A Simpsons solution to a very real problem.
Graeme O’Meara | Contributing Writer
The plot of a Simpsons episode nearly came to life last week when a ‘crackpot idea to circumvent America’s debt ceiling gained currency.’ The story is as follows: the debt ceiling is a self imposed upper bound on the maximum amount the US Treasury can borrow to fund its expenditures when there is a deficit between tax receipts and fiscal outlays. A sluggish economy and waning tax receipts (let alone pumping money into troubled banks and funding the 2009 fiscal stimulus) have caused US debt levels to soar. Essentially, the exchequer finances are like a flooded room where water is rising toward the ceiling and Congress have had to raise that ceiling on several occasions to keep the US economy above water, the last rise being January 2012 to an all time high of $16.394 trillion. The Republicans’ stance on this issue is to try to drain the room of water by forcing the Obama administration to cut expenditures and hike taxes. By divine coincidence this would also mean cuts to Medicare which they politically oppose. Unfortunately, increasing taxes and imposing austerity on an ailing economy is at odds with economic logic and may actually be counterproductive.
With the US public debt now at the ceiling, the House of Congress can prevent the administration from borrowing to fulfil normal day to day expenditures as laid out in the national budget. With the Republicans dominating Congress, they now hold the trump card and are threatening to either force the administration into spending cuts which they favour or allow the government to default on its debt obligations. This would mean the yield on Treasuries securities would rise and send shockwaves across financial markets, which consider these securities risk free. And Republicans are unlikely to agree to abolishing the ceiling altogether.
Now enter a legal loophole which allows the US Treasury to mint commemorative coins in any denomination it desires. Once this is lodged into government’s account at the Federal Reserve, it can use the cash to fund its day-to-day outlays. The reason for the coin is that Federal government cannot simply print money to pay its bills, it must issue bonds (i.e. borrow – which it’s not allowed do when debt hits the ceiling) which the Federal Reserve buy with freshly printed greenbacks (well, not literally).
What’s most intriguing is how this would fair out in practice and its effect on inflation. In terms of currency, the Fed issues notes and the Treasury issues coins, and both are respective liabilities of each institution because they are redeemable and ‘payable to the bearer on demand.’ When the Fed buys coin from the Treasury, it prints money and lodges it into the Treasury’s account at the Fed; this is exactly the same as quantitative easing.
Both coins and notes are part of the monetary base, the pure liquid currency in circulation and in deposit accounts, upon which loans and other forms of credit are produced, to form the overall money supply. However, when the Fed buys coins, just as when it buys bonds from the government, its assets rise (while newly printed cash means its liabilities rise) and therefore the monetary base does not expand because it is taking in coins, not issuing them. Thus, the monetary base will not expand until the government’s $1 trillion makes its way, somehow, to commercial banks – perhaps first into citizens’ pockets and then into their bank accounts.
As this $1 trillion trickles into the monetary base (through the hands of the public), will it spur inflation? Some commentators argue that since the US economy (much like the Eurozone) is in a liquidity trap it will not be inflationary because interest rates are near zero. It would be inflationary if the Fed printed new money to give to the government in return for the coin, but not if the Fed sold some assets and took money out of the system to give the government for the coin; in econ jargon this is known as ‘sterilising’ so that there is no effect on the base. To control inflation, the Fed adjusts interest rates through the monetary base (by printing money and giving it to banks, boosting their reserves and allowing them to lend more) and causing the interbank market to bring down the interest rate. But where there is excess money in the system, it is difficult to raise interest rates. This would arise if the Fed simply printed new money in return for the coin. The dilemma poses the question of whether quantitative easing is easily reversed in an environment of low interest rates.
Suppose the Fed sucked money out of the system to give to the government for the coin. This means its assets (e.g. government bonds) are $1 trillion lower. With lower assets and very low interest rates, this could impair the Fed’s ability to combat inflation if it started to rise. To combat this, the Fed usually withdraws excess monetary base (reserves) out of the system by selling off some of its asset in return for cash. This would push up interest rates since available bank reserves would become scarce. Alternatively the Fed could offer interest payments on reserve accounts held by commercial banks, giving them an incentive to return some of their reserves to the Fed. Trying to curtail inflation is a tricky task when interest rates are near the floor and the Fed’s asset base is $1 trillion lower.
It seems fortunate that the idea is off the table (for being politically undignified), firstly because it could relieve the Fed of a major predicament down the line, and secondly because it is monetizing the national debt which violates the mandate of the Federal Reserve and compromises its independence as a central bank. On the latter point, not only would it make Bernanke look bad, but it would likely be exploited by future presidents down the line. The upside is that it would buy time for negotiations on the debt ceiling and avoid a semi default by the US government which would trigger utter chaos. Perhaps the way forward would be Paul Krugman’s idea of moral obligation coupons: the government issues pieces of paper in return for cash which they will redeem after a year, but there is no legal obligation to repay them as they’re not officially debt?
