You are here: Markets » The Trillion Dollar Coin would be bullish for Treasurys
I just wanted to follow up on Randy Wray’s last post to look at this Trillion Dollar Coin idea from an investing perspective. I believe the coin would be bullish for Treasuries because it lowers average Treasury duration and alters private portfolio preferences in a manner similar to quantitative easing. Otherwise, it has no real economy effects.
We discussed similar mechanics in 2010 regarding QE2 when Randy wrote his post about QE2 being the equivalent of issuing Treasury Bills. In that case, the Federal Reserve was buying longer duration US government bonds, making them relatively more scarce for bond market investors. The result was that average duration for all Treasurys outstanding was shortened. Moreover, to the degree investors had a duration preference as pension funds do in order to match liability duration, the shortening of duration should therefore be Treasury bullish, ceteris paribus. In practice, however, what we saw is that increased inflation and policy interest rate expectations worked at cross purposes with the QE and so interest rates were not lower post-QE than pre-QE.
In the present situation, we are faced with a situation in which the US could default on its bonds voluntarily because Congress failed to raise the debt ceiling. This has been a long time coming. I wrote as early as November 2010 that the debt ceiling default issue would be a negotiating tactic we should expect Republicans in Congress to use. Voluntary default is a political risk that the United States has, much as Ecuador and Russia had when each nation defaulted voluntarily on bond principal and interest payments that they had the funds to make. In fact, I started calling US debt voluntary default the “Ecuador Risk Factor” in 2011. From a ratings perspective, this willingness to default voluntarily is a very serious risk for any sovereign debtor. I believe that it warrants additional downgrades to the US credit rating as I said when this issue was first raised. The risk should also slightly increase longer duration yields due to higher default risk premia.
Now, here’s the trade for investors.
If the US Congress were to authorise raising the debt ceiling, the US Treasury would match the deficit that resulted from expenditures which the US Congress has already appropriated by issuing Treasury securities as mandated by law. However, if Congress were to refuse to raise the debt ceiling, the US government would face voluntary default as it would not be legally permitted to issue more Treasury securities. Faced with default, the US government could mint platinum coins and deposit them at the Federal Reserve in lieu of issuing Treasury securities via a loophole in existing law (see here for a full explanation).
If the US government were to issue platinum coins in lieu of Treasury securities, this would effectively be an asset swap. Conceptually it is similar to what QE2 did, swapping long duration Treasurys for Treasury bills. Here with the coin, for US government liabilities we would be swapping interest-bearing Treasurys that would be issued if the debt ceiling were raised with non-interest bearing platinum coins if the debt ceiling were not raised. Therefore, the trillion dollar platinum coin idea means a net increase of coin seigniorage, draining income from the private sector that would accrue via bond interest payments.
As with QE2, there are no real economy effects here. This is an asset swap. The same logic applies here that we saw with QE2. Average duration for all Treasurys outstanding will shorten. Shifts in private portfolio preferences would be Treasury bullish and bullish for risk assets to where investing funds are diverted (stocks, corporate bonds, precious metals). In practice, we could get increased inflation expectations here. So despite the bullish impact of the shortened duration, it is not clear if the Platinum Coin would be bullish for Treasurys. Moreover, it is likely that the Platinum Coin would harden battle lines and further the austerity that was begun during the fiscal cliff debate. And this would make spending cuts and/or additional tax increases likely. That’s bearish for the economy and bullish for bonds.
Overall then, I would expect the Platinum Coin idea to lead to shorter Treasury duration, political gridlock, austerity and then recession. This is Treasury bullish, but bearish for risk assets. I will follow up this post with more ideas for Credit Writedowns Pro members as the debt ceiling crisis progresses.
About Edward Harrison
Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.
Like us on Facebook
Follow Edward on Twitter
- AIIB Prelude to SDR Decision
- Repeat after me: sectoral balances must sum to zero
- Greek default
- Front-running the Fed on interest rate hikes
- Currency wars, the Swiss franc, policy divergence and Fed rate hikes
- Wolfgang Schaeuble the Salesman
- Five Investing Themes That Need Further Examination
- Why Understanding Money Matters in Greece
- Albert Edwards on China
- When do we decide that Europe must restructure much of its debt?
- How to look at the Greece bailout deal
- Negotiating strategies and political constraints regarding Greece
- A decision-tree framework for thinking about the Greek – Troika negotiations
- Tax Anticipation Notes: A Timely Alternative Financing Instrument for Greece
- Syriza and the French indemnity of 1871-73
- Gauging the financial crisis end game
- Why quantitative easing and negative interest rates will fail
- Pie in the Sky
- Yanis Varoufakis on fiscal waterboarding and Ponzi austerity
- The convergence of safe asset yields toward zero
- Daniel Alpert on the Euro and QE
-  Raoul Pal: The Fed against the world means serious market and economic volatility
- Evan Engstrom on net neutrality
- Mark Weisbrot on Europe
-  The strong dollar and the very bad Austrian bank
-  Celente: “Greece should have never been in the euro”
-  Boom Bust, Fed Edition (Part II)
- Andrea Terzi on inflation and QE
- Steve Hanke on China and Greece
-  Europe joins Chinese bank as Greek woes continue