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Friday, January 11, 2013

Flaws in the "Trillion Dollar Coin" Gambit

A cohort of bloggers has been flogging the idea that, to sidestep the legislative obstacles to increasing the debt ceiling and operate the government and avoid default in the face of the ceiling, the Secretary of the Treasury should cause the U.S. Mint to mint a "trillion dollar coin" out of platinum (which I will refer to as a "$1T Coin" for brevity's sake), the denomination being roughly equal to the anticipated sum of net debt the Treasury would otherwise have issued to fund the projected deficit over the next year.  The coin would not contain a trillion dollars worth of platinum at market prices, which would require so many tons it is practically impossible, but would simply have a platinum content and be assigned a nominal value by the Secretary of  "one trillion dollars" on its face.  

The Secretary is then to deposit the coin in a bank -- necessarily one of the Federal Reserve Banks, as opposed to a commercial or savings bank, because 1) no commercial bank could take such a deposit without its capital ratios being driven to impermissibly low levels and 2) no commercial bank has enough disbursable money to honor checks and withdrawals in the size contemplated.  Then, having created a deposit account of $1,000,000,000,000, write checks against it to meet the obligations of the US over the course of the next year.

There are two versions of what happens then. In one scenario, the Republicans recognize they have been outfoxed and drop their opposition to the debt ceiling, at which point the Secretary returns to issuing debt and, once a trillion dollars of proceeds have come in, redeems the coin and directs the Mint to melt it down, restoring the status quo.  In another, the Fed, concerned about the inflationary impact of one trillion dollars of new money being injected into the economy without an offsetting withdrawal of liquidity from the issuance of new Treasuries, sells Treasuries from its own, recently expanded balance sheet to effectuate the offset. The latter variation puts in place a remarkable role reversal, in which the Fed takes over the Treasury's historical function of selling Treasury debt to the markets and the Treasury takes over the Fed's historical role as the creator of money.  Equally remarkably, it causes the Fed to perform a 180-degree pivot and switch from deflation fighter to inflation fighter overnight,

The gist of the argument economically is that the United States has a fiat currency and all money it creates has that nominal value assigned by "the gubmint" so this is just a larger denomination of an unquestioned principle: this is just what money is.
These blog posts give you some basic background on the idea, and the history of its dissemination and identify its most breathless advocates in the blogosphere. 

A good portion of the argument in favor of the idea has been legal in nature, seeking to convince the reader that the Treasury Secretary can do this as a legal matter.   Having time on my hands and liking this kind of outside the box proposition, I spent some time looking at the issue, although I don't claim to be an expert in this topic, either before or after my study of it.  I conclude that

1) there are a variety of rules or guidelines in statutory construction and there is at least a plausible "plain language" argument that the Secretary can direct the Mint to mint a $1T Coin;

2) the Treasury Secretary's willingness to exercise such presumed authority is a necessary but not sufficient condition to the practical implementation of the gambit; the cooperation of the Federal Reserve System is also required;

3) under the same "plain language" approach to statutory interpretation that supports the Secretary having power to create a $1T Coin, the Fed has a similar discretion not to cooperate; it may conceivably be required to take the deposit but it is not obligated to create the amount of money needed to turn the single coin into usable denominations of money; and

4)  an overlooked provision of Federal law prohibits the Fed and Treasury from collusion in monetizing the federal deficit, and should apply to this proposal as well.

1.  Under a plain language reading of the statutes on coinage prerogatives, the Treasury Secretary is authorized to create platinum coins in whatever denomination s/he deems appropriate.  Section 5111(a)(1) plainly authorizes the Secretary to mint coins in amounts "necessary to meet the needs of the United States.”  31 U.S.C. §  5112(k) in its entirety says "The Secretary may mint and issue platinum bullion coins and proof 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."

