Imperfect precious metals markets

Those believing in the theory that financial and commodity markets were perfect should have a look at the development of gold, silver and platinum during this past week. The major fundamental factors for the fair valuation were more or less neutral. Nevertheless, these three metals posted stronger losses between 2.1 and 5.2 per cent. Only palladium ended the week marginally higher.

The precious metals came under selling pressure on Monday and Friday. The reasons for the losses provided by market reports are demonstrating that markets do not react rationally. On Monday, analysts blamed the debt crisis in the eurozone as one reason for the losses. However, there were no news out of Spain and as we pointed out last week, it is not very likely that the Spanish PM would be forced to resign and that snap elections would have to be held. Fears about the Spanish government are like a storm in a tea cup. It was also quite clear that the meeting of eurozone finance ministers would not lead to a decision on a bailout for Cyprus as politicians wait for the presidential election before taking a final decision. In Italy, former PM Berlusconi reduced the difference in opinion polls to Mr. Bersani, who was still in the lead. And that Pope Benedict announced his resignation is by no means a reason to sell gold.

The second reason for the drop of precious metals prices on Monday was according to a market comment from Barclay’s the start of the lunar new year celebrations in many Asian countries. As Chinese investors absorb supply, analysts at the British investment bank feared that supply would weigh on prices in other trading centers. However, as the date of the lunar new year is not coming as a surprise and well known in advance, it should have been discounted already in the prices. Furthermore, if buyers of precious metals form rational expectations, they should have expected that prices might be under pressure when China is out of the markets for the week long holidays. Thus, a rational investor would defer buying to profit from the expectation of declining prices. Therefore, demand should have shifted towards the holidays in China and this should compensate the lack of demand from Chinese investors.

On the other hand, also short-sellers would know that Chinese investors would not be in the market during the lunar new year holidays. Thus, they also might defer selling short to have a stronger impact on pushing prices down. However, in this case, they would have to lease gold to meet the obligation to deliver in the spot market. As a result, gold lease rates would have to increase. Gold lease rates increased only slightly on Monday. Stronger increases took place later during the week and the week before. Nevertheless, the development of the gold lease rates indicates that large speculative investors are getting more bearish on gold. This is also confirmed by the recent CFTC report on the ‘Commitment of Traders’, which showed a further drop of the net long position held by large speculative accounts from 137,465 to 126,835 futures contracts at the CME’s COMEX division.

Unlike some well-known bond fund managers, who appear to talk their book almost daily on a television station, many hedge fund managers holding gold make no comments in public about their investments in precious metals or ETF’s on physical metals. Thus, the public has to wait until the filings of those hedge fund managers with the SEC will be released. During the final quarter of 2012, there were already indications that hedge funds turned more negative on gold. One of those indications was the development of the net long-positions in the CoT report. Now, the SEC filings revealed that Soros Capital and some other major hedge funds (Tiger, Moore) had reduced their investment in the SPDR Gold Trust ETF considerably in Q4 2012. This information was the trigger for the sell-off on Friday.

From a movie title, we know that “the postman always rings twice”. Many investors and traders appear also to react twice. The selling of shares in the gold ETF took place in the final quarter of 2012. When gold priced headed lower, they followed the price momentum and also sold. Now, they received the information why gold traded down some month ago and sell again. This is not a rational behavior but just following the herd instinct. First, the SEC filings provide no indication that Soros Capital and other hedge funds still reduce their position in the gold ETF. The selling in Q4, despite being massive, could be just part of reallocating funds to investments, which appeared to be more lucrative. It was also reported that Soros Capital made a gain of more than 1bn US dollars in speculating on a weaker yen, since it became official policy in Japan after the victory of PM Abe in November. Second, despite the liquidation of positions by major hedge funds, the gold holdings of the SPDR Gold Trust increased in Q4 by around 30 to 1,350.8 tons. However, since the start of this year, they fell back to almost the level at the beginning of Q4.     

