The popular solution to the debt ceiling crisis from the left wing of the blogosphere is to have the Treasury Department issue a couple of $1 trillion platinum coins. Most people in the middle and right of center dismiss this as some sort of wacko, unconstitutional extreme action and there is shock that the White House has not dismissed it out of hand.
Even the lefties seem to thinks it's wrong on a fundamental basis with comments like, "Do we really want leaders who are willing to take advantage of any loophole to do things that are contrary to the intent of a law just because it suits their purposes?"
All of these are over simplifications of the actual issue: Constitutional constraints make it likely that the White House will have to use the coining money solution for an actual debt ceiling crisis.
Market Reaction
The existence and legality of the coin solution means that the market will behave significantly different than it did to both the 2011 debt ceiling and recent Fiscal Cliff crises.
The additional fact that the coin solution would effectively increase quantitative easing (QE) by around $75 billion per month will probably get Republican leaders to quickly do anything they can to prevent it.
Let's go through the logic, the Constitution, and the law below.
The White House:
- ...Doesn't have the ability to issue new debt above the debt ceiling - this is reserved for Congress in Article I, Section 8 of the Constitution. The debt ceiling is actually a preauthorization on debt to fund the government which was started in 1917so Congress would not have to approve each individual debt issuance. Yes-it was designed to make governing easier.
- ...Is not going to say: "Okay, we've hit the debt ceiling so we're going to close down the government." This would be economic suicide.
- ...Can't say the above because of the 14th amendment: "The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned." Not paying the interest on previously issued debt would invalidate existing debt so it just can't be done.
- ...Has been authorized by Congress to issue coins, specifically unrestricted amounts of platinum coins, "in amounts the Secretary (of the Treasury) decides are necessary to meet the needs of the United States".
- ...Will therefore simply order the Secretary of the Treasury to issue a $1 trillion coin and deposit it with the Federal Reserve Bank. No need to issue debt to pay the required interest on existing debt. This solution does make you wonder why Geithner is leaving just before he'd be forced to do this. A little disagreement on how hard he's willing to push his friends? More likely, he's tired of the BS.
- ...Has a budget for running the federal government that has been authorized by Congress. This is not a situation where the government must be shut down because of lack of budget as in 1995 and 1996.
- ...Must pay the interest on existing debt by coining money, so it probably should continue to run the government by coining money. The White House has the responsibility to do as Congress has authorized it and coining money will be the only authorized route if the debt ceiling is not raised.
This logic chain is important because the Supreme Court will almost certainly be asked to decide if the above is constitutional. While it's unlikely that using the 14th Amendment to raise the debt ceiling is constitutional, there's no constitutional argument against coining money to pay for authorized programs and debt.
If the Treasury coins money to finance the estimated $900 billion of deficit spending in 2013, it will effectively remove approximately $75 billion per month of new debt supply. The current QE4 program by the Fed is purchasing $45 billion of long-term U.S. government debt so this is a negative swing of approximately $145 billion from 2012 (the deficit was higher in 2012). The existing supply of U.S. bonds would actually shrink by $45 billion each month if the coinage option is implemented -- expect a big spike down in interest rates and up in bond prices.
Stronger Ground
Overall, Obama is in a stronger position than he was on the Fiscal Cliff and his recent statements that he would not negotiate indicate that he understands this. Republicans don't seem to understand all the Constitutional constraints that the President is under as they scoff at his no-negotiation on debt stance.
It's very unlikely that a $1 trillion coin will be minted as Republicans will come to a compromise to avoid blame. The importance of the coin option is that it reduces the perception that Republicans will be able to cause a crisis, minimizing the downside to the market.
This means that playing the down side by shorting the market may not be as productive it was prior to the Fiscal Cliff and 2011 debt crisis. In 2011, the S&P500 dropped 6% in the week before a compromise was announced and then dropped another 11% (17% total) before starting to rally. Leading up to the Fiscal Cliff, the market dropped only 3% (December 18-28) before rallying 4%.
Wrong Side Of The Trade
Shorts may be caught on the wrong side of the trade as a significant short term market rally from reduced uncertainty should result if/when Obama were to announce that he had a legally vetted, constitutionally sound plan using the short-term issuance of coinage to ensure that government functions during any debt ceiling negotiations. It's unlikely to be as large as the 16% S&P 500 pop that occurred in the three months after the 2011 crisis due to the higher current market level (1460 vs 1099). The rally should be strong enough to breach the 2008 high, which is only 6% above current levels.
While the market may go lower between now and the estimated debt ceiling crisis date between February 15 and 28, the coin option eliminates certainty of a lower market. Aggressive investors should consider establishing a leveraged long position such as the 3x PROSHARES ULTRAPRO S&P 500 (UPRO) where there is certain profit in the "crisis averted" rally - as long as you don't get too nervous if/when the market dips before the rally.
Market advances after the initial "crisis averted" rally will still depend on government actions as debt reduction can be bad for the economy and market. New opportunities for shorting will become evident after the rally.