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

Posted by Brad McMillan, CFA, CAIA, MAI

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

and tagged Fiscal Cliff, Politics and the Economy

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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.

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