Brian Jacobsen

A trillion dollar coin? A bad idea if you actually think it through

AdvantageVoice® Blog—1-14-13
Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist

I haven’t traced the origins of the “trillion dollar coin” idea, but it seems to have gotten some attention.  Here’s why I think it’s a bad idea.

What is the trillion dollar coin idea? 
The basic idea is that the president can avoid the debt ceiling imposed by Congress by having the Treasury mint a trillion dollar coin, made of platinum, deposit it with the Fed, and then make payments as usual without violating the debt ceiling.

Why platinum, and is it legal?
Congress has the constitutional authority to “coin Money” (Article I, Section 8 of the Constitution, and I have no idea why the “M” is capitalized in the constitution).  Congress has delegated most of this authority to the Federal Reserve System.  The Federal Reserve can print money in the form of “Federal Reserve Notes” (those bills you carry in your wallet, which are printed by the Bureau of Engraving and Printing).  The authority to create coins is delegated to the U.S. Treasury. 

The Bureau of Engraving and Printing is part of the U.S. Treasury.  When the Federal Reserve wants to put more currency in circulation, it orders it from the Bureau.  The Federal Reserve pays the costs of printing the money, but it effectively sells the currency to the public at face value.  The face value is significantly more than the cost of printing it, so the Fed makes a profit on this process.  That profit is called “seignorage” by economists.  Coins, created by the U.S. Mint, are also part of the U.S. Treasury.  The Treasury sells them to the Federal Reserve at face value, not at the cost of producing them.  So, if the Treasury minted a coin with a trillion dollar face value, the Federal Reserve would pay the Treasury a trillion dollars for the coin.

Congress has severely limited the Treasury’s ability to coin money by setting specific criteria for how much it can coin and what the composition of the coins must be.  According to advocates of the trillion dollar coin, there is a “loophole” in the law (Section 5112(k) of Title 31 of the U.S. Code) that allows the Treasury Secretary to mint coins made of platinum of a denomination of his choosing. 

Based on my experience from law school and practicing law for a bit, I would argue that you need to read the whole section of the law and not just this subsection to understand what it means.  Section 5112(a) says the Treasury may only mint and issue specific denominations of coins.  Subsection (k) seems to me to only allow the Treasury Secretary to pick amongst the nine denominations enumerated in subsection (a), not to create a brand new denomination. 

Could the Treasury actually deposit the coin at the Fed? 
I don’t think so. From an accounting perspective, the Treasury may deposit funds from the “General Fund” at the Fed, and the  authority to coin a platinum coin falls under the “numismatic” authority of the Treasury (numismatic just means that the coins are for collectors).  Proceeds from the Numismatic Public Enterprise Fund cover expenses of minting the coin, and the excess is transferred monthly into the General Fund(see Section 5134 of Title 31).  However in order to get the money into the Numismatic Public Enterprise Fund, the coin would first have to be sold to the public (Section 5132 of Title 31). 

Unless the Treasury could find someone with a trillion dollars, the whole trillion dollar coin idea would fail.

Am I missing something?
This is just my naïve reading of the law.  There is also a whole “legislative intent” problem that any law student or lawyer knows: When interpreting what a statute means, you may have to investigate what lawmakers intended when they created the law.  It’s pretty clear to me that Congress has delegated to the Federal Reserve the conduct of monetary policy, not the Treasury, and the trillion dollar coin would be a usurpation of this power.

Why else is the trillion dollar coin a bad idea? 
It’s a step down the road to hyperinflation.  If the Treasury suddenly minted a coin to avoid the debt ceiling, it could not credibly commit to not doing it again.  Even if the Federal Reserve was to sell an equivalent amount of assets to make sure the monetary base was unchanged as a result of the deposit of the coin, investors and the public would rationally believe this could happen again and again to completely monetize the debt, which would lead to rapid inflation and much higher interest rates.  If the Fed had to sell Treasury securities because of the deposit of the coin, the Fed would be getting rid of marketable securities and replacing them with an illiquid asset.  That would almost guarantee that the Fed couldn’t shrink its balance sheet, even if it wanted to.

The reputation the Federal Reserve has built to control inflation could be completely undermined.  A reputation is a hard thing to build, but an easy thing to destroy.  The trillion dollar coin would destroy the credibility of the Federal Reserve as an inflation fighter and the U.S. Treasury as an issuer of debt.

Is the trillion dollar coin less bad than default?
Some advocates of the trillion dollar coin claim that if we have to choose between defaulting on the U.S. debt and using the trillion dollar coin, the trillion dollar coin is the “less bad” alternative.  This is a false choice. 

Defaulting on the U.S. debt is not a logical or practical consequence of hitting the debt ceiling.  The cash flow into the Treasury is ample enough to cover interest costs on the U.S. debt, and the Treasury must make these interest payments a priority.  Even if the cash flows weren’t adequate, default would not be the worst idea.  Yes, a default would be bad, but hyperinflation is probably worse.  To see this, look at the difference between Iceland and Zimbabwe.  Iceland defaulted on its debt, but has returned to the credit markets.  Zimbabwe had hyperinflation and is still locked out of credit markets.  Also, you only have to look to the U.S. back in 1979 to see that a technical and temporary default doesn’t permanently cripple an economy.  Hyperinflation is always—and everywhere—a bad thing.

The trillion dollar coin idea is proposed as a way for the president to side step the debt ceiling.  Personally, I like President Bill Clinton’s idea that President Obama should say that he’ll simply ignore the debt ceiling, and let Congress sue him if it wants.  That would probably be a faster and easier way to short-circuit the debt ceiling debate than pursuing a Gremlin of a strategy.  Remember Gremlins?  They were cute, but evil.

The views expressed are as of 1-14-13 and are those of Chief Portfolio Strategist Brian Jacobsen, Ph.D., CFA, CFP®, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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