Objections have been levied that the creation of a $1T Coin was not plausibly intended by subsection (k), which, the objectors say, was meant only to authorize commemorative coins in amounts too small to impact the money supply or the fisc.  Indeed, the bill that incorporated 5112(k), Pub L 104-280, was mostly but not entirely focused on commemorative coins and there is no evidence of any Congressional discussion about conferring unlimited money-making power on the Treasury Secretary.  Common sense suggests such a shift would have engendered some discussion, so, along the lines of Sherlock Holmes's "the dog that didn't bark", it is rational  to read the statute in a less radical fashion. The coin’s proponents have responded at length, and have managed to evoke an endorsement of their interpretation from Professor Laurence Tribe at Harvard Law School, who is indisputably one of the leading Constitutional scholars, living or dead, although it must be  note that the analysis does not involve any Constitutional interpretation, but simple statutory construction, and Tribe has elsewhere vigorously argued against literalism in interpretation (that's the main theme of his book "The Invisible Constitution").  And elsewhere in this blog I have noted how Tribe's views have seemed to switch polarity depending on which party controls the law-making arms of government.

Although I think it flies in the face of common sense to argue that two houses of Congress intended to effect a fundamental and historic change to decades of Federal Reserve control over the monetary policy of the United States via a commemorative coin law without any public debate of the policy change, I won’t dwell on that arguments any further as I have something different to offer on the topic.

Section 5111(b) says that the Treasury has a “coinage profit fund”, which the Secretary shall credit “with the amount by which the nominal value of the coins minted from the metal exceeds the cost of the metal.”  So, the “coinage profit fund” grows by a trillion dollars less the cost of minting the $1T Coin. That cost would be very small -- the coin would contain a small amount of platinum, not a trillion dollars worth at market prices (if such an amount could even be mined and smelted). So there would be a very large “coinage profit”or what economists call "seignorage".  5111(b) goes on to say that “The Secretary shall deposit in the Treasury as miscellaneous receipts excess amounts in the coinage profit fund.”.  So the “coinage profit fund” is just a bookkeeping entry; the Treasury now grows by $1T. 

2.  Title 31 has nothing more to tell us about the next step in the proposal, the deposit of the $1T Coin into an account of the Treasury at a Federal Reserve bank.  The Secretary has to do that because, the $1T is made up of millions of smaller expenditures and the Secretary needs to be able to write lots of checks and make lots of payments out of the $1T sum, all for smaller sums  than $1T.  

The basics of the depository relationship are promulgated in 12 U.S.C.  § 391: “The moneys held in the general fund of the Treasury … may, upon the direction of the Secretary of the Treasury, be deposited in Federal reserve banks, which banks, when required by the Secretary of the Treasury, shall act as fiscal agents of the United States; and the revenues of the Government or any part thereof may be deposited in such banks, and disbursements may be made by checks drawn against such deposits.”

Similar language, from the perspective of the Federal Reserve Banks, appears in 12 U.S.C. § 342: “Any Federal Reserve bank may receive from any of its member banks, or other depository institutions, and from the Unites States, deposits of current funds in lawful money…”  Assuming the $1T Coin is lawful money, the Federal Reserve Banks are clearly authorized to take it in deposit.  

Some may note the repeated use of the word “may” in each of these statutes, which posits some sort of discretion is reserved to the actors involved.  Is it the Secretary alone who has discretion or do the Federal Reserve Banks as well?  I think there are enough references to the "direction of" and "required by" the Secretary to suggest that the  Federal Reserve Banks are obligated to take the $1T Coin in deposit.  However, note that a semicolon separates the parts of 342 that contain those phrases and the final text which refers to disbursements by check.  The semicolon certainly quashes any implication that the references to the Secretary directing and requiring the Fed carry into the statement about honoring disbursements by check.  (I'm not going to bother with case citations; this is a blog post not a brief or law review article and there is enough law on this kind of close reading of statutes that any trained lawyer knows the statement I just made is as supportable as any legal argument in support of the $1T Coin gambit).

