Canada's Trillion Dollar Coin
End of the Gold Standard
In 1971, Richard Nixon refused to settle U.S. international debts by paying with its gold stock, or as euphemistically described, he "closed the gold window". Under the Bretton Woods agreement at the end of WWII, currencies around the world had been pegged to the U.S. dollar, and the U.S. dollar was pegged to gold. The U.S. had most of the gold because it had been a safe haven during the war and because it received payment for supplies delivered to allied countries. But as post-war U.S. military expenditures and overseas investments ramped up, the U.S. sent more and more dollars overseas that gradually transformed the country from a creditor to a debtor nation. When France had the temerity to request conversion of its U.S. dollar balances into gold, the loss of the gold stock could have led to American retrenchment. After all, when Great Britain found its gold stocks rapidly depleting prior to the Lend-Lease arrangement with the Americans, it was forced to sell all its overseas assets to raise the funds to pay its bills.
The U.S. took another route. Rather than selling assets to raise funds or cutting back on overseas military expenditures, it ended payment in gold, and practiced a policy of "benign neglect" of its negative trade balance. What to do with accumulating U.S. dollar balances abroad was now the problem of other countries. As parity to gold broke down, so did parities between currencies which now became free-floating and no longer convertible on demand to any other asset such as gold. The monetary system had undergone a quantum transformation and consequently so had the rules for how it operated.
And yet the majority of economists, business commentators and politicians carried on blithely as if nothing had changed, and as if many of the old rules still applied. Under the old rules, governments could run out of money because demands could be made for conversion to U.S. dollars and ultimately gold. But under the new system, countries with free-floating non-convertible fiat currencies such as Japan, Canada and the United States (but note: not households, provinces or Eurozone countries which now no longer have monetary sovereignty) could pay without limit any obligations denominated in their own monies. In September 1997, then US Federal Reserve Chairman Alan Greenspan made the following comments:
"...... monetary authorities—the central bank and the finance ministry—can issue unlimited claims denominated in their own currencies ,,,,,. This power has profound implications for both good and ill for our economies.........a government cannot become insolvent with respect to obligations in its own currency. A fiat money system, like the ones we have today, can produce such claims without limit."
Balanced Budgets - with Exceptions
Nonetheless, the conventional wisdom maintained that government was like a household and had to live within its means since it could only raise so much money and was carefully watched by the bond vigilantes. Hence good financial management meant curtailing deficits, carefully monitoring debt-to-GDP ratios and moving towards balanced budgets. The fiscal capacity of governments was considered either limited in fact, as it had been, or alternatively, it should be limited through voluntary or legal restraints as a matter of fiscal prudence.
Why would this view be maintained? As John Kenneth Galbraith has noted, economists are especially economical when it comes to ideas. They make them last a lifetime. It usually takes a new generation before a conceptual revolution is accepted. And for many, as Chairman Greenspan intimated above, limitless government spending could be dangerous if misused, so best to keep these powers from being widely and popularly known. Well-known Keynesian economist and text-book author Paul Samuelson stated:
"I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control."
It is usually only in extraordinary circumstances such as war or financial crisis that the true possibilities of the sovereign government purse are revealed. According to economist Michael Hudson:
When World War I broke out in August 1914, economists on both sides forecast that hostilities could not last more than about six months. Wars had grown so expensive that governments quickly would run out of money. It seemed that if Germany could not defeat France by springtime, the Allied and Central Powers would run out of savings and reach what today is called a fiscal cliff and be forced to negotiate a peace agreement.
But the Great War dragged on for four destructive years. European governments did what the United States had done after the Civil War broke out in 1861 when the Treasury printed greenbacks. They paid for more fighting simply by printing their own money. Their economies did not buckle and there was no major inflation.
Deficit spending also became necessary during WWII as military outlays far outpaced receipts from taxation. This led to increased debt-to-GDP ratios of over 120% in both Canada and the U.S. These expenditures resulted not only in increased arms output, but also increased civilian production and increased savings. The war was fought, broadly speaking, from an expanding economy, employing the plant and labour that had been idle during the Great Depression. In the post-war period, both countries did not sharply cut back expenditures, but on the contrary built infrastructure, welcomed immigrants and introduced many new social services. With booming economies and full employment, the debt-to-GDP ratio declined and during the period 1948 to 1967 there were only minor recessions with reasonably stable prices.
Extraordinary government money creation was also evident during the financial crisis in 2007 when trillions of dollars were used to support the banking system in the U.S. Ben Bernanke, Chairman of the US Federal Reserve was interviewed by Scott Pelley on the program 60 Minutes and asked where this money came from:
PELLEY Is that tax money that the Fed is spending?
BERNANKE It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.
Bernanke is describing the way that governments make payments in a modern monetary system. A commercial bank's Central Bank account is increased and a deposit appears in the account of the payee. (Or a cheque is issued which similarly ends up as an increase in the host bank's Central Bank reserve account once the cheque holder deposits it in his or her personal account.) All government spending by computer keystroke is performed in the same way irrespective of any accompanying monetary or fiscal operations. As Bernanke implies, there is no direct relationship with taxation or borrowing.
Debt-issuance as a consequence of net public spending (deficits) is entirely voluntary and need not rise $-for-$ with net spending. According to Australian economist Bill Mitchell:
The institutional arrangement is a political construct designed by neo-liberals post the collapse of the Bretton Woods convertible currency system (1971) to limit government activity.
U.S. Fiscal Cliff and Coin Seigniorage
In the U.S, the self-imposed link between debt issuance and government spending has led to the recent "fiscal cliff" troubles. Since the U.S. has a legislated limit to federal debt, and the debt is matched with spending, Republicans and Democrats are squabbling over what increases in taxes and/or cuts to services are required as a quid pro quo to reach agreement on lifting the debt ceiling while also restricting the growth of future debt.
But another method for solving the crisis - Platinum Coin Seigniorage - has been proposed that demonstrates the arbitrary institutional nature of the U. S. dilemma.
According to American blog commentator Joe Firestone:
Congress delegated the US Mint the authority to coin fiat money, the value of whose metal content, with respect to certain types of coins, need have no relation to its face value, which can be as high or low as the Mint wants to make it.
"..since high value coins are legal tender, the Mint, and the Treasury, can force the Federal Reserve to transform high value coins into reserves, by just depositing them into the US Mint’s Public Enterprise Fund (PEF) account, which the Fed must credit with reserves in return for the high value coins.
For example, if the Mint deposits a $One Trillion coin in the PEF, then the Fed must accept the coin and credit the PEF with an equivalent value of electronic credits in reserves. Then, the Treasury has the authority to “sweep” the PEF of all seigniorage, i.e. profits resulting from the Mint/Fed transaction.
The Treasury has thus been able to fill its spending account with money without issuing new debt. And it can use the proceeds to pay off all existing U.S. intergovernmental debt which would result in renewed spending space under the current debt ceiling. In fact, with a coin of sufficiently high denomination, enough reserves would be created in the government account to pay off to private or foreign investors all U.S. government debt obligations as they came due.
But according to Firestone, the major significance of this manoeuvre is not just the end-run around the debt limit, but the symbolic shattering of the notion of the Government Budget Constraint:
The big story about Platinum Coin Seigniorage is not the Trillion Dollar Coin and its possible implications for solving the debt ceiling crisis, as the mainstream has been telling us. Instead it is the great crack it creates in the wall of gold standard-based constraints still hanging over our politics and economics, and the increased fiscal and policy space this gives us to use to solve our various national problems. It is the authority the Executive Branch of Government now has to break through these constraints, and begin to unify the financial functions of government behind the public purpose.
In other words, government deficits could be used as a policy tool rather than a policy target. After the private sector has made its spending decisions, the federal government could spend at whatever level is necessary to ensure all human resources of the economy are productively employed. The size of the deficit, whether large or small, would be a floating residual, depending on what government injection (or withdrawal by tax) is necessary to assure the economy is running at full capacity, but not beyond. This approach is, of course, contrary to the conventional view which treats deficits with alarm, but accepts high levels of unemployment as a natural result. The purpose of taxation, in this modern money perspective, is not to raise revenue but as a tool to control aggregate demand so that the total of public and private expenditures do not exceed the productive capacity of the economy, and therefore do not cause inflation.