Technically, gold is in a difficult position. With the plunge on Friday, gold has fallen below two stronger support levels, but managed to close above the lower support level at 1,600$/oz. The trend following indicators turned bearish and the increase of the ADX indicator points to a strengthening trend behavior of gold after many months of range trading. However, it is not yet an all clear for gold bears. First, the stochastic oscillator points to an already oversold market. Second, two support lines cross at 1,584$/oz, which is another hurdle the bears would have to surpass. Thus, a test of this support zone might be a good buying opportunity as long as the fundamental factors for precious metals remain positive.

Regime shift in precious metals markets

It was a mixed week for precious metals, with gold ending almost unchanged and platinum was the only metal posting a stronger gain, while silver and platinum closed lower in the weekly comparison. While gold and silver followed more the movements of the safe haven government bonds of the US Treasury and the German Bunds since the start of the year, the US dollar became the dominating factor after the ECB meeting. However, the reasons, which first led to a rise of precious metals and then triggered a drop on Thursday, are not based on a sound analysis. It is more following the herd instincts like lemmings.

At the start of the week, it was reports about political developments in Italy and Spain, which pushed German Bunds and US Treasuries higher. This also had a positive impact on precious metals. In Italy, the former PM Berlusconi is still lagging in polls behind the centre/left. However, he gained in popularity and reduced the lead of the centre/left to just 4 percentage points according to latest polls. But it is still not sufficient to form a new government. The centre/left under Mr. Bersani could form a coalition government with incumbent PM Mr. Mario Monti. Nevertheless, investors are worried that Mr. Berlusconi could become the next PM again. His promises made in election campaigns would be a clear end of the austerity policy. And this would also imply that Italy would not qualify for the ECB’s OMT program, which was the major factor for falling yields on Italian government bonds. However, analyzing past election campaigns of Mr. Berlusconi, analysts and investors should know that his campaigns are based on his media empire and populist promises. Mr. Berlusconi has to fight again for political survival to prevent from being sentenced to jail. But unlike in the past, the Italian industry association is not remaining silent but voices opposition to a return of Mr. Berlusconi to power. Thus, markets should have priced in that Mr. Berlusconi would catch-up in opinion polls.

The former treasurer of the leading Spanish Popular Party, Mr. Barcenas is subject of criminal investigations for some weeks already. On request from Spain for official aid, Swiss authorities found a bank account of Mr. Barcenas with a deposit of 22mn euro. One Spanish paper, El Mundo, reported that Mr. Barcenas delivered various leading members of the Popular Party cash in letters, but did not provide any proof. At the end of last week, another Spanish news paper, El Pais, published handwritten accounting notes, which link payments also to Spanish PM Mr. Rajoy.

As the Spanish opposition parties called for the resignation of Mr. Rajoy, many analysts and traders believed that the Spanish PM would have to resign. This demonstrates again the lack of political understanding among analysts. The opposition can not oust the incumbent PM. In the Spanish parliament, the Popular Party has a vast majority and it is rather unlikely that they force Mr. Rajoy to step down. Also snap elections are therefore not very probable. Fears among analysts and traders that a change of the government, which is not a likely scenario, would lead to an end of the austerity policy are also not rational. Markets have forgotten that it was the socialist government under Mr Rajoy’s predecessor, which included the obligation to balance the budget in the constitution even before this became part of the eurozone stability pact. Thus, the flight to the German Bunds and into the precious metals was not based on a sound rational analysis but driven only by fear.

On Thursday, the safe haven government bonds rallied, but the precious metals did not follow. Quite the opposite, they were pulled down by a weaker euro against the US dollar. The trigger was the reply of ECB president Draghi on a question about the euro exchange rate. However, markets did more react on what they wanted to hear than what Mr. Draghi actually said. First, Mr. Draghi pointed out that the ECB has no exchange rate target. This should be well understood by analysts and traders as the ECB emphasized again and again that its sole task is to maintain price stability. Second, Mr. Draghi attributed the recent appreciation of the euro as a result of confidence in the euro returning. As the fall of the euro against major currencies last year was based on fears of the euro falling apart, the fight of the ECB to do everything necessary to keep the euro intact would lead to a strengthening of the single currency. The ECB must have taken this into account and it was also welcome to reduce the inflation rate again towards the target.

