This post builds on my previous two, in order to explain exactly what the platinum coin is, and what it should be expected to do. The important point from the first post is some information about what liquidity management is and why it sets the interest rate, and the second gives some background about double-entry accounting, and why we want the government to have persistent negative equity. So this post will run on the assumption that negative public equity is both necessary and good (or at least, not bad), and if there are any problems with that belief, they should be directed at the previous post.
The first big question is, exactly what happens when the government deficit spends? But this first requires explaining the distinction between MB and M3, or the terminology I usually use, "base money" and "broad money."
Somewhat unimportantly, coins and bills in circulation count in both categories, while coins and bills sitting in bank vaults are base money. Most importantly, though, electronic cash held by banks as assets makes up the bulk of the base money (this money is called reserves), while broad money is money held by banks' customers as deposits, savings, CDs, and the like. Excluding paper and coins in circulation, one way of viewing this distinction is that base money is an asset of banks and a liability of the central bank, while broad money is an asset of customers and a liability of banks.
As a bit of a tangent, there's typically more broad money than base money, because while it's still true for banks that equity = assets - liabilities (and banks are expected to keep positive equity), their only liability for retail banking operations is customer deposits, while they can have several classes of assets. Chiefly, banks can have base money, loans, and low-risk securities. This is the sense in which we could say that broad money is a leverage of base money: there's a larger amount of broad money "backed" by a smaller amount of base money. (Base money, in turn, is backed by nothing except the government's promise to accept it in payment of taxes and fees. But I still promise to write more about the fiat in fiat money later.)
The other thing to talk about is transaction clearing. Specifically, this is the question: what happens when a person A gives a check for $m to a person B? Person B takes the check to his bank, let's call it Bank B, which makes a note of it and presents it to Bank A (the bank of person A, or in any case, the bank having the account the check was written against). Bank A lowers the deposits of person A's account by $m, then informs the central bank of this transaction. The central bank transfers $m of reserves from its (reserve) accounts from Bank A to Bank B. When Bank B receives the reserves, it then increases person B's account by $m.
Public spending and taxing works basically the same way. In addition to banks having reserve accounts at the central bank, the Treasury has several accounts. When the government, say, electronically transfers a social security payment $ss to an old person C (who banks at Bank C), Treasury tells the central bank about the spending, which reduces Treasury's general account by $ss and increases Bank C's reserve account by $ss, and tells it about the spending. Bank C then increases old person C's deposits by $ss. Paying your taxes electronically or with a check is just the reverse operation.
This was all background to be able to answer a more important question: what exactly happens when the government deficit spends, and matches its spending with bond issue? Note that, like everything else here, this explanation is stylized, not least because Treasury maintains a buffer in its general account, so these two operations are somewhat decoupled in reality, but this should get the idea across.
So Treasury holds a primary bond auction in which the organizations who know the secret handshake get to participate. (There are more primary auction participants than those, but you still need to know a secret handshake to join in.) Some bonds go into mutual funds or bond index funds or are held by investors or by foreign investors or foreign banks or foreign central banks, and the rest end up held by US banks in the reserve system. I'll be focusing on banks, though after this post, thinking through the motives and mechanics of the other bondholders should be feasible.
When a bank gets a bond, then, its reserves are reduced by the sale price of bonds it bought, and those reserves are transferred to the Treasury's general account. Note that bank-bought bonds don't affect deposits; instead, they make deposits slightly more leveraged. In principle, this could drive the interbank lending rate up, though in reality, it's probably negligible. This is because Treasury only sells bonds so it can then spend the money.
When Treasury spends the money back, as above, both reserves and deposits are increased by the amount of the spending. From the former perspective, this serves to return aggregate reserves to their previous level. (They may shift around some.) From the latter, this increases deposits by the amount of the spending. The net effect of public spending with debt issue, then, is that deposits are increased by the amount of the spending, and reserves are unchanged. (This still increases the leverage of broad money, though by less than it at first appeared. And in any case if this drives the interbank rate too high, the central bank will buy any excess bonds.)
