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U.S. Secretary of the Treasury Timothy Geithner, right, listens to Federal Reserve chairman Ben Bernanke, left, at the Treasury Department for the meeting of the Financial Stability Oversight Council in Washington, Nov. 13, 2012. (Gary Cameron/Reuters)
U.S. Secretary of the Treasury Timothy Geithner, right, listens to Federal Reserve chairman Ben Bernanke, left, at the Treasury Department for the meeting of the Financial Stability Oversight Council in Washington, Nov. 13, 2012. (Gary Cameron/Reuters)

U.S. has alternatives besides minting $1-trillion coin Add to ...

The U.S. Federal Reserve and the Treasury Department have rightly killed the $1-trillion coin proposal. Issuing the coin would be poorly understood by the public, could spook foreign investors and it would give the Treasury Department money creation powers that are best left to the Federal Reserve.

This proposal, however, was not rejected because the Fed would be unable to counteract the inflationary effects of the coin. There are at least two ways the Fed could reduce the money supply at the same rate it is increased by the platinum coin.

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The straightforward way is for the Treasury Department to take the $1-trillion from the platinum coin and use it to purchase U.S. government debt from the Fed at market prices and then retire that debt. The Fed’s balance sheet currently reaches nearly $3-trillion dollars, so such a sale is easily feasible. By transferring this debt from the Fed to the Treasury Department and then retiring it, the government’s debt is reduced by $1-trillion, thus avoiding the debt ceiling. The money supply is unchanged because there is no cash in the transaction; it is a simple swap of a platinum coin for bonds.

The complicated way is for the Federal Reserve to sell bonds to the market at the same rate as the government spends the newly created money. For the average month, the U.S. deficit is roughly $100-billion. When the debt ceiling is reached, the government would have to finance this through the cash from the platinum coin, not debt, so the U.S. would need an off-setting reduction in the money supply. To offset the added cash, the Fed would not have to sell $100-billion of their debt portfolio per month, though, as under QE3 they are currently purchasing $40-billion in mortgage-backed securities. The first step would be to simply cancel these purchases. Then, instead of being a net buyer of roughly $9-billion dollars of debt per week, the Fed would be net sellers of roughly $14-billion dollars of debt per week. Given the size of the U.S. economy and the demand for relatively safe assets, there is no reason to believe the Fed would have difficulty doing so.

There are many reasons why the Fed and Treasury Department made the right call in killing the coin. Fears of inflation was not one of them.

Follow on Twitter: @mikepmoffatt

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