In Canada, even though we do not have a mandated debt ceiling, the Harper government is fixated on balancing the budget by the 2015 election and maintains that government must live within its means, even at the expense of old age pensioners whose first payment will be deferred two years, so that ostensibly government can keep its finances sustainable in the long term.
Seigniorage in Canada
While the blogosphere and even the mainstream U.S. media have been considering the merits of Platinum Coin Seigniorage of various denominations, there seems to be little discussion in Canada of how this unconventional monetary transaction might relate to our own situation.
Since we don't have a debt ceiling, we do not need a monetary manoeuvre to avoid it. But a discussion of coin seigniorage and the role of our Mint might be useful simply as an educational exercise to raise public awareness of alternatives to what our government claims is its exemplary record of good financial management through prudent spending at at time when 1.3 million Canadians are still unemployed, when the middle class is hollowing out, and when inequality continues to rise.
The Royal Canadian Mint Act tells us that the "objects of the Mint are to mint coins in anticipation of profit and to carry out other related activities." Also the Governor in Council may authorize the issue of non-circulation coins of a denomination listed by schedule, and that the Governor in Council may, by order, amend that schedule by adding or deleting a denomination. Currently the highest denomination listed is a one million dollar coin, but as indicated above that can be easily revised. The Act requires that all coins of the currency of Canada that are produced at or supplied by the Mint shall be delivered to the Minister of Finance or such person as the Minister of Finance may designate. To pursue the argument, let us assume that the government gives instructions for production of a one trillion dollar Canadian coin.
A Bank of Canada fact sheet explains how the Government can accrue seigniorage profits:
The Minister of Finance pays the Royal Canadian Mint to produce and distribute all Canadian circulation coins. It costs the Mint about 12 cents to produce and distribute a dollar coin. Consequently, this Crown corporation generates for the Government of Canada approximately 88 cents in seigniorage on each $1 coin sold to financial institutions at face value. Since coins have a very long life and the government does not redeem surplus coins, seigniorage is generated at the time of sale and accrued to the Government of Canada.
Would there be any difficulty for the Government of Canada to deposit its trillion dollar coin, produced at minimal cost, into its own account with the Bank of Canada, and hence increase its spending reserves through seigniorage profit?
It might seem strange for the Government to record a profit through transactions with an entity is owns as sole shareholder, but the Bank of Canada has this to say about seigniorage on bank notes:
In compensation for the issuing of bank notes recorded as a liability, the Bank of Canada acquires interest-bearing federal government securities (treasury bills and bonds).......In recent years, just over $35 billion in notes has been in circulation. The interest revenue of the Bank of Canada has fluctuated between $1.7 and $2.2 billion per year. A small portion of this—$130 million, on average—has been used to finance the Bank's general operating expenses. The remainder has been paid to the Receiver General. Seigniorage revenue thus allows the federal government to finance a portion of its expenditures without having to collect taxes.
The last sentence bears repeating: Seigniorage revenue thus allows the federal government to finance a portion of its expenditures without having to collect taxes. This revenue is created by interest paid by the federal government to its own wholly-owned subsidiary which then refunds the profit to the government shareholder. And according to the authority of no less than the Bank of Canada, this internal bookkeeping operation allows the government to spend without having to collect taxes!
If that is the case, then what are the limits of seigniorage profit, and why does the mainstream always consider taxes necessary to fund the government? Would there be any difficulty for the Government of Canada to deposit its trillion dollar coin ordered from its own Mint into its own account with the Bank of Canada, and hence to magnify its spending reserves merely through seigniorage profit?
According to the Currency Act, "a coin is current for the amount of its denomination in the currency of Canada if it was issued under the authority of the Royal Canadian Mint Act..."
It also states that a tender of payment of money is a legal tender if it is made in coins that are current, and in the case of coins of a denomination greater than ten dollars, a payment may consist of not more than one coin, "and the payment is a legal tender for no more than the value of a single coin of that denomination."
So if the coin is "current" and even appears to meet the criteria to be "legal tender" according to the Currency Act, and has been created under the aegis of the Government of Canada by the Royal Mint, could there be any grounds for the Bank of Canada to refuse to accept the deposit for the government's account?
