The Debt Ceiling, Platinum Coins, and Other Nonsense

In the coming months, it is very likely that the president and Congressional Republicans will once again go to battle over the debt ceiling. Like many others, I am already lamenting the idea of more “negotiations” between the president and Congress. However, unlike others I see this as a problem with the debt ceiling itself, not the Congressional Republicans. So long as it is within their power to use the debt ceiling as a bargaining chip, they should be free to do so if they wish. (They should recognize, of course, that this is not as strong a bargaining chip as they realize, however. A refusal to raise the debt ceiling without spending concessions from the president is simply a game of chicken. Anti-coordination games are unlikely to be the best strategy for achieving one’s objective.)

Nonetheless, a growing subset of individuals who believe that the Congressional Republicans are recalcitrant have suggested that the president authorize the Treasury department to mint a $1 trillion platinum coin (because this is within constitutional authority) and deposit it with the Federal Reserve to enable the payment of the federal government debt. The argument is that in doing so the president can circumvent the debt ceiling within constitutional limits. In addition, advocates argue that, since the coin will never circulate, the minting of the coin will not be inflationary.

If this idea sounds ludicrous, that is because it is.

Minting a platinum coin sufficient to pay off the deficit is what is traditionally known as monetizing the debt. To put it bluntly, large-scale debt monetization is bad. This is traditionally how hyperinflations start. Nonetheless, we are told that we needn’t be concerned because the coin won’t circulate. This would seem to ignore two factors: (1) the point of the coin is to pay for the debt, and (2) money is fungible. Thus, if the Treasury minted a $1 trillion platinum coin and deposited it at the Federal Reserve, the entire point of doing so would be to allow the Federal Reserve to make payments on behalf of the Treasury for government spending that exceeds tax revenue. Even if the coin itself doesn’t circulate (how could it?), the money supply can still increase substantially as the Treasury writes checks out of its account at the Federal Reserve.

Advocates, however, dismiss this possibility. Josh Barro, for example, argues:

[Inflation] is a more serious objection, and it gets at what the platinum coin strategy really is — financing the federal government’s operations by printing money instead of borrowing it. The trillion- dollar coin will never circulate, but it will be used to back cash payments coming from the Treasury that would have otherwise been financed by bond purchases.

If the government financed itself this way in general, that would absolutely be inflationary. But the president can hold inflation expectations steady by making absolutely clear that the policy will not lead to a net change in the money supply over the long term. Obama should pledge that once Congress authorizes additional borrowing, he will direct the Treasury to issue bonds to cover the government’s coin-backed spending and then to melt the coin.

I similarly believe that expectations are important. However, Barro seems to fall into the growing category of folks who think that expectations are all that matters and that policymakers can perfectly affect expectations. An announcement from the president that the increase in the money supply isn’t permanent does not guarantee that the minting of the coin is seen as such. In order to believe that the money supply would not increase, we would not only have to believe that the Treasury would commit to borrowing money in the future once the debt ceiling was lifted, but also that the Treasury would borrow enough money to finance the previously financed cash payments necessary to enable them to withdraw the $1 trillion coin. In other words, we would have to believe that the Treasury could perfectly commit itself to actions it would prefer not to take. Or we would have to assume that the Federal Reserve would conduct large scale asset sales to prevent increases in the money supply. Put differently, in the midst of conducting large scale asset purchases, the Fed must commit to large scale asset sales to prevent the money supply from growing by more than they wish as a result of the minting of the coin. The policy would not only tie the hands of monetary policymakers, but forcing the Federal Reserve to conduct such policy is a threat to its independence. And if inflation expectations became unanchored, this could exasperate the effects of the increased money supply and the coin could be particularly harmful.

Advocates think that it gives the president an upper hand in debt ceiling negotiations. However, all it does is increase the stakes of the chicken game. The platinum coin is a bad idea.

14 responses to “The Debt Ceiling, Platinum Coins, and Other Nonsense

  1. I don’t think it would have that much of an effect..

    Issuing a single coin of a massive denomination is a bit foolish. There is no reason not to issue thousands of $100,000 coins as needed.