3.  Since the creation of the Federal Reserve System in 1913, the creation of money for purposes of circulation has been principally within the control of the Fed.  The physical currency that people have in their wallets or mattresses and call "cash" is what Federal law refers to as Federal Reserve notes.  Given the denominations that have been used heretofore, the vast bulk of money in circulation in the US is in the form of Federal Reserve notes, not coins. 

The process by which the Fed money is creates money is too detailed for this post; for these purposes, only two points needs to be understood:  1) The Fed, not the Treasury creates money in the form of Federal Reserve notes, and 2) the Fed is indisputably intended to be an independent decision-maker when it comes to creating money. 

Title 12, Chapter 3, subchapter XII of the US Code governs the creation of Federal Reserve Notes and makes these points very clear:  first, Section 411 provides: “Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are authorized...."

 Second, Section 412 defines the process leading to any such issuance: “Any Federal Reserve bank may make application to the local Federal Reserve agent for such amount of the Federal Reserve notes hereinbefore provided for as it may require .…” 

Finally, Section 414 provides: “The Board of Governors of the Federal Reserve System shall have the right, acting through the Federal Reserve agent, to grant in whole or in part, or to reject entirely the application of any Federal Reserve bank for Federal Reserve notes….”

The italics in those quotes are, of course, mine to show the discretion of the Fed in creating money.  But don't just note (1) the discretion of the Board of Governors to reject any application from one of the Federal Reserve Banks for the issuance of Federal Reserve Notes, or (2) the discretion of the individual Federal Reserve Banks not to apply for $1T in Federal Reserve Notes in the first place, but the complete absence of the Treasury from the process. The Treasury has no power to compel any Federal Reserve Bank to create Federal Reserve notes, and thus no power to break the $1T coin into smaller, usable amounts over the objection of the Fed.  It may have a deposit at a Federal Reserve Bank in the amount of $1T but it has no power to make that bank issue money in smaller amounts on account thereof.  The deposit of the $1T Coin and the transformation of that sum into $1T of usable denominations are legally two different things and the latter is completely controlled by the Fed, beyond Treasury’s fiat. 

4.  The last sentence of 12 U.S.C. § 355(1) provides a clear statement of policy prohibiting the Fed from monetizing Federal debts except through open market purchases.  Section 355 lists the “Powers and Duties of Federal Reserve Banks”.  The last sentence of 355(1) however contains a limitation on one type of transaction: 

"Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to principal and interest may be bought and sold without regard to maturities but only in the open market."

That prohibits non-open market transactions between the Fed and a counterparty in obligations of the US. That counterparty could be a member bank, getting a sweetheart price, but it equally bans the Fed from buying new Treasuries directly from the government.  Treasury and the Fed are not allowed to get together and collusively monetize Federal debt, each of them has to go to the capital markets and take market prices.  This is an important form of discipline on them both and on the ability of the political branches to control the Fed and the money supply for political purposes.

While the $1T Coin is not itself a Treasury instrument, it is obviously the functional substitute for one in this context.  This is one of the basic tenets of monetary theory regarding a fiat currency -- the sovereign's currency is just the same as a demand note on the sovereign.  There is no basis to distinguish between a coin issued by the Treasury denominated in X dollars and a demand note issued by the Treasury in the same amount.  In a fiat currency, they are identical. 

If there were no debt ceiling, Treasury would raise cash to deposit in its accounts at a Federal Reserve Bank by issuing debt instruments at market prices.  In the proposal, it simply substitutes the $1T coin for the Treasury issuance as a matter of form, then goes to the Fed -- with something for which there is no evidence of any market price, of any transaction with any third party – and says “this is worth $1T”.  It’s completely collusive if the Fed accepts that at face value and functionally and substantively what the last section of section 355 is meant to prohibit.

Why should the Fed say no?  I will offer two reasons, one institutional, the other economic. 

