Is the Trillion Dollar Coin really just a gimmick?
What it is. How it works. Why it might just make sense.
If you have been following the debate about the Trillion Dollar Platinum Coin (the Coin), one of the things you will notice is that its biggest backers tend to have pretty radical politics.
They don’t seem to take the potential risks of the plan seriously (one major proponent talked about ‘sending troops to the Fed’) and they tend to be proponents of Modern Monetary Theory (MMT). For those not up to speed, MMTers want to do some very unconventional things like keeping interest rates on public debt at 0 while using capital or reserve requirements, price controls, and taxation to control inflation.1
If you are in the White House or US Treasury, even if you are somewhat tempted by the Coin option, there is no way you can be seen to seriously listen to people, who, on the face of it, don’t seem to really care all that much about the credibility and durability of the institutions of the US State.
There are more mainstream voices like Paul Krugman and Matt Yglesias who support the idea but they tend to present it as a sort of gimmick of last resort. Something that is self-evidently silly but preferable to an actual default.
Then there are others in the mainstream who see the Coin as completely unserious. For example, this is The Economist’s take:
Intuitively I agree with this. It absolutely does feel like a gimmick, but the more I’ve looked at it, the more I’ve come to think that its not as gimmicky as it seems and hardly more wacky than the monetary experiments of the last 15 years.
I therefore want to make the best possible case for the Coin, both from an economic and political economy perspective.2
First off, what is the Debt Ceiling? And why is it a problem?
The Debt ceiling is a cap on the face value of debt that the Federal Government can have outstanding at any given time. It currently stands at $31.4 trillion.
Originally it was proposed by Congress as a way to actually increase the flexibility of the Executive in WW1. Up to that point, Congress had to raise taxes or issue debt to fund each policy on an individual basis which became too complicated and too restrictive.
As the debt limit gets close to being reached, Congress needs to pass a new law increasing or suspending the ceiling, without which, the Federal Government defaults on its debts.3
Up until the 1990s, this wasn’t much of a problem.
But then it started to be used as a political weapon by Republicans in Congress against Democrat Presidents:
In 1995/6 Gingrich refused to raise the debt limit in a dispute that involved two Government Shutdowns and Clinton being forced into running Budget surpluses.
In 2011 the debt ceiling was raised with only two days to go with Obama forced to agree to significant spending cuts. The US credit rating was downgraded for the first time in its history.
In 2013 there was a partial Government shutdown until agreement could be reached.
So long as the Republicans calculate that the Democrats get blamed more for a default than they do, they can pretty much demand whatever they want from a Democrat President4.
This time around, the Debt ceiling will be reached in early summer. It would have already been reached if the Treasury had not implemented ‘extraordinary measures’ such as redeeming and suspending investments by Federal Pension Funds in special issue US Government bonds.
Whatever happens in this debt ceiling fight, it’s guaranteed that we are going to end up back here time and time again.
And every time this happens, Democrat administrations go into the fight with next to no leverage.
The Coin is an attempt to change this calculus…
What is the Trillion Dollar Platinum Coin?
In the 1990s the law was changed so that the US Mint could strike a platinum coin of any denomination. This was done to increase revenues to the Mint by selling special items to collectors. All other coins are restricted to much much smaller denominations.
Using this law, the Treasury Secretary could order the striking of a platinum coin with a huge face value - say a trillion dollars. (Note that there is no limit on the number of coins or the exact denomination. So, the Treasury Secretary can get as many of these coins minted as she likes. They can also have any face value. e.g. $1bn, $10bn, $1tn, $10tn etc etc)
The Treasury can then use this money to pay for things instead of issuing more bonds. No new debt would need to be issued, and the problem of the debt ceiling would be circumvented. The threat from GOP lawmakers on the Capitol would be neutralised. The Government can then get on with the tax and spend plans that have already been agreed by Congress.
The mechanics of the Coin
Before the Coin is struck, a highly simplified version of the Fed’s balance sheet looks something like what I've put together below:5
On the liabilities side notice the US Treasury Account. This is basically the Government’s bank account, currently with a balance of $570 billion.
On the assets side, notice the ‘Coin’ balance which currently stands at only about $1 billion. Unlike banknotes which the Fed creates itself, coins are made by the US Mint. Only coins that are being held by Federal Reserve banks actually appear on the balance sheet.
The process goes something like this:
i) The US Mint strikes some coins
ii) Federal Reserve Banks buy these coins at face value from the Treasury with newly created central bank money credited to the US Treasury Account.
iii) As the Fed now own these coins they show up as an asset on the Fed balance sheet
iv) The coins are then sold to commercial banks. When that happens they are removed as an asset from the Fed balance sheet and Bank Deposits on the liabilities side reduce by the same amount.
