investment insights
Harvesting the Magic Money Tree
Lombard Odier Private Bank
Key takeaways
- Modern Monetary Theory says that a government that prints its own currency cannot default
- MMT argues that government spending is only problematic if it triggers inflation and politics should focus on resource availability, not projects’ costs
- MMT questions monetary policy’s focus on targeting inflation
- The theory does not offer a policy framework and does not identify when inflation threatens and hands monetary policy to politicians’ spending pledges
- MMT does offer a useful reminder that we should question the past decade’s unconventional monetary tools.
The United States’ gross national debt has increased from USD 1.5 trillion when Ronald Reagan left office in 1989 to more than USD 23 trillion today. US debt has been a political obsession for far longer. Since its 18th century founding, the US federal government has registered a debt in every year but 1835.
Proponents of Modern Monetary Theory (MMT) say that it is a mistake to obsess over repaying government debt because it is wrong to think of national debts in the same terms as a household’s liabilities. MMT is shorthand for a two-decade old theory that says currency is a public monopoly, issued by a state. Debt, for a sovereign government with the ability to issue its own currency, is just an accounting measure, they say. Government debt is a measure of a net surplus (minus tax revenues) spent in the economy.
“Their red ink becomes our black ink, and their deficits are our surpluses,” says economist Stephanie Kelton, a professor of public policy at Stony Brook University and former advisor to Bernie Sanders’ 2016 presidential campaign. In other words, a government deficit represents an injection of money and a surplus in the real economy. To describe the figure as a deficit is to see the figure only from the government’s accounting perspective.
MMT’s advocates, of whom Professor Kelton is the most visible and prolific, argue that the only limits to government spending are in the real economy, because (as former Federal Reserve Chairman Alan Greenspan said in 2005) “there is nothing to prevent the government from creating as much money as it wants.”
The theory usefully questions the four-decade old conventional economic and policymaking obsession with inflation and raises the idea that governments might be more fiscally flexible. It is no coincidence that the discussion is especially topical at a time of persistently low interest rates.
In a US election year, this is a significant and timely discussion when politicians are debating the need for, and calls to finance, a Green New Deal aimed at addressing climate policy and inequality. It also follows unprecedented levels of central bank support for financial assets over a decade that has widened inequalities.
Hyperinflation fears
Critics point to the dangers of hyperinflation. The cost of a Green New Deal (GND), estimated at USD 16.3 trillion, compares with US Gross Domestic Product of USD 21.3 trillion. The proposed legislation would guarantee labour rights, commit the US to renewable energy sources and invest in clean infrastructure, transport, farming and housing to make the US fossil fuel free by 2050.
If the only spending constraint under MMT is that at some point it will create inflation, then at these levels of investment, choices about costs nevertheless look inevitable. Notably, some of the GND’s most vocal supporters, including Representative Alexandria Ocasio-Cortez, have publicly backed MMT.
MMT wants to shift political discussion away from how to pay for policies and towards ‘do we have the resources’? Hyperinflation should not be a concern, say MMT theorists, as long as there is enough labour, goods and services for the government to buy without undercutting and competing with the private sector.
In this thinking, a government cannot afford a project only when the economy is at full employment and there are no spare goods and services to avoid competing with the private sector for resources. Even that should not be a concern, the most ardent claim, because government spending increases opportunities for private sector investments.
Challenging orthodoxy
Nevertheless, MMT offers no policy framework. Economic theory already says that governments should spend more when interest rates are low. And MMT cannot help identify when inflation becomes economically problematic. It also ignores that as soon as there were a forecast for rising inflation, a government would have to make tough spending and tax decisions.
Secondly, even if there was no risk of hyperinflation, there may be other side effects to fiscal leniency. Such government spending would raise redistribution issues, the risk of crowding out the private sector, asset price inflation and even greater inequality.
Another problem with MMT is that the responsibility for monetary policy then slides into the political realm. Last year in the US we saw pressure from the White House on interest rate policy and there are even discussions about merging the Fed with the US Treasury, a suggestion that confuses the purposes and roles of each as well as threatening the credibility of the central bank’s ability to manage inflation.
The Fed’s role is to keep the prices stable and maintain employment and set interest rates to support banking liquidity independent of political interference. The Treasury’s job is to manage US revenues through taxes, import duties and paying for Congress’ appropriations. Any suggestion that the government through the US Treasury would “print money” in response to Congress’ spending plans risk undermining demand for US sovereign debt and see investors asking for higher interest rates.
There is very little chance of MMT becoming economic orthodoxy, in part because it looks so politically counterintuitive to tell voters to ignore debt. And so in this persistently low-return environment, we continue to favour carry strategies, in particular real estate, high-yield fixed income and emerging market debt in hard currencies where we expect spreads to remain stable.
However, even if MMT does not become more widely accepted, it stresses the importance of fiscal flexibility, at a time when current monetary tools are in short supply to stimulate economic growth and address the inequalities exacerbated by the past decade’s unconventional approaches.
Wichtige Hinweise.
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