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More Problems with the Trillion Dollar Coin

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.

  • Here are my petit comments on the issue of the government sending a coin to the Fed Pawnshop

  • Paul Marks

    A one ounce platinum coin would be worth, around about, two THOUSAND Dollars – not one TRILLION Dollars.

    Nothing more really needs to be said.

  • Pacioli

    I think your main premises start to get derailed here: "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 statement is not really true. There is nothing about the Fed's actions which "enable" the Treasury to issue new debt. The Treasury issues new debt independent/regardless/unrelated to any actions of the Fed.

    Here is a more carefully researched synopsis of how the platinum coin would be consistent with the current QE program, what the exit protocol is (when the time comes), and why it would be a non-event in terms of private sector net financial assets:

  • Rob R.

    I agree with everything that Steve says in this post apart from a quibble on point 3. While the coin indeed has inflationary potential would not this potential be prevented from being activated by the fed pursuing its current mandate ? That is: if the government started to spend the money and generate inflation would not the fed correspondingly tighten monetary policy to allow the inflation part of its mandate to be met ?

  • lukas

    Isn't the idea for Treasury to use that $1T to pay off $1T worth of federal debt held by the Fed — debt which has already been monetised through OMO's, but still counts against the debt ceiling, would be officially annihilated.

  • Pacioli

    What happened to the Selgin post that was up earlier today?

  • BillWoolsey

    The Fed doesn't buy government bonds directly from the Treasury, but the current process is a bit of a shell game. The Fed sells them for the Treasury to primary security dealers. Then the Fed buys government bonds from the primary security dealers. The Treasury has the Fed sell however many the Treasury needs to refinance the existing debt and fund the current deficit. And then the Fed buys however much the FOMC thinks is appropriate to adjust interest rates such that employment is high and prices stable. Well, you know, macro policy of some sort.

    As Steve explained, the interest income the Fed earns on the government bonds is mostly transfered back to the Treasury.

    To the degree the Fed buys bonds that it has sold for the Treasury, the result is the same as if the Fed just created money and gave it to the Treasury to spend. However, under the current set-up, the Fed can always change its mind and sell the bonds that it had bought to other investors. If it had just created money and given it to the Treasury, it wouldn't have anything to sell to reduce the quantity of money when it thinks that is the best monetary policy.

    With the Platinum coin gambit, the Treasury is directly creating the money. Now, the $1 trillion denomination appears to confuse people. Suppose they just made them $100 and made them out of nickle plated copper and used them to buy stuff? The sellers would deposit the coins at their banks, which would deposit them at the Fed. The Fed would have the coins as assets and the reserve balances of the Fed as liabilities. The Fed isn't creating the money. The Treasury is.

    The single $1 trillion coin has the Treasury deposit the coin. The Treasury now has $1 Trillion in a reserve balance at the Fed. Because of the way the Fed reports things, this wouldn't count in the measures of reserves, base money, or any measure of the quantity of money.

    When the Treasaury beings to spend the money, then those selling to the Treasury will deposit their checks in their banks. That will be new money–M1, M2, and MZM. And then their banks will deposit the checks at the Fed. The Fed will transfer funds from the Treasury's balance to those of the banks. That will count as bank reserves and base money.

    So, new money will be created as the Treasury actually spends money. If rather than a single coin of really high denomination, the Treasury deposited coin of more modest denomination (say $20 billion) as needed to cover expenses, it would be more obvious.

    Now, if the Fed remains commmitted to macro stability, it would need to respond to this by selling off its other assets–government bonds and mortgage backed securities. Given current conditions, they would probably slow their purchases of bonds and the like.

    Now, if conditions change as everyone hopes they will, the Fed will have to switch from buying to selling bonds and mortgage backed securities. If they run out, then there will be nothing more they can do. They cannot sell the trillion dollar coin.

    The trillion dollar coin will fund about one year of budget deficit. If a new coin is issued each year, then the Fed will run out of other assets pretty quickly. And the Fed will not be able to offset the inflationary effects of the coins.

    That doesn't make inflation inevitable. If the debt limit were increased, the Treasury could return to funding the deficit by selling bonds and stop minting and spending coins. And it could also sell extra bonds and hold the funds in its deposit account at the Fed. The Treasury could also run budget surpluses and accumulate funds in its deposit account at the Fed. Once it has "saved up" $1 trillion, it can take the coin back from the Fed and melt it if they wanted, though there is really no reason to melt it.

    P.S. I like the stauatory debt limit and I think that the face value of the coins issued by the Mint should be counted under the debt limit. If the price level, or even the inflation rate, is the nominal anchor, then coins are really a type of government debt.

    • Rick

      " . . . under the current set-up, the Fed can always change its mind and sell the bonds that it had bought to other investors."

      Isn't that ability of the Fed to "change its mind" really the heart of the problem? If so, why do we tolerate this discretionary power in the Fed? Why not simply demand that any funds held for us by our local banks be held exclusively in current U.S. coin (whether the current coin is made of platinum or steel, and whether or not the depositor ever takes physical possession)? Doesn't doing this end the "shell game"?