"Full Faith & Credit" when the inmates take over the asylum

[Kevin K.]

At the moment it looks like 2011 all over again, with our elected "leaders' flirting with default on U.S. Treasury obligations. Predictions I've read are for a major spike in interest rates along with a major, albeit perhaps temporary, stock market correction. I've read Browne pretty carefully but I don't recall any "Plan C" escape from having half the portfolio's assets in Treasuries when the inmates in Congress take over the asylum and threaten to make the full faith and credit of the U.S. government as much a threat as a promise.

Why put up with the low interest rates on fully 50% of the PP's assets if the "flight to safety" angle is no longer meaningful? Between Quantitative Easing aka printing money during normal levels of insanity and threats of default every time it comes time to pay for monies already spent it makes me think that ~5 year corporates, GNMA's and the like, perhaps all U.S. or with an unhedged foreign allocation, might be more in keeping with curent (un)realities. Thoughts?

[Kshartle]

Anything can happen in the short run. What volatility are you willing to handle in the long run and what risk in the short run?

The treasuries now? The look horrific. The government looks like a bad bet that is getting a great high price now.

I'm staying away.

[Gumby]

At the moment it looks like 2011 all over again

Cool. The PP did fine the last time we had a real debt ceiling crisis. Looking forward to a repeat of 2011!

[MediumTex]

At the moment it looks like 2011 all over again, with our elected "leaders' flirting with default on U.S. Treasury obligations. Predictions I've read are for a major spike in interest rates along with a major, albeit perhaps temporary, stock market correction. I've read Browne prety carefully but I don't recall any "Plan C" escape from having half the portfolio's assets in Treasuries when the inmates in Congress take over the asylum and threaten to make the full faith and credit of the U.S. government as much a threat as a promise.

Why put up with the low interest rates on fully 50% of the PP's assets if the "flight to safety" angle is no longer meaninful? Between Quantitative Easing aka printing money during normal levels of insanity and threats of default every time it comes time to pay for monies already spent it makes me think that ~5 year corporates, GNMA's and the like, perhaps all U.S. or with an unhedged foreign allocation, might be more in keeping with curent (un)realities. Thoughts?

You do remember what happened to interest rates in 2011 as U.S. default dominated the news, right?

Take a look at what happened to TLT in the middle of 2011 as U.S. default began to look like it was a possibility:



Far from a spike in interest rates, interest rates collapsed.

Why would it be different this time?

The inmates running the asylum has always been a core assumption on which the PP was based, otherwise it wouldn't have 25% of its assets in gold.

[Kevin K.]

Thanks for the wise perspective Gumby and Medium Tex.

Your dry humor about the situation, MT, reminded me of one of your many previous classic comments about Treasuries vs. other bond options: "they're still the best horse at the glue factory." I need to do a better job of keeping that in mind!

[Gumby]

Thanks for the wise perspective Gumby and Medium Tex.

Your dry humor about the situation, MT, reminded me of one of your many previous classic comments about Treasuries vs. other bond options: "they're still the best horse at the glue factory." I need to do a better job of keeping that in mind!

Not only that, but Treasuries are the only horse at the glue factory for those who are holding dollars. You can't purchase Japanese Government Bonds with Dollars (you have to trade your Dollars for Yen first). You can't buy German Bunds with Dollars (you have to trade your Dollars them for Euros first). If you try to rid yourself of Dollars by buying assets (such as Gold) someone else just gets your dollars. In ALL of those situations, the private sector is solely limited to Treasuries when it comes to holding dollar-denominated government securities. There is no other choice. And since many entities are required to hold dollar-denominated assets, Treasuries are a no-brainer for taking dollar reserves out of the private banking system for a return.

[notsheigetz]

I had zero experience buying U.S. government debt before starting the PP a few years ago and had no clue about how LT's actually respond to various economic conditions. Since then I've observed not only the effect of a government shutdown as MT has described but also the S&P downgrade in 2011, in which people were dumping stocks and buying LT's. That really blew my mind.

So the bottom line is I still have no clue about how LT's respond to economic conditions but I think trying to figure it out might be a pointless exercise.

[moda0306]

Well treasuries seem to operate under the assumption that they're nominally risk-free. This essentially makes them feel like interest-bearing cash. However, the if the government has a short-circuit that will make this not happen, the most important thing is understanding what will happen to the dollar and to gold, as well as interest rates on the bonds they don't default on.

Part of me thinks depression-inducing financial crisis. Part of me thinks dollar collapse.  Maybe hyperinflationary depression?  I really don't know.

