Modern Monetary Theory – Our Salvation or our Downfall?

Part One of Two

Charles W. Kraut                                                                                                       5 July 2020

Executive Summary

Modern Monetary Theory (MMT) is being promoted by Democrats, liberals, Socialists, and Progressives as a panacea for America’s economic woes.  This paper will explore the fundamentals of MMT and the glowing claims made for it.

Before doing so, we will briefly discuss the history of money, stressing the tendency for people to prefer money with intrinsic value.  Simply put, money with intrinsic value – such as gold or silver coins – is wealth.  “Fiat” money, or money created by government edict with no backing, has no intrinsic value and should not be considered wealth regardless of the amount one may possess.  This is a vital distinction in a world that seems to know the price of everything and the value of nothing.

Because MMT is a major campaign issue, and because variants of MMT have been in operation for many years (particularly since 1971 when the U.S. dollar suddenly became a fiat currency) when they go to their polling places in November voters need to know whether this proposed major change in economic policy will prove out to be successful or disastrous.  According to our analysis, there seems to be no middle ground. MMT will be one or the other.

The debate should center around the history of the dollar during the tenure of the Federal Reserve, the dollar’s status as the world’s reserve currency, and the creation of the Petrodollar and other devices designed to ensure the dollar’s dominance.  What has happened is perhaps less significant than what has not happened: though the U.S. dollar continues its long decline since the Federal Reserve assumed responsibility for preserving its value, the official rate of inflation has actually declined.  Based upon our government’s penchant for deficit spending and paying for it with money created ex nihilo, most schools of economics would have predicted massive inflation by now, perhaps even a hyperinflation such as that experienced by Germany in 1923.

The great unanswered question is this:

In light of the potential damage already done to the U.S. Dollar by eliminating its intrinsic value, the creation of dollars out of thin air by the Federal Reserve, and the enormous deficit spending of the U.S. Government particularly during the current COVID-19 pandemic, is it possible that inflation can be kept bottled up by fiscal policy, as claimed by the advocates of MMT?

Introduction

Money was first created anciently to alleviate the difficulties of barter.  Under a barter system, if you wanted to buy something you needed to offer the seller something that he or she wanted. If you did not have such a thing, you might need to go through a second, a third, or even a fourth person to obtain the thing you needed for your barter.

Money was developed through a great deal of trial and error. There was great variation in its form between communities and cultures. Some items, like the tally stick used by the Aurignacians, are said to date back to 30,000 B.C.

As a medium of exchange money facilitated transactions between people. It enabled significant advances in human civilization, for with the standardization of a medium of exchange the nations of the world could trade with one another, each benefiting from its competitive advantages.

For thousands of years continuing into the Industrial Revolution tribes, peoples, communities, and nations used items as money ranging from rare seashells and beads to large carved circular stones to precious metals including gold and silver. Experience dictated that whatever was used as money should possess these attributes:

1.      It should be easily divisible,

2.      It should have its own intrinsic value,

3.      It should be relatively scarce, and

4.      It should be difficult to counterfeit.

The importance of Intrinsic Value

Appropriately, virtually all the currencies of which we have knowledge consisted of items that had an intrinsic value. It is only in our “modern” era that we have felt sufficiently confident to declare gold “a barbarous relic.”

Gold and silver were prized because of their scarcity, though both have been subject to counterfeiting. The famous “V” nickel, for instance, was first invented in 1883 with a large capital “V” on the reverse without the word “Cents.” The United States Mint quickly recognized its mistake when these nickels began appearing plated with gold and were being passed off as $5 coins.

More recently, some people in China have become expert at counterfeiting silver 1-ounce Chinese Panda coins, closely matching in weight and identical in size and image to the real thing, but lacking even a gram of silver.

This notion of intrinsic value has been essential down through the centuries. It was so important to the Constitutional Convention of 1787 that Article I, Section 10 of the Constitution of the United States specifically states that “No State shall . . . coin Money [or] make any Thing but gold and silver Coin a Tender in Payment of Debts . . .”

