Inflation and the Trillion Dollar Coin

Despite talk during the conventions about simple math, it is clear that those in Washington still fail to understand this whole economics thing.  This is seen by the continued attempts at reviving the economy through stimulus spending despite this strategy never working.  Further evidence was presented today when the proposal to mint the trillion-dollar platinum coin.

The trillion-dollar coin idea works as follows:  Apparently the mint has the ability to mint coins in whatever denomination they wish provided they are made of platinum and present it to the Federal Reserve.  (The Federal Reserve is a private business that has the ability to create or remove money from the economy by selling bonds to the banks or buying bonds from the banks.)  The Federal Reserve will then give $1 Trillion to the Treasury, thereby adding $1 Trillion in cash without raising the debt ceiling.

The trouble with this idea is that it will cause inflation with abandon since it is essentially printing money.  The issue is that additional money will be created without anything of value being created in exchange for the money.  Money only has value because people know that it can be exchanged for something they want at a future date.  If more money is created but additional goods and services are not created in exchange, the value of the money decreases since there will be the same amount of value in the economy but more money.

To understand this, imagine that there is a person who grows carrots and another who grows pigs.  The producer of carrots may trade some of his carrots for a ham or some pork chops.  Now the carrots would be ready in june, but the ham would not be ready until the fall, so the carrot producer might give the carrots to the pork producer in exchange for some  coupons, each worth a certain amount of pork when it is ready.  The producer of the carrots would accept the coupons because he feels it has value that he can redeem later.

Now imagine that coupons are produced and given to someone who produces nothing.  If the person who produces the pigs only has one pig, the producer of carrots runs the risk of not being able to get pork when the fall comes because the other person who got the coupon out of thin air may very well get there first.  He might require more coupons for his carrots and the pork producer might require more coupons be exchanged for each piece of meat.  Because the individuals could not eat the coupons in the winter, they would be willing to provide more coupons for less meat.  Because there is no longer an equal exchange of goods for goods represented by the coupons, they become less valuable.

The previous tactic of borrowing money and using that money to purchase things is not very effective, as can be seen by the virtual lack of any economic growth since the stimulus plan in 2009, despite an enormous amount of money being borrowed and spent (on the order of a trillion dollars).  At least in that case, however, that money was raised through borrowing with the commitment to provide something of value in the future in exchange for the money being generated.  This helped to prevent extreme levels of inflation since it is expected that more things will be produced in the future that the holders of the bonds can purchase even if there was not an increase in the number of goods available to cover the increase in money available right then.  The value of the bonds is also locked up in the bonds.

If money is now created without even a committment to provide something in the future, the result can only be inflation.   This, combined with a lack of incentive to work and provide things of value since there is little difference in income between those who are working and those who are not, may very well lead to a period of stagflation.  This is where prices rise but there is no economic growth.

Let’s hope that unless they plan to put a trillion dollar’s worth of platinum in that platinum coin this idea does not come to be implemented.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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