26 

Mr. ELY. If I could just add something to that, there has been 

this discussion of we will pay the interest, but not repay the principal. In effect, what that is is a forced rollover of the debt. 

Now, if you take Treasury bills, bills get paid off because the government sells new bills. If you say, ‘‘Okay, we are not going to pay 

off the bills as they are maturing,’’ effectively, that has the same 

cash flow effect for the Federal Government as paying them off and 

rolling them over. So nothing is gained, in my opinion, by delaying 

the payment of maturing debt. 

But the effect of paying on the markets, of not paying off maturing debt I think would be catastrophic, because people, particularly 

institutional investors, have cash flow programs that are based on 

known maturity dates for their debt. 

If they don’t get it, it may actually cause severe financial problems in some circumstances, but certainly really rattle the market. 

So I think one option that is, as a practical matter, not on the table 

is not paying debt as it matures. 

Chairman PAUL. Of course, the other side of the argument is 

what we are looking at is something even more catastrophic with 

an inflationary blow-off, and that can be very, very tragic. 

Dr. Ebeling, did you want to make a comment on that? 

Mr. EBELING. I do. I think that the soundest policy, the one that 

would send the right signals to our international creditors, to set 

a tone in the United States, is precisely to say we will meet our 

financial obligations as interest and securities become due and that 

we are going to adjust our domestic spending to assure that. 

The fact is, obviously, nobody wants their ox to be gored while 

others don’t. But it seems to me that if we had the political will, 

which means the Members of the Congress make these decisions, 

to say that we are going to meet our financial obligations on the 

debt as they come due, but we are going to be reducing spending 

across the board by 5, 10 percent to see that it is covered without 

getting an increase in the debt limit, certainly, that sends the right 

signals internationally. 

And it makes every American realize that nobody is getting a cut 

that they are not—well, that another person is, and that everyone 

has to bear the burden of this precisely because the promises have 

been greater than the tax structure and the economy can sustain. 

I think that if it is across-the-board, it is very difficult to say that 

someone is getting something of a deeper cut or burden compared 

to someone else. 

That requires political commitment and willingness to do it as 

well, but what else are you going to do? Do you want to be in this 

situation, maybe not today? You could raise the debt limit. You 

could put it off 2, 3, 4 years. But do you want to be put in the position in our own circumstances of a Greece or a Portugal? Eventually, you cannot keep this going. 

Chairman PAUL. Right. My time has expired. 

Now I am going to recognize the gentleman, Mr. Luetkemeyer, 

from Missouri. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

The reason for my question a while ago was we had a discussion 

with Chairman Bernanke in this committee at one point, and, obviVerDate Nov 24 2008 17:49 Jun 29, 2011 Jkt 066866 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\66866.TXT TERRIE
27 

ously, you gentleman answered the question the opposite of the 

way he did, which is not surprising. 

Another question for you with regards to the discussion we had 

with him with regards to the Fed and their policy, he made the 

point during the discussion that with QE2, look at how great the 

stock market is. It has all gone up. 

And my concern is, I am not sure you can use the stock market 

as an indication of the strength of the economy, when you are looking at 9 percent unemployment. 

Can you tell me the relationship between the stock market and 

our economy, the jobs, Fed policy? Can you kind of put it into—that 

is a broad thing to talk about in just a 30-second sound bite, but 

it would seem to me that I think the stock market is an institute 

unto itself. It is a daily reaction to what is going on in the world 

versus a long-term thought process or process on long-term thinking about really where our economy is going. 

Would you care to comment or give me some thoughts on it? And 

we will go right down the line. I would like to have everybody’s 

comment. 

Mr. EBELING. I think that what we have seen for the last 21⁄2

years with this huge run-up in the stock market has basically been 

due to Fed policy. It is not due to anything of a natural and normal 

recovery in the economy, which has been delayed by, as I also mentioned in my written remarks, regime uncertainty. 

