Thursday, January 10, 2013

Interlude: Change in my Pocket (goin' jing-a-ling-a-ling)

Before I get back to my series on the meta-euvoluntarity of the Constitutional Amendments, I want to devote  a post to something that's been buzzing around the econ and law blogs lately. You might have read about a proposal that runs something like this: the US Treasury, under its authority to utter currency strikes a coin redeemable for $1 Trillion. Tim Geithner at his George Raft-iness saunters over to The Bernank and flips the coin over to him in exchange for a thousand billion dollars' worth of interest-bearing Treasury instruments (though if it's legal tender, there's nothing really stopping them from picking up all the garbage CDOs that ended up on the Fed's balance sheet, but let's not complicate this any more than it already is) You can read two defenses of the proposals here (h/t Tyler Cowen). You can read heaps of scorn elsewhere. (more below the break)

Opinions seem split on whether or not to describe this as either a) monetizing the debt or b) pseudo-default. If you buy Diehl's arguments, "[t]here are no negative macroeconomic effects." and "the Fed could ship the coin back to the Mint where the accounting treatment would be reversed and the coin melted. The coin would never be “issued” or circulated and bonds would not be needed to back the coin." According to Krugman, " issuing short-term debt and just 'printing money' (actually, crediting banks with additional reserves that they can convert into paper cash if they choose) are completely equivalent in their effect, so even huge increases in the monetary base (reserves plus cash) aren't inflationary at all." The way I read this, Krugman is in the (a) camp, and Diehl is in the (b) camp. Either way, both are arguing for a free lunch, Diehl on the grounds that it's all just accounting legerdemain anyway and Krugman on the grounds that in a liquidity trap, creating base money is like pissing in the sea: every little bit counts, but you're not going to drown any turtles.

I think the answer to whether or not this plan either monetizes the debt or is equivalent to default lies in what happens to the coin after it finds its way to 33 Liberty Street, New York, NY 10045. If the Board can turn right back around and convert the coin into MZM--into ten billion Benjamins (and it doesn't matter if they actually do, only if the marginal investor thinks they can), then that is unquestionably debt monetization, it does not count as default one bit; it's just converting maturities from ten years (or whatever) to zero day. This practice has a rich historical legacy and analysts know how to approach it. If the Board must stuff the coin into the vault or just remit it back to the Treasury to be melted down, then it's an empty MacGuffin, a smirking fiction that allows the government to cancel debt obligations that one part owes to another (and from an EE perspective, this restriction is a key distinction). The practice of debt forgiveness also has storied precedent, though there may be something novel in this particular instance. I think it's not unreasonable to consider the white elephant version of the trillion dollar coin as tantamount to a plain vanilla sovereign debt default, though with the critical caveat that no citizen or institutional bondholders will be menaced.

The larger point which more directly touches on EE considerations is more generally in the realm of debt forgiveness. It's possible that you're either old enough or well-read enough to recall various debt forgiveness schemes that folks over the years have cooked up for, say, Haiti have done little to deliver on grand promises of economic development. Usually what happens is that France will end up anchoring expectations of future bailouts, so lenders will cheerfully pick up junk bonds from Port au Prince under the expectation that Paris will set them afloat when the time comes. Papa and Baby Doc have no incentive to curb spending habits, lenders have no real skin in the game, and French taxpayers are ultimately on the hook for the bill. I admit I don't think these two situations are the same. The public choice analysis is probably similar, but the platinum coin under the melt-it-down scenario shouldn't generate moral hazard in the FOMC the way debt forgiveness in developing economies does with international rent-seekers.

Does the Treasury really retain the conventional capacity to exchange exotic specie (yes, that's sort of a dark joke) with the Federal Reserve? Are we in a Bayesian game where one branch is (a) and the other (b)? If so, what uncompensated externalities will we find down each branch of the game tree? More to the point, what is the BATNA of not minting the coin? If you can convince me that a reasonable alternative is for Congress to curb spending, I'll eat my hat. In fact, I'm willing to make a modest bet that nominal government spending won't actually decrease over the next decade. I might even be willing to make a bet at odds that real spending won't actually decrease over the next decade. Feel free to contact me by e-mail if you're interested.

Trillion-dollar coins: probably not all that euvoluntary.

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Do you have suggestions on where we could find more examples of this phenomenon?