Reinhart-Rogoff One More Time: Why the 90 Percent Never Should Have Been Taken Seriously by Dean Baker

In effect, Reinhart and Rogoff were making the same sort of claim about debt and GDP. Let me try to explain this in a way that even an economist can understand it. 

I have often pointed out that the value of long-term debt fluctuates with the interest rate. I didn't think this is a secret, but apparently few economists have followed what happens to bond prices when interest rates change. The point is that the value of our debt will plummet if interest rates rise, as the Congressional Budget Office and other forecasters expect. This means that we could buy back long-term debt issued today at interest rates of less than 2.0 percent for discounts of 30-40 percent. This would sharply reduce our debt-to-GDP ratio at zero cost.

Yes, this is really stupid, but if you believed the Reinhart-Rogoff 90 percent debt cliff, then you believe that we can sharply raise growth rates by buying back long-term bonds at a discount. It's logic folks, it's not a debatable point -- think it through until you understand it.

So, interest rates rise. A 30-year Treasury loses value, going from 2 percent interest to 5 percent interest, and from the price of 188 to 115. What happens when the Fed buys the debt back?

Is it an open market operation?

http://en.wikipedia.org/wiki/Open_market_operations

Since most money now exists in the form of electronic records rather than in the form of paper, open market operations are conducted simply by electronically increasing or decreasing (crediting or debiting) the amount of base money that a bank has in its reserve account at the central bank. 

...

In the United States, as of 2006, the Federal Reserve sets an interest rate target for the Federal funds (overnight bank reserves) market. When the actual Federal funds rate is higher than the target, the New York Reserve Bank will usually increase the money supply via a repo (effectively borrowing from the dealers' perspective; lending for the Reserve Bank). When the actual Federal funds rate is less than the target, the Bank will usually decrease the money supply via a reverse repo (effectively lending from the dealers' perspective; borrowing for the Reserve Bank). 

In the U.S., the Federal Reserve most commonly uses overnight repurchase agreements (repos) to temporarily create money, or reverse repos to temporarily destroy money, which offset temporary changes in the level of bank reserves.[4] The Federal Reserve also makes outright purchases and sales of securities through the System Open Market Account (SOMA) with its manager over the Trading Desk at the New York Reserve Bank. The trade of securities in the SOMA changes the balance of bank reserves, which also affects short term interest rates. The SOMA manager is responsible for trades that result in a short term interest rate near the target rate set by the Federal Open Market Committee (FOMC), or create money by the outright purchase of securities.[5] More rarely will it permanently destroy money by the outright sale of securities. These trades are made with a group of about 22 (currently 18 as an immediate aftermath of 08/09 credit crisis) banks or bond dealers that are called primary dealers. 

Money is created or destroyed by changing the reserve account of the bank with the Federal Reserve. The Federal Reserve has conducted open market operations in this manner since the 1920s, through the Open Market Desk at the Federal Reserve Bank of New York, under the direction of the Federal Open Market Committee. The open market operation is also a means through which inflation can be controlled because when treasury bills are sold to commercial banks these banks can no longer give out loans to the public for the period and therefore money is being reduced from circulation.

 http://en.wikipedia.org/wiki/Primary_dealers

As of October 31, 2011 according to the Federal Reserve Bank of New York the list includes:^[10]

• Scotiabank Global Banking and Markets
• BMO Capital Markets Corp.
• BNP Paribas Securities Corp.
• Barclays Capital Inc.
• Cantor Fitzgerald & Co.
• Citigroup Global Markets Inc.
• Credit Suisse Securities (USA) LLC
• Daiwa Capital Markets America Inc.
• Deutsche Bank Securities Inc.
• Goldman, Sachs & Co.
• HSBC Securities (USA) Inc.
• Jefferies & Company Inc.
• J.P. Morgan Securities LLC
• Merrill Lynch, Pierce, Fenner & Smith Incorporated
• Mizuho Securities USA Inc.
• Morgan Stanley & Co. Incorporated
• Nomura Securities International Inc.
• RBC Capital Markets, LLC
• RBS Securities Inc.
• SG Americas Securities LLC.
• UBS Securities LLC.

The New York Fed has a list of changes since 1999.

So they're part of the system and get free money deposited to their accounts when the Fed wants to create jobs. They get money pulled from their accounts when labor markets are "too tight" and workers are able to bid up their wages.