Modern Monetary Theory – Our Salvation or our Downfall?

Part Two: Conclusion

Charles W. Kraut                                                                                                       5 July 2020

Modern Monetary Theory

We need to define Modern Monetary Theory to place it in context. One of the best descriptions I have seen comes from Michel Montaigne, a graduate student at Oxford. 

In 2019 Michel wrote:

“To a degree it is almost a fringe theory (at least by some estimates) - there is a decent amount of debate as to how much credence we should lend MMT or whether or not it is valuable to the field of economics. In general, MMT appears to (at least for the moment) have more detractors than supporters. Simply put, MMT is used to describe the operation of monetary systems within a modern capitalist framework for the purposes of providing empirical support for certain policy prescriptions (interest rate changes, for instance). Like some of the Keynesian thought that preceded it, one of its defining features is that money creation is largely a response to natural expansions and contractions relative to demand (the ‘endogenous money’ part of monetary theory). Often this means that MMT advocates just turn their attention to fiat-money and how it is produced and supplied - usually before government spending and often in lieu of raising taxes.

“If you wanted to go into a bit more of the history there is the popularised budget constraint angle (I am borrowing this from this fellow Thomas Palley, who wrote a fairly comprehensive paper on this topic five years ago) by which

G - T = θ + β

(G = government spending, T = net tax revenues after transfers and interest payments, θ = amount of budget deficit financed by issuing high-powered (sovereign) money, and β = amount of budget deficit financed by selling government bonds.)

“The point here is that MMT looks to go beyond or completely avoid these types of budgetary constraints. In this regard MMT claims that the “standard” approach of taxes and bonds are better understood as stability mechanisms rather than sources of government revenue, and that central banks should essentially be allowed to create money as they see fit (or, rather, as their modelling indicates).”

In other words, MMT takes advantage of the current fiat currency system in use around the world. It proclaims that since money has no backing there is only one effective limit to how much of it may be created and spent by government.  The limiting factor is inflation; if inflation occurs (as reflected in consumer prices and wages; most other economic indicators used previously have little meaning in MMT) the amount of money creation must be slowed or stopped.  To re-balance the economy taxes may be levied to reduce the amount of money in circulation.

The chart on the right, published by https://assignmentpoint.com, shows various flows of funds within the economy and how MMT would address them in an effort to promote stability. It is actually a good description of how the economy might work under MMT.

 

Below is a chart of economists and schools of thought (Keynesianism, Austrian economics, Monetarism, and so on) that describes how MMT came to be.

 

Those who propose Modern Monetary Theory (MMT) as our salvation are mostly the same people who like to buy votes and get their names on giveaway legislation. They have some faint awareness of the enormous problems they have created, including the demise of the American middle class. The most vocal proponents of MMT have no concern that the “happy days” may not last forever. For decades they have been building up a knowledge base of how, with the unlinking of the dollar and gold and the move to a fully fiat currency, along with enormous deficit spending year after year, and coupled with unlimited Quantitative Easing (QE) by the Federal Reserve, inflation as computed by the US Bureau of Labor has not soared into the stratosphere.  As far as the government is concerned, inflation is very benign.[1]

Consumer Price Index (CPI) Inflation, June 2019-May 2020
A German 100 Billion Mark note issued in 1923.

After all, we have the famous example of Germany in 1923, when inflation was running in the thousands of percent each month, and people who had millions in the bank were getting letters from the bank saying that their account was being closed because the value of their money was too little to justify having an account.

We also have the example of Zimbabwe in 2007-2009, where in its peak month in November 2008 the inflation rate was 89.7 sextillion percent. You can today purchase 100 trillion Zimbabwe dollar notes on eBay as collectors’ items; by the time those notes were printed they wouldn’t even buy a hamburger.

Zimbabwe 100 Trillion Dollar note issued in 2008

 

These events happened simply because the government printed too much money, and that money was not backed by anything. It had no intrinsic value, and therefore it failed. Why didn’t that happen in the United States of America? This is key, because without a good explanation the proponents of MMT gain significant support for this theory of theirs.

