Monthly Archives: January 2013

Trillion Dollar Coin

There has recently been much talk about the US Mint creating a Trillion dollar coin, which would be an artifice to deal with the approaching debt ceiling limit, and thus buy some time (around one year) for the budget issues to be resolved. This would allow the government to continue to operate normally, until the debt limit is raised by Congress. The amount of one trillion dollars corresponds approximately to the annual deficit of the U.S. government. Even the Nobel-prize winning economist Paul Krugman has supported this rather strange idea in a NY Times article.

U.S. Platinum Eagle coin

U.S. Platinum Eagle coin

The concept is not brand new; it has been around since before the 2011 debt ceiling crisis. The U.S. Treasury has announced this past week that they will not mint such a coin. The idea is legal, although absurd, but it does illustrate some important points.

As we know, the concept of a debt ceiling is already rather artificial, as pointed out by this article in the Economist: http://econ.st/VkF8m2. The debt is a result of expenditures that have already been authorized by Congress. Since the entire global economy is built around the U.S. dollar as the primary reserve currency, not raising the debt ceiling and threatening default would be highly damaging, likely forcing a downgrade of the U.S. government’s credit rating, and an immediate recession, not only in the U.S. but in much of the world economy as well. The debt ceiling is a political construct designed to focus minds on what level of new spending should be authorized, but not raising the ceiling would be highly damaging and unthinkable in practice.

The trillion dollar coin concept is predicated on a platinum coin because, unlike gold and silver coinage, the denomination, weight and specifications for “platinum bullion coins” are left to the discretion of the Secretary of the Treasury. Thus, the executive branch could independently authorize and mint the coin (or coins), without approval from Congress. A nominal amount of platinum, one ounce or ten ounces or a hundred ounces or more, could be stamped with a $1 trillion value by the U.S. Mint, under authorization by the Secretary. The platinum coinage law was passed by a Republican Congress in 1996 (http://en.wikipedia.org/wiki/Trillion_Dollar_Coin).

This is fiat money, but all of our money is fiat money, whether coins, currency, or checking account balances stored as bits within a computer system. The two principal different kinds of money are actually “debt-free” money and “debt-laden” money. Our currency is issued as Federal Reserve notes, which are debt-laden. New money is only created in the Federal Reserve System as banks make new (net) loans. A new loan is a checking account entry created out of thin air, and offset by an obligation to pay back the nominal amount plus interest over time. That checking account deposit can be converted to currency, or used to write checks. And any time you use your credit card you are, with your bank’s “help”, creating new money, at least until you pay the bill, and for longer if you don’t pay your balance in full at the end of the month.

Coinage in any denomination, including a trillion dollar platinum coin, is debt-free money. The relatively small amount of coinage in circulation is the only debt-free money we have. Until 50 years ago there was also debt-free paper money, in the form of U.S. Treasury notes, but no longer. The debt-laden Federal Reserve Notes have fully supplanted those. The problem with debt-laden money is it forces ever-increasing debt. The money is created at the time of a new loan, but not the money to pay the interest on the loan. Where is that going to come from? New money must be created in the future, in conjunction with new debt. Thus our debt-laden monetary system is not only inherently inflationary, but inherently unstable as not everyone can find the money to pay off debts. But the bankers like it that way.

The trillion dollar coin would not add to monetary reserves, and also would not add to debt; initially it would lower the debt. The Treasury could use the coin to retire 1 trillion dollars worth of existing Treasury bonds and bills by exchanging the coin for Treasury debt held at the Federal Reserve. The Fed’s monetary reserve balance would be unchanged, + $1 trillion of coin, -$1 trillion of Treasuries. The platinum in the coin, although of a nominal amount, would have more intrinsic value than the paper in the Treasury certificates. Those redeemed securities could be shredded by the Treasury or burnt in the fireplace in the Secretary’s office. Then, over the next year, the Treasury would issue new debt, up to $1 trillion worth, but not be in danger of hitting the existing debt ceiling for this period of time. That’s the whole point of the idea.

The monetary reserves on the Fed’s books would not increase; initially they would have just executed an exchange of the coin (or coins – why not one million coins of $1 million value each?) for Treasury obligations. Is this a free lunch? No, of course not, but the important point is that for the Main Street economy what matters is circulating money, which is a function of loans outstanding and loan demand, not of monetary reserves. Those reserves flow back and forth between the Fed and commercial banks, but do not create loan demand. Inflation comes from overall money and loan demand in the economy relative to the supply of goods and services, not from the level of reserves.

This is why inflation in the real economy is low at present, because consumers and businesses aren’t increasing spending at the same level as a few years ago. Quantitative easing (which a trillion dollar coin issuance somewhat resembles) doesn’t change that reality. QE does show up in financial assets, because when the Fed purchases Treasuries or mortgage securities in the open market to add to its balance sheet, checking account balances of the primary bond dealers are credited. The dealers then put that money to work in the financial marketplace, either by buying other existing Treasuries, or more likely, corporate bonds, stocks, emerging market securities, etc.

If issuance of trillion dollar platinum coins were to become a recurring practice, the Fed would run out of Treasury and government agency holdings to swap and then with whom would one place the coins? I don’t think foreign Treasury bond holders in the U.K., China, Japan and elsewhere would agree to such an exchange. Neither would commercial banks in the U.S. unless it were forced upon them. If multiple trillion dollar coins were just stacked up at the Fed as QE5, 6, 7, then the Fed would be depleted of its $3 trillion stock of treasuries and mortgage securities and thus lose the ability to sell Treasuries in open market operations. It would, as a consequence, lose control of its ability to manage the money supply. The inflation initially in the financial marketplace would over time create “wealth effect” spending and loan demand that would be inflationary in the real economy. And the Fed would have lost its power to raise interest rates and slow inflation through Treasury open market sales.

Not that this scenario would necessarily be bad; one would be setting the foundations in place to change the Fed’s status as an independent quasi-private, quasi-governmental institution, and “fourth branch of government” and to make it instead an arm of the Treasury Department. This would be part of the process of returning the control of money supply issuance to the government, where it resided prior to 1914, and for most of the nation’s history. The current Fed exists especially for the benefit of the commercial banks, who get to touch new money first, as it is created. They create money out of thin air and charge interest on what they create.

Increasingly our economy has become “financialized” and the banks (especially the money center “too big to fail” banks) are less and less responsive to the needs of the real economy and consumers. Instead, they are more invested in making money with money through derivatives, securitization and high levels of leverage and thus risk. If instead of a single trillion dollar coin, one produced a million coins of a million dollar denomination, then these could be put into “bank circulation” as part of the reserve balances of the commercial banks. Or one could just as well do something similar with paper money, by issuing debt-free Treasury Notes, as was done for one hundred years, during and after the Civil War. (Such a re-introduction of Treasury Notes would require authorization by Congress).

Thus the trillion dollar coin discussion, even though it may be a “crackpot idea” according to the Economist, illustrates some very important issues in monetary theory – in particular, the difference between debt-laden Fed-issued money and debt-free Treasury-issued money.

 

 

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