With the United States rapidly approaching the debt ceiling limit, a dysfunctional and divided Congress appears unable to agree on either spending cuts or an increase in the debt ceiling.  Absent some grand Congressional compromise, America’s nonstop trillion dollar deficit spending will rapidly push the nation to the brink of default before the end of next month.

Although the idea of default seems like a low probability to many people, if such an event were to occur, the result could be disastrous to both the markets and the economy.  Americans have always been able to come up with ingenious solutions before falling off the precipice and this time is no different.  The idea of minting a $1 trillion dollar face value platinum coin to cover our spending needs has quickly garnered national attention.

Predictably, opinions vary greatly as to the legality and efficacy of using a coin worth about $1,700 to fund a trillion dollars worth of spending.  The trillion dollar coin idea, ridiculed as irresponsible by some, is seen by others as a legitimate manner in which to resolve our deficit crisis.  For fiscal conservatives, the mere thought of proclaiming a common coin to have a trillion dollar value in order to remain solvent, is a wretched sign of how incredibly tenuous the financial condition of the United States has become.

In no particular order, here are some of the arguments regarding the trillion dollar coin.

U.S. Rep. Greg Walden (R-Ore.) announced that he would introduce a bill to stop the proposal to mint high-value platinum coins to pay the federal government’s bills.   Rep. Walden said, “Some people are in denial about the need to reduce spending and balance the budget. This scheme to mint trillion dollar platinum coins is absurd and dangerous, and would be laughable if the proponents weren’t so serious about it as a solution. I’m introducing a bill to stop it in its tracks.”

A Washington Research Group analyst said, “The President could assert that that 14^th amendment negates the requirement for Congress to raise the debt ceiling.  Or Treasury could mint a $1 trillion platinum coin and deposit it at the Federal Reserve.  Neither are great options.  We see chaos if the market has to confront Treasuries where the debt is backed by Congress and those where it is not backed by Congress.  For banks, this might be as bad as an actual default. The economic uncertainty could cause lending to grind to a halt, the disruptions could cause unemployment to spike which means higher loan losses, and interest rates could skyrocket as the market is unsure whether one of these creative solutions is even legal.”

According to Bloomberg:

In general, the Treasury Department is not allowed to just print money if it feels like it. It must defer to the Federal Reserve’s control of the money supply. But there is an exception: Platinum coins may be struck with whatever specifications the Treasury secretary sees fit, including denomination.

This law was intended to allow the production of commemorative coins for collectors. But it can also be used to create large-denomination coins that Treasury can deposit with the Fed to finance payment of the government’s bills, in lieu of issuing debt.

What the law should say is that the executive branch may borrow to pay whatever obligations the federal government has, but may not print. Unfortunately, when we hit the debt ceiling, the situation will be backwards: The administration will not be allowed to borrow, but it can print in unlimited quantities.

Economist Paul Krugman, who believes that the United States effectively has no limit on its spending ability, thinks using a $1 trillion dollar coin would solve our debt limit crisis.

Should President Obama be willing to print a $1 trillion platinum coin if Republicans try to force America into default? Yes, absolutely. He will, after all, be faced with a choice between two alternatives: one that’s silly but benign, the other that’s equally silly but both vile and disastrous. The decision should be obvious.

Enter the platinum coin. There’s a legal loophole allowing the Treasury to mint platinum coins in any denomination the secretary chooses. Yes, it was intended to allow commemorative collector’s items — but that’s not what the letter of the law says. And by minting a $1 trillion coin, then depositing it at the Fed, the Treasury could acquire enough cash to sidestep the debt ceiling — while doing no economic harm at all.

The American Enterprise Institute explains how the platinum coin concept would work:

There are limits on how much paper money the U.S. can circulate and rules that govern coinage on gold, silver, and copper.  BUT, the Treasury has broad discretion on coins made from platinum.  The theory goes that the U.S. Mint would create a handful of trillion dollar (or more) platinum coins.  The President would then order the coins deposited at the Fed, who would then put the coin(s) in the Treasury who now can pay all their bills and a default is removed from the equation.  The effects on the currency market and inflation are unclear, to say the least.

According to CNN:

Normally, the Federal Reserve is charged with issuing currency. But U.S. law, specifically 31 USC § 5112, also grants Treasury permission to “mint and issue platinum bullion coins and proof platinum coins.”

This section of law was meant to allow for the printing of commemorative coins and the like. But the Treasury Secretary has the authority to mint these coins in any denomination he or she sees fit.

Why The $1 Trillion Platinum Coin Idea Won’t Work

The genesis of the trillion dollar platinum coin scheme derives from the law (Title 31, Section 5112, (31 U.S.C. § 5112(k)) passed by Congress under their constitutional power to coin money and regulate the value thereof.  This particular law was passed to give the U.S. Mint the authority to produce the American Eagle Platinum Bullion and Proof coins, without restriction to the American Eagle products program.

The Secretary 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.

