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More Problems with the Trillion Dollar Coin
Posted By Steve Horwitz On January 11, 2013 @ 10:59 am In Commodity Money,Inflation & Deflation | 8 Comments
A few folks have already chimed in on this topic in other places. Lars Christensen has one of the better posts over at Market Monetarist, if for no other reason than rightly pointing out how this gimmick undermines the rule of law and the idea of rule-based monetary policy. I agree with pretty much everything he says there and just want to make an additional point or two here, including noting why it is more likely to be inflationary than open market operations.
My co-bloggers can correct me if I'm wrong on anything below, but it seems to me that minting a trillion dollar coin as a way around the debt ceiling, though gimmicky, is just a more naked form of monetarization than the Fed normally engages in. However, it does carry with it a greater risk of inflation as well as setting a precedent for finding even cheaper ways for the US government to continue its fiscal profligacy.
If the assumption is that the Treasury mints the coin and then the Fed purchases it for $1T, the difference with normal open market operations is just a matter of what's on the asset side of the Fed's balance sheet and the bypassing of the banking system. Normal open market operations, or even quantitative easing, involve purchasing either government bonds or mortgage backed securities or whatever else the Fed is authorized to purchase these days. The Fed buys those from organizations who take the proceeds and put them in their banks, and the banks get credited for that amount in their reserve account at the Fed. The Fed gains the asset of the financial instrument and the liability of the new reserve deposit they owe the bank. When the Fed buys currently existing government bonds, it returns the interest to the Treasury which enables it to issue an equivalent amount of new debt at the same cost. That’s why money creation through normal channels facilitates new borrowing.
With the coin, what the Fed gets on the asset side is the coin and the liability is a direct credit of $1T to the Treasury. At least that's how I presume it would work. Notice that the end result is identical to open market operations: the government can now spend $1T more than it could previously without having to pay any more interest on new debt. The coin involves no new debt at all – just the straight out creation of $1T in new money directly to the Treasury's account. In open market operations, new debt can be issued but those interest payments are (largely) canceled out by the Fed returning to the Treasury the interest on the bonds it purchased. The Treasury gets the $1T not as a direct injection ex nihilo from the Fed, but through the public's willingness (presumably) to buy the newly issued debt.
And this is one major objection to the coin: it's straight monetization. Rather than relying on the willingness of the public to continue to support large deficits by purchasing newly issued debt, it simply creates a trillion dollars and hands it to the Treasury. The Treasury does not have to worry about whether it can sell the new debt it would have had to issue with standard open market operations. And it does not have to worry whether the interest demanded by the public on that new debt is greater than the interest returned to it on the old debt the Fed buys up. The coin is pure, naked monetization that removes any semblance of cost constraints on the Treasury.
The inflationary potential is also great, and moreso than open market operations, because the Treasury will with certainty spend the new funds, while banks might let them sit in their reserves. Note too that injecting a trillion dollars through the banking system is more expensive because those new bank reserves now earn interest. A quarter point doesn't sound like much, but when it's 0.25% of $1,000,000,000,000, you're talking real money.
The trillion dollar coin is a really bad idea for several reasons:
1. It violates the rule of law and undermines anything like a rules-based central bank policy.
2. It further encourages US fiscal profligacy by finding a way to fund excessive government expenditures that does not even bear either the cost of paying interest on reserves or any interest differential between new and old debt, as the Treasury would if the Fed used standard open market operations.
3. It has a much greater inflationary potential than open market operations because a direct infusion to the Treasury will definitely be spent while injections of reserves into the banking system will likely not enter the spending stream.
Bottom line: this is a really, really bad idea as it manages to simultaneously undermine any semblance of sanity in both monetary and fiscal policy simultaneously. That it is being seriously discussed, if not endorsed, by Nobel Prize winners is a sign of how far economics has fallen as well as how much of a mess US fiscal and monetary policy has become.
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