Wednesday, January 9, 2013

Trillion dollar coin an insult to the Fed, not common sense

Before I get to the proposed solution to the anticipated U.S. debt ceiling crisis of just printing the money to keep the spending flowing (by striking a $1 trillion coin) thus obviating a need for Congressional authorization for additional borrowing, I'll make a comment on the nomination of Chuck Hagel for Secretary of Defence.

The contributors to paleocon flagship The American Conservative are positively giddy, saying "No matter how the battle over his confirmation goes, it will  be educational and point the country in a better direction."  Libertarians who have distinguished themselves from and taken issue with neoconservatism in the past like the CATO Institute are also pleased, with Justin Logan of the view that "Hagel successfully running the DC gauntlet could be a perestroika moment in the American foreign and defense policy debate, and possibly even loosen the neoconservative stranglehold on the GOP."  Fact is, the conservative pundit class is far more neo-con heavy than popular support would suggest (implying the reality of an influential lobby), and neo-con nostrums are received wisdom across the "right wing" spectrum of talking heads, from David Frum to Charles Krauthammer.  The one palecon pundit with name recognition, 74 year old Pat Buchanan, is widely perceived as a crank.  If the Hagel nomination stays in the headlines it may create an opportunity for a new generation of paleocon voices to attract a following.  Last month the self-described neo-con John Agresto penned a very interesting piece on the need for neo-cons to re-evaluate.

Now what about #MinttheCoin?  Apparently the first appearance of this idea is a comment by a lawyer named "beowulf" (later identified as one Carlos Mucha) on Brad DeLong's blog in July 2010.  Beowulf expanded on the notion in his own blogpost in January 2011.  The concept then got traction on mainstream media hosts in July 2011 as the then debt ceiling debate caught fire.  The idea rests on a legal loophole created by Congress in 1996 that authorized the Secretary of the Treasury to mint "platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time."  Note that although there is a legal limit to how much paper currency can be in circulation, no such limit is specified here.  The U.S. Mint would book the difference between the coin’s face value and its cost of production as seigniorage (marketing and distribution is normally deducted as well but those costs should be negligible here).  As the Mint explains, seigniorage is part of "off-budget receipts" and "is deposited periodically to the [United States Treasury] General Fund where it reduces the government’s need to borrow."

A lot of the media hosted bloggers haven taken issue with the legality of the scheme.  But ask yourself if it is legal for the U.S. Mint to issue a $100 coin and use the seigniorage (which will be a little less than $100) to "reduce the government's need to borrow" by that amount.  Obviously it is.  Now why is it not legal to issue ten billion of those coins?  And if that's legal what's the substantive difference between that and a single trillion dollar coin?  Now Canada has a "general anti-avoidance" rule whereby the government can challenge your exploitation of a tax loophole if the Crown can prove that your schemes are "so inconsistent with the general scheme of the [Income Tax] Act that they cannot have been within the contemplation of Parliament."  But that sort of rule has to be specifically enacted, it's not part of the common law.

What about the economics?  Suppose Timothy Geithner stops off at the Mint to collect the trillion dollar coin in person and on his way over to the Federal Reserve to deposit it happens to stop at a cinema and see a show.  While sitting in his plush seat the coin rolls out of his pocket and ends up on the carpet.  After leaving the cinema he notices the coin is missing and rushes back to the cinema.  But it just so happens that you came upon the coin first and you are already on your way to your local bank to deposit it (knowing that you would have a hard time getting change at the local mall).  Now instead of the U.S. Treasury getting to write cheques on that trillion without having to borrow the money, you get to do so!  Now suppose the minting of the coin and Geither's actions happened to have been done in secret (perhaps to be announced later) and the management of your bank took no particular note of your deposit.  Without the public info that might create expectations of inflation (and no additional lending by your bank on the basis of your deposit) would there be any inflation?  Not so long as you haven't spent any of it.  But if you did spend it it would eventually drive up inflation because each or your purchases would add to the quantity of dollars while the supply of goods and services remained the same.  Note that this inflation would not happen if you borrowed the money because the borrowed money would have already been introduced into circulation.

Now Paul Krugman (visage at right from TPM) had me puzzled when he seemed to pooh-pooh the coin on January 2, saying "to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base."  Krugman, of all people, succumbing to inflation fears?  Krugman seemed to quickly refind the courage of his convictions, however, saying on January 8 "mint the darn coin."

