The Magic Trillion-Dollar Coin

Includes: DIA, QQQ, SPY
by: Macro Investor

There is a bit confusion around on the impact of the Trillion Dollar coin that is being talked about these days. Here's the backstory.

The Govt. has hit the debt ceiling, and unless Congress votes to raise it, USA will go into default. The Republicans in the Congress, freshly bruised from the Fiscal Cliff crisis, have pledged to not raise the debt ceiling unless the Democrats agree to major spending cuts. The Democrats have dug in.

So, at least the theory goes, the Treasury can simply print a Trillion Dollar coin, the Feds can exchange it for freshly minted cash, and off we go without triggering the default. This is perfectly legal, if rather unusual. Civilized countries usually have a functioning Govt. which would raise the debt ceiling to pay for spending already approved and executed by the Govt. in the form of past legislature. But, if indeed USA doesn't have a functioning Govt., the Magic Coin will be the salvation. Or, so, at least, is the talk of the town.

I really do not want to argue this way or that about whether printing the coin is a good idea. That's a political matter, and as an investor I have one and only one goal - to make as much money as possible regardless of politics. So, I will stick to financial aspect of things in this article.

First, let's dispel some myths. There is a talk of massive inflation if the Trillion Dollar coin is minted. Truth is, the Trillion Dollar coin would not in any way increase the money supply more than just raising the debt ceiling. If the debt ceiling is raised, the Treasury will print Trillion Dollars of paper, also known as Treasury Bonds, and the Feds will exchange that for money. However, absent a debt ceiling increase, the Treasury can't print the paper debt. But it can print the Magic Coin. Since the coin doesn't increase the money supply any more than issuing paper - or to be more correct, electronic - debt would do, there is no additional deleterious effect on the money supply. Yes, it will make the US look like idiots, but political idiocy doesn't raise inflation. Not yet, anyway. Otherwise inflation would be very high in the USA already.

Second, there is a talk about the Feds being unable to continue QEternity if the debt ceiling is not raised. This is not true in any way. The Govt. won't be issuing, but the Feds will just buy from private parties. This will result in a bond rally like it is going out of style and yields would plummet to less than 1% for the long bond by my estimate. (Incidentally, I wouldn't be surprised if the long bond hits 1% even without the debt ceiling mess, as the Fed is now buying ~90% of new issues, and there is a real increase in demand for US Treasuries in the private sector because of Dodd-Frank, but that's for another day.) Some commentators think that the Fed won't overpay so much to continue QEternity. Trouble is, that argument is nonsense. The Fed is not "investing" in bonds. It is managing the money supply. Since it creates money out of thin air, it can't really have a loss per se. The sole purpose of the Fed buying and selling bonds is to manage M2, and not to act like a hedge fund manager.

Finally, there is chatter that even QEternity continues, and even if the US doesn't go into default because of the Magic Coin issue, there will be lack of confidence in the US Govt., and investors worldwide will dump bonds and cause yields to go up. Note that this is just counter to argument 2, which states that yields will go down and there will be a massive Treasuries rally, which will force the Feds to stop QEternity. You can't have both at the same time. Either bonds go up or they go down. If they do go down, then the sellers of those bonds will have to find some other bond of similar stature and float to replace their holdings. The two obvious choices are EU bonds and Yen Bonds. The less we say about EU bonds the better, as interest rates just dropped to negative there. Japan is trying to reflate and will fight tooth and nail from having the Yen go up from bond purchases. So, capital flight to Japanese bonds is unlikely as well.

So, bottom line, there is no immediate threat to interest rates, money supply, and such from the debt ceiling crisis. The market being the drama queen that it is, will likely start to drop in about 4-5 weeks, which will be the time to sell, and then buy back the week of the final negotiations, to get positioned for the relief rally. I personally plan to do just that.

Disclaimer: This is not meant as investment advice. I do not have a crystal ball. I only have opinions, free at that. Before investing in any of the above-mentioned securities, investors should do their own research, consult their financial advisors, and make their own choice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .