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.