If Krugman is correct that there isn't an economic policy objection, and there isn't a legal issue, then what's the problem?  Consider the case where you've just found that trillion dollar coin.  What could then stand between you and anything money could buy?  The bank, of course.  If the bank accepts your deposit, you're gold (or platinum?).  As a for-profit institution, your bank should be eager to take your deposit, since it could vastly expand its (loan) business, but the Federal Reserve is not a profit centre.  The Fed is not going to want to be a party to a major transaction that serves the government's fiscal purposes instead of its own monetary purposes.  Now the Fed might not object to accepting the coin if the transaction were guaranteed to be a one-off.  It already has close to $3 trillion on its balance sheet and plans to add another trillion in 2013 anyway (in part through purchases of more than double the average daily supply of mortgage-backed securities aka MBS) so what's another trillion.  The Fed could additionally "sterilize" the coin in terms of inflation by selling off a trillion of its other assets early.  The contemporary Fed furthermore has an inflation fighting tool at hand in that it can pay interest on reserves so that banks are content with that income and don't lend on said reserves (see again the hypothetical above where your local bank just happens to ignore your trillion dollar deposit instead of expanding its lending business).

Now to be sure, there are real risks to yet another expansion of the Fed's balance sheet, not least of which is the substantial risk that markets will not react well to the unwinding the Fed's oversized balance sheet (what is going to happen to housing if, or more precisely when, the Fed stops buying and instead dumps its trillion in MBS on the market?).  When you ask the people who say that there are no economic concerns at all, "why not mint $16 trillion in coins and pay off the whole debt?" they wave the question away as crazy talk but the question illustrates how the risk of inflation and financial instability is on a continuum.  Of greatest concern to the Fed, however, would be the precedent set with regard to who controls its balance sheet (and monetary policy in general).  At the end of the day, the trillion dollar coin "solution" to the debt ceiling means printing money instead of borrowing it.  In terms of the mechanics there isn't a lot of difference between quantitative easing to stimulate the economy and printing money to finance the government's deficit spending but politically the difference is huge.  The Fed wouldn't just be surrendering its independence, it'd appear to be doing so to Democrats in Washington over the objections of Republicans.  Imposing on the central bank like this is the sort of thing one expects of Hugo Chavez, not the U.S. Treasury.

Now a reasonable question to ask here is why the Fed's current handling of coinage doesn't amount to a threat to its independence.  After all, I've called attention to continuums (or, depending on your view, used the "slippery slope" argument) with respect to both the legality of a trillion dollar coin scheme and its economic consequences.  Coin currently counts for $2.1 billion or 0.07% of that $2.9 trillion in Fed assets but what is fundamentally different if that number changes to become closer to the $0.93 trillion currently in MBS?  The distinction here is that the current volume of coin reflects the public's demand for it, not the government's.  As the Economist points out, if financial institutions were actually requesting trillion dollar coins to use in private transactions then, yes, the Fed could go along with the scheme while plausibly arguing that it was not just dancing to the government's tune.  Note, however, that even if one were to mint a million million dollar coins (something that's more plausible in terms of economic utility than a single trillion dollar coin), in 2002 the total coin in circulation was only $32 billion, or 3.2% of a trillion, and the total of both U.S. currency and coin was less than two-thirds of a trillion.  Even a tenth of a trillion in additional coinage can't be justified except by admitting that it would have to be handled by the Fed and in order to facilitate Washington's deficit financing.

The trillion dollar coin scheme is thus unworkable, but it's unworkable because the Federal Reserve Board of Governors will refuse to cooperate.  It's not Obama's reputation but Bernanke's that will take this option off the table.  If somehow the Fed did go along, investors would become extremely nervous.  At a minimum, the Fed chair would feel compelled to spin the stunt as his own idea, applied to a unique circumstance.  On its face, yes, a fear that the U.S. will inflate away its debt is less grave than the shock of an outright default by not raising the debt ceiling (one can argue that various personal transfers like social security cheques could just be trimmed instead of any "defaults" but the brake on spending would be so great it would dwarf any "fiscal cliff" concerns to date).  But a default would surely never be allowed to happen again, whereas if the Fed steps in to help the Treasury Secretary manufacture a trillion or two out of thin air (or an ounce of platinum) what's to stop that from happening again?  The very fact that the consequences wouldn't be so immediately horrific would raise greater fears for the long term.

UPDATE January 10:

WIRED has a fuller background on "beowulf" and the origins of the idea.  Apparently the blogosphere discussion dates back to May 2010 on Warren Mosler's blog.

It's struck me that the best counter to the contention that the Fed would see this coin idea as a challenge to its independence is the fact that the Fed is already on track to have a balance sheet of four trillion by Christmas.  One could therefore reasonably argue that the only real issue is the optics of the Fed's desires as opposed to the Fed's desires (unless the Fed is particularly insistent that a large fraction of the money printing continue to support housing as opposed to general government expenditure).  By that angle, all the Whitehouse has to do is work behind the scenes to get some Fed people to raise the coin idea and make some public statement indicating that they're open to it.  That could both resolve much of the independence concern and make the move an easier sell politically.  Now the Fed might object anyway even if it didn't see an independence issue, but in that case their objection would be more like an objection to NGDP targeting that we've often heard from central bankers; that is, that a concern is not just the theory but retaining the confidence and understanding of the general public.