Written by John Lounsbury
In a companion article it was argued that the debt ceiling law was unconstitutional as a matter of logical principle. The argument made there was that only three possible actions for the president would follow the government running into a debt ceiling that was not raised. And all three of those actions would involve acts that would violate provisons of the constitution and legislation passed and signed into law based on those provisions. Thus, it was argued, if a law (the debt ceiling law) could create situations whereby all courses of action would provoke a constitutional violation, then the law must be unconstitutional. But that is an incomplete argument.
What was not addressed in the prior discussion? The monetary authority available for continuing authorized government spending after an unmoved debt ceiling has been reached does exist. The arguments in the preceding article addressed only the fiscal operations available, and, therefore, did not consider all options.
Authority for Coinage
The Department of the Treasury is authorized to provide coinage for the country. A 1996 law provides for platinum coins to be minted in any denomination value designated by The Secretary of the Treasury without limitation by the amount (value) of the platinum contained therein. This has lead to the proposal for the creation of debt-free money through seigniorage. Suggestions have been made that a coin could be designated to have $1 trillion value and deposited at the Federal Reserve to cover government expenditures up to that amount without the issuance of debt. Joe Firestone has suggested that there is no logical reason to limit coin value to $1 trillion - he has asked: "Why not $30 trillion?" Or $60 trillion?
While many notables have discussed coin seigniorage positively, a greater number have argued against its consideration.
Premium Bond Issuance
This propsal has been explained by a number of people, but perhaps any better than Matt Levine at Bloomberg. (Read his recent piece, which has links to older articles.)
The idea is that when market rates are at a certain level, bonds that pay a higher coupon sell at a premium. For example a $100 bond with 30-years to maturity that pays 15% would have a market value somewhere around $280 if the current market rate is only 4%.
So in the current environment the government could fund $1.1 trillion in spending but only increase the national debt by $400 billion. Yes, interest would constitute $44 billion more in annual expense for the next 30 years than if $400 billion in bonds were issued with 4% coupons. But future interest payments are not included in an accounting of the current national debt which is run basically as a cash flow accounting entity. So $700 billion has been spent into the economy (created) above what would have occurred with issuance of $400 billion in bonds at 4% rather than 15%.
Of course such premium bond implementation would need to be done in advance of actually hitting the debt ceiling and only creates a delay in reaching the ceiling. The only way to extend government operations indefinitely would be to issue bonds with extremely high interest rates (say, for argument sake, 50%). Such bonds could be sold with a nominal face value, say $10 for a very high issue price (like $100) which would be equal coupon payments of $5 per annum. The current sale value would be increased by the present value of the $90 maturity value difference discounted for 30 years.
As a practical matter the premium bond issuance process merely delays reaching a debt ceiling.
New Twist: Negating the Government Interest Costs
The Federal Reserve could buy the premium bonds and hold them as they are already holding trillions of Treasury and MBS (mortgage backed securities). The earnings of the Federal Reserve are returned to the U.S. Treasury each year so the net cost of carrying the premium bond debt would be close to zero if none were held outside of the Fed balance sheet.
This process is merely a continuation of the large scale asset purchase programs of recent years (LSAP, aka QE).
There is a little problem when the premium bonds mature. If the Fed has created $275 billion to buy these bonds and only receives $100 billion principle at maturity, there is a big loss. If no other accounting is applied the Fed would be writing off $175 billion at maturity, or by allocation in increments over the intervening years.
I have yet to find someone who explains to me how the Fed handles capital loss write offs. Perhaps a reader of this discussion will enlighten me and our readers.
Payment of High Interest Rates to the Public
But what if the premium bonds are sold to the public? Doesn't that cause a big problem for the government? Actually, no. The government has created an additional $1.1 billion of spending and is paying nearly the same total interest as if $1.1 in 4% coupon bonds had been issued. The bonds were priced to equilibrate the present value of the cash flow to maturity.
So the government total expense is the same as if the debt ceiling had been raised and conventionally price bonds issued.
The increased money spent into the economy and the resulting interest payments on the Treasuries issued are actually stimulative for economic growth. The additional money spent into the economy is $700 billion ($1.1 trillion spent minus $400 billion taken out of the economy to buy the premium bonds). The higher interest payments are also stimulative over the following years.
Note: The contractionary effect of QE for several reasons including return of interest payments to the government instead of payment into the economy has been pointed out by several GEI contributors, including Paul Kasriel, Warren Mosler, Van Hoisington and Lacy Hunt.
Other Discussions of Debt-Free Money
A thorough discussion of the ideas mentioned above has been presented by others including Joe Firestone at New Economic Perspectives in a six part series, and Scott Baker at OpEd News. (Note: both Firestone and Baker have contributed to Global Economic Intersection.)
Firestone discussed another funding option I have not discussed above: issuance of debt in perpetuity. Similar to callable corporate preferred stock, such debt (known an "consols") would never mature unless called by the government but would pay fixed rate forever (an infinite annuity) until and unless called for a payment specified at time of issue. Barry Ritholtz recently had a short discussion of the history of the UK Consol back to 1742. These instruments still trade today in London and have a current yield of 4.4% based on discounted price for the 2.5% coupon instruments.
Baker also discussed still another option not discussed above: the printing of United States notes ("greenbacks") to pay obligations of the federal government (but not by law allowed for the reduction of debt already issued). This proceedure was followed by Lincoln during the Civil War when banks demanded usurious interest to fund additional government debt.
Note: GEI contributor Derryl Hermanutz has written a number of articles on the nature of debt-free money, see here and here. In the near future we will be publishing a multi-part series "A Treatise on Money".
So there are fiscal implementation processes that that are in effect monetary actions, equivalent to the government creating money rather than the usual process of banks creating money and lending it to the government. The availability of these measures to remove the constitutional dilemma of the executive branch to an unmoved debt ceiling could be used to defend the constitutionality of the debt ceiling law. The basis of the argument is that the executive has means available to go around the impossible choice of only three fiscal actions (from the previous article):
- Issue more debt above the debt ceiling;
- Increase taxes by executive order to cover the appropriations;
- Make executive decisions on which appropriations will not be funded, breaking any government contracts necessary to do so.
But those who would have to argue in court that the extraordinary means we have discussed here would negate a challenge to the debt ceiling law would be those very unlikely to support the implementation of these psuedo-monetary policy practices.
However, in the Wonderland of American political economy, it is not inconceivable that an argument might be supported for presenting one position, with same argument denounced the very next day for a different purpose.
Such is the nature of the American political exhibitionist that such an eventuality cannot be dismissed. And the next time all these questions may be back on the table is only about three months away. (See GEI News.)