Potential Impact of a Trillion-dollar Coin
Understanding the idea behind a trillion-dollar coin offers a glimpse into the inner-workings of U.S. economics. Unlike countries that do not author their own policies about money and can thereby be forced into default when they run out, the U.S. can create stacks of paper money or precious coins.
The trillion-dollar coin concept also offers a quick lesson about inflation. In 1913, the U.S. Federal Reserve (the Fed) began issuing bank notes, but coins remained issued by the Treasury as they had been before that. Normally, the Fed, as head of the private banking system, buys coins upon demand from banks and pays for them by printing money. It deposits that money in the Treasury's account at the Fed. If the U.S. Mint had created the $1 trillion coin, it would have been deposited into the Federal Reserve, which would then have printed the money and deposited it in the Treasury. The U.S. would have been able to pay its bills and default would have been taken off the table.
While the effects of such a move on the economy and inflation are not clear, the concept polarized financial experts. Detractors of the trillion-dollar coin idea were sure it would cause inflation to spin out of control. Proponents suggested it wouldn't necessarily have caused a rise in inflation because Treasury deposits aren't part of the U.S. monetary base -- until they are spent, that is. When Treasury deposits are spent, the money moves to commercial banks, which could eventually trigger a rise in inflation. Until the trillion-dollar coin is spent, that isn't likely to happen. And even then, the federal government still holds the reins on interest rates [source: The Economist].
Understanding the inflationary impact of a trillion-dollar coin involves the Equation of Exchange, which illustrates the relationship between an increase in money supply and an increase in prices. The money in circulation times the rate at which it is spent (velocity) will equal the total spending [source: Investopedia]. The effect could have been similar to what the U.S. already has experienced during the most recent recession: The nation's monetary supply has tripled since December 2007, but inflation has not because the velocity of money has declined – the Fed holds more than $1 trillion in reserves [source: Soltas].
The outcome of a now-fictional trillion-dollar coin could have affected price stability, too. There are reasons governments don't simply print more money whenever they need it. Chief among them is that doing so can lead to price instability, something that's never good during a country's financial recovery.
But some say the real reason the trillion-dollar-coin idea did not go anywhere was political – minting it would have violated the Fed's independence, as well as the intent of Congress in creating a debt ceiling [source: The Economist].