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Can the Treasury Department really run out of money?

Probably not, because the Federal Reserve would probably not bounce a check from Treasury. But that might violate the debt ceiling.

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In truth, the Obama administration is either fibbing or misunderstanding the financial system. The United States almost certainly enjoys unlimited overdraft protection from the Federal Reserve because there is almost zero chance the Federal Reserve would ever bounce a check written by the U.S. government.

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Think about it. The check comes into the Federal Reserve. It looks at the U.S. government balance and discovers that we’re at zero. What does the Federal Reserve do?

I’m pretty sure the Federal Reserve would go ahead and credit the bank submitting the check with the deposit to account for the fund transfer.

Legally, this is a bit murky. It’s not clear that the Federal Reserve would be required to clear a check that exceeded the amount on deposit. It may be within its authority to reject the check.

But rejecting a check written by the government of the United States would probably violate the dual mandate of the Fed to pursue maximum employment and price stability. A U.S. government that bounced checks would just introduce so much chaos the Fed would likely be obligated by its core mandates to credit the check.

This leads to the next question: Would having the Fed credit the account of a bank that presented a check on the U.S. Treasury Department's empty account amount the incurrence of new debt in violation of the debt ceiling?

The law is not exactly clear on this point. The debt ceiling applies to the face amount of obligations issued under Chapter 31 of Title 31 of the U.S. Code—basically, Treasury notes and bills and the other standard kinds of government debt—and the “face amount of obligations whose principal and interest are guaranteed by the United States Government.” But overdrafts on the Federal Reserve wouldn’t be Treasurys and they aren’t explicitly guaranteed by the U.S. government.

They’re more like unilateral gifts from the Fed.

And guess what? The Treasury is allowed to accept gifts that “reduce the public debt.” Since these overdraft gifts from the Fed would allow the government to spend without incurring additional debt, it seems very plausible to argue that this kind of extension of U.S. credit would be permitted under the debt ceiling.

Notice that this would do something very odd. It would give the U.S. Treasury Department control of the money supply—something usually credited to the Fed. But by writing checks on an empty bank account, the Treasury would be inflating the money supply. It would be printing money to pay its bills, more or less. Monetizing its obligations, rather than borrowing or taxing to pay them.

In order to keep inflation under control, the Fed would have to intervene to soak up the extra dollars by selling securities.

Here’s how Peter Morici, the former chief economist at the U.S. International Trade Commission, describes it:

Now, the Treasury could print money to pay its bills, and the Fed could soak up the excess liquidity by selling its Treasury holdings. Between the Fed’s holdings of Treasurys, and Fannie Mae and Freddie Mac bonds and other securities held by the Fed, this drill could keep the government going and all creditors paid for another 18 months.

So the Treasury cannot actually run out of money. It can only run out if it decides—that is, if Secretary Geithner and President Barack Obama choose—to stop writing checks sufficient to pay all of our obligations.