With the Trillion Dollar Coin, the process would be the same, but the Coin would stay on the Fed Balance sheet as its clearly not going to a commercial bank or going into general circulation.
Once the Trillion Dollar Platinum Coin is struck and sent to the Fed, the balance sheet will look something like this:
Now the US Treasury Account has an extra trillion dollars to pay for government functions and to fulfil its bond coupon payments. The debt ceiling is no longer a dangerous cliff-edge.
The Economics of the Coin
Minting the Coin is basically just printing money! And obviously that sounds bad to most people! Images of the Weimar Republic or Zimbabwe come to mind. But I think this is a result of poor perceptions and explanations of what Central Banks and Governments actually do. In actual fact, they print money all the time!
Indeed there is no real difference between minting the Coin and doing Quantitative Easing (QE). With QE:
i) The Fed creates new central bank reserves
ii) Puts these reserves into circulation by using them to buy e.g. Government bonds from the private sector
This is what it looks like on the Balance Sheet:
The only real difference between this and the Coin is that the money goes into circulation instantaneously, whereas with the Coin, the money supply only increases when the Government pays for stuff, at which point the Treasury account decreases by X and Bank deposits increase by X.
The obvious objection here is that the Fed is currently fighting inflation. It should not be doing QE or anything remotely similar to it. This is completely correct, but the Fed has all the tools it needs to completely neutralise this.
If it wants to, it can do quantitative tightening (QT) of a size that exactly equals the increase in Bank Deposits from spending of the Coin. In other words, as the central bank money created by the Coin gets spent out of the US Treasury Account and moved into Bank Deposits, the Fed can sell an equivalent amount of US Government bonds or Other Assets.
The net result is that the Balance Sheet would be no bigger than it would have been without the Coin. Assuming the $1 trillion was spent and the Fed did $1 trillion of QT, the balance sheet would look something like this:
The Fed could also raise the Fed Funds rate and interest on reserve balances (IORB) as appropriate to keep monetary conditions where they want them to be.
Eventually, once the debt ceiling is increased sufficiently, the Coin can be melted down and removed from circulation. The Fed can make any adjustments (i.e. buying bonds) to keep its Balance Sheet at a constant size.
So far, from a mechanical perspective, I’ve shown that the Coin is a probably a valid way to get around the problem of the debt ceiling without any changes to monetary conditions. But there are plenty of things to still consider…
Practical Considerations for minting the Coin
Many supporters of the Coin see it as a last minute manoeuvre if no sensible agreement can be reached in Congress. In theory this makes sense. You can use the Coin as leverage to try and force the Republicans to be more reasonable but avoid using such an uncertain and badly understood loophole unless you really have to.
Unfortunately this would not be such a great idea. Although the Coin is almost certainly legal, there would most definitely be a legal challenge.
Assuming the Coin was minted at the last moment and accepted by the Fed, market participants would be in a state of panic until the Supreme Court came to a final judgement.
Payments using the Coin would go out but market participants would be asking searching question like: what happens to payments that have gone out if the Supreme Court rules the Coin to be illegal? What happens to spending on the military or medicare if the Coin is ruled invalid?
This market panic would probably be incredibly damaging and similar, in the short run, to a default. Sure, in the end, I suspect the Supreme Court would rule that the Coin was fine. But it would be too late to stop significant market turmoil for potentially weeks or months.
What this means, in my opinion, is that for the Coin to be viable, it needs to be minted as soon as possible. It doesn’t really matter how you do it. Perhaps start minting $10 billion dollar platinum coins and send one to the Fed every day. Or you could send the $1 trillion dollar coin right away. The point is to get the legal battle rolling so that a judgement can be made before the Debt ceiling is met.
Assuming the courts rule in favour of the Coin, the debt ceiling has been circumvented already. If there ends up being a deal in Congress and the Coin is not needed this time, the legal uncertainty has been settled ready for inevitable future debt ceiling negotiations.
Addressing Serious Objections to the Coin
The mechanics of the Coin are sound and I’ve covered the issue of legality, but there are more serious objections concerned with things like credibility and trust. Let’s look at some of these…
Objection 1: The Coin sets a bad precedent. Presidents could become tempted to use this power to massively ramp up Government spending for political purposes. This could be very inflationary.
Reply: Congress still needs to approve laws that involve spending or taxation. A President couldn’t just mint $10 trillion and then hand it out. Beyond the problem of the debt ceiling, the Coin does very little for a heavy spending President.
Objection 2: The Coin would undermine the Fed’s independence as it would have to cooperate and coordinate with the Executive Branch in its attempts to circumvent the legislative branch - the branch from which it derives its powers and independence.
