Here's one of the wilder suggestions floating around for what the President could do if Congress fails to raise the debt ceiling.
To explain the idea, let me begin with some basics on how the banking system functions. If some day you were to bring that jar of coins sitting on your dresser to deposit them in your bank account, the bank would credit your account with the amount of the deposit, and you could then use those funds to write checks.
Similarly, your bank may have an account with the Federal Reserve. If your bank brought some currency or coins in to deposit them with the Fed, the Fed would credit their account by that amount. These deposits with the Fed are known as reserves. A bank can use its reserves to pay for anything it wanted, for example, by instructing the Fed to transfer those reserves to some other bank in payment for an asset that the bank purchased.
The U.S. Treasury also has an account with the Fed. When you write a check to the IRS, your bank's account with the Fed is debited and the Treasury's account is credited. The Treasury can use those funds to buy anything it wants, by instructing the Fed to transfer those reserves back to some bank to whose customer the Treasury wishes to make a payment.
Although Congress has prescribed limits on the Treasury's ability to print currency or mint coins of copper, nickel, silver, or gold, the law specifically says (hat tip: Brad Plumer) that there are no restrictions on what kind of platinum coins might be issued:
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.
Artist's conception: this is not a real coin! Image created by Econbrowser.com.
This provision was intended to allow the Treasury to create special platinum coins for collectors, and American Platinum Eagle coins have been issued in denominations up to $100. So what if Secretary Geithner's discretion led him to mint a couple of trillion dollar American Platinum Eagles?
What would the Treasury do with a trillion dollar coin, you ask? Why, deposit it in their account with the Fed, of course. The Fed would then credit the Treasury's account with 1 trillion dollars. The Treasury could in turn then order the Fed to transfer those reserves to the accounts of any banks to whom the Treasury owes money. The result is that the Treasury's bills are all paid with money that would be newly created by the Fed.
Brad Plumer asked Joe Gagnon, an economist whom I respect, what he thought of the plan:
"I like it," says Joseph Gagnon of the Peterson Institute for International Economics. "There's nothing that's obviously economically problematic about it."
I think Joe says that in part because he finds (as do I) political posturing over the debt ceiling so ridiculous. Once Congress has specified a level of spending and a level of taxes, the amount the Treasury needs to borrow is completely determined by those two decisions. To pretend that there is some separate, third decision of whether to borrow money is simply political theater aimed at the most gullible of voters. Another reason for Joe's endorsement of the plan may be that he favors substantially more expansionary monetary policy, which direct monetization of a few trillion dollars worth of federal spending unquestionably would be.
But even if you grant those two arguments, there is nonetheless something very troubling from an institutional perspective about the proposal. It basically amounts to the assertion that the Treasury Secretary has the unilateral power at any time to monetize completely the entire U.S. debt. The Treasury could issue a dozen or so of these coins and then pay off the Treasury's debtors at maturity just by writing a check written on its resulting ginormous account with the Fed. The creation of this power is I suspect something that Joe and every other sensible economist would view with abhorrence.
The plan requires the Fed and courts to play along. The Fed would need to agree to credit the Treasury's account for the deposit of the coins. I doubt the Fed would voluntarily hand over complete control of the nation's money supply to the Treasury in this manner. And the courts would be asked to confirm that legislation originally intended to satisfy a small group of numismatists in fact ceded authority to the President to monetize the entire outstanding debt of the U.S. government.
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It's a cute idea to address a valid current concern, perhaps. But there has to be a better way to solve this.
By. James Hamilton
Source: http://www.econbrowser.com/archives/2012/12/trillion_dollar.html
Actually both of these have been dealt with. Legally, it does not appear as if anyone would have legal standing in any court to sue the Treasury over such action. It does not prevent the FED from managing the money supply. The FED still retains the power to buy and sell existing Treasuries as well as tying up excess reserves within the banking system by paying interest on reserves.
http://neweconomicperspectives.org/2012/12/new-msm-trillion-dollar-coin-wave-heres-the-big-story.html#more-3986
My only quibble with the piece above is where it says "If your bank brought some currency or coins in to deposit them with the Fed, the Fed would credit their account by that amount." That never happens. The coins and currency stay in the banks vault. The only physical transactions between the Treasury/Federal reserves is when a bank orders currency and coins. The Treasury delivers them and the bank pays for them with reserves - which is to say electronic "points". Even when the government spends - let's say they write me a $1000 check. I take the check to my bank. The bank marks up my bank account by $1000 with their electronic "points" and the Fed adds reserves in the same amount (in electronic "points") to the banks reserve account and deducts $1000 (in electronic points) from the Treasuries reserve account at the Fed. Likewise, when I pay taxes, my bank deducts the amount (in electronic "points") from my account, the Fed deducts the same amount of reserves (in electronic "points") from the banks reserve account, and the Fed adds a like amount in electronic "points" to the Treasury's reserve account at the Fed. If I cash a check at my bank, the cash comes out of the vault, which also reduces their reserves by the same amount. There is more than half our GDP cleared in electronic "points" every two weeks which completely dwarfs the amount of physical money transactions. When the government spends $100 billion it does it like this 1,000,000,000 which is ten computer strokes plus three strokes for commas and one that says "ENTER."