Institutionally, the Fed has historically presented itself as independent of the political branches in the management of the money supply.  Such a perception is considered vital to a sound currency, i.e., one that retains its purchasing power reasonably well against other currencies and against domestic assets and liabilities, and a sound currency is generally considered vital to a sound economy. There are ample instances throughout history of a currency controlled by the sovereign being debased for political ends, and high inflation and economic peril resulting shortly thereupon.  Keynes wrote in "The Economic Consequences of the Peace" that "Lenin was surely right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency".  And, proving the accuracy of Keynes's statement, within a decade after he  wrote that, Germany had its hyper-inflation and the Nazis began their rise.

By cooperating with the $1T Coin strategy, the Fed would be surrendering its institutional independence concerning the creation of money to Treasury (and, given that Treasury Secretaries serve at the will of the President, to the President).  In succeeding years, President Obama and his Treasury Secretary could repeat the practice; succeeding administrations could do so as well. There is no reason future resorts to the gambit would be limited to just the amount necessary to cover a deficit; it could be used in any amount.  (Already, one of the blogger proponents on firedoglake says $1T is "small ball" and the coin should be $16T, the size of all federal debt, or even $100T). The Fed’s role in creating money would be reduced to a largely mechanical, passive, subordinate agent of the executive branch, like a dog waiting for its master to come and take it for a walk on a leash.  One would expect the individuals who would make the decision to cooperate or not to feel strongly about this radical diminution of the role of their institution.

Economically, look at two things:  the money supply and the Fed balance sheet. There are several competing and overlapping concepts of what a nation’s “money supply“ is. For this purpose, I will refer to the “monetary base” of the United States, which the St Louis Fed tells usis the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks” and with a reasonable degree of accuracy captures the money everyone in the economy owns at a given time; presently it’s approximately $2.6T, according again to the St Louis Fed.  So the injection of $1T in new money into the economy through Treasury spending over the course of the year, without some action to offset that, would increase the monetary base by about 38%, which is a dramatic increase likely to produce inflation in some amount. 

Now the response to this is obvious: It doesn’t go into the monetary base and the economy all at once, but only as it is disbursed over a year and Treasury is supposed to disburse that money over the year anyway, because it’s Federal spending in the normal course, so it’s not per se inflationary. It’s just a question of how you manage its injection over the course of the year and what steps you take to withdraw a more or less comparable amount of money from the economy over the same time; and, since the supply of new Treasuries will be far below the demand that is customarily present, the Fed can sell old Treasuries from its balance sheet to meet that demand and you wind up in the same place.

So we turn to the Fed’s balance sheet to see how this is so.

The Fed published its consolidated balance sheet weekly and you can see the latest one at Item 8 on this webpage.  It shows the Fed has $2.9T in total assets, of which $1.68T are Treasuries.  So it is true – for one year and some portion of a second – that the Fed could offset the monetization of the $1T Coin.  But the strategy would either become outright inflationary in the second year or have to be abandoned, with the political process reverting to the standoff / technical default risk that exists today. However, I think it is reasonable to predict that, as the market realized the Fed’s supply of Treasuries would be exhausted in the second year, rates would rise and the value of Treasuries would fall on account of the expectations of either default from an end to the gambit or inflation on account of continued use of the gambit without any means to offset the monetization of the deficit. 

So based on these reasons, I think the Fed would have a sound basis to decline to cooperate with Treasury in the $1T Coin gambit.  The Fed would say in effect, it can’t work for more than a year; we’ll all be back here in a worse position; we’re not going to compromise our independence and if we did it would have detrimental long term effects on the soundness of our currency; and we are legally within our rights to decline to do so and in deed we may be prohibited from doing this.  In recall that in 2011 when the debt ceiling was then at issue, Ron Paul called on the Fed to solve it by destroying the Treasuries it held, thereby reducing the amount outstanding by the amount destroyed.  I don't recall anyone thinking the Fed would take his advice, which isn't that much different in principle than the $1T Coin gambit.  

I am inclined to think a sensible administration would take this into account and not go down such a road in the first place, notwithstanding the way its allies in the blogosphere are pounding the drum for it.

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