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How the Platinum Coin Could Work (or Backfire)

January 11th, 2013

by Mohamed El-Erian

of PIMCO

The unusual move of minting a large platinum coin might shock politicians into cleaning up the fiscal mess. But the rest of the world may see it as inflationary.

FORTUNE -- In just a few weeks, the "platinum coin" option has gone from a wacky idea to becoming the subject of serious discussion among academics, market participants and, yes, some politicians. In itself, this evolution says a lot about the state of U.S. Congressional dysfunction, especially when it comes to economic governance. It also raises some intriguing possibilities.

The platinum coin option is, according to many experts, a perfectly legal way for the Administration to preemptively remove the threat of another debt ceiling debacle in the next few weeks. Here is how it would work:

Under legal authority it already has (which is meant for decorative coins), the U.S. Treasury would issue to itself a very large platinum coin -- say a single, trillion dollar denomination. The coin would be deposited in the Treasury's account at the Federal Reserve. Against this "credit," the Treasury would withdraw from the central bank more conventional forms of money and use them to meet payments obligations that have already been approved by law.

The key here is that the Treasury would raise money without borrowing. Thus, the increasingly binding debt limit would not apply; and Congressional Republicans would be unable to hold the country hostage as happened just 18 months ago.

The U.S. Treasury has been strategically silent on this option. When asked, the Administration has wisely pivoted to the importance of Congress finally stepping up properly to its economic governance responsibilities. But this has not forestalled an increasingly active discussion of the idea -- first in academia and now among global investors and within various political circles.

How about the market implications? Here, much would depend on whether the coin option is viewed as an end in itself or a means to an end. Let me explain.

I suspect that market reaction would be generally calm if the option were used as a way to diffuse what could otherwise be a repeat of the debt ceiling debacle in the summer of 2011 -- when political brinkmanship and bickering harmed growth, risk assets and the country's credit rating.

Indeed, some argue that, by broadcasting very loudly the dysfunction of Congress and essentially embarrassing its members, such an unusual (and for many -- and here you can pick your preferred wording -- unthinkable, unprecedented, absurd, creative, etc.) approach could provide the catalyst needed to shock our politicians into more constructive behavior, thereby reducing headwinds to growth and job creation.

It could also encourage Congress to deal once and for all with the oddity of having to consider both annual budgets and disconnected debt limits. In fact, there is a reason why this dual approach is not prevalent outside our borders. It is both redundant and harmful.

Congress has the power of the purse. And it exercises it through the annual budgetary process. The superimposition of a separate debt ceiling process adds little in terms of checks and balances; and, in today's highly polarized and overly-insular corridors of Congress, it serves as an unproductive disruptor.

What if the coin approach were to prove an end in itself? Here the consequences would be quite different I suspect.

Markets would worry about whether the approach would add considerable fuel to the fires of Congressional discontent, dysfunction and polarization. Political risk would increase, serving to price out an even greater array of job- and growth-enhancing investments by the private sector.

Meanwhile, the rest of the world could well view this policy approach as potentially inflationary, and also indicative of a superpower that has lost its way. All of which would be detrimental to equities, bonds and the value of the US dollar.

It was not so long ago that sensible people would have deemed a platinum coin option as a laughable non-starter. The fact that it is being now discussed so widely speaks loudly to the mess Congress has gotten itself (and the country) in.

The best way forward for everyone is for Congress to change the way it is currently handling its important economic responsibilities. Should this fail to occur, options such as the platinum coin will garner lots of attention in the months and years ahead.

It would be a loss for all, domestically and around the world, if the unthinkable becomes the only operational approach for the U.S. In the process, Congressional approval ratings would also dip below 10%, raising uncomfortable questions about the current state of our representative democracy.

Mohamed El-Erian is the CEO and co-chief investment officer of PIMCO. President Obama recently appointed El-Erian to head the U.S. global development council.

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