Will platinum be the new gold standard?

Former republican lawmaker Ron Paul advocated for a long-time that the US should return back to the gold standard. This appeal was also supported by Paul Ryan, who ran for vice-president last year. In Idaho, republican lawmakers even brought in a bill to make gold coins a legal tender. However, according to a plan currently being discussed, platinum might be the metal setting a new standard.

In a last minute compromise, as we expected and pointed out several times in this blog, the US Congress avoided a fall of the US economy over the fiscal cliff. However, there was a deep split with the Republican Party. The tea party wing lost the battle in the House as a sufficient number of moderate Republicans voted with Democrats to pass the bill. But this compromise postponed the decision on spending cuts by two months and it should be part of a compromise for lifting the debt ceiling.

The debt ceiling is a legal construct, which is only applied in the US because it is an inconsistency of a fiscal system. The right to determine the budget is the primary right of every democratic parliament. However, in the US, the parliament passes a budget law authorizing the administration to spend money. But with the debt ceiling the lawmakers could prevent the president to borrow the money for fulfilling the legal obligations. There is a dispute among lawyers whether the debt ceiling would not be overruled by constitutional obligations. However, since the start of this year, also an economic plan to circumvent the debt ceiling is hotly debated.

This plan emerged already in the middle of last year. Last week, it has been discussed on Bloomberg Blog and TV and was the topic of a comment by Paul Krugman in the New York Times. It is also widely discussed on Twitter under #MintTheCoin. This plan exploits a legal loophole provided by 31 USC § 5112. Normally, the US Treasury can not issue coins without the approval of the US Congress, but this law makes one exception. The US Treasury can mint platinum coins with whatever specification the secretary regards as appropriate, including the denomination. The intention of this law was to allow the production of commemorative coins for collectors.

The plan proposed is to mint a super platinum coin with the denomination of 1 trillion US dollars. According to this plan, the coin could then be deposited at the accounts held with the Fed to finance the payment of the government’s bills. As this coin would be legal tender, the Fed would have to buy this coin at the denominated value and would have to credit the amount on the accounts of the US Treasury. The difference between the costs of minting the coin, which is to a large extend only the cost of the metal and one ounce of platinum might suffice, and the denominated value is called the seigniorage. The seigniorage is a kind of windfall profit for the government and is normally treated as ordinary revenue, like tax revenues. In many countries, it is not treated as government debt. Otherwise, this plan would not work.

In terms of national accounts, the Fed is part of the state sector. Thus, debt issued by the US Treasury and bought by the Fed in the secondary market cancels out each other. However, it is still counted as outstanding debt of the US Treasury and is relevant for the debt ceiling. Depending on how debt bought back by the US Treasury is treated, one possibility would be that the US Treasury mints the super coin, deposits it at the Fed. With the proceeds, the Treasury buys back notes and bonds from the Fed. This would have the advantage that the balance sheet of the Fed would not be inflated. At the end there would be only an asset swap – the Fed would hold the super coin instead of US Treasury paper. For the Fed such an operation would have another advantage. It would reduce the risk on the balance sheet of holding Treasury paper in the case of rising yields on US Treasuries. Unlike for notes and bonds, there is no depreciation risk of the super coin. It will always be worth its denomination. This would also mitigate the fears of several FOMC members, which voiced concern of continuing QE at the current pace, according to the FOMC minutes released this week. In the case that such an operation would reduce the amount of outstanding debt with respect to the debt ceiling, then, the US Treasury would have again sufficient leeway to fund its expenditures by borrowing in financial markets.

Some commentators compared this plan with the hyper-inflation in Germany during the time of the Weimar Republic or with Zimbabwe. This is absurd and economic non-sense. It only demonstrates that the critics lack basic economic 101 understandings. Such a super coin could not be a coin in circulation. Not even Warren Buffet, Bill Gates or Carlos Slim could buy this coin as they are just billionaires. However, in the Weimar Republic or in Zimbabwe, everybody had bills denominated in millions or even billions. Even in the case that the super coin would lead to a rise in the size of the Fed balance sheet, it is not going to lead to hyper-inflation as the critics pretend. The US Treasury can not just spend all the money for purchasing goods and services. The restrictions of the budget still apply. In addition, the Fed still has its weapons to contain negative impacts on the money supply. Furthermore, inflation rises if aggregate demand exceeds aggregate supply. Even with avoiding the fall over the fiscal cliff, the US economy is still far from a situation that aggregate demand will exceed output potential and would trigger accelerating inflation rates.

Some commentators pointed out that such a plan was already made by the Simpsons a long time ago. The author of this blog was never a follower of the Simpsons and thus had to rely on links provided by those commentators. However, there was only a one trillion dollar bill – no mentioning of coins. Those commentators referring to the Simpsons have also not understood the plan. A bill would not solve the problem of the US Treasury with hitting the debt ceiling soon. A US dollar bill is issued by the Fed. Coins are minted by the Treasury and sold. Selling or depositing the coin is the crucial condition for the US Treasury to stay afloat after hitting the debt ceiling.

Minting a platinum coin is a smart plan and excellent arrow in the quiver of US President Obama for the negotiations with Republicans on spending cuts and lifting the debt ceiling. Whether it will be realized depends on the Tea Party wing of the Republicans. If they continue their fundamental opposition and remain unwilling to compromise, then the odds for minting a super platinum coin could increase. Thus, platinum might set a new standard. However, it would not be comparable to the gold standard as this coin would not come into circulation.