This is also the reason that there'll always be demand for public debt: since reserves are unchanged by the deficit, there's always money available to buy the debt, and of course, the only reason anybody buys public debt is for the yield.
There's another important corollary of all this, namely, that deficits increase deposits by the amount of the deficit regardless of whether deficits are paid by issuing debt, or by merely issuing new money. The usual difference that's cited is instead the effects of public debt and cash on lending activity, though on the demand side, the decision to take out a loan or not is based primarily on the offered interest rate, which (to beat a dead horse) is set by the central bank. The only caveat is that if there were no bonds with which to carry out liquidity management, then the central bank would need to offer interest on excess reserves at the desired rate. With this caveat in mind, it's not clear how deficits funded by new cash are supposed to increase deposits more than deficits financed by public debt---and anyway, when considering that mv = pq, the 'm' in question is deposits, not reserves.
Now it's time to finally get around to the actual subject at issue, namely, the trillion dollar coin, which I'll abbreviate TDC.
It's fairly well-known by now (to Americans, anyway) that the perceived necessity for the TDC comes from a particular dysfunction of the Congress: on the one hand, Congress sets the budget, which Treasury is then expected to carry out, but on the other, Congress has to authorize debt issue (which it now does through the so-called debt ceiling). The more extreme conservatives have decided to go along with the former, but not the latter, and as should be very apparent by now, it's of supreme importance that public debt remain risk-free.
But there's an interesting quirk in the monetary system: The Federal Reserve (our central bank) and Congress are the only entities with the power to issue money, but the actual production of money is carried out by the Department of the Treasury (which is part of the executive). Specifically, paper money is produced by the Bureau of Engraving and Printing, while coins are created by the US Mint. When the Fed needs more physical money, it tells the Treasury, which then makes and sells the money to the Fed.
In the 1990s, a law was passed allowing the Treasury to make commemorative coins out of non-gold, non-silver precious metals, without a specified face value of the coins. In principle, this means that the Treasury could mint a platinum coin with a face value of one (or sixty or whatever) trillion dollars, then deposit it at the Fed. The Fed is obligated to accept any legal tender, and of course legally-minted coins would qualify, even if they're not standard.
So what would happen? Well, Treasury would create a trillion dollar asset and liability on itself (in the form of the coin, since money is a liability on the issuer). By giving the coin to the Fed, the trillion dollar asset goes onto the Fed's balance sheet, and it creates a trillion dollar liability (namely, a deposit in the Treasury's spending account), and the Treasury would gain a trillion dollar asset (the asset side of its general account). There would be no immediate effects of this (outside wailing and gnashing of teeth on the opinion page of the Wall Street Journal), because so far no accounts have been changed in the private sector.
This would, however, enable Treasury to engage in a trillion dollars of deficit spending without corresponding debt issue. To summarize the effects of this, outlined earlier, deposits will go up by the same amount they'd have gone up if more debt had been issued (namely, $1T), but reserves would also go up by $1T. This would make cash more plentiful in the reserve system, which would push the interbank lending rate down. At this point, the Fed would have to choose between using some of its own bond holdings to push the rate back up, or in a pinch, they'd have to offer a support rate on excess reserves at the policy rate.
Of course, right now, it's very "six of one, half a dozen of the other," since the policy rate is already so close to zero already, and the nominal interbank lending rate can't go negative through liquidity management.
The more important implication, and the reason we could/should at least talk about shooting for the moon---and issuing a $60T or $1Q coin---is that this demonstrates in a very tangible way how currency-issuing governments are not constrained by taxes or private demand for bonds. But, at the very least, when you read other articles on this subject, whenever people wave their hands about vague threats of inflation, you should probably laugh a little to yourself: as long as the central bank does its job, there's no conceivable way in which the TDC will actually increase deposits above the level they'd get from the same deficits and equal amounts of debt.