The tale of the trillion dollar coin

This is my Perspective column from this week’s Fund Strategy magazine.

Just when the American economic debate seems like it cannot get any weirder it does. As in a Hollywood movie the sequel is generally worse than the original.

After the fiscal cliff, or strictly speaking the second episode of the fiscal cliff, there was the trillion dollar platinum coin. Heavyweight thinkers were seriously entertaining the possibility of minting a coin with a face value of $1 trillion (about £620 billion) and the White House, at first at least, refused to rule out the possibility

Eventually the Obama administration came to its senses but it is worth examining the bizarre episode in more detail. Although the technical aspects of the story were well explained in places the underlying principles tended to get lost.

The minting of the extraordinary coin was suggested as a way to get around another self-imposed obstacle in American law: the debt ceiling. According to this rule the Treasury can only borrow up to an authorised maximum.

To raise the ceiling needs congressional approval. Without such permission the government could default on its debt.

With the Republican majority in the House of Representatives hostile to increased spending it looks like the Obama administration will hit the limit soon. Yet the Treasury does not have the legal authority to print extra money as a way of circumventing the limit. Only the Federal Reserve, under a mandate from Congress, has the authority to print notes.

That is where the coin idea arises. In the summer of 2010 a blogger who goes by the tag of “Beowolf” suggested that minting a platinum coin could circumvent the debt ceiling. Although the Treasury does not have the power to print notes it can mint coins for commemorative purposes.

The Fed would have to accept such a coin for deposit, even if it was not pure platinum, as it would be legal tender. It would therefore be forced to print notes to pay for it. In effect the result would be a form of quantitative easing through a peculiar route.

Beowolf’s identity is known, evidently he is a lawyer from Atlanta, but his proposal attracted little attention for the first two years. Then as the current federal debt approached the current ceiling of $16.4 trillion it began to draw attention from high profile journalists. It eventually reached the point where Paul Krugman, a Nobel laureate, endorsed the proposal and the White House had to take a position on it.

Although the Obama administration finally decided not to go ahead it is worth examining the discussion more closely. It was widely acknowledged that the proposal was ridiculous but at the same time the alternative was viewed as even worse. So Krugman argued that Obama: “will, after all, be faced with a choice between two alternatives: one that’s silly but benign, the other that’s equally silly but both vile and disastrous. The decision should be obvious”.

There was also a debate about the likely inflationary implications of increasing the money supply by so much. Krugman argued the standard Keynesian line that inflation was unlikely to be stoked in such a sluggish economy. Others argued the contrary view that inflation was the likely result.

However, two fundamental points were largely missing from the discussion. There was little understanding of the anti-democratic thrust of the discussion. This in turn is related to the lack of long-term economic thinking.

Although the point was largely hidden in the discussion the trillion dollar coin proposal was essentially a technocratic trick to avoid democratic debate. Under the American constitution of 1776 it is Congress, particularly the House of Representatives, which holds the power of the purse. The president can only spend money with congressional approval. This remains a good principle as congress is subject to more direct popular control than the president.

The nature of the relationship was blurred with the creation of the Fed in 1913. Although the Fed is responsible for printing money it does so under authorisation from Congress.

Congress has given ever more leeway to the president to spend money for many years. Yet control of expenditure is meant to be a key way of limiting executive power.

If the Obama administration wants to raise more funds it is right that it should win the debate in Congress to do so. In the event it fails to win the discussion it should bow to democratic pressure.

Economic evasion parallels this political evasion. For many years administrations of both stripes have helped to maintain a credit bubble rather than tackle fundamental economic weakness. Public spending has been kept high and, with the help of the Fed, interest rates have remained low.

This has created a situation where America’s short-term economic figures are flattering. GDP growth only looks relatively strong because the deficit remains high.

Sooner or later a reckoning is likely to come. Postponing the challenge, through a trillion dollar coin or some other trickery, is only likely to make matters worse in the long-term.