Third, Mr. Draghi pointed out the the ECB council would have to observe the further development to assess whether the euro strength is only temporary or permanent and whether it would have an influence on its target. This was a more academic statement. Of course, the development of the euro must have a negative impact on the ECB’s target of price stability to trigger any policy action. So far, the strength of the euro is welcome, as it helps to reduce inflation. Only if a permanent appreciation of the euro would lead to inflation falling to dangerously low levels, the ECB would see a necessity for policy action. However, the markets took this as a signal for a further rate cut. The traders and analysts completely overlooked that Mr. Draghi emphasized several times that the current ECB interest rate policy is very accommodative. The ECB still expects that the Eurozone economy will pick up steam in the second half of this year. Thus, we would not rule out another rate cut if the economy situation worsens considerably. However, at present, another rate cut is not a very likely scenario.

           

Further speculation on a rate cut by the ECB to weaken the euro might prevail in the short run. However, as the ECB is likely to keep rates on hold, traders who sold the euro might have to buy back. The political development in Spain and Italy might be supportive for the precious metals. Thus, further range trading of gold and silver is the most likely scenario. Platinum and palladium are expected to perform still better than gold and silver. But some profit taking can not be ruled out.

Fed and US labor market report lift precious metals

After a weaker start, precious metals recovered lost ground. Only platinum failed to end the week higher. Last week, the precious metals decoupled somewhat from the movements of the safe haven government bonds. The influence of the usual major fundamental factors became stronger again.

There were two major events, which had an impact on precious metals, the FOMC meeting and statement as well as the US labor market report. For financial and commodity markets, the most important phrase of the FOMC statement was: “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee will continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”

Markets were relieved that the FOMC continues quantitative easing. However, a rational investor should have priced in this decision by the voting members. The vast majority of the FOMC already voted for these measures in December. The US economy has slowed lately somewhat due to weather related disruptions as the FOMC noted also in the statement. Therefore, it was rather unlikely that a majority of voting members would now terminate QE only one meeting later. The FOMC will not stop quantitative easing also at the next couple of meetings; bar there would be a miracle in the US economy.

Nevertheless, we still expect that the minutes will also show that the discussion about the risks of quantitative easing for the balance sheet of the Fed and for the political independence of the Fed will go on. Yields on 10yr US Treasury notes have touched the 2% mark several times last week. The risk of a break through this resistance level is increasing. A break above this resistance could lead to a rise by another 25 basis points to 2.25%. Given the low coupon and the high duration of the on-the-run issue, such a small yield rise is sufficient to produce capital losses, which wipe out the coupon income of more than one year. Thus, rising yields pose a risk for the profit and loss statement of the Fed. Like any other bond investor, also the Fed would have to consider this risk seriously.

Even in the case that the FOMC would already decide to terminate buying bonds in the second half of this year, this would not change its interest rate policy. The target for the Fed Funds rate would remain at the exceptionally low level until one of the two thresholds, either for inflation or unemployment rate, are reached. Normally, this should still be positive for precious metals. However, as many investors have the wrong belief that QE would be necessary for rising prices of precious metals, discussions about an end of QE could cap attempts of precious metal prices to move higher.

Precious metal prices also rose after the release of the US labor market report. However, it was somewhat strange that also stock and bonds markets rallied after the figures were out. The report of January is always a bit difficult to interpret due to the annual benchmark revisions. Nevertheless, the report was not that bad to justify a rally in the bond markets. The non-farm payroll figure was slightly below consensus, but preceding months had been revised higher. Thus, overall, there were more new jobs created than economists predicted. Benchmark revisions also had an impact on the household survey. The increase of the unemployment rate from 7.8 to 7.9% was the result of annual population adjustments as the number of unemployed persons was little changed at 12.3 million. That the labor market report does not change the short-term outlook for the Fed policy did not justify the rally. Later during the trading session, US Treasury note and bond futures pared the gains and fell even below price level prevailing before the release of the labor market report. This pulled also precious metals lower again, but they managed to close higher on the day.

