Will He Say He Has No Choice or Will He Use Seigniorage?

The media and much of the blogosphere are framing the coming debt ceiling decision as one in which the Republican-majority House may refuse to extend the Federal debt ceiling, thus forcing both a Government shut-down, and also a possible default of the US in paying its debt obligations to its creditors. Republicans saying they will not vote to extend the ceiling see this as an opportunity to force spending cuts out of the Democrats and the Obama Administration.

This second round of hostage-taking is no surprise given that the Administration folded like a cheap suit a few weeks ago, when the Republicans got an extension of the Bush Tax Cuts and also a great deal on the Estate Tax, in return for some concessions the Administration could use to save its face, but without any deal however, on either extending the debt limit, or getting the Omnibus spending bill to fund the Government in 2011.

So, the Administration left these two hostages on the table for the Republicans to take in the new Congress. And, as a result, the Republicans are now stepping forward to say they want many more “spending” concessions in return for extending the debt limit.

The President is making a lot of noise about the dangers of default through Austan Goolsbee, the Administration's Chief Economist, and we can look forward to real shock doctrine treatment over the next few months, informing us about the evils of default and urging everyone to come together with some sort of compromise that, of course, will involve no tax increases for the wealthy, or cuts in defense, but a cutting away of programs for people, which are termed “discretionary” or “welfare” or "entitlements" by deficit hawks, including this President. There will be a big kabuki show, and Wall Street will pressure both the Republicans and the President to come together in a “compromise,” while progressives will be exhorted not to be purists, and instead to be “adults” about the necessity of dealing with the hostage takers and “cutting” or is it “gutting” Social Security and Medicare.

Now, I'm not sure the Administration wants to run through any scenario other than the one I've just outlined, because it seems to me that this President has a Hooverite pay as you go agenda; that he's planning to implement at whatever cost to the American Middle Class and the poor. This man approaches economics as if the period 1930 – 1980 never happened. Centrist Democrats and Republicans are his partners in implementing this plan. The Republicans provide the extremist shocks, and then “force” the Democratic Party "adults" to make cuts that are supposedly “distasteful” to them.

We've seen this charade a number of times now. The debt ceiling issue may just be the latest shock administered to get people to accept the austerity program outlined by the Co-Chairs of the Catfood Commission, Erskine Bowles and Alan Simpson, even though every public opinion poll, most recently the 60 Minutes/Vanity Fair poll [1], has shown that heavy majorities are against what they recommend.

Whether this kind of scenario is what the Administration is planning or not, however, I think it's still useful to pull off the mask and point out that President Obama does have a real choice on the debt ceiling issue. There is an effective response he can make to a failure to raise the debt limit. In fact, he can begin to respond even before there is a Congressional vote on the debt ceiling.

The response I'm referring to has just been outlined in a post by Beowulf [2], called “Coin Seigniorage and the Irrelevance of the Debt Limit.” Here are some the key assertions of the post:

If you think about it, it does seem odd that the US Government is the monopoly supplier of US dollars and yet our politicians go through life thinking the government will run out of money unless it can borrow more. Of course that’s not true, the coins in your pocket are legal tender and yet were not issued against debt. They’re minted by the US Government, backed only by the gilt-edged credit of the American people, no one is paid interest on it and they don’t add a penny to the statutory debt. What’s more, the use of coins as legal tender is scalable, they could replace the use of Tsy debt sales. No, you wouldn’t have to carry more coins in your pocket. Nothing would change except Tsy would be credited by the Federal Reserve for the sale of interest-free Treasury coins (presumably of large denominations) instead of interest-bearing Treasury bonds.

The two great powers of a sovereign state are the monopoly of violence and seigniorage, the profits from the creation of money. If the federal deficit (that is, expenditures in excess of tax receipts) were funded by seigniorage revenue, not only would there be no debt service owed on the money, there’d actually be no deficit. Seigniorage (whether generated by the Federal Reserve or by the US Mint) is supposed to be booked by Treasury as “miscellaneous receipts”, since the funds can appropriated for other govt uses, it actually reduces the deficit dollar for dollar. . . . The bottom line is, the Secretary of Treasury already has the authority to create money without debt so there’s no fiscal reason to raise the debt limit. What’s more, since the Federal Reserve began paying interest on reserves in 2008, there’s no longer a monetary reason to raise the debt limit either.