The fact is the economy was thrown out of the severe imbalance 

due to the monetary expansion and interest rate manipulations of 

the bubble years from 2002 to 2007. And it is necessary for these 

misallocations of resources, investment mistakes, to sort themselves out. 

But the fact is that instead of allowing the market to properly 

correct, the Fed bought up these mortgage-backed securities and 

distorted the housing market. What are houses worth? Nobody 

knows. We think they are at the bottom. But what do we know 

about the real supply and demand? 

So there is uncertainty in the housing market. This has affected 

the construction industry. The fact is the ones who have benefited 

are some people in the stock market and in the financial market. 

If you break down the government statistics that have been coming out every month about GDP and employment figures to sectors 

of the economy, as 2008 and 2009 rolled on, you saw falling employment in virtually every sector of the economy except the one. 

If you look at the little sectoral breakdowns, that was the financial 

market. 

It seems that no one from the top to the teller in the retail bank 

office lost their job. And that is because the Fed basically bolstered 

the financial market for their bad decisions, which they felt confident would be bolstered because of expected bailouts. And it has 

fallen upon the rest of the economy while the economy has not been 

left alone to properly adjust. 

Mr. LUETKEMEYER. Thank you. 

Mr. Ely? 

Mr. ELY. The stock market is based on—and values in the stock 

market are based, as much as anything else, on expectations. What 

are future earnings going to be and future dividend levels? And so 

28 

the market tends to be a leading indicator in a crude way of where 

the economy is going. 

But the market doesn’t always get it right. It tends to undershoot 

and overshoot. And the real question is, how has the market gotten 

ahead of itself, given some of the factors that you pointed out, such 

as the very high unemployment rate? 

Ultimately, the stock market has to reflect the real economy, and 

the fact is we have a weak economy. The unemployment rate is 

still at very high levels. We are running these huge deficits, as we 

have been talking about here. So it may be a situation where the 

market is ahead of itself, and that is why I don’t think we ought 

to place too much emphasis on where the market is and focus more 

on what is happening in the real economy. 

Mr. SLAUGHTER. That is a great question. There is a positive effect from stock market valuations to the broader economic performance, but it is not lockstep, and it is not what drives economic performance overall. 

You can look at the balance sheets of households. Only about half 

of households own any equities directly or indirectly. And for the 

median household, the single biggest asset on its balance sheet is 

the equity it may have in its home. The home prices matter a lot 

more for the typical family. And for income statements for most 

households, it is to have a job and what is their earnings for that 

job. 

If you look at the recovery, a lot of the publicly traded companies, a lot of them, the revenue growth such as they are realizing, 

if any, is coming from outside the United States. It is the Caterpillars and the Deeres and companies like that reporting huge revenue growth around the world, especially in emerging markets. 

So I think the challenge that you rightly point to is how can we 

get job creation in America? We need it from all kinds of companies 

now, U.S.-based and foreign-based. We need it from big and little 

companies, but creating jobs linked especially to exports and investment opportunities around the world, not as much as we have 

been discussing, the things like consumption spending in the 

United States. 

But if you look at—that comes back to, in part, the fiscal conversations we are having in this hearing. If you look at recent surveys of small business owners in the NFIB, the single biggest problem that a lot of these firms cite is there is some combination of 

poor sales, but also government uncertainty, uncertainty over tax 

rates and government regulation. 

Mr. LUETKEMEYER. Okay. I see my time is up, but I want to 

thank you gentlemen for being here. 

It seems as though there is an underlying theme through all of 

this, and it is confidence in the ability to get our economy going. 

It is confidence in the ability of the Fed to manage. It is confidence 

in the ability of financial institutions to work back and forth and 

believe that they are going to be able to get their money back when 

invested. 

As somebody in the financial industry, the whole thing is held together by confidence, believing that we can do business with each 

other and be able to get our money back. I think we have a huge 

confidence problem right now. 

29 

Thank you, gentlemen. 

Thank you, Mr. Chairman. 

Chairman PAUL. Thank you. 