As argued in some of the commentary above, it seems clear that the law would allow the Secretary to authorize the U.S. Mint to produce a platinum of any stated denomination, including one trillion dollars.

The Federal Reserve would receive a coin on which would yield a profit of $1 trillion dollars based on the concept of seigniorage, which is the difference between the cost to produce the coin and the “face value” of the money stamped on it by the U.S. Mint.  However, under the rules of both the American Eagle program and other commemorative programs, the coin does not become “legal tender” until the U.S. Mint is paid for the coin with other legal tender or an appropriately valued amount of bullion.  Until the U.S. Mint was paid, the Federal Reserve would possess a rather beautiful coin worth only about $1,700, representing the intrinsic value of the platinum contained therein.

In the recent case of the government confiscation of 1933 Saint-Gauden Double Eagle gold coins from the heirs of Israel Swift, the court ruling confirmed the validity of the legal tender concept.  In the court ruling, Judge Davis cites precedents, including the government’s original case against Israel Swift in 1934, and confirmed that until a U.S. Mint coin is bought and paid for, the coin is not considered to be legal tender.  The concept of a coin not becoming legal tender until it was paid for was further confirmed in the sale of the Fenton-Farouk 1933 Double Eagle gold coin.  When the Double Eagle was sold on July 30, 2002, for $7.6 million, an additional $20 was required to be paid to “monetize” the face value of the coin in order for it to become legal currency.

Exactly how would the U.S. Mint be paid in order for the $1 trillion coin to become official legal tender?  If the Federal Reserve accepts the trillion dollar coin from the U.S. Mint, they would incur a $1 trillion liability to the U.S. Mint.  To offset the liability to the U.S. Mint, the U.S. Treasury would have sell $1 trillion in bonds which can’t legally be done due to the limits placed on its borrowing capacity by the debt ceiling limit.  The idea of a $1 trillion platinum coin becomes a fatally flawed solution that solves nothing.

So why can’t the Federal Reserve simply “print money” to pay for the $1 trillion coin?  As explained by Paul Krugman, the Fed does not legally have the power to print money, with one rather dubious exception.

First, as a legal matter the Federal government can’t just print money to pay its bills, with one peculiar exception. Instead, money has to be created by the Federal Reserve, which then puts it into circulation by buying Federal debt. You may say that this is an artificial distinction, because the Fed is effectively part of the government; but legally, the distinction matters, and the debt bought by the Fed counts against the debt ceiling.

Furthermore, Krugman admits that the platinum coin idea is a “gimmick” since the coin would effectively have the same value as other outstanding Treasury debt and the Treasury would have to eventually buy the coin back with additional borrowings.  Somewhat surprisingly, Krugman also concedes that despite the fact that much of the government’s current spending is financed by the Fed’s money printing, we cannot ignore the ultimate consequences of huge holdings of Treasury debt held by the Fed.

It’s true that printing money isn’t at all inflationary under current conditions — that is, with the economy depressed and interest rates up against the zero lower bound. But eventually these conditions will end. At that point, to prevent a sharp rise in inflation the Fed will want to pull back much of the monetary base it created in response to the crisis, which means selling off the Federal debt it bought. So even though right now that debt is just a claim by one more or less governmental agency on another governmental agency, it will eventually turn into debt held by the public.

The entire concept of the United States funding itself with a manufactured $1 trillion dollar coin of nominal intrinsic value is fraught with danger since it highlights the extent to which we are willing to debase the value of the U.S. dollar to continue massive deficit spending – at some point our creditors will begin to take notice.  Think of Japan and China who each hold more than $1 trillion in U.S. Treasury debt securities.

Aside from the fact that the minting of a $1 trillion dollar coin is probably legal, it is not a workable solution since the coin would be of no value until it was paid for as explained above.  As discussed in Bloomberg, instead of pursuing dubious policies that will ultimately alarm the nation’s creditors, the challenge of compromising on the debt ceiling should be viewed as an opportunity for Congress to take responsibility for the nation’s future fiscal policies.

Watch what he did, not what he says. President Barack Obama says he won’t agree to spending cuts in return for Republicans’ raising the debt ceiling. Yet he did exactly that in 2011. And he should do it again.

The debt ceiling ought to be raised because nobody has a plan to eliminate the deficit immediately, and there is no popular support for doing what that would take. A congressman who isn’t presenting and supporting a zero-deficit-now plan has an obligation to give the federal government the additional borrowing authority that continued deficits make necessary.

For liberals, that’s the end of the matter. The debt ceiling should be raised without any spending cuts attached, and ideally it should be raised to infinity. One common argument goes like this: Since Congress sets spending and tax levels, no good purpose is served by holding a separate vote making it possible for the government to follow Congress’s original instructions.

That argument would have more force if the federal budget were the result of a deliberate policy. Instead, more and more of our spending rises on autopilot because of decisions made long ago, and nobody is forced to take responsibility for the gap between revenue and commitments. Bills to raise the debt ceiling are the only occasions when congressmen and the president come close to doing so. They are thus appropriate moments to attack the trends that are driving our rising debt.

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