    They would increase base money, one way or another. And if the Fed thought the base was too high, it would have to sell off other assets.

    The problem would hit when it runs out of other assets and all it has left is coins.

    Then, the Treasury has to sell interest bearing government bonds to retire the coins.

    I don’t understand why the Treasury can’t do this with dollar coins.

    Of course it is just a work around based upon the claim that “coins” aren’t really a liability of the government

  2. I think this is wrong. The Fed clearly has last mover advantage.
    They are already expanding base at 1.5$ trillion a year, so the treasury doing so would simply mean front-loading some asset purchases. They could include the minted coins in the QE program and adjust the size accordingly. They have $3 trillion assets currently, they can offset a few coins easily. After that they need to rise rates to cut the multiplier, but again they have quite a bit of scope.

    I think you’d need the treasury to start minting 5$ trillion a year for a couple of years before the Fed would lose the ability to still control inflation.
    It would clearly be a bad idea, but that’s different from the current proposal.

    I also fail to see how the executive could get out of the impasse. I am not convinced the President could unilaterally decide to keep paying bond coupons either. I doubt bonds stand higher in the creditor chain than other liabilities, so I doubt he could simply decide to keep paying some people and stiff others. Even if they are senior liabilities, it would definitely be a default event.

    I really don’t see an alternative…

  3. Bill and acarraro,

    I am not saying that it is impossible for the Fed to conduct the relevant open market operations.

    The main problem is that this forces the Federal Reserve to commit to actions it does not want to. Specifically, the Fed (whose policy is to purchase long term Treasuries and MBS) would have to sell these assets along with T-bills on a large scale.

    In addition, having already paid for the excess spending, would the Treasury really want to borrow the money after the debt ceiling is lifted?

    I am not saying that the Fed and the Treasury wouldn’t take the right course of action, but there is a positive probability that they wouldn’t and this can potentially affect expectations.

    The biggest issue here is the effect on inflation expectations. Since Volcker took over as Fed chair, the modus operandi of the Federal Reserve has been to manage inflation expectations. When the federal government decides to monetize the debt, the Federal Reserve’s ability to manage inflation expectations can be sufficiently hindered. Under this scenario, the mechanics of open market operations might not be sufficient. In addition, simply making an announcement that this is temporary is also not likely to be sufficient.

    Finally, I see a number of alternatives to this policy. (1) Give the Republicans the minimum necessary to get them to raise the debt ceiling. This shouldn’t be hard. No matter what they say, they don’t want to take the blame for a technical default. (2) I don’t know that it would be a wide-sweeping power grab for the president to simply instruct the Treasury to keep issuing debt and making coupon payments. The spending has been appropriated. The debt ceiling simply gives the Treasury authority to borrow.

  4. So are you saying it would be better to go down the 14th amendment route and to declare the debt limit unconstitutional? I don’t really have a problem with that to be honest. I doubt it would have different effects though. Do you really believe that it would be optimal to default rather than inflate if you couldn’t fund the debt in the market? I think it would be an easy decision and that at that point inflation would be the last problem in people’s mind…

    I actually think that the republicans have the right to shutdown the government if they think that;s the best policy. But I think they should do it by refusing to pass the continuing resolution instead of refusing to raise the ceiling. It’s not that dissimilar in practice, but it avoids the rather terrible idea that you can make incompatible laws.

    I really hate the idea that they are pretending not to want the spending when they vote for it in the end. Even if it’s not called a budget, it still appropriates the spending as you say.

  5. acarraro,

    I think that we are in agreement about many points here. I agree that Republicans are well within their rights to use the debt ceiling to leverage spending cuts. I don’t think it is the best way to do it, but that’s another issue. I also agree with you that I think it is disingenuous to appropriate the spending and then refuse to increase the debt ceiling on the grounds that the government is spending too much.

