Denarius Ex Machina

by Benjamin Studebaker

As the United States approaches yet another debt ceiling fight, an interesting idea has surfaced that might allow the whole mess to be circumnavigated altogether–the minting of a trillion dollar super coin. There are a few things to examine with regard to this proposal–why are we considering it, can it be done, what consequences would it have, and what are the possible alternatives?

Why the Coin?

The goal of the coin proposal is to take the debt ceiling off the table as a negotiating tool for the Republican Party. As it stands, the US government bizarrely and uniquely structured such that passing spending bills and authorising borrowing are not done together, but separately. This allows congress to pass spending bills but to then refuse to pass legislation permitting the state to borrow money to pay those bills. Congress requires that Obama spend money through legislation while simultaneously refusing to permit Obama to borrow the money necessary to achieve that purpose. The goal for the republicans is to force the president to make concessions to them in exchange for their permitting him to borrow money to fund the projects they themselves approved. If the debt ceiling is not raised, the law will require the president to spend what money the state has left to it until it goes bankrupt and defaults. A default would be an economic catastrophe for the people of the United States and must be avoided. It is essentially a form of hostage taking–the republicans put a gun to the head of the American economy and demand spending cuts in exchange for not pulling the trigger. How does the coin avoid all of this? There is a loophole in existing legislation permitting the government to print coins of any denomination. The law was intended for ceremonial purposes, but it could be used as a tool of unorthodox monetary policy. The federal government could mint a trillion dollar coin (yes, like in the 1998 episode of The Simpsons) and deposit it at the Federal Reserve, using that money as a stop-gap to continue to successfully pay its debts. Instead of borrowing the money, the government would create it out of thin air, and so no additional debt would be taken on and the debt ceiling avoided.

Can it Be Done?

The intent of the law in question clearly has nothing at all to do with the state’s economic policy, and it’s very possible that a court would strike down the coin on that basis. However, more and more people, including the fellow who wrote the law in question are beginning to get behind the idea, and it’s become increasingly likely that, should the republicans use the debt ceiling to take the economy hostage again, the coin will be used. At the very least, the administration may bluff and pretend it is willing to mint the coin in order to dissuade republicans from pursuing the hard line in the first place.

What are its Consequences?

At first glance, the coin sounds deeply inflationary and deeply irresponsible. However, because of the precise economic conditions of our time, the macroeconomic consequences should be far less substantial than is widely feared. The relevant condition is that of the liquidity trap, the situation in which the Federal Reserve’s interest rate is set at the minimum possible value, the “zero lower bound”, yet unemployment remains above and growth remains below their respective target levels. In this scenario, creating additional money is not inflationary unless spending and consumption increase as a result, and then it is only inflationary once the economy reaches full employment and the economy returns to performing at potential. This may sound preposterous and far-fetched, but the available data over the last few years shows it to be true.

Here we can see the interest rate riding along the zero lower bound, as it has been doing since just before Obama took office:

Here we can see the Federal Reserve tripling the monetary base from around $800 billion to over $2.5 trillion, creating a bunch of money out of thin air through a process called “quantitative easing” in which it buys bonds from people with money it prints:

Here we can see all of that additional money failing to translate into high rates of inflation:

The inflation target set by the Federal Reserve is 2%, historically quite a low number, and one which the central bank is meeting easily despite having created well over a trillion dollars in new money previously by quantitative easing. It stands to reason that, if the Federal Reserve can create in excess of $1.7 trillion in new money through QE without seeing punitively high inflation, it can do the same through the coin, particularly if, as expected, the Federal Reserve counters taking on the coin by selling its own bonds.

But would any of this spook the country’s creditors? Not in the least. Because the United States has its own currency over which it controls its own monetary policy, investors know that the United States cannot be forced into a default and that its bonds remain safe places to put their money in a time of economic uncertainty–it can always print more money or devalue the dollar if it runs into any real trouble (as say, Britain did in the nineties with actually expansionary economic consequences). It is for this reason that interest rates on American bonds remain very close to their historic low, below 2%:

Countries that truly are having problems financing their debts usually either have lots of debt in foreign currencies that they do not control or themselves do not control their own currencies. Greek debt was sold for interest rates as high as 40% (and still goes for over 10%), while other troubled countries like Spain and Italy have run rates in the neighbourhood of 7%, the mark usually considered dangerous. With a flexible currency of its own and an active central bank, the United States does not have the same absence of control characteristic of countries running those high interest rates, and minting the coin and avoiding a conflict in which one political party tries to create a debt crisis for its own benefit would, if anything, improve market confidence rather than harm it.

What Else Could We Do?

There are two other potential options:

  1. The 14th Amendment
  2. Fiscal Cliff Round II

The president could declare congress’ refusal to raise the debt ceiling unconstitutional via the 14th Amendment, which reads:

The validity of the public debt of the United States…shall not be questioned.

While provocative, it would put an end altogether to fights over debt ceilings. The only other alternative is to do the same old thing–give into the hostage-taking and have additional rounds of negotiations that only result in further austerity during a time of high unemployment and weak growth. Keep in mind, both of the coin and the 14th Amendment were options available to Obama during the original debt ceiling fight in 2011, but he chose not to use either of them, instead passing the Budget Control Act, which only served to create the fiscal cliff. It was a cowardly, stupid move by the president.

I recall something George W. Bush said in 2002 that I think Obama should heed:

Terror must be stopped. No nation can negotiate with terrorists. For there is no way to make peace with those whose only goal is death.

What the republicans are doing, trying to artificially engineer a debt crisis in order to extract budget cuts and the bleeding of the welfare state, amounts to economic terrorism. If they succeed, they will harm far more people directly than anything Al Qaeda has managed to pull off.  There is no way to reach an agreement with people whose only goal is to roll back our economic policy to pre-Keynesian times and who are willing to pursue that goal by threatening to hurt the country. They are not reasonable people, they do not deserve to be listened to or negotiated with in a reasonable way. Mint the coin or use the amendment, Mr. President. Defend America from economic terrorism and the stone-age economics it propagates.