The thirteen colonies had learned a hard lesson during the American Revolution. The Continental Congress invented paper money, which they named the “Continental.” The idea was that the colonies would have to go into “temporary” debt to finance the American Revolution. The British, according to The Lost Science of Money[1], printed

and circulated massive quantities of counterfeit Continentals, which helped to destroy people’s confidence in them.  Congress realized that money without intrinsic value could not be forced upon the people by government fiat. Though laws were passed making it illegal to refuse to accept Continentals for payment, the currency failed and needed to be replaced by real money.

In addition to the language in the Constitution quoted above, the Congress in 1792 passed the Coinage Act, authorizing three gold coins in addition to silver coins. This served until the Civil War, when the Federal government, failing to learn the lesson of the Continental, issued “greenbacks.”  Once again, our government issued a currency that had no backing except for the full faith and credit of the United States, and it failed.

It is easy to understand why money needed intrinsic value anciently. Issuing governments

might fail, empires might fall, and their currencies become worthless. When you bought something with a “hard” currency (a currency with intrinsic value) the seller knew he was receiving something of value comparable to what he was selling.  The only concern the seller might have is whether the money he was receiving was counterfeit. How many times have you seen someone in a Hollywood Western bite a coin and try to bend it?

Intrinsic value has been a cornerstone of money almost from the beginning. It is a concept deeply ingrained into our consciousness. We use money expecting it to be accepted by those to whom we tender it. We have confidence in the money because it has something behind it. At least, that used to be the case.  Credit cards, debit cards, electronic funds transfers, and the creation of money out of thin air have affected our understanding of the nature of money as well as how we use it. There has been significant political pressure to remove any backing from our dollar.  Why would a politician or a special interest group be interested in debasing our currency in that manner? 

Counterfeiting by government

When an item like gold, which has an intrinsic value (albeit a fluctuating one in today’s environment), is utilized in trade there is always the risk that the nation’s gold supply will become depleted.  This is one of the reasons why it is important that a balance of trade be achieved between trading partners.

Like a genuine barter system, if the value of our exports to, say, Great Britain, is exactly equal to the value of our imports, we have a balance of trade.  When that condition exists neither trading partner will be required to send or receive tons of gold to the other partner(s) to balance the books. Governments have always been nervous about shipping off tons of their national gold holdings to satisfy trade debts. Many world leaders have correctly felt it important for their country to maintain a significant position in gold to help stabilize their currency and their economy.

That might not have been a concern when America was running huge trade surpluses each year.  However, as the Japanese economy rebuilt after World War II, and as China abandoned much of the Cultural Revolution to rescue its battered economy, America began to run significant trade deficits.  Fortunately for the United States Treasury, President Nixon “closed the gold window” in 1971, as mentioned below, and with the stroke of a pen unilaterally removed the United States from its global currency commitments.  The dollar would never again have any intrinsic value.  For a time, at least, it would enjoy the full faith and credit of the United States – as our country shifted rapidly from the wealthiest nation in the world to the greatest debtor in history.

Conspiracy theorists, media pundits, and some economists believe that producing a genuine “fiat” currency without any gold or silver backing is little more than counterfeiting.  After all, if the government is not held responsible for the amount of currency in circulation, is there any limit to the amount they may produce?

Controlling the dollar’s value

Governments occasionally get nervous about private ownership of gold among their subjects or citizens - or perhaps they want to “flex their muscles” and force their citizens or subjects to do what the government decrees.  You might think that private ownership of gold and silver is a good thing, and you would be right.  Since both metals have intrinsic value, they may serve as a store of value regardless of what happens to the currency.

During the Great Depression, in 1933 President Franklin D. Roosevelt ordered all Americans to surrender all their gold in any form (including legal tender coins) to the government by a certain date of face heavy fines and even imprisonment. Immediately after this confiscation, for which Americans were paid $20.67 per ounce of gold turned in, FDR raised the price of gold to $35.00 per ounce, where it remained for decades.  This reprehensible maneuver was a severe blow to the American people. It significantly devalued the dollar, but it was a boon to our government as it struggled to pay the bills of FDR’s numerous make-work and giveaway programs.