It's hard to predict an economic reaction when you can't even understand the fundamentals of the asset you're holding.

I think the off-chance that our government is dumb enough to actually default on debt leaves me wanting to hold plenty of mattress cash.  Our banking system would fall apart, as treasuries are so intertwined with it, so the idea of collecting .2% interest to take on all that risk seems excessive.

But really, MR is only as descriptive as our government is willing to stick with the same way of doing things.

My concern is more that if the dollar doesn't somehow collapse, but is instead strengthened by a global financial crisis, where does that leave gold?

If our treasury interest rates go up, depression ensues, where does that leave gold's pricing trigger of "negative real interest rates."  It seems to me part of what makes golf perfect in the PP is that having the world's reserve fiat currency so prevalent makes gold perform as a sort of leveraged arbiter on the "fairness" of the bonds we're holding.  It wouldn't work similarly if there was no "(nominal) risk free rate of return," or more specifically, without the perception of the lack of that nominal risk.

This whole debt ceiling thing really doesn't seem to help anyone.  It just adds a ton of uncertainty as to whether the banking system will completely unravel. It's so silly. Issue the damn platinum coin and be done with it.  Ironically, it could theoretically prevent a hyperinflation (assuming that's one possible result if such an up-ending of the US banking system).

[Libertarian666]

Well treasuries seem to operate under the assumption that they're nominally risk-free. This essentially makes them feel like interest-bearing cash. However, the if the government has a short-circuit that will make this not happen, the most important thing is understanding what will happen to the dollar and to gold, as well as interest rates on the bonds they don't default on.

Part of me thinks depression-inducing financial crisis. Part of me thinks dollar collapse.  Maybe hyperinflationary depression?  I really don't know.

It's hard to predict an economic reaction when you can't even understand the fundamentals of the asset you're holding.

I think the off-chance that our government is dumb enough to actually default on debt leaves me wanting to hold plenty of mattress cash.  Our banking system would fall apart, as treasuries are so intertwined with it, so the idea of collecting .2% interest to take on all that risk seems excessive.

But really, MR is only as descriptive as our government is willing to stick with the same way of doing things.

My concern is more that if the dollar doesn't somehow collapse, but is instead strengthened by a global financial crisis, where does that leave gold?

If our treasury interest rates go up, depression ensues, where does that leave gold's pricing trigger of "negative real interest rates."  It seems to me part of what makes golf perfect in the PP is that having the world's reserve fiat currency so prevalent makes gold perform as a sort of leveraged arbiter on the "fairness" of the bonds we're holding.  It wouldn't work similarly if there was no "(nominal) risk free rate of return," or more specifically, without the perception of the lack of that nominal risk.

This whole debt ceiling thing really doesn't seem to help anyone.  It just adds a ton of uncertainty as to whether the banking system will completely unravel. It's so silly. Issue the damn platinum coin and be done with it.  Ironically, it could theoretically prevent a hyperinflation (assuming that's one possible result if such an up-ending of the US banking system).

Is this part of "MR"?

[moda0306]

Well the government's ability and likelihood of various actions, including default or how to legally avoid it during a debt ceiling hold up, is part of MR. The trillion dollar coin was a legal option they observed was an easy option to get around the debt ceiling issue, and their analysis, based on the machinations of our financial system, is that it wouldn't likely be inflationary, which I agree with.

The opinion of whether these should be used is not really part of MR.  MR is mostly a tool I've used to make me more comfortable using the PP investing strategy, which works markedly better when gold is operating not as a commonly-used medium of exchange, but as a store of value in the midst of a fiat currency arrangement and default-risk-free government debt.

Part of me wants a solution on this mostly because it's hard to analyze the macroeconomic strength of a portfolio if there is uncertainties as to how the fundamentals of the assets within it are designed to work, and what changing those fundamentals will do to the payments system.

[Kshartle]

What is the platimun coin supposed to do again? - Sincere honest question

Is it supposed to take care of the problem of unemployment, millions of people relying on transfer payments in their old-age, health care, the military empire, government pensions, student loan debts that will default etc. - Rehtorical joke question

[moda0306]

Technically, the government doesn't have to go into debt to issue coins... The treasury is actually granted the right to mint them with no mandate in how they are used.  If the treasury minted a trillion dollar coin and deposited it at their account at the fed, this would give them $1 trillion in their bank account that they can now spend without increasing our national debt above the debt ceiling. 

For the purposes of this thread, let's just assume that it would allow the treasury to get around the debt ceiling issue without having to cut spending that's already been approved by congress.

