The Flipside of the Trillion Dollar Coin

As outlandish as the idea of the $1 trillion platinum coin at first appears, it gives us a glimpse of a monetary arrangement that, although far from ideal, is superior to the current system. Now that the Obama Treasury has definitely ruled out the scheme to mint the coin to circumvent the gimmicky debt ceiling, it is instructive to take a closer look at the reason why it did so and to articulate the lessons that can be learned from the episode.

To begin with, the scheme has ramifications far beyond a one-off political trick to avoid the debt ceiling. Indeed, it presented an implicit challenge to the much vaunted and sacrosanct "independence" of the Fed. That is why, from the very beginning, Fed worshippers in the establishment media – left, right and center – mercilessly mocked the idea and denigrated its supporters as grossly ignorant or irresponsible, although they dared not spell out its full policy implications.

No doubt the Fed was acutely aware of the threat posed to its independence by the coin gimmick. As a senior administration official revealed, had the Treasury minted and tried to deposit the coin, the Fed would have refused to credit the Treasury's account for the $1 trillion. This indicates the overweening arrogance of the Fed – as well as its great power – because the Fed was in effect threatening a president and a member of his cabinet with an illegal action. For even though they are not intended for circulation, US commemorative coins, which the platinum coin would have been, are legal tender at their face value.

One of the few commentators to fully articulate the anti-Fed implication of the trillion-dollar coin was Michael Sandler, a left-wing populist blogger and self-described "Political Economist, Climate Change Professional, and Sustainability Advocate." Although his article is mostly nonsense on stilts, Sandler does recognize that the coin scheme provided an entrée to wresting control of the money supply away from the unelected bureaucrats at the Fed and returning it to Congress and the Treasury. Sandler promotes a monetary reform program based on the template developed by the anti-Fed American Monetary Institute. He welcomes the minting of the trillion-dollar coin as a step toward implementing a central element of this program:

Repeal the congressional mandate for the Treasury to issue debt when it deficit spends. Instead, the Treasury could be allowed to spend money into circulation directly, or use debt-free instruments (of which the coin is one example) in its money creation process (with or without the Federal Reserve).

A common objection to such a proposal is that if money were under the control of the Treasury, monetary policy would become a political football, inflation would be rampant, the United States would founder in a sea of red ink, the dollar would tank on foreign exchange markets, blah, blah, blah. But how much more inflationary would monetary policy become than it is right now? The unelected and unaccountable bureaucrats at the Fed have fastened on the US economy a regime of zero interest rates, indefinite quantitative easing, and the insane targeting of a real variable (the unemployment rate) using nominal variables (i.e., the money supply, nominal interest rates). This is a reversion to stone age Keynesianism. Indeed, current Fed policy has enabled a fiscal policy of high deficits and rapidly mounting national debt, anyway.

But let us grant for the sake of argument that congressional control of monetary policy alters the mix of financing government spending toward less taxation and more deficits paid for by money creation. From the point of view of Austrian public finance theory, the method of governmental "revenue extraction" does not matter nearly as much as the total amount extracted. For all government spending, including transfer payments, drains resources from productive uses in the private economy and squanders them on the wasteful spending of politicians and bureaucrats. Government spending is either consumption spending that directly satisfies the preferences of members of the political establishment and their special interest constituencies, or it is investment in waste assets because it is not based on the profit and capital-value calculations that guide the decisions of private entrepreneurs and capitalists. It is in effect a redistribution of income and resources from the productive to the unproductive, from the “taxpayers” to the “tax-consumers.”

The total amount of government spending is therefore what Murray Rothbard called (p. 339) "government depredation on the private product." For Austrians, then, the method of financing government depredation – whether it be taxation, borrowing from the public, or money creation – is of secondary importance. Thus, at a given level of government spending, siphoning off resources from the private economy via deficits financed by money creation is no worse than extracting them through taxation. Indeed inflationary finance may even be preferable to taxation because the threat of physical coercion implicit in taxation has a detrimental effect on the direct utility of private individuals that goes beyond the expropriation of their income. As Rothbard (pp. 10-11) put it,

[W]hy should anyone believe that a tax is better than a higher price? It is true that inflation is a form of taxation, in which the government and other early receivers of the new money are able to expropriate the members of the public whose income rises later in the process of inflation. But at least with inflation people are still reaping some of the benefits of exchange. If bread rises to $10 a loaf, this is unfortunate but at least you can still eat the bread. But if taxes go up, your money is expropriated for the benefit of politicians and bureaucrats, and you are left with no service or benefit.

Needless to say, from the point of view of consumer welfare and economic efficiency, Austrian economists unquestionably prefer a smaller government budget financed by deficits and money creation to a larger budget that is in balance. For example, if confronted with a choice between an annual U.S. government budget of $2 trillion financed wholly by money creation and a balanced budget of $4 trillion, Austrians would without hesitation choose the former as less disruptive of the market process and less injurious to the welfare of individuals who earn their income through peaceful production and voluntary exchange. It is thus the total level of depredation on private producers and consumers, as reflected in government spending, that matters most for the Austrian economist; deficits and debt are at best of secondary importance and at worst a diversion from the true fiscal burden of government.

Obviously, congressional control of the fiat money supply is far from the ideal monetary system, which involves the complete separation of government and money through the establishment of a commodity money, such as gold, the supply of which is determined exclusively by market forces. Nonetheless, there is much merit in replacing the opaque and pseudo-scientific control of "the money supply process" by the entrenched bureaucrats of the Fed with overtly political control of money by elected officials and partisan Administration appointees.[1] There are a number of benefits of stripping the Fed of its quasi-independent status and transforming it into a handmaiden of the Treasury, in the mode of the trillion-dollar coin idea.

First, money would be created in a transparent manner that is understandable to the public at large. The Treasury would simply send an administrative order to the Fed to credit its checking account with the sum of money needed to pay the government’s bills that are not covered by tax revenues. Now, formally, this order would be called a “Treasury bond,” but it would not be a bond in the economic sense because it would not be exchanged in financial markets. Nor would the “interest” that the Treasury may pay on these pseudo-bonds really be interest because it would not be determined by supply and demand on financial markets. Rather it would be a payment to reimburse the administrative costs of the Fed and its amount would be completely controlled by the Treasury. It thus becomes pellucidly clear to the public that every single increase in the money supply engineered by the Treasury is not to “stabilize the economy” or “prevent a financial meltdown,” but to benefit the specific individuals and firms receiving the government checks. The new money is being created from nothing to purchase military aircraft from Boeing, to subsidize agribusiness giant Archer Daniels Midland, to bail out General Motors, etc.

This contrasts with the arcane process by which money is now created, which involves the Treasury issuing debt that is purchased by private entities, mainly banks and other financial institutions, and then eventually repurchased by the Fed via open market operations. In this way the Fed circuitously “monetizes the debt” and expands the money supply while pretending to control interest rates. Invisible to the lay person is the fact that twenty or so privileged Wall Street banks and financial institutions – so-called “primary dealers” – that sell bonds to the Fed profit immensely from the money creation process. Also benefitting are the fractional-reserve banks that get hold of the newly created reserves and their business clients who borrow the money at reduced interest rates and spend it to appropriate extra resources before prices have begun to rise.

Giving the Treasury control over the money supply by drawing checks on deposit balances that it “borrows” from the Fed yields another benefit. It not only shuts the Fed out of financial markets and renders the money creation process transparent, it also completely cuts out the fractional-reserve bank cartel from a central role in the money-creation process. This would mitigate that process’s tendency to create business cycles. When new money is injected into the economy via open market operations, as it is today, it expands bank reserves. The lending out of these created reserves by fractional-reserve banks artificially reduces the interest rate below the natural level determined by the voluntary saving of private income-earners. The distorted interest rate falsifies the profit and wealth calculations of entrepreneurs and households causing malinvestment and over-consumption and precipitating the boom-bust cycle that usually culminates in run-away asset bubbles and a financial crisis. In contrast, when the Treasury creates money it does so by writing checks for bureaucrats’ salaries, for entitlement payments, and to pay vendors for government purchases. This mode of money creation causes what Ludwig von Mises called “simple inflation,” which does not generally perturb financial markets and systematically distort interest rates. As Mises (p. 570) explained, financing Treasury borrowing directly from the central bank is no different from a government simply issuing fiat money to finance its spending:

Political and institutional convenience sometimes makes it expedient for a government to take advantage of the facilities of banking as a substitute for issuing government fiat money. The treasury borrows from the bank, and the bank provides the funds needed by issuing additional banknotes or crediting the government on a deposit account. Legally the bank becomes the treasury’s creditor. In fact the whole transaction amounts to fiat money inflation. The additional fiduciary media [i.e. unbacked notes and deposits] enter the market by way of the treasury as payment for various items of government expenditure. It is this additional government demand that incites business to expand its activities.

Furthermore, Mises argued (p. 570), this kind of simple inflation is not likely to produce financial conditions that lead to a business cycle:

The issuance of these newly created fiat money sums does not directly interfere with the gross [i.e., nominal] market rate of interest, whatever the rate of interest may be which the government pays to the bank. They affect the loan market and the gross market rate of interest, apart from the emergence of a positive price [i.e., inflation] premium, only if a part of them reaches the loan market at a time at which their effects upon commodity prices and wage rates have not yet been consummated.

In other words, the (non-bank) recipients of government checks would tend to allocate the new money between consumption and saving roughly in the same ratio as the rest of their income. Thus the prices of consumer goods and investment goods would rise in roughly equal proportion and the market interest rate would not be systematically displaced from its natural or equilibrium level. The result would be inflation, but no business cycle.

Last but not least, as an adjunct of the Treasury, the Fed would no longer function as bailer-outer of last resort, a role that is held in unquestioned importance by almost all contemporary economists, but which infects the entire financial system with pandemic moral hazard. No longer would the Fed be able to surreptitiously, arbitrarily, and without democratic oversight or accountability bail out all manner of financial institutions not only in the United States but in foreign countries. A partisan Treasury under the watchful eye of the congressional opposition and in full view of the public will have to make these decisions. I daresay that with the Fed neutered and unable to leap to their rescue at the first sign of distress and with their requests for bailouts subject to full scrutiny by a skeptical Congress and public, fractional-reserve banks would run their affairs much more prudently.

Let me be clear: my intention is not to deny that the trillion-dollar coin is a ludicrous and dangerous idea; it is rather to point out that the Fed is a more ludicrous and dangerous idea.

January 31, 2013