Despite FDR’s gold confiscation our currency nominally remained backed by gold (or silver, as indicated by Silver Certificates - $1 to $1,000 bills redeemable in silver issued by the U.S. Government between 1878 and 1928.  In 1928 all but the $1, $5, and $10 silver certificates were removed from circulation.)

Nixon removes the gold backing

In 1971 President Richard Nixon, in response to a significant rise in inflation, initiated a series of drastic economic measures.  They included wage and price freezes, surcharges on imports, and the unilateral cancellation of the direct international convertibility of the U.S. dollar to gold.  By severing the relationship between gold and the dollar Nixon eliminated the dollar’s intrinsic value.  It was no longer worth anything except for the faith of the American people in it. 

The U.S. dollar, in other words, became the greatest confidence game in history – and the United States government, some say, the world’s greatest counterfeiter.  Our government was printing a currency and proclaiming that it had value even though it had absolutely no backing except the full faith and credit of the United States.  Subsequently, even that phrase was removed.  If you look at your paper money today you will see no backing and no guarantee.  What you see today is a Federal Reserve Note bearing this disclaimer:

“This note is legal tender for all debts, public and private.”

The U.S. dollar is a “fiat currency.” Almost all the world’s currencies are fiat currencies today, though China is planning on introducing a gold-backed renminbi and some nations in the Middle East may produce a gold-backed dinar or other currency.

Why did we go from “here to there?”

This is a question few Americans are qualified to ask – and fewer still would understand the process underlying the events. Let’s lay it out in chronological order:

1.      The Continental Congress issued the “Continental” currency.  It had no backing because the Congress had no gold or silver to back it.  It failed due to massive counterfeiting.  It was America’s first experiment with fiat money, and it failed.

2.      Congress authorized the printing of the “greenback” during the Civil War to fund the war effort.  It had no backing, and it failed.

3.      1913: The Federal Reserve Act passed, and the infamous Federal Reserve was created with one mandate: to stabilize the value of the U.S. dollar.  Largely because of the actions of the Federal Reserve, the U.S. dollar lost more than 93% of its value over the next hundred years.  This happened even though gold and silver backed our dollar even after FDR’s confiscation of gold. Perhaps the only good thing about the Federal Reserve Act was that it restricted the amount of money that could be printed and it mandated that every dollar printed be backed by at 40% of that amount in gold owned by the Federal government. (Subsequent legislation eliminated that restriction.)

4.      1933: FDR confiscated gold from Americans.  Gold would never again be used in U.S. legal tender coins.

5.      1964: Congress authorized the elimination of silver in U.S. dimes, quarters, half dollars, and “silver dollars.”  Beginning in 1965, only specially minted “proof” coins not intended for circulation contain 90% silver – except for half dollars, which contained 40% silver through 1970.

6.      1971: Nixon closed the “gold window,” unilaterally violating the Bretton Woods Agreement of 1944 that had been signed by all 44 Allied nations in World War II. Nixon also imposed a 90-day wage and price freeze to combat rising inflation. It failed, and actually increased inflation.

7.      1973: The price of gold was allowed to float freely after Nixon finished decoupling gold from the dollar.  Its price quickly rose to $120 per ounce. At the same time inflation was in the double digits.

8.      1975: Americans were once again allowed to own gold.

While the U.S. was devaluing the dollar by permitting small increases in the price of gold, other nations were revising their “gold standard” and printing more money than their gold reserves might permit under the Bretton Woods Agreement. Thus ended a century of the gold standard, and the era of fiat money began.

Deficits as far as the eye can see

Once the dollar had no backing, other nations eliminated their currencies’ ties to gold as well. Now well into the Progressive Era that began in the United States with Teddy Roosevelt[2], Congress and successive Presidents decided it was time to fully implement federal spending that would eliminate poverty, end recessions, stimulate the economy, and create full employment – at least, that is what was promised.  LBJ had faced the question of “guns or butter,” and he decided on both: the Great Society programs and the Vietnam War.  The government ballooned as hundreds of new bureaucracies were created and staffed with tens of thousands of highly paid employees.

