Wonking Out: Coins and Credibility

Franklin Roosevelt took the United States off the gold standard soon after his inauguration as president in 1933. It was an essential move: The nation was in the midst of a banking crisis, and to end that crisis the Federal Reserve needed the freedom to print money as needed. But even some of Roosevelt’s own aides were aghast: Lewis Douglas, his budget director, reportedly blurted out, “This is the end of Western civilization.”

Last time I checked, civilization was still here. But there are echoes of the gold standard debate in some of the discussions about how to deal with Republican brinkmanship over the debt limit. As I mentioned in my newsletter last week, one possible way out would be to exploit an apparent legal loophole by minting a platinum coin with a huge face value, say $1 trillion, depositing that coin in an account at the Fed, then drawing on that account to pay the government’s bills.

Let me say right away that there are some good reasons to be uneasy about minting the coin. The Fed, which is semiautonomous, might not agree to play along. The strategy might face legal challenges. And by resorting to this gimmick we would be sending the world a signal that we’re a messed-up nation having big problems governing itself — although the truth is that we are a messed-up nation thanks to the nihilism of one of our two major parties, so minting the coin would arguably just be acknowledging the obvious.

But I’ve been told that some senior administration officials have been making another argument against the coin or any similar strategy, one that echoes Lewis Douglas — namely, that going that route would undermine the credibility of the dollar. And that’s all wrong.

First things first: Minting the coin would not amount to financing the budget deficit by printing money.

What we actually mean when we talk about “printing money” is an increase in the monetary base — the sum of cash in circulation and the reserves held by private banks, mainly in the form of deposits at the Fed. The Fed’s economic influence comes from its ability to increase the monetary base at will, normally by buying federal debt from banks and paying for those purchases by crediting the banks’ accounts with money that’s essentially created out of thin air.

So wouldn’t allowing the Treasury to pay its bills by drawing on an account also created out of thin air — on accepting the coin, the Fed would simply declare that the Treasury had a $1 trillion account — mean increasing the monetary base? Not if the Fed didn’t want it to.

You see, past monetary operations have left the Fed in possession of a huge portfolio, including more than $5 trillion in U.S. government debt. And the Fed could and surely would “sterilize” any effect of federal withdrawals on the monetary base by selling off some of that portfolio.

Think of the Treasury and the Fed — which has some policy independence but is financially just part of the federal government — as a single entity. Right now that consolidated entity is paying some of its bills by selling bonds to the private sector. If we minted the coin, it would still be doing the same thing; the only change would be that instead of selling newly issued bonds, it would be selling existing bonds currently owned by the Fed. From an economic point of view, this would make no difference at all.

So what are people who talk about credibility worried about? One argument, highlighted the other day by my Times colleague Peter Coy, is the claim that fiat money — money not backed by gold or some other asset — is basically a con game and that minting the coin would give away the con. That is, according to this argument, money has value only because people expect other people to accept its value, and tricky financial maneuvering might break the spell.

But as many people have pointed out, fiat money isn’t valuable just because of self-fulfilling expectations; it’s also what we use to pay taxes, which gives it a substantial anchor to reality.

And as a practical matter, moneys never collapse simply because people lose faith in their value. Hyperinflation, in which the purchasing power of money plunges, does happen — but that’s almost always because other governments are willing to print money to cover their deficits, which the U.S. government won’t.

(An aside: If you want to see assets that have value mainly because everyone expects everyone else to consider them valuable, the best historical example is … gold. Its price is far higher than one could justify by its nonmonetary uses, but people still consider it valuable because of its traditional monetary role — a role it no longer plays. And let’s not even talk about cryptocurrencies.)

So as long as the U.S. government doesn’t rely on money creation to pay its bills, the dollar won’t collapse. But wouldn’t minting the coin create a temptation to start doing just that?

Well, governments sometimes do cause high inflation by relying on the printing press. Right now, for example, there is the case of Venezuela and … well, actually, Venezuela is the only example right now, and has been for some time.

The truth is that governments rarely if ever start printing money with abandon simply because they can’t resist the temptation. Hyperinflation is usually a byproduct of extreme political dysfunction, which leaves governments unable to raise revenue or limit spending. I wish I could say that America is safe from that kind of extreme dysfunction — but the troubles facing our democracy have nothing to do with budget mechanics and can’t be solved by banning creative finance.

In general, credibility is overrated as a factor that should be guiding policy. If we get substantive policies right, credibility will follow; if we don’t, attempts to be acceptably orthodox won’t matter.

For now, the right thing to do is to find a way to keep paying the government’s bills in the face of political sabotage, even if that involves gimmicks that exploit legal loopholes. Sometimes doing things that can sound silly is the only responsible course of action.