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Putting The Fed In Your Pocket

There are some crazy ideas that are just plain crazy, but many include a glimmer of reality underneath. That glimmer is what is disturbing about recent talk of solving the nation’s budget impasse with a $1 trillion coin.

When you think the idea all the way through, the proposed coin is just a convenient way to put the Federal Reserve Bank in the pocket of free-spending politicians. I don’t believe such a coin will ever be issued; in fact, I am 99 percent certain that it won’t. (In today’s Washington, I don’t think anyone can be 100 percent certain of anything.) But my confidence is only partly due to the fact that the super-coin idea is so deranged that it was originally meant as a joke. Mostly, I am sure the coin will not be issued because the Fed is already in politicians’ pocket, and issuing the coin might actually offer the central bank a way out.

To understand why, we need to start at the beginning.

The federal government is spending about $1 trillion more every year than it collects from taxes and other sources. It has to borrow to make up the difference. The accumulated debt recently reached the congressionally authorized ceiling of about $16.3 trillion, so the Treasury is currently resorting to emergency measures to pay the nation’s bills. Sometime in the next two months, the maneuvering room provided by the Treasury’s fiscal finagling will be exhausted. At that point, either Congress must authorize more borrowing or the government won’t be able to pay all its debts. Some items would be paid, others would not; the Treasury has not divulged its contingency plans, if it has any. But the only sensible option is to come to an agreement with Congress to raise the debt limit before we reach that point.

Congress is perfectly willing to do this, but Republicans, who control the House and have some influence in the Senate, want to impose spending cuts that President Obama and his fellow Democrats find unacceptable. We seem to be headed for a debt-ceiling cliffhanger to echo the one we had in mid-2011, when the nation lost its AAA credit rating from Standard & Poor’s.

This is where the proposed $1 trillion coin enters the story. Awhile back, Congress authorized the Treasury to mint platinum commemorative coins and to assign to those coins any value it chooses. The assumption was that such coins would be priced to make them attractive to collectors, thus satisfying some market demand and letting the government pick up a few bucks in the process. But the law does not place any limits on how the Treasury can exercise this authority.

So the idea is for the Treasury to mint a single coin and assign it a value of $1 trillion. Or maybe mint two such coins. The Treasury would then bring the coin(s) to the Fed, which, as the government’s banker, would duly credit the Treasury’s checking account with the appropriate number of trillions. The result: Instant spendable money, without having to borrow any of it. The debt limit becomes irrelevant.

The idea is ridiculous only in its extremity. Since the days of King Croesus of Lydia, who minted the first standardized gold coins in the sixth century B.C., every sovereign has ensured that the face value of each monetary coin is greater than the value of the metal required to make it. This policy is essential because, if the coin is worth more than face value when melted down, the society ends up with a lot of melted metal and no currency in circulation. Such a policy is also profitable for the sovereign, because the government acquires goods and services at the coin’s face value, even though it costs less than that to manufacture. This form of arbitrage is called “seignorage.”

Platinum traded at around $1,600 per ounce last week. Assuming a one-ounce coin of pure platinum, and assuming another $1,600 for design and production costs (I suggest they use a portrait of President Obama on the obverse and an empty cash register drawer on the reverse), the Treasury would make a profit on each coin of $1 trillion, less $3,200. Not a bad day’s work.

This scheme would permit the Treasury to create a very large sum of money from a small amount of platinum. Though this is not precisely creating money from “thin air,” the idea is the same. If it works, why stop at just one or two coins? The entire federal budget is less than $4 trillion, so with four of those coins, we could give the Internal Revenue Service the year off. With a good-sized roll of such change, we could fund Social Security for decades.

This sort of thing has been actually done, though usually with paper rather than platinum. The Confederate States of America printed the money it needed to fight the Civil War. When I was a boy, a century after the war’s end, gift shops sold worthless confederate bank notes as souvenirs. Kids my age often hung them on their bedroom walls.

Germany’s Weimar Republic did the same thing in the 1920s, with similar results. So did Brazil in the 1970s and ‘80s, when it destroyed a currency called the cruzeiro, created a new currency called the cruzado, and promptly destroyed that one too. Present-day Zimbabwe’s central bank is the proud author of a Z$100 trillion bill. I saw one offered for sale on eBay last week, for $6.49 - in American money, naturally.

Proponents of the $1 trillion coin assume that the Fed will actually accept the metallic gimmick as money. Maybe, but if it did, Fed Chairman Ben Bernanke and his colleagues might as well resign and go home. The Federal Reserve Act created the central bank as an independent entity a century ago and gave the Fed - not the Treasury - the power to create money, precisely in order to avoid what happened to the Confederacy and its currency. You don’t need to lose a war to destroy an economy; you just have to mismanage it. Nobody, after all, has invaded Zimbabwe.

The Fed, however, might just assert its independence and reject the Treasury’s proffered coins. Uncle Sam would then find itself out of cash, and we would have to resume a serious discussion about the debts we continue to rack up and just how high we want to set the national credit limit.

This brings us to a final realization: Even with a debt ceiling raised sky-high, or removed entirely, as the president would prefer, nothing much would change. Raising the limit, by itself, does not give the Treasury any money. The Treasury would still have to issue debt, and somebody would have to buy that debt. For now, foreigners and other investors still reeling from the financial crisis are willing to keep putting their money in Treasury obligations that are virtually guaranteed to lose value due to inflation. But everything has its limits. When the day comes that nobody outside the government wants to buy our Treasury debt, what will happen?

You guessed it. The Treasury will take its debt right down to the Federal Reserve, which will then face a choice: create the money to buy the debt itself, or let the government’s financial house of cards collapse, taking the global economy with it. The Fed will buy the debt. Of this, I am 100 percent certain.

The only way out is to get our budget and our borrowing under control before we reach the point where nobody other than the Fed wants to be our Treasury’s creditor. Periodic debt ceiling debates are a vital check on politicians’ tendency to keep spending and spending, right until they run out of cash and have to give serious consideration to crazy schemes.

Like issuing $1 trillion coins, for example. It’s crazy, but not so crazy that I’m 100 percent sure it cannot happen.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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