We still regard the major fundamental factors as positive for the precious metals. However, during the first month of 2013, gold and silver were more influenced by the movements of the safe haven government bonds, the US Treasuries and the German Bunds. These bond markets could continue to correct and yields increasing further. This could have a negative impact on gold and silver and might even more than compensate positive fundamentals.

PGMs perform again best amongst precious metals

Gold and silver ended the week lower with a loss of around 1.5% for gold and 2.2% for silver. Both metals gave back the gain of the preceding week and gold even closed lower than 2 weeks ago. On the other hand, platinum gained 1.5% on the week while palladium rose by 2.9%.

After a positive start, gold and silver plunged on the last two trading days of the week. On both days, the three major fundamental factors for the price development of gold and silver according to our fair value models had been positive. Normally, flows into the risky assets and commodities had been favorable for gold and silver last year. However, this is not the case in this year so far. Gold and silver get under selling pressure when investors also move out of the safe haven government bonds, the US Treasury notes and the German Bunds.

On Thursday, the Bund future initially rallied on disappointing flash estimates of the Markit PMI for France, which came in far weaker than expected. Also a surprisingly strong flash estimate for the German PMI did not change the direction. Gold and silver could not profit from this move, but came under stronger selling pressure inline with Bunds and US Treasuries after the release of US economic data. The initial jobless claims number surprised for the second week with a further decline to 330,000. This points to a better labor market report released next Friday, on February 1. In addition, the flash estimate of the Markit PMI for the US manufacturing sector jumped from 54.0 to 56.1, which indicates that the US economy is probably expanding at a faster pace again. The leading indicator compiled by the Conference Board also posted a stronger than expected increase of 0.5%.

On Friday, traders cited the new home sales report as a reason for the continued sell off in gold and silver. While the number of new home sales remained below the consensus estimate, the previous month’ number had been revised considerably higher. In Germany, the ifo business climate index also surprised with a stronger than expected increase, which pulled the Bund and the US T-Note futures lower.

Many market participants believe that the economic recovery might be stronger and that the Fed might stop QE earlier than assumed. They also believe that QE would be a necessary condition for higher gold and silver prices. However, this is not the case as we have pointed out several times. Nevertheless, QE is certainly a supportive factor. But even without QE, gold and silver prices could move higher as stronger GDP growth and a fall of the unemployment rate are necessary conditions for terminating QE. In this case, however, also the output gap narrows and the risk of inflation picking-up is increasing. This would be positive for both metals for two reasons. First, both metals are bought as a hedge against inflation. Thus, it would not be rational to lift the hedge just when the need for the hedge is most urgent. Second, with a stronger economy, at least two of the major fundamental factors will improve further. Stock markets are likely to rise further and also the price of crude oil is probably rising with stronger economic activity, unless new technologies lead to supply increasing stronger than demand.

Even if believes are wrong or not rational, they could nevertheless move the markets. Holdings at the major US gold and silver ETF held quite well, or even increased during the last couple of months, whereas large speculative accounts reduced their net long position in the Comex gold and silver future. But now also the ETF holdings declined. The holding in the SDPR Gold Trust ETF declined by 6 to 1,329.9 tons while the iShare Silver Trust holdings decreased by 266.2 to 10,468.76 tons. This decline reflects a shift in sentiment among the more medium- to long-term oriented investors.

Whether gold and silver remain within the recent sideways trading range will depend on two events in the coming week. First, on the statement of the FOMC, which will be released after the meeting on Wednesday, January 30.  Second on the US labor market report released on Friday, February 1. If any of these two events will increase the fear of an earlier termination of quantitative easing by the Fed, then the selling pressure on gold and silver could increase. In this case, the PGMs will probably continue to perform better than the other two metals in the precious metals segment.