    However, I would also note that debt monetization is essentially equivalent to a default. I think that if the federal government minted a platinum coin to pay off its debts, this would send a very strong signal to the rest of the world that the government is incapable of resolving its debt issues in a first-world fashion. This could have a very deleterious effect on the value of the dollar. I think that it is hard to compare the relative effects of an actual default and a debt monetization, but I don’t see the latter as being obviously preferable to the former in any meaningful sense.

    Also, in my view, fighting it out in the courts is a terrible option, but I think it is a less terrible option than default or monetization.

  6. I disagree that it’s difficult to compare default to inflation.

    Default is like Lehman, inflation is like the government bailout.

    I know I’d much rather have the government bail out banks than having to go through the courts to allocate losses. It’s a bit weird here since the government is bailing itself, but the panic a true default would generate is immensely costly. Think about the massive deflationary effect of a default. Everybody would want little green pieces of paper as the are the only safe asset now. At least treasury were still a safe haven in 2008. It’s beyond scary in my mind.

  7. acarraro,

    Monetizing the debt is essentially equivalent to default. There are effects on income distribution either way, albeit different effects. I think that you might be underestimating the costs of inflation. High and/or variable rates of inflation are very costly. See Leijonhufvud’s classic, “Costs and Consequences of Inflation”: http://www.econ.ucla.edu/workingpapers/wp058.pdf

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  9. I am not arguing that inflation has no cost (even if I think the variable part is much more problematic than the high part in my mind).

    I am just discussing revealed preferences here.

    When AIG was bankrupt, the government bailed it out. It didn’t decide to tear up all the contracts AIG signed and sort the problem out in the courts. I think there is a reasonable consensus that it was a good idea to do that. In similar other circumstances (every banking crisis I have ever seen), the basic reaction is not to unwind the entire financial system, but bail it out.

    If you think a US default would not entail a collapse of the entire US financial system, then we disagree. Given that it surely does (since regulation pretty much guarantees that bank capital is invested in treasuries), and that the Fed has the ability to print an unlimited amount of cash (at a significant inflation cost I agree), it would be contrary to past experience for the Fed to do nothing and let the system fail.

    Ergo if the debt becomes unsustainable, it will be almost certainly monetized. That;’s what has always been done in similar circumstances.

    I am not arguing about the fact that you shouldn’t try to avoid such a result. You surely should. I am simply saying that it makes little difference how the debt is funded between monetary base and bonds for the time being. What matters is the deficit not how it’s funded.

    The republicans have 2 ways to reduce the deficit: one with no nasty financial implications (simply shutting down the government by not passing the budget) and one which is totally irresponsible (refusing to raise the debt ceiling).

    I personally think it’s morally wrong to approve the spending (as they did a week ago by extending the unemployment benefits) and then refusing to pay for it.

  10. “But the president can hold inflation expectations steady by making absolutely clear that the policy will not lead to a net change in the money supply over the long term. Obama should pledge that once Congress authorizes additional borrowing, he will direct the Treasury to issue bonds to cover the government’s coin-backed spending and then to melt the coin. ”

    The entire basis of this plan is that Republicans in Congress will back down completely after the President embarrasses them using Executive Branch work-arounds instead of functioning as a Republic as the founders intended. Does this really sound feasible to people?

    Why do so many people think a failure to raise the debt limit will cause default, missed payments on debt, or a 14th amendment crisis? Payments on debt continue to be a fraction of the total spending of the government and are still well below tax receipts. It’s the new spending that comes to an end unless Turbo Tax Timmy @ Treasury decides to default on debt payments in order to continue new spending [entitlements, defense, and government operations].

  11. James, I think you are incorrect.

    If the US government was a company, there is no way it would work. Refusing to pay suppliers or workers in order to pay bondholders or banks would quickly lead to a court order to stop those payments (and possible some pretty serious charges for the directors) unless the bondholders have some kind of seniority/security.

    I don’t know of any law which would allow the government stop ignore spending that has been appropriated (while I know laws about the fact that the executive cannot refuse to spend the money that has been appropriated). Bondholders are not senior to other creditors of the government.

    Considering that congress has just approved a law which increases government deficits by a few hundred billion for this fiscal year, I am not sure how you can argue that congress doesn’t want to borrow that money.

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