What I Learned: How The U.S. Fed Views Its Deficit and How Bitcoin Relates
A new Fed paper reveals the growing tension between government spending and decentralized alternatives
Hi everyone,
I hope you're all having a great weekend. One interesting thing caught my eye this week surrounding a paper published by the Federal Reserve Bank of Minneapolis. The paper discusses the feasibility of the government operating under a long term deficit and how banning bitcoin could help this.
Can The Government Operate Under Permanent Primary Deficits?
On October 17th, the Federal Reserve Bank of Minneapolis published a 40-page working paper discussing whether or not it's possible for the federal government to run under a long-term permanent primary deficit.
Setting aside the complex math and economics jargon in the paper, the authors essentially argue that in a world without bitcoin, or similar assets, the government could, in theory, operate permanently under a deficit.
In other words, the government simply stops trying to maintain a reasonable and acceptable level of spending over the long term, and instead opts to permanently fund its operations through debt.
Whether explicitly stated or not, based on the rate of increase in government debt over the last 100 years, this does appear to be the status quo.
The upcoming U.S. election between Harris and Trump is unlikely to be a departure from the current trend. According to the Committee for a Responsible Federal Budget, both candidates are likely to add to the current debt between $3-8 trillion over their respective terms.
The issue raised by the authors, however, and what makes the piece particularly interesting to me, is the acceptance that in a world where bitcoin or similar assets exist, this approach becomes impossible over the long term.
A Simple Explanation
The government needs money to pay for things like roads, schools, the military, etc. If the government does not collect enough money in taxes to pay for these things, it will need to either print more money or take on debt by issuing bonds. Usually, it's a combination of both.
Focusing on the sale of bonds, here is the key point: If people believe the government will be able to pay them back in the future, they will be happy to buy bonds since, in return for lending the government money, they get a bit more money back in the form of interest. It's a win-win. The government gets immediate cash, and people get a safe way to store wealth.
But, if people don't believe the government will be able to pay them back, they might choose to store their wealth in alternative places, like bitcoin.
In this scenario, the government would no longer be able to raise cash through the sale of bonds and would instead be required to "balance the budget" - or in other words, reduce their spending.
Why it's interesting
Keep in mind the above explanation is a gross simplification. There are other considerations such as raising taxes higher or printing money. But what's significant about the paper is that the authors conclude that at some point, in order to continue operating in a deficit, the government would need to either impose a tax on using or holding bitcoin, or ban it altogether.
There are several issues with this conclusion that have people upset. The first is that bitcoin is not the only alternative asset class. Individuals and organizations could choose to store their wealth in other currencies or gold, for example. The second issue is the feasibility of banning bitcoin. In 2024, cryptocurrencies, particularly bitcoin, are already well established as an asset class. BlackRock's bitcoin ETF, launched at the beginning of the year, is already a $30 billion fund, as of November 2024. Banning the asset would be not only draconian, but a step backwards from the current direction. Furthermore, the bitcoin network of users is global, and it could be argued that the qualities of bitcoin in fact favour its use in developing markets rather than those already considered developed. A successful bitcoin ban in the United States, therefore, may indeed slow its adoption but is unlikely to curb it entirely, and thus be unlikely to be enforceable over the long term.
Third, and perhaps most interesting to me, is what this says about the mindset of many modern economists and politicians. Instead of considering the possibility that government spending and debt might be in a state of overreach, they instead immediately point to wealth storage and investment alternatives and essentially blame them for the problem.
Instead of viewing bitcoin as a threat to government fiscal policy, perhaps it should be seen as a signal that the current approach to government spending needs reassessment. The mere fact that individuals and institutions are seeking alternatives to government bonds suggests a growing concern about the sustainability of perpetual deficit spending.
As we move forward, the key question might not be how to maintain the ability to run permanent deficits, but rather how to create a more sustainable fiscal system that doesn't require such extreme measures. The rise of bitcoin and other alternative assets might just be the wake-up call needed to spark this important conversation.