PGMs outperform gold

Despite profit-taking on Friday, which set in with the opening of stock market trading in Europe and the rebound of safe haven government bond futures, platinum and palladium closed the week strongly higher. While gold managed to post a gain of 1.25%, the PGMs ended the week almost 3% up. Only the price of silver rose stronger by gaining 4.6%. Platinum traded briefly above gold for the first time since summer 2011. Now, the crucial question is, will the PGMs also perform better than gold for the rest of the year? From our point of view, this is the most likely scenario.

The prices of PGMs are expected to increase on balance in 2013 due to favorable supply and demand factors. We pointed already out that Johnson Matthey predicted in its interim report the platinum and palladium would be in a supply deficit in 2013. Also Norilsk Nickel expects that the Russian supply of palladium is going to decline as Russian inventories fell. Earlier this week, Anglo American Platinum, which is the world’s biggest producer of the white metal, surprised the market with the announcement to mothball four shafts and to sell one of its mines in South Africa. The company also plans to cut 14,000 jobs in South Africa. The decision of Amplats reflects the struggle of South African mining companies, which are faced with input costs rising three times faster than inflation, instable power supply. Also safety stoppages as well as violent labor conflicts weigh on mine operators.

While supply is likely to decline more than Johnson Matthey predicted in November, demand is expected to increase stronger. The automotive sector in Europe is in dire situation as figures showed again this week. However, more important is the global car production, which is still increasing, especially in China. The Chinese GDP grew again stronger in the final quarter of last year. This indicates that demand for cars will also increase further. Also the US economy is expanding and private consumption is one the rise. Therefore, we expect demand for the PGMs to increase and thus, the supply deficit is likely to increase due to declining production and higher demand.

One indicator to gauge the performance of platinum compared to gold is the platinum/gold ratio. A rising ratio indicates that platinum performs better than gold. However, gold shows the better performance when the ratio declines. We have developed a forecast model for the platinum/gold ratio, which is based on the same fundamental factors as in the fair value models for precious metals. A rise of the S&P 500 index as a proxy for global economic perspectives as well as higher crude oil prices have a stronger positive impact on platinum and thus lead to an increase of the ratio. Also an increase of the yield on 10yr US Treasury notes is positive for platinum/gold ratio. An increase of the US dollar index, i.e. a stronger US dollar, is negative for the price of all precious metals. However, a firmer US dollar weighs more on gold than on platinum, thus, also an increase of the US dollar index is a positive factor for the platinum/gold ratio. All the four factors are significant even at the 1% level.

In the forecasts submitted to the polls of ThomsonReuters and the London Bullion Market Association (LBMA), we predicted that the precious metals will have a positive performance in 2013. However, the PGMs are likely to perform better than gold and silver, which are more in the focus of investors and speculative traders.

Gold, the Fed and Chinese Inflation

After several weeks of consecutive losses, gold and silver managed to close the week slightly higher. The PGMs recovered stronger. While palladium closed 1.6% higher, platinum gained 4.6% on the week.  Also gold and silver were trading higher, but both metals declined last Friday by about 1% whereas the PGMs closed slightly higher. The reason for the fall of gold and silver given by a market report was the Chinese inflation rate in December.

The consensus of economists forecast predicted already an increase of the Chinese inflation rate from 2.0% in November to 2.3% in December. However, the inflation rate jumped to 2.5%, which led to the fear that the People’s Bank of China would provide less monetary stimulus to foster the GDP growth. China has been hit by a severe cold, which has a negative impact on cabbage, a main aliment during the winter season. Thus, the rise of cabbage prices was the major culprit for the jump in the inflation rate. That this increase of the Chinese inflation rate is the reason for the fall of gold and silver on Friday is not a convincing argument for several reasons.

China plays an import role for the demand of physical gold. If inflation were really a concern, then Chinese investors would be expected to buy more gold as a hedge against inflation. Selling the protection against inflation does not make sense in this case. And indeed, gold and silver did not come under stronger pressure during the Asian trading hours.

