In the Fiscal Cliff negotiations both Democrats and Republicans accept at face value the assumption that a balanced budget is:
- A really good thing
- Necessary for the survival of the Republic
- The 11th Commandment
What happens if they are wrong?
This holiday season the latest movie version of The Hobbit by J.R.R. Tolkien is vying with Fiscal Cliff Part Two for viewer attention. In Tolkien's world, the forces of evil or modernity represented by the World of Men have brought great destruction (collateral damage) to the formerly idyllic world of Middle Earth. The hero of the story, a hobbit named Bilbo Baggins, is able to steal a magic rock called the Arkenstone, which holds promise to return the world of Middle Earth to its former idyllic state. To do so the forces of good must band together to defeat the evil of the new order.
The current struggle over federal budgets bears some similarity to Tolkien's world. In his view both sides of the debate would be on the wrong side of history, threatening to bring great destruction upon the little people as they engage in a titanic battle for control of the kingdom.
To the right side of the field the combatants pine for the return to a world of order where a dollar was convertible into shiny gold pieces that Gollum, Tolkien's caricature of selfish greed incarnate, would give his soul to possess. Most of the players on the right understand that modern governments are not going to surrender their sovereignty to an arbitrary precious metals based monetary standard. Thus they are focused on balancing the federal budget as their closest viable alternative.
On the left side of the field, the warriors are anxious to maintain their control of the populace by doling out silver pieces to more and more of their constituents. Unfortunately silver tarnishes quickly, particularly when alloyed with base metals, and even the warriors of the left generally acknowledge that there is a risk of accelerating inflation if they go too far in this direction. Since neither side is willing to tax the general populace to support the social programs of the left or the global armed presence favored by the right, they are increasingly dependent on continued budget deficits at a historically unsustainable rate. Rogoff and Reinhardt, in their seminal treatise, This Time is Different, have provided ample historical evidence that similar episodes have generally not ended well.
Since the deficits can only be sustained through borrowing or the creation of new money, the Federal Reserve has fallen into a state of monetary capture in which it has now committed to create $85 billion in new money monthly for the foreseeable future to fund the deficit and governmentally supported housing finance programs. This is roughly the amount of the budgetary shortfall so it is not a stretch to conclude that we have now reached a form of full deficit monetization.
Chairman Bernanke has assured us that this time really will be different because he holds in his vest pocket a secret plan for controlled exit from the program of monetization, beginning when unemployment again hits 6.5%. This he believes will keep inflation within a projected 2% annual boundary. His only caveat seems to be that he needs some help from Congress and the administration to bring the deficit under control at just the right time so that the monetization will no longer be needed when the time comes to implement the plan. Best of luck on that one.
Rather than battle to the death, the warriors are busily searching for a large vat of silver polish through tax increases for the "bad guys" who make too much money and cuts to the budgetary priorities supported by the other team. They hope that by shining the silver a bit the public will be satisfied that the world has returned to normal. They can then race home to join their families and friends for the upcoming winter solstice feasts. Within a few months the warriors will come back to the table to fight the next battle over the federal budget ceiling, the primary lever wielded by the right in their quest to protect the value of the dollar.
Far from the field of battle, a group of hobbits, centered in a small village at the edge of the known world (the University of Missouri - Kansas City), live in an alternative universe called Modern Monetary Theory. In this universe money has become disembodied from all connection to tangible assets. Conveniently they have provided a magic window to their universe at their website New Economic Perspectives.
The MMTers dare to utter the heretical view that money is not intended as a store of value, but instead that it is a tool to be used by government to facilitate the exchange of goods and services and to assure the society's resources are being productively employed. They also generally believe that there are massive underutilized resources that can be put to productive work so long as sufficient fiscal support is thrown at the problem. In general they believe that we are in what Keynes called a Liquidity Trap and that in such a state government can provide almost unlimited stimulus without creating an inflationary crisis. The corollary is that failure to provide such support will condemn millions of Americans to continued unemployment or underemployment.
Given that background it's time to introduce you to the Trillion Dollar Coin "TDC" and Platinum Coin Seigniorage "PCS". Participants in the Fiscal Cliff debate assume that government can only fund itself through taxation or borrowing. From the time money was invented, however, sovereigns have concluded that there is a far easier path, through the manufacture of money itself.
Seigniorage: a government revenue from the manufacture of coins calculated as the difference between the face value and the metal value of the coins.
Modern hard money advocates seem to assume that a gold standard is equivalent to the valuation of a currency based on the commodity value of underlying precious metals into which the currency is freely convertible. In the real world that has rarely been the case. For most of human history money has been worth what the sovereign deemed it to be. It costs the U.S. government about thirty cents to make a presidential dollar coin. The difference between that cost and the one dollar face value is seignoirage. The trade is even better in the case of $100 bills, which only cost the government about ten cents to print and which are shipped all over the world by the billions. Governments throughout history have funded their operations on similar profits from the issuance of currency.
Today governments can be much more efficient in their generation of seignoirage. While the U. S. still profits handsomely by printing and shipping $100 bills to countries like Zimbabwe, these profits pale in comparison to the Federal Reserve's ability to fund trillion dollar annual federal deficits with electronic entries of ones and zeros in its virtual ledger books. The most profligate third century Roman Emperor would be green with envy.
But there's a catch. Laws on the books limit the government's ability to finance itself by placing a limit on the amount of federal debt that can be issued, even if the debt is being issued to an arm of the government, the Federal Reserve. Thus every year or so Congress gets to hold the government hostage. Using the budget ceiling as a lever, Congress can wrest concessions from executive branch ranging from grand bargains on entitlements to pork barrel spending in local Congressional districts. This occurs notwithstanding that Congress has already authorized/instructed the executive to spend the money in budgets previously adopted by Congress.
While the Treasury has always had the option of issuing coinage to pay its bills, the 1.4 trillion plus dollar coins that would be needed to generate sufficient seignoirage to cover the deficit would weigh approximately 1,543,235 tons and nobody wants those things anyway.
That's where the hobbits of MMT land come in. An enterprising Bilbo Baggins has discovered his Arkenstone in an obscure statute passed by Congress to satisfy the desire of the hard money crowd for precious metal based U. S. coinage. 31 USC § 5112 ((K)) provides that "The Secretary (of the Treasury) may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary's discretion, may prescribe from time to time."
While this provision was clearly adopted to satisfy the demands of collectors and bullion hoarders, on its face the statute would enable unlimited issuance of very large denomination coins with virtually infinite seignoirage. According to its advocates, by having the Treasury issue as few as five platinum coins, each with a face value of a trillion dollars, and using them to repurchase and extinguish large amounts of federal debt currently held by the Federal Reserve, the president could eliminate the constraint of the debt ceiling for the remainder of his term in office.
For the moment this issue remains in the realm of the theoretical. The concept is so alien that even commentators of the most liberal bent hesitate to take it seriously. Yet some are speaking seriously about other approaches to the debt limit that would entail even more naked usurpations of executive power, including this gem:
"... the 'you and whose army' theory that even if the President breaches the debt ceiling, no one could do anything about it because they would have no standing to sue"
A comprehensive and fairly clear explanation of the proponents' thought process with regard to PCS can be found in this article by Joseph Firestone.
It appears that there is serious discussion afoot aimed at pressuring President Obama to engineer a transfer of power to the federal executive branch comparable in scope to the historical shifts engineered by Lincoln and Franklin Roosevelt during previous times of great crisis in America. This topic has gotten little coverage to date in the serious economic and political press.
Don't doubt for a minute that we will begin to see such suggestions in spades should the Republicans stand firm when the debt ceiling issue again comes to the fore in early 2013. There will be tremendous pressure to give the President unfettered authority to spend all budgeted funds. Since the Congress seems incapable of adopting a budget, does this mean that all de facto spending authority will soon be transferred to the executive branch? The implications for the debt (TNX), foreign exchange (DXY) and equity markets (SPX) of such a transfer of power are more significant than any single factor currently driving the markets.