A serious wonk debate has broken out over the trillion dollar coin and its ramifications. As I said 18 months ago when I first discussed the coin here, this idea was never going to come to fruition, but it made for a seriously important discussion regarding our monetary system. All roads lead to MR on this debate, whether through MR co-founder Carlos Mucha, who founded the coin idea or the inevitable debate over government self financing and JKH’s Contingent Institutional Approach).
Paul Krugman asks the question that all of this debate inevitably leads to:
“what happens if the US government issues a trillion-dollar coin to pay its bills?”
I would change the question slightly for the sake of simplicity. Instead of a coin, what if the government used its powers as an autonomous currency issuer to just create bank deposits?
It might help to step back a second first before we jump in the mud here. The monetary system we currently have does not operate as most people believe. The government doesn’t “print money” (except in the literal case of cash notes and coins), but is actually the issuer of net financial assets. So, when Peter uses his Treasury Direct account to buy a government t-bill he is divested of a bank deposit that ultimately allows the government to spend a bank deposit into Paul’s account. Peter gets a US T-bill, no longer has a bank deposit and Paul ends up with a bank deposit. There is the same amount of bank deposits in the private sector, but there is an additional financial asset in the form of the bond.
But what if the government didn’t sell t-bills? Instead of divesting Peter of a bank deposit (and giving him a NFA as t-bill) the government would just type a bank deposit into Paul’s account when Congress wants to spend. So Peter still has his bank deposit AND Paul has a net financial asset in the form of a bank deposit. The government, in this case, is a pure issuer of money. If one were so inclined to call t-bills pure “money” you could claim that the first and second example are virtually the same (aside from the obvious politics involved).
The question this argument really gets at the heart of is the moneyness of government bonds versus bank deposits. I have argued that t-bills have a very high level of moneyness. That is, they are highly liquid and risk free, but not pure money. For instance, if two men are standing in Wal-Mart, one holding $100 in cash (or a credit card) and the other holding $100 in physical t-bills they do not both have money in the eyes of Wal-Mart (the problem of money is not defining it, but convincing others to accept it). Ie, they cannot both ring the register. One must sell his t-bills to the other to obtain the cash for purchases. Now, technology is reducing the discrepancy in “moneyness” between these assets, but the inconvenience of transferability still exists to some degree. A bank deposit will always have a higher level of “moneyness” than a t-bill. How this discrepancy influences inflation is up for debate.
But an equally important debate rages over the monetary base and Krugman’s “dead presidents” (cash). Ultimately, the question in the above discussion leads to a debate over inflation, the degree to which the Fed maintains control of the money supply and the very design of our monetary system. But first we should agree on a few things:
- Money is almost entirely endogenous in our monetary system. Ie, the money supply is determined by private banks who issue loans based on the demand by their clientele.
- The money multiplier is not just broken. It is non-existent. Bank loans create deposits. Banks find reserves after the fact if they must.
- The central bank can influence the cost of supplying these loans, but has far less control over the demand for this money.
- The terms “base money” and “high powered money” are unfortunate terms that should be done away with as they put the cart before the horse in terms of understanding the first three bullet points here.
If the bullet points didn’t help connect the dots already, we should all be realizing that the Fed has less control over the money supply than most of us have been led to believe. The money supply being endogenously controlled by the banking system means that the Fed can influence the cost of money, but cannot completely control the supply of money. The money supply is largely regulated by market conditions and the demand for loans. In other words, the money supply is almost entirely privatized in the USA. The Fed tries to influence the cost of this money by gauging economic conditions and forecasting policy changes to economic agents.
So, what happens to this system if the government self finances? Obviously, we’re entering a monumental paradigm shift. We’re transferring from a system where money is created endogenously by banks who compete to issue money, to a system where the government exogenously creates money. It’s
almost impossible difficult to say whether one system is more inflationary than the other. But what becomes clear in a system of government self financing is that the existence of private banking becomes increasingly less significant which would render the need for the central bank as increasingly less significant (since the central bank exists to support private banks and operates policy through the banking system).
The trillion dollar coin is not a debate about Fed influence, inflation and dead presidents. It is a debate about a monumental paradigm shift in our monetary system. A debate that shakes the core of modern banking and the monetary system we have designed around a market based money issuing system where banks compete privately to issue money as debt.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.