As it has been the case so often during the last couple of weeks when gold dropped, the plunge set in with the start of trading in the US. This was also the case last Friday that gold plummeted after the start of trading at the Comex. In the early US morning hours, also the stock market and US Treasury notes headed lower. US traders and investors having sold gold on the fear of rising cabbage prices in China would slow global economic growth did not act rationally. The PBoC follows the headline inflation but even central banks focusing on the headline CPI inflation usually take seasonal impacts into account. Therefore, as long as the PBoC does not expect that the seasonal distortion will have a lasting impact on the inflation rate, there is no reason to provide no further monetary stimulus.  Furthermore, even after the increase in December, the Chinese inflation rate is still well within the target zone.

Gold and silver trade more in line with risky assets and this was probably also the main reason that both metals came under pressure at the start of US trading. The wrong conclusion many investors and traders drew from the Chinese CPI figure was only one factor. The earnings season started in the US and on Friday, Wells Fargo reported its earnings for the final quarter in 2012. Despite a record gain beating earnings estimates, analysts found a fly in the ointment. The net interest rate margin declined. However, in an environment of falling yields and money market rates close to zero, this should not come as a surprise. Nevertheless, it was another reason for the negative start of the US stock market.

Another widespread misperception is that quantitative easing is a necessary condition for rising gold and silver prices. Flows into an asset could come from three different sources. The first is from reallocating funds from one asset into another one. Selling US Treasury notes and investing in gold is one possibility. However, it is not necessary that the buyer of the notes is the Fed. Only a few primary dealers have this access. Other investors would have to sell Treasury paper to primary dealers or other investors. Certainly, QE made it easier and provided many sellers with a better price compared with a situation without QE. Nevertheless, QE is not necessary for this process. The second source is by net savings, which is also not directly dependent on QE. The third source is from borrowing with current assets serving as collateral. Again the possible leverage does not depend directly on QE, but the purchases of central banks had a positive impact on asset prices.

The minutes of the latest FOMC meeting as well as comments from various council members during this week had a negative impact on the price of gold. Thus, the correlation between the price of gold and US Treasury notes has increased again lately. For an exit of the Fed from QE there are two possible reasons. The first is of course the economic development and the potential risk of future inflation getting out of control. The second is balance sheet considerations, which some members of the FOMC brought forward.

If the Fed will end QE for the first reason, it should not be negative for gold and silver but positive. In this case, the US economy will grow stronger and the output gap will narrow again. Risky as well as tangible assets will perform better. Also yields on US Treasury bonds and notes should increase and for some maturities should become positive again in real terms. However, also a slight positive real return for medium-term maturities should not be a reason to sell gold as along the Fed does not abandon the current Fed Funds target rate. The FOMC indicated that this would not be the case before mid-2015.

While operation twist was neutral for the balance sheet of the Fed, outright buying of mortgage backed bonds and US Treasuries will extend the balance sheet by $85bn every month. Despite the looming hit of the debt ceiling, the US Treasury is unlikely to default. As outlined last week, minting a super platinum coin could avoid this scenario. Thus, the Fed does not need to be worried about a default risk of the Treasury paper held. However, rising yields could pose a risk for the balance sheet in the case of marking-to-market valuation. Last Friday, Philly Fed president Charles Plosser pointed out the risk of rising bond yields on the exit from QE. Certainly, bond markets will anticipate an end of bond purchases by the Fed, which will lead to rising yields. And yields are also likely to increase after the Fed terminates QE as the shortfall of a total of $85bn of bond demand would have to be compensated. However, the US Treasury market misinterpreted the comments from Mr. Plosser, who is a long-time critic of QE. The risks of an exit do not imply that the FOMC will continue QE infinitely  But the US Treasury market rebounded after this comment, ignoring the inflation warnings of Mr. Plosser. This also supported gold and silver and prevented another weekly loss.

The current sentiment among large speculators is negative for gold, as the latest CFTC report on the commitment of traders underlines again. Thus, gold and silver are likely to be caught in a trading range, with the risk to downsides overweighing the chances for a breakout to the upside. But as we expect that the economic situation in the US will improve and that Asian economies will grow also stronger again, the outlook for the major fundamental drivers of gold remains positive. Thus, the current sideways market might offer good opportunities to buy gold and silver for a medium-term investment horizon.       

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.