While the Bank of Canada Governor is appointed for a seven year fixed term and has considerable independence, if a profound disagreement on the conduct of monetary policy were to occur, the Bank of Canada Act permits the Minister of Finance, with the Cabinet's authorization, to issue a written directive to the Governor specifying a change in policy, and the Bank must then comply with that directive.
Deficit Spending for Managing the Real Economy
So it would seem that nothing would prevent the Government of Canada from making the deposit and now having one trillion dollars of bank reserves in its account, with which it could wipe out its accumulated national debt as bonds came due, and still leave several hundred million to its credit at the Bank of Canada. The government did not need to sell any bonds nor resort to taxation to fund itself in order to commence wiping out the national debt. And whatever the debt, it still has not one cent more nor less in spending power than it did before because its spending power was never previously limited except by self-imposed constraints.
Another clue that bonds do not finance government expenditures occurs when the federal government has a budget surplus rather than a deficit. Bonds are still issued, but not because they are needed to finance government. The Bank of Canada uses bond purchases and sales to control the amount of bank reserves in the system and therefore to influence interest rates. Government bonds are also helpful for the financial sector as as a way to price risk and also as a risk-free investment compared with actual business loans which can always go bust. And the arrangement conveniently provides a mechanism for the government to subsidize the financial system in a way not easily noticed by the public.
But whether federal bonds are issued or not, and regardless of accumulated debt, the fiscal capacity of the government does not change since it can never run out of fiat money. What is of primary importance is the effect of any increased government spending on the real economy. Too little expenditure and there may be insufficient demand accompanied by high unemployment. Too much expenditure, and if demand exceeds productive capacity, then inflation can result. The limitless purse does not eliminate the necessity for government expenditures to be wise, and to be made in amounts that appropriately complement spending decisions of the private sector.
A new school of economics known as Modern Monetary Theory, which studies central bank operations in economies operating with free floating non-convertible fiat currencies, sums up the difference between the federal government, which is a currency issuer, and entities such as households, which are currency users:
A household, the user of the currency, must finance its spending, ex ante, whereas government, the issuer of the currency, necessarily must spend first (credit private bank accounts) before it can subsequently debit private accounts, should it so desire. The government is the source of the funds the private sector requires to pay its taxes and to net save (including the need to maintain transaction balances), making government solvency in its currency of issue a given and a non issue. A sovereign government can always afford to purchase anything that is available for sale in the currency it issues and pay any entitlement/liability that is denominated in the same currency.
In this age when austerity is touted as the only way forward, it is important for the public to understand that claims our government cannot afford measures to protect the health and welfare of the population are based on ideology rather than necessity. The current budgetary framework entrenches the power and the privileges of existing elites who will still do well when government services are reduced, when tax rates are low, and when inflation is kept in abeyance by a depressed economy with a significant level of unemployment. When the Harper Conservatives promises prudent financial management, that is the scenario they are offering.
Alternative to Austerity
But an alternative exists. The federal budget could be treated like the control on a thermostat. If there are rising prices and the economy is too hot, turn down government spending. And if is too cold, then crank it up with infrastructure and direct job creation programs so that people can get off unemployment insurance or welfare and find satisfaction in contributing to society.
Canadians should not accept cutbacks to food inspection, water quality and marine safety. Our society has many people looking for work. And there are many jobs needed that could help young people learn, provide services to seniors and save the environment. Municipalities are demanding more resources to fix our crumbling infrastructure. If it is to serve the broad public purpose, the federal government cannot abdicate its responsibility to act decisively with counter-cyclical policies that keep the economy functioning at full employment. As John Maynard Keynes put it many years ago:
The Conservative belief that there is some law of nature which prevents men from being employed, that it is “rash” to employ men, and that it is financially ‘sound’ to maintain a tenth of the population in idleness for an indefinite period, is crazily improbable – the sort of thing which no man could believe who had not had his head fuddled with nonsense for years and years.
And to those fiscal Mother Hubbards running our country who still maintain that government coffers are bare, or that debt is unsustainably high, Canadians can point out that the till can easily be replenished. Just deposit the trillion dollar coin created by the Royal Mint into the government account, and this time let the majority of Canadians, rather than the favoured financial few, enjoy the immense profits that come from arrangements supposedly needed to "fund" the federal government.
Larry Kazdan CGA is is a graduate of York University in sociology and history, and retired from public accounting practice.