Everything beyond that, and we're probably rehashing arguments we've had 30 times.

[Kshartle]

If the treasury minted a trillion dollar coin and deposited it at their account at the fed, this would give them $1 trillion in their bank account that they can now spend without increasing our national debt above the debt ceiling. 

So it's just a gimmick that legally allows the government to "print" one trillion dollars in new base money that is sent out to people who will use it to buy stuff from businesses that then deposit it in the bank whereby the banks now have additional reserves they can loan out which then go out and are used by people to purchase new goods and services which then deposit it in the bank thereby allowing new reserves and new loans etc. etc.

How is that not just inflationary money printing? How does this not affect the general price level? You can make the argument that some other force will offset the new money and prevent prices from rising significantly but it obviously makes the money supply larger than it otherwise would be.

If you think it doesn't, then why do you think the government goes through the trouble of taxing (which is horribly destructive to productivity since the more you produce the more you are taxed) or the trouble of borrowing (which sucks up available credit away from valuable market driven endevours and towards government redistribution schemes? If they can just make a coin to give them 1 trillion to spend without ill effects they why not just make 3.8 of them every year?

Any theories on that last question? Any ill effects of minting the coin and spending the dollars?

If this is hijacking the thread then please ignore. If this is too contentious then please ignore. I am curious though if anyone thinks the platinum coin option is helpful and not harmful then why don't they do it?

[Libertarian666]

If the treasury minted a trillion dollar coin and deposited it at their account at the fed, this would give them $1 trillion in their bank account that they can now spend without increasing our national debt above the debt ceiling. 

So it's just a gimmick that legally allows the government to "print" one trillion dollars in new base money that is sent out to people who will use it to buy stuff from businesses that then deposit it in the bank whereby the banks now have additional reserves they can loan out which then go out and are used by people to purchase new goods and services which then deposit it in the bank thereby allowing new reserves and new loans etc. etc.

How is that not just inflationary money printing? How does this not affect the general price level? You can make the argument that some other force will offset the new money and prevent prices from rising significantly but it obviously makes the money supply larger than it otherwise would be.

If you think it doesn't, then why do you think the government goes through the trouble of taxing (which is horribly destructive to productivity since the more you produce the more you are taxed) or the trouble of borrowing (which sucks up available credit away from valuable market driven endevours and towards government redistribution schemes? If they can just make a coin to give them 1 trillion to spend without ill effects they why not just make 3.8 of them every year?

Any theories on that last question? Any ill effects of minting the coin and spending the dollars?

If this is hijacking the thread then please ignore. If this is too contentious then please ignore. I am curious though if anyone thinks the platinum coin option is helpful and not harmful then why don't they do it?

I think that would be a great improvement over the current system.

[Kshartle]

I think that would be a great improvement over the current system.

It would permit huge sections of the government to be eliminated such as the IRS. It would remove the penalty of production that people have by earning more. Both of these would be beneficial.

But as you know, the government would just go berserk and eventually confiscate all property by creating money and buying it. Judging by the current crop and their moral depravity this would only take a few years.

I just want to point out the insanity of saying we need an organization that does not respect property rights in order to secure property rights.

[Libertarian666]

I think that would be a great improvement over the current system.

It would permit huge sections of the government to be eliminated such as the IRS. It would remove the penalty of production that people have by earning more. Both of these would be beneficial.

But as you know, the government would just go berserk and eventually confiscate all property by creating money and buying it. Judging by the current crop and their moral depravity this would only take a few years.

I just want to point out the insanity of saying we need an organization that does not respect property rights in order to secure property rights.

Agreed. It would still be a lot better than the current system, especially if they sent me one of the coins. I'd just have to be careful not to take it on my rowboat. 

[MediumTex]

Thanks for the wise perspective Gumby and Medium Tex.

Your dry humor about the situation, MT, reminded me of one of your many previous classic comments about Treasuries vs. other bond options: "they're still the best horse at the glue factory." I need to do a better job of keeping that in mind!

The treasury bond market is probably the most misunderstood PP asset.

The financial press either really doesn't understand the treasury market or they are just very cynical in publishing these Chicken Little stories about default, spiking interest rates, etc.

I'm not passing judgment on anything the government is doing, I'm just trying to understand the cause and effect relationships as they currently exist.

[Gumby]

Technically, the government doesn't have to go into debt to issue coins... The treasury is actually granted the right to mint them with no mandate in how they are used.

It's not that the government "doesn't have to go into debt." It doesn't go into debt. They make a profit! Every quarter in your pocket is an example of debt-free money. The government actually sells these pieces of metal to banks and technically makes a profit every time a quarter enters circulation. That profit (less the cost of the metal in the coin) is written as "income" for the Treasury — although, technically, a fiat government is never rich or poor since it is never reserve constrained. This is one reason why the government justifies selling commemorative coins — since they sell at a premium.

Coins have always been debt free money.

The only difference here is that the Treasury Secretary has the authority to create a platinum coin of any face value he wishes (currently not true of other metals in the legal code). So, issuing a $1 Trillion platinum coin is sort of like the Treasury minting trillions and trillions of quarters. A single platinum coin just takes a little less work

So it's just a gimmick that legally allows the government to "print" one trillion dollars in new base money that is sent out to people who will use it to buy stuff

Good question, but no. That's not what it's for — though I could see why you'd want to jump all of that. First of all, the Treasury never spends on anything unless a program has been voted on by Congress — Schoolhouse Rock, style. There is no $1 Trillion party that takes place when a $1 Trillion coin is issued. Nothing changes other than the Treasury doesn't need to go through a rigged bond auction to fulfill its Constitutional mandate of paying bills.

So, during a debt ceiling standoff, here's what would happen:

The Treasury secretary could order the production of a high-denomination platinum coin and deposit it at the Federal Reserve, where it would count as a government asset and give the country more breathing room under its debt ceiling. Once Congress raised the debt ceiling, the Treasury secretary could then order the coin destroyed.

Source: http://www.nytimes.com/2013/01/13/us/po ... iling.html

In other words, it wouldn't be inflationary unless Congress decided to spend more than usual. But, increasing spending seems highly unlikely since Congress is so gridlocked on everything these days.

Basically it's just an accounting gimmick that gives the Treasury the authority to skirt around the self-imposed debt ceiling. It just temporarily stops the debt ceiling clock. That's all.

[Kshartle]

In other words, it wouldn't be inflationary unless Congress decided to spend more than usual. But, increasing spending seems highly unlikely since Congress is so gridlocked on everything these days.

Basically it's just an accounting gimmick that gives the Treasury the authority to skirt around the self-imposed debt ceiling. That's all.

It allows the government to spend one trillion dollars it did not take in by borrowing or offset with the collection of 1 trillion dollars in taxes correct?

Do you think the government would credit itself 1 trillion dollars and not spend it? If they spend it, don't you think that will reduce the amount they take in by borrowing and/or just increase their spending? I would think it would do one of the two or a combination. I don't believe the government can have one trillion in it's piggy bank for long without spending it. In theory it can but what are the chances? Are they higher than one in a trillion? 

[Gumby]

It allows the government to spend one trillion dollars it did not take in by borrowing or offset with the collection of 1 trillion dollars in taxes correct?

It only "allows" the Congress to send out checks on "approved" spending that has already been decided on. There is no extra spending being done here if the coin is later destroyed.

Do you think the government would credit itself 1 trillion dollars and not spend it?

Congress can only spend if Congress votes to spend. Congress is highly gridlocked and can barely pass a bill on the pledge of allegiance.

If they spend it, don't you think that will reduce the amount they take in by borrowing and/or just increase their spending? I would think it would do one of the two or a combination. I don't believe the government can have one trillion in it's piggy bank for long without spending it. In theory it can but what are the chances? Are they higher than one in a trillion?

We are talking about Congress paying bills that were already passed in earlier budgets. You are talking about future spending — which is anyone's guess. If the intention of the coin is to destroy it once the debt ceiling is passed, then it is a non issue. If the coin were to stay on the government's balance sheet permanently — then it certainly might have inflationary results if Congress were enticed by it. But, it's a little silly to think that way when Congress is never constrained (since it is FIAT).

We are a fiat nation. Congress doesn't have any spending restraints — just inflationary constraints.

[Kshartle]

We are a fiat nation. Congress doesn't have any spending restraints — just inflationary constraints.

The money spent will be money that was not in existance prior. The spending will not be offset by taxes, or come from dollars that were already in existance and aquired through borrowing.

The point is spending does not have to increase for it to be inflationary.

Do you believe if the government stopped borrowing and taxing and instead funded the entire budget with trillion dollar coins this would not cause the money supply to increase, regardless of whether or not they spent more than would have otherwise?

Why would they destroy the coin? How does, destroying the coin call back the trillion dollars spent? Will they only destroy it if they can borrow one trillion or tax one trillion to offset the "loss" in their accounts?

[moda0306]

Kshartle,

For the most part, the market sets inflation expectations based on the idea that taxes and spending will continue as they are approved by congress, not as limited by the debt ceiling.