I now recognize the gentleman from Arizona, Mr. Schweikert. 

Mr. SCHWEIKERT. I love this, where I can get another question 

this quickly, Mr. Chairman. 

Back in sort of the circle I was trying to—and I appreciate you 

indulging me, because I have been trying to get my head wrapped 

around some of this—how much of a benefit do you believe we have 

had? Because I am looking at the short end of our interest rate 

curve right now and we basically have free money. And if you look 

at also throw a little inflation on top of that, it is almost people 

are giving us money and almost taking a hit on it. 

How much of that, though, is because of the world situation 

around us? With turmoil in the Middle East, is there a flight of 

capital? I read stories about how much capital is actually leaving 

countries like Russia, even the things we have seen in the EU. Are 

we just really lucky right now? Let us start from Doctor—yes, no? 

Mr. EBELING. I think there has been a degree of luck. You might 

have read in the press like I did that the Russian government is 

thinking of imposing more export controls on capital leaving the 

country, precisely because people earn money in the Russian economy from resources and raw materials, etc., and then they also 

want to park their money outside of Russia. That is very much the 

case, yes. 

Mr. ELY. But I, whether or not it is lucky is a matter of where 

you sit. If you are a saver, if you are a senior citizen, you are getting killed from an income standpoint by these very low interest 

rates. And for people in their working years, what is the incentive 

to save when you go to a bank and maybe it was 75 basis points 

or a percent on your CDs? 

So for the debtor, these low rates are a great idea and a great 

benefit, but for the creditors, who are as much owed as is owned, 

they are really taking a beating on this. And it looks like it is going 

to continue for a while. So again, a matter of whether we are lucky 

depends so much on where you sit. 

Mr. SCHWEIKERT. Understood. When I ask that question, I am 

actually asking for a series of my concerns of what happens when 

we start to get real pricing of risk. 

Mr. Slaughter? 

Mr. SLAUGHTER. You are definitely right that if you look at the 

fall of 2008, despite the crisis that we are having here in America, 

demand for Treasuries surged in part because of the fear and uncertainty about some of the other countries at the financial crisis 

there and what was happening to their sovereign debtors. 

And so I think you hit upon an important point, which is our fiscal conversations we need to increasingly see in a global context. 

It is not just what we do here. There is a limited pool of savings 

in the global economy, and where those savers choose to allocate 

what assets they want to buy of U.S. Treasuries relative to other 

assets in the world, it is not just what we do, it is what other countries are doing. 

And to the extent that if they can continue to make progress— 

the U.K. is having some serious fiscal conversations today and how 

30 

that plays out, I think, will be very instructive for our country— 

the more other countries are able to address their fiscal challenges 

and we aren’t, that compounds the problems that we have been 

talking about today. 

Mr. SCHWEIKERT. Okay. And, Mr. Chairman, Dr. Slaughter, my 

understanding, and you shared with me over the last 12 months, 

or 11 months as it may be, the Fed has consumed what percentage 

and how much of U.S. sovereign debt issue? 

Mr. SLAUGHTER. Meaning of the United States? 

Mr. SCHWEIKERT. Yes. 

Mr. SLAUGHTER. One of my fellow panelists may know the numbers better than me, but it is a pretty high fraction of the net new 

debt that Treasury has issued—has a net been bought by the Fed. 

Mr. SCHWEIKERT. Is it close to 80? What percentage of new 

issuances have been financed through the Fed? 

Mr. EBELING. The figure that I found was that just U.S. Treasuries, they have bought about $1.2 trillion. 

Mr. SCHWEIKERT. Okay. What percentage of all issuance is that? 

Mr. EBELING. The total issuance of debt, let us say, since 2007– 

2008, has been an additional 3.6— 

Mr. SCHWEIKERT. I am just trying to do the QE2 math in my 

head. 

Mr. ELY. Can I interject something here? When you talk about 

how much the Fed’s Treasury holdings have increased, that is only 

looking at one side of the equation. The other side is, where did the 

Fed get the funds to buy those Treasuries? 