The rise of the 1%

One of the reasons why America has not seen significant consumer price inflation is because we have seen tremendous price inflation in financial assets. These include collector’s items, paintings and other forms of art, fine wines, high end real estate, rare coins, precious gems, and stocks and bonds.

During each of these bailouts, from the failure of the Continental Illinois Bank in 1984 to the Long Term Capital Management failure in 1998, to the failure of Lehman Brothers and AIG in 2008 and others, the entire global financial system was seriously imperiled. In fact, it is said that if Long Term Capital Management had been allowed to collapse it would have taken the entire world financial system down with it.

There is a long and sad history to all this going back to the creation of the Federal Reserve in 1913 which we will not go into in this report. The Federal Reserve, which is neither federal nor a reserve, was created to benefit America’s banks and especially its bankers. Though the Federal Reserve does not bear sole responsibility for the unprecedented concentration of wealth we see today, it certainly got the ball rolling and has been instrumental in advancing that movement.

Congress made one particularly good move to reduce the power of the banking system in the United States. The 1933 Glass-Steagall Act created a wall of separation between commercial banks and investment banks. This was essential, for it made investment banks solely responsible for their own conduct.

Commercial banks offer savings and checking accounts and Certificates of deposit. They make loans. Investment banks invent new and creative ways to invest money. They, including companies like J.P. Morgan, Chase, Mellon, and Citi, along with Lehman Brothers, Salomon Brothers, and others, do four things commercial banks are not allowed to do:

1.      Deal in nongovernmental securities for customers.

2.      Invest in non-investment grade securities for themselves.

3.      Underwrite or distribute non-governmental securities.

4.      Affiliate or share employees with companies involved in such activities.

Glass-Steagall may not have gone far enough in limiting the authority of commercial banks, but in 1932 many of the activities engaged in by investment banks today have not yet been invented, just as the Federal Reserve’s Federal Open Market Committee had not yet been created.

Unfortunately, the remnants of Glass-Steagall were repealed by Congress in 1999.  It was claimed that it was not fully effective in doing what it was supposed to do. Glass and Stegall certainly did not envision institutions that were deemed “too big to fail.”

Subsequent legislation, including the PATRIOT Act of 2001, the Dodd Frank Act of 2010, and others have further weakened the position of the American people while greatly strengthening the hand of the “too big to fail” corporations. Instead of giving Americans reason to have confidence in their fiat currency, Congress instead repaid the hundreds of millions of dollars in campaign contributions they have received from these organizations to greatly strengthen the big banks.[2] In so doing Congress has aided and abetted the rise of the 1%, who now own as much as the entire American middle class, who comprise 40% of the population.

The chart below was assembled by Bloomberg from data provided by the Federal Reserve.

Note the differences between 2006 (lower chart) and 2019; the top 1% owned 25% of the wealth (which we assume is a percentage of the wealth in private hands in America), while by 2019 that percentage had grown to 29%.  The share of wealth held by the top 10% grew from 59% in 2006 to nearly 64% in 2019.  In 2019 the top 1% were worth almost as much as those in the 50-90% category; by now they may own more than the 50-90%.At the same time, the wealth of the bottom half of America is about 20% of what the top 1% own. 

This may be the greatest concentration of wealth in history. Historically, concentrations lower that this have led to unrest and even to revolution. Much of the concentration of wealth can be attributed to the actions of Congress, investment banks, and the Federal Reserve.  As we discuss MMT it will be important to remember that the Federal Reserve has played a particularly important part in enriching both the 90-99% and the 1%.

The velocity of money

We mentioned above that much of the bailout money and money created by the Federal Reserve has found its way into Wall Street rather than to Main Street. 

To quote Investopedia:

The velocity of money is important for measuring the rate at which money in circulation is being used for purchasing goods and services. It is used to help economists and investors gauge the health and vitality of an economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.

Velocity of money  . . . shows the rate at which money is being transacted for goods and services in an economy. While it is not necessarily a key economic indicator, it can be followed alongside other key indicators that help determine economic health like GDP, unemployment, and inflation. . .

Economies that exhibit a higher velocity of money relative to others tend to be more developed. The velocity