Reply: The Fed has to respond to spend and tax plans of the Government come what may. That’s always been true and continues to be true. Of course that won’t stop Congressional Republicans from getting riled up.
However, a legal judgement as described above would probably stop them really going after the Fed directly. Instead they would be more inclined to try and repeal the law that lets the Coin be minted in the first place. That’s totally legitimate, but they don’t have the numbers. They’d need both Houses of Congress and the Presidency for that. And in that scenario if they want to cut spending then that’s their prerogative anyway.
Objection 3: It would become harder for the Fed to explain its monetary policy. Whenever it sells bonds it will have to explain whether this is to neutralise the effect of the Coin or to cool the economy. The risk is that this uncertainty creates the risk of inflation by de-anchoring inflation expectations.6
Reply: This is a fair objection but most professional investors will not be confused. The Fed can even say which portion of bonds they are selling to neutralise the Coin and which portion they are selling to tighten monetary policy. It’s not that complicated. To the extent that it is a problem, it's still probably preferable to letting the Republicans impose deep cuts either in this debt ceiling fight or in a future one.
Objection 4: Minting the Coin doesn’t actually bring the debt ceiling saga to a close. If anything House Republicans will dig their heels in. The Treasury will have to keep minting coins and eventually the Fed will run out of assets to sell to neutralise its impact.
Reply: The Coin isn’t magic or a free lunch. It’s also less potent when monetary conditions need to be tightened as the Fed can only sell so many assets. But that doesn’t meant that it cannot give significant room for the Government to avoid potentially large spending cuts that the GOP are likely to demand.
It’s also a play for time. If, in 2024 the Democrats keep the Presidency, win the House and retain the Senate, they can abolish the debt ceiling, or at least make it more sensible (by making it as a % of GDP or auto-increasing the ceiling every time a Bill involving spending becomes law). If the Republicans win the Presidency then the debt ceiling won’t be a problem.
If the current limbo continues (Democrat President, Republican veto in Congress) the Coin option will have been exhausted. But at least it will have given crucial years for the Government to pursue its policy objectives and to find other ways around the ceiling.7
Objection 5: This is just such a big gimmick that it will completely freak people out. It’s just too big a risk to gamble like this with the Government’s credibility and with the safety of US Government bonds - the safest and most liquid asset class in the world.
I think this is everyones reaction to something like this. But in reality, things never quite change as much as you think. QE sounded just as crazy to many when it first got going:
Just look at what’s happened to the Federal Reserve Balance sheet since the 2008:
And yet, the world didn’t cave in because of all this. Fundamentally the idea was not hyper-inflationary. It’s much the same in this scenario. There is no vicious cycle, no short squeeze, no confidence deficit big enough to really cause a problem so long as the courts say it’s legal before you need to rely on it. If it’s legal, and the Coin is minted, nothing will stop the Treasury honouring its obligations. The money supply will be no bigger8. Calm heads will prevail. Life will go on.
Conclusion
The Coin is widely seen as a gimmick which fair enough. It sort of is. It’s a legal loophole. But it’s a gimmick that works, and a gimmick that is far more democratic and economically sound than the debt ceiling.
And if you think about it, the debt ceiling itself is as much, if not more of a gimmick..
Both Houses of Congress and the President can sign off on laws that involve spending, only for one House of Congress to later invoke a law originally intended to increase the Government’s flexility, as a way to bring the country to the verge of a default.
How is that any more serious than minting a Trillion Dollar Platinum Coin?
I’m not criticising MMT per se here but the ideas are pretty radical. These aren’t ideas that are likely to change peoples minds so are best put to one side here.
There is a serious legal angle to all of this but I won’t go into that much detail here. It is almost certainly legal but that doesn’t mean there wouldn’t be legal challenges. I address this later on in the post.
Some argue that the so-called ‘Public Debt Clause’ in the 14th Amendment of the Constitution makes the whole idea of the debt ceiling unconstitutional but this is even more opaque and would probably take longer to settle legally than litigation over the Coin.
While it is almost certainly a very bad judgement by the GOP that’s currently how they see things.
The numbers here are pretty much correct but with all these balance sheets I’ve done some rounding up and down to make things add up in a simple way. Things like the Fed’s capital and FX reserves are omitted.
One of the most challenging objections put forward by Josh Barro.
Other options include issuing premium bonds or perpetual bonds. You can read about the pros and cons of this here. TL:DR - This solution kind of works but it would involve playing around with the structure of the biggest largest, most liquid and safest asset class in the world.
Assuming the Fed offsets the Coin by selling bonds as explained earlier in the post.