The Trillion Dollar Coin and Monetary Policy in the U.S.

Let’s Learn Something Today!

If you read the news, you've probably heard the story floating around about the trillion-dollar coin.  The trillion dollar coin is a concept that emerged during the United States debt-ceiling crisis in 2011, as a proposed way to bypass any necessity for the United States Congress to raise the country's borrowing limit, through the minting of very high value platinum coins.  The concept gained more mainstream attention by late 2012 during the debates over the United States fiscal cliff negotiations and renewed debt-ceiling discussions.  In early January the widely read economist Paul Krugman endorsed the idea and asserted that opposition to the idea was coming from people unwilling to admit the truth that "money is a social contrivance".  Ultimately, the idea was nixed, but the fact remains that it’s out there, and it’s terrifying.

An obscure statute authorizes the Secretary of the Treasury to mint platinum coins "in the Secretary's discretion," in any denomination.  Granted, the intent of this statute was to give the treasury the ability to mint commemorative coins and the like…but since that was never actually specified, there’s technically nothing stopping the Treasury from minting coins in any denomination it wants!   

Currency is surprisingly abstract as a concept.  Money is whatever you agree to accept in trade, with the understanding that others will accept it in turn.  If there's a $20 bill in your wallet or purse, you view it as valuable because you know that others will as well.  If you have $1 million in a bank account, you view it as valuable because you know that others will as well.  But you can't eat a $20 bill or sleep under a bank account.  Money is valuable only if others agree that it is.

Even if money is backed by some precious substance such as gold, the abstraction doesn't change much.  You can't eat or wear gold.  You view gold as valuable only because you know that others will as well.  Whether a thin sheet of linen-like paper or a gold ingot or a string of digits on an electronic financial statement, money is, itself, worthless.

That money has value only when others think it does is why currencies collapse.  The ruble and the Zimbabwean dollar lost value when no one wanted them, because a person holding this currency couldn't be sure that others would also view it as valuable.  But if Barack Obama ordered the minting of a trillion-dollar platinum coin, and it was viewed as having a trillion dollars' worth of value, then it would.

Of course because the denomination is so large, there is no free-market forum to test the value of a trillion-dollar coin.  On a practical basis, if one were minted it would be transferred to the Federal Reserve under heavy guard -- strictly for show, since if you stole a trillion-dollar coin there would be no place to spend it -- and the Fed would use the "value" of the coin to buy $1 trillion worth of Treasury bills and bonds, thus giving the government another trillion dollars to spend.

Bear in mind, that's how the past six years of irresponsible debt-based federal giveaways -- two years under George W. Bush, now four years under Obama -- have been funded.  The Federal Reserve keeps buying Treasuries, or mortgage-backed securities issued by Fannie Mae and similar federal agencies.  That gives the executive branch money to spend.  One division of government tells another, "Here is a new string of numbers," and money comes into existence.

What's underlying these transactions?  Nothing, beyond the belief that strings of numbers issued by the United States are more likely to be useful in trade than strings of numbers issued by, say, Greece.  Because the credibility of the United States is so high, its strings of numbers bear heft.  But if government keeps printing money and talking about obvious gimmicks such as trillion-dollar coins, how long will that credibility last?

The United States is able to print money out of thin air, without the risk of inflation, because of the trust the markets of the world have with our economic system.  The monetary base has expanded by more than threefold since the start of the recession in December 2007, but there has been no acceleration of inflation.  Why?  Because the velocity of money has declined as banks hold $1.5 trillion in excess reserves at the Fed; and the markets do not doubt the Fed's commitment to price stability.  They trust it will eventually withdraw the expansion of the monetary base.  For now.  But this only works as long as the markets trust us. 

Honestly, this whole issue, as absurd as it sounds, reminds us just how tenuous things can be with regards to our monetary system.  The Treasury and the Fed can just create money out of thin air because the world has decided that it trusts us, trusts our economy, and therefore chooses to accept our currency in exchange for goods and services.  The U.S. Dollar is still seen as the preeminent currency in the World…for now.  But if a government keeps printing money out of thin air to cover its lavish spending, how long will that trust last? 

You want to see a real fiscal cliff?  Check in with me when the world decides to reject the U.S. Dollar as unstable, and it is no longer seen as valuable in the world.  Is this likely?  Well, more likely today than it was yesterday…I guess we’ll see how much or little that means, though, if the government can’t get our fiscal house in order.