Congress doesn't set spending/taxation policy based on the amount of dollars in their treasury account, so it really doesn't give them any flexibility than simply not having a debt ceiling would.

And you might want to revisit the idea that banks lend reserves.  The reserve ratio is set by the fed to be whatever it needs to be to allow credit-worthy borrowers to borrow within the keepings of their mandate.  Reserves essentially are made whatever they need to be to strike a "healthy" balance of growth and inflation (or lack thereof).  In the current environment there is such low demand for loanable funds even at super low rates that whether the bank holds a dollar or a t-bill is mostly irrelevant to the bank, and as soon as it would become relevant, the fed makes sure that as long as inflation isn't heating up, the banks get the reserves they need to make the loans they want to make.

This is another reason why we really, really need to rethink what "money" is in terms of balance-sheet economics.  The government essentially uses t-bills and interest on reserves as a lending management tool, so they can keep the economy from heating up too much.  Now of course they  could always stop doing this, and we should very well be aware of that, but that is a policy decision that would involve adding a lot of new uncertainty to the banking system, which the fed tends to hate, for better or worse.  Keep in mind, though, that this uncertainty could also be disasterous for the very "savers" that we think of as being potential victims of fed policies.  A breakdown of our payments/banking system's trust in T-bills is hardly good for the little old lady trying to glean a safe, fixed income out of her savings.

[Gumby]

The money spent will be money that was not in existance prior.

If you hadn't noticed. This happens every single day. So, you are simply complaining about the inflationary effects of every day government spending.

The spending will not be offset by taxes

It rarely is — that's why we have "National Debt" of $16 trillion.

or come from dollars that were already in existance and aquired through borrowing.

Even when the government borrows, the private sector retains the bond as an asset (50% of our PPs, mind you). So, now you are complaining about the composition of Private Sector savings — and you have never proven that changing the composition of private sector assets from bonds to cash results in inflation.

The point is spending does not have to increase for it to be inflationary.

Prove it.

Do you believe if the government stopped borrowning and taxing and instead funded the entire budget with trillion dollar coins this would not cause the money supply to increase, regardless of whether or not they spent more than would have otherwise?

That's not what we are talking about here. You are in fantasy land now.

Why would they destroy the coin?

Because the private sector wants Treasury Bonds — not cash. Banks can't really get a return on their cash reserves — they prefer bond issuance instead. And the Fed wants to maintain a certain balance of bonds and cash in the private sector.

How does, destroying the coin call back the trillion dollars spent?

The Treasury would simply resume issuing bonds once the silly debt ceiling is raised and the coin could be destroyed the moment they issued enough bonds to bring its account into balance from the few billions of dollars that were spent in the interim.

Will they only destroy it if they can borrow one trillion or tax one trillion to offset the "loss" in their accounts?

If the Treasury deposited the coin at the Fed on a Wednesday, and Congress decided to pass the debt ceiling a week later, they would probably just need to have an extra $1 billion or $2 billion auction to make up for the lost auctions that didn't take place. Most of the $1 trillion coin would have never been spent. You are thinking in extremes for no reason.

[Gumby]

KShartle,

Alternatively, the government doesn't need to destroy the coin. Since the Fed owns a few Trillion in US debt, the coin could simply be used to cancel existing debt held by the Fed. The Fed would simply remove existing debt from its balance sheet (i.e. ceremonially giving the "debt" back to the Treasury) and the Fed can absorb the coin into its vault as an asset. The private sector would have no more money other than the spending that is already approved.

So, there are many ways to use the $1 trillion coin and not cause massive inflation. It really is just an accounting gimmick. And honestly, we are talking about FIAT money here. The whole monetary system is an accounting gimmick, if you hadn't noticed!

[Kshartle]

So, there are many ways to use the $1 trillion coin and not cause massive inflation. It really is just an accounting gimmick. And honestly, we are talking about FIAT money here. The whole monetary system is an accounting gimmick, if you hadn't noticed!

You've inserted the word massive not me.

If the government prints money to fund it's purchases rather than tax or borrow does this expand the money supply yes or no? Let's keep it simple and not change the subject.

Moda said "it wouldn't likely be inflationary" which I think means he doesn't believe prices would be affected as a result. Price movements depend on a lot of other factors so let's set them aside for a moment.

Does the government printing money, or minting a trillion dollar coin or whatever to legally permit it to spend without taxing or borrowing increase the money supply? Yes or no there is no maybe here. You can't control the other factors, this is the only variable in question.