The Independent Market Observer

1/10/13 - Planning for Failure: The Trillion-Dollar Coin

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jan 10, 2013 8:25:33 AM

and tagged Fiscal Cliff, Politics and the Economy

Leave a comment

trillioncoinI’ve said it before and will say it again: the debt ceiling debate, coming shortly, is the real thing we need to worry about. The deal over the fiscal cliff settled the immediate risk to the economy—although everyone’s taxes went up, they went up much less than they could have, and spending power was therefore preserved. Spending cuts, which will hit at the same time as the debt ceiling, will also be a headwind to the economy, but they are necessary and can be phased in to cause minimal harm. The one thing that could really blow us up is failure to resolve the debt ceiling issue. This is why it is actually encouraging to see active planning for failure. Given the risk, we should have a plan.

I talked in a previous post about the political options —how the Senate has, twice now, cut a deal with White House approval and essentially dared the House to vote it down. That remains, in my opinion, the most plausible option, but there are others, which range from the serious to the absurd. Let’s start with the serious:

  1. A Senate deal forced through the House. This has been done successfully before, but it looks more questionable this time, as the House will be expecting it. Each time, it has been more difficult and resulted in a shorter-term solution. There may be one more bite on the apple, but it is not certain. Feasibility: Medium to high, but any solution would be short term and probably partial.
  2. Scrip could be issued instead of actual cash payments once the Treasury hits the wall, enabling operations to continue despite the debt ceiling. The scrip would not be debt because it would not pay interest and would not mature, but it would be a cash alternative that would be transferable, probably to financial institutions, at a high percentage of face value. This method was used by California in 2009. Although there would certainly be problems with this solution, there is precedent—it worked in California—and there appear to be no insurmountable constitutional problems. This proposal is detailed in an article in today’s New York Times. Feasibility: Pretty high.
  3. The trillion-dollar coin. Among others, Paul Krugman has proposed that a platinum coin with a denomination of $1 trillion be issued and deposited at the Federal Reserve, which would then transfer the money to the Treasury’s account. Voila! No more problem. There is apparently a clause (intended for commemorative coins) that allows the Treasury to mint platinum coins of any value it wants. It’s tough to know even where to start discussing the problems with this option, but it does seem to be legal, and economically it is not that different from what we are doing now. The problems would be political, and they would be big. Feasibility: Low.
  4. The president could plausibly invoke the 14th Amendment to lift the debt ceiling, based on the language “the validity of the public debt of the United States . . . shall not be questioned.” The White House recently ruled this out, but it could remain an option if necessary. The downside? The questionable legality, the almost certain legal challenge, and the potential constitutional crisis would not really reduce the uncertainty. Feasibility: Very low.
  5. A grand bargain. Both sides could come together on a deal that raises the debt ceiling and has a credible mix of spending cuts and tax reform to create a sustainable solution over time. Feasibility: Very low, unfortunately.

So there we are. We do have options, some of which are actually both plausible and effective. I suspect it will be the Senate deal, but if that fails, scrip will certainly be an option. As for the trillion-dollar coin plan, all I can do is link to a Mark Twain story I have always liked that has a slightly similar theme.


Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®