And where they have come from is basically a tremendous in- crease in the funds, up to now roughly $1.5 trillion, that banks 

have on deposit in the Fed. So then, arguably, it is the banking industry through the Fed that has financed much of the increase that 

we have seen in outstanding Federal debt. The Fed is just kind of 

a middleman. 

Mr. SCHWEIKERT. Mr. Chairman, Mr. Slaughter, isn’t this sort of 

right, because in many ways you just closed the circle, because I 

was going to make the argument that the Fed is a huge, huge 

buyer of new issuances. They are not as interest rate sensitive, 

where your banks may say, ‘‘Look, I am not going to buy this. I am 

going to buy an agency product.’’ And is that one of the things that 

has helped push down these interest rates in the short term of the 

curve? 

Mr. SLAUGHTER. So, again, I had stressed for many, many years, 

the Fed on its balance sheet, a sizable fraction of its total assets 

have been Treasury securities at different maturities. That has 

been in part because of the liquidity and transparency of Treasury 

markets. They value being able to conduct monetary policy in their 

open market operation. 

So I think the larger challenge for the United States you have 

hit upon, which is it is the demand from other savers in the United 

States and, importantly, demand from the rest of the world for U.S. 

Treasuries that increasingly will shape what happens with interest 

rates that we have to pay as a country. 

Mr. ELY. And if I could add to that, and the reason that will be 

the case that other foreign countries, foreign investors become more 

important is because the United States continues to get deeper into 

31 

debt to the rest of the world. And so as an economy as a whole, 

we are sucking in more and more of the world’s savings. 

Just imagine that the United States was not in that debtor position. In effect, we would owe the money to ourselves in terms of 

the economy as a whole. But we are in hock to the rest of the 

world, ultimately, because of our low savings rate in this country 

that has led to this $3 trillion-plus net debtor position that we 

have. 

Mr. EBELING. If I can add just one more point here, there is a 

bit of a musical chairs situation here. The Fed goes in and buys 

up all of these Treasury securities and mortgage-backed securities 

out of bank portfolios. Then they pay these banks an interest rate 

higher than market rates to park the money that they have created 

with the Federal Reserve. 

It still ends up being money that the Federal Reserve created out 

of thin air. It may have this appearance on the ledger book, assets 

and liabilities— 

Mr. SCHWEIKERT. It is a three-legged— 

Mr. EBELING. It is still funny money. 

Mr. SCHWEIKERT. It is a three-legged stool, where there is a premium paid within it, Mr. Slaughter. 

And thank you for tolerating my rambling, Mr. Chairman. 

Mr. SLAUGHTER. I was just going to echo Mr. Ely’s insight. Japan 

is a good example. Japan’s debt outstanding as a share of GDP is 

now approaching 200 percent. A major reason we have not had an 

international financial crisis related to the yen is because the large 

majority of that debt outstanding is held by Japanese households 

due to their high savings rate. 

Mr. SCHWEIKERT. The internal, yes. 

My last statement, and I will share this with you, Mr. Chairman, 

because you and I have had this conversation on the side, is one 

of my great, great fears is with the Fed intervention in U.S. sovereign debt and some of the other mechanics out there, we have no 

real pricing for risk. 

We are approaching a debt ceiling. We are approaching a lot of 

these untenable numbers, but yet the old days when we used to 

look at bond futures and say, ‘‘The market is starting to price risk,’’ 

in many ways the Fed’s actions now, it is hard to know what is reality in the market anymore. Thank you, Mr. Chairman. 

Chairman PAUL. And I thank the gentleman. 

This hearing is now finished. The Chair notes that some members may have additional questions for this panel, which they may 

wish to submit in writing. Without objection, the hearing record 

will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. 

[Whereupon, at 11:40 a.m., the hearing was adjourned.] 

(33) 

A P P E N D I X 

May 11, 2011 

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