Deficits were the inevitable result of all this spending.  From 1971 to 2020, Federal spending deficits averaged $368 billion per year.  That number, however, is misleading.  From 1929, the year of the initial stock market crash that brought the “roaring Twenties” to an end until 1970, the year before Nixon closed the gold window, Federal deficits averaged $6.6 billion per year.  From 1971 to 2020, Federal deficits averaged $368 billion per year. However, from the moment Barack Obama entered the White House deficits soared.  Remember, his “mandate” was to end the global economic crisis, and he was given a relatively free hand to do so.  All politicians love to spend someone else’s money.  As Margaret Thatcher famously stated, “The problem with Socialism is that sooner or later you run out of other peoples’ money.”

Federal deficits from 2008 through the estimate for 2020 average $1,334 Trillion per year. That includes the estimated Federal deficit for 2020, but Congress may decide to spend much more money it does not have before the year is out.

Why has deficit spending become the law of the land?  Simply because Congress can get away with it.  Congress and the President use the power of the purse to buy votes.  If you look at the legislation they are passing, they are using taxpayer dollars and borrowed funds to buy the votes of illegal aliens, big banks, and special interest groups – but that is an article for another time.

The monster the United States Government has created contains more than 2,000 giveaway programs, some of which are politically untouchable like Social Security. Some of them, like Medicare, are open-ended in the amounts to which Uncle Sam is on the hook. Then we have the COVID-19 “black swan” event, for which our “compassionate” elected officials saw an opportunity to buy more votes and seize more power.  That too is an article for another time.

The point is that Congress and our Presidents have lost all sense of responsibility to the people who put them in office. Our debt today is unpayable even if deficit spending ended tomorrow.  We have, as a nation, mortgaged our children’s and grandchildren’s futures.

How did this all come about?  Here is what Henry Hazlitt had to say in his famous book Economics in One Lesson:

The entire history of the Progressive movement has been written in this way, through misdirection, deception, and unrelenting pressure. Progressive campaigns have undermined our Constitution, our institutions, our religious faith, our relations with foreign nations, and our economy. FDR’s legislative programs, intended to get the United States out of the Great Depression, began the process of seriously undermining our economy as they continuously robbed Peter to pay Paul. In such an environment, both Peter and Paul are robbed of something essential; their capacity for self-reliance and their initiative to create a better life for themselves and their families.

LBJ was only one in a long series of Progressives, but his Great Society programs stand out because they squandered hundreds of billions of dollars in making the problems they were supposed to solve worse – and in some instances, much worse.

The politicians have created such a mess that the General Accounting Office (GAO) now informs us that the “untouchable” or “unlimited” giveaway programs, though financially insolvent, must not even be given serious examination. We are told that we are now obligated as a nation to spend whatever sums are demanded on these programs. Questions may not be raised as to these programs’ efficacy, for to challenge them is to be labeled a racist – or worse.

The United States of America today is both financially and morally bankrupt. The economic system laid out by John Maynard Keynes, a Nobel laureate, has wreaked havoc across the world. Though he has been largely discredited, his ideas are still the basis for all our government’s economic policies.

However, Keynes said some important things which we have ignored. To his credit, he stressed that during the “good times” a nation must a) pay down the debt it accumulated during the “bad times”, and b) build up its reserves in anticipation of the next “bad times.”  Just as surely as Andrew Cuomo disregarded the advice of his counselors prepare for a “rainy day” such as COVID-19, our government has failed to take advantage of the so-called “best economy ever” to prepare for the next inevitable economic decline.  Government spending has gotten so far out of hand that the deficits have continued and even increased during the “good times.”

(continued in Part 2 of 2)

[1] Zarlenga, Stephen (2002). The Lost Science of Money. Valatie, NY: American Monetary Institute, pp. 377-387

[2] For more information on the rise of Progressivism in the United States, please see Will you Help Save Your Country?, Charles Kraut, Y Mountain Press, Provo, Utah, 2013.

[3] Hazlitt, Henry, Economics in One Lesson, Laissez Faire Books, Baltimore, MD, 1996, p.75.