The point is, in section 5136, Congress characterizes the exchange of coinage produced ex nihilo by the US Mint for the face value equivalent in Federal Reserve notes (or more typically, by marking up the balance in Tsy’s reserve account) as a “sale”– “Provided further, That the Fund may retain receipts from the Federal Reserve System from the sale of circulating coins at face value for deposit into the Fund“. What’s more, the statute also says, “at such times as the Secretary of the Treasury determines appropriate, but not less than annually, any amount in the Fund that is determined to be in excess of the amount required by the Fund shall be transferred to the Treasury for deposit as miscellaneous receipts“. Unless Congress intended “receipts… from the sale” to not mean exchange revenue and for “the public”, “miscellaneous receipts” and ultimately “seigniorage” to have each have two different meanings depending on whether we’re referring to the US Mint or to the Federal Reserve System, my suspicion is that Mint seigniorage and Fed seignoirage were intended to be treated the same for budgetary purposes.

If, in fact, Mint seigniorage is legally indistinguishable from Fed seigniorage as miscellaneous receipts revenue, it does offer an escape hatch (or more like a subway tunnel really) if Congress refuses to increase the statutory debt limit this spring. The Secretary has rather broad authority to mint coins, Congress was apparently feeling generous when it authorized platinum coins in 31 USC 5112(k) (“with such specifications, designs, varieties, quantities, denominations, and inscriptions and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe…”). If deficit spending was paid for (eliminated actually) with miscellaneous receipts revenue generated by selling the Fed jumbo denomination coins, and since the Federal Fund Rate can now be pegged with Interest on Reserve payments in lieu selling Treasuries to drain excess reserves, Tsy could fund govt operations indefinitely without ever raising the statutory debt limit. . . .

There's much more in Beowulf's very important post, which “goes into the weeds” of seigniorage a good bit, and you should read it all. To put the main point a little more simply. The Treasury, which the US Mint is part of could order the mint to produce special very large face value Platinum coins (e.g. each coin might have a face value of 50 Billion USD), and to deposit those coins in the Mint's account at the Fed. The Fed could not refuse the coins or fail to credit their face value because they are legal tender. Since the Fed is technically in the private sector, acceptance by them of a deposit in the form of the jumbo coins, resulting in the markup of the Mint's Account by their face value, gets recorded technically as a sale of the coins to the private sector. The receipts from the “sale” representing the Mint's seignorage profit, may then be periodically swept into the Treasury General Account, and would go into the category of “miscellaneous receipts” to the Treasury lifting its Treasury's revenue total.

Enough jumbo coins could erase the annual deficit, and since part of government expenditures in any year involves paying off interest and principal on the national debt, enough of them would also erase the national debt over a decade or more. There would be no national debt to leave to our grandchildren, and also there would be a continuously declining debt-to-GDP ratio. Technically, there would also be no more deficit spending, even though in most years, Government spending would continue to exceed tax revenues.

So, the bottom line here is that coin seigniorage looks like a solution to the debt ceiling crisis and also to Congress's requirement, which is the cause of our having a national debt, that the Treasury must issue new debt when it plans to deficit spend. The big question is whether President Obama will use seigniorage to answer the threats of the tea party hostage takers and defuse the present situation, or whether he will say that he has no choice but to compromise with them, even though he could use seigniorage to render their threats impotent.

Of course, things are not as simple as I've just framed them. If the President were to start using seigniorage, the Republicans would probably respond by holding the Omnibus spending bill hostage and attempting to shut down the Government that way. But if they do that, I think they're likely to find themselves in a much more difficult political position than they are in now.

First, Mr. Obama will be much more popular than he is now by virtue of rendering their debt ceiling threat impotent. He will have humiliated them, and he will be much more popular in the country because he will be perceived as acting strongly and cleverly to get around them to avoid a shut-down of the Government and the possibility of default.

Second, when they come back for their second bite at the shut-down apple, they will also find that they won't be able to use the ballooning deficit/national debt rationalization to justify their attempts to hold the Government hostage to get cuts in discretionary spending and the social safety net. President Obama will have, by then, demonstrated, that by using seigniorage he can take the deficit and debt issues completely off the table.

Once they are off the table, the way will be clear for a great debate over full employment vs. avoidance of inflation as two primary goals of responsible Federal fiscal policy. The conservatives, of course, will want to avoid any possibility of inflation by restricting Federal spending and keeping unemployment high. But they won't win that debate until there is measurable inflation to frighten people with. And we probably won't see that until full employment comes back.

(Cross-posted at All Life Is Problem Solving [3] and Fiscal Sustainability [4]).