Borrowing vs. minting, what difference does it make?
Article 1 Section 8 allows the government to acquire money to pay its bills in three ways: taxtion [Clause 1], borrowing [Clause 2], and coining of money [Clause 5]. And 31USC5112(k) allows the Treasury to mint arbitrarily coins of any denominations. For the past 220 years since the founding of the Treasury, the U.S. has covered its tax deficits by a combination of borrowing and minting, e.g., in 2011 the ratio was about 100 to 1. But, we are spending $250 billion per year in interest on our debt, so why not cover the entire deficit by minting trillion-dollar coins? Per Paul Krugman:
… at least as I understand it, the letter of the law [31USC5112(k)] would allow Treasury to stamp out a platinum coin, say it’s worth a trillion dollars, and deposit it at the Fed — thereby avoiding the need to issue debt [borrow money].
In reality, to pursue the thought further, the coin really would be as much a Federal debt as the T-bills the Fed owns, since eventually Treasury would want to buy it back. So this is all a gimmick — but since the debt ceiling itself is crazy, allowing Congress to tell the president to spend money then tell him that he can’t raise the money he’s supposed to spend, there’s a pretty good case for using whatever gimmicks come to hand.
But leaving the debt ceiling on one side, isn’t it true that since spending can currently be financed by Fed money printing, we shouldn’t care at all about the notional debt owed to the Fed? Alas, no.
It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.
Krugman has been making the claim that “in normal times” covering the deficit by issuing fresh money would be more inflationary than than raising the same amount of money by issuing (selling) Treasury bonds.
Other things being equal, in one case the private sector has X dollars of T-bond. In the other case, they instead have an additional X dollars of money in the bank. But note that banks are always happy to monetize T-bonds for a fee, either by buying them or by issuing loans against them. Yes, there is a slight loss of liquidity, that fee, but that gets compensated by the interest earned on the bonds. Frankly, I don’t see much difference, when it comes to bidding up the prices of assets and services. The best that I can say for Krugman’s claim is that all bonds lose value when interest rates go up, which they always do in times of inflation. So bonds do provide a stabilizing effect, if the Fed loses control of interest rates. But, meanwhile, interest the $250 billion per years is increasing and crowding out healthcare, food stamps, etc. And the national debt is providing people like Pete Peterson and his side kick Barack Obama with a boogey-man story to scare naive villagers into scrapping our social safety net.
I want to address specificially this claim by Krugman:
It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought.
Let’s say that Krugman is correct. So what difference would it make if instead of T-bonds the Fed held the equivalent amount in platinum coin? If somehow de-monitizing T-bills fights inflation, i.e., trading them for real dollars, the Treasury could always sell the same amount of T-bonds at auction to provide the same T-bonds for money swap. The private sector doesn’t really care how fresh the T-bonds are or whether they buy them from the Treasury or the Fed.
Illustration by DonkeyHotey licensed under Creative Commons