In a real sense, the American government has pursued a policy of debt monetization ever since it began efforts of quantitative easing earlier last year. The Federal Reserve was buying up government debt with cash that had freshly rolled off the printing presses, but the U.S. is loath to dub its efforts as debt monetization. Luckily for it, even as a second round of quantitative easing looms large (and it is very likely to happen), the U.S. has not been dubbed as attempting to pursue a policy of debt monetization. That’s because if their efforts were labeled as debt monetization, there would be no foreseeable manner in which anyone would accept the rock-bottom treasury yields on offer today.
Conversely, the fed is labeling the U.S. as a safe haven for investments. One plausible explanation for this is that investors perhaps see quantitative easing as a temporary attempt to strengthen the U.S economy that has been savaged by the aftereffects of the economic crisis that has gripped the globe. Once these efforts have achieved their avowed aims, a policy of fiscal and monetary austerity and sustainability can be pursued so as to preserve the purchasing power that the Treasury now holds.
But does it truly matter if we label these efforts as debt monetization or quantitative easing? Perhaps debt monetization is even the preferable option, especially when you compare it to the alternative; serious deflation and a double-dip recession. The latter will give rise to several other ailments, such as a drop in the tax revenues raked in by the government and this will make servicing any and all debts that much harder. It is perhaps just a matter of being picky with the terms chosen, but the one certainty is that debt monetization is a tricky slope that is slippery and perilous.
From a historical perspective, the west has always seen monetary authorities being kept independent from fiscal authorities. This does not allow a government to fully finance itself and if the government then has a fiscal deficit to face up to. It can only manage this then by borrowing from the debt market. This makes the government accountable and disciplinary action can be taken if spending spirals out of control. It is a bit odd then to see the Federal Reserve and the Treasury have been hand in glove since around 2007 and the line dividing the fed’s policies and fiscal policy has been blurred, rather unfortunately.
China, the single largest creditor on the books of the United States, was already grumbling when the first round of quantitative easing was undertaken, so it is easily assumed that they will not look at a second round of quantitative easing with much glee. The monetization of government debt is not something Beijing will look upon kindly and the full-blown consequences of being dubbed a debt monetizer are quite severe.
The most obvious one is the offloading of government debt and the fed would become the only lender to the U.S government, a dangerous scenario to be in. That would dilute the value of the U.S. dollar and also erode purchasing power of all dollar-holders. The domino effect will be manifested in a lowered standard of living, lower imports, and perhaps the loss of its status as a reserve currency. The U.S. needs to do all it can to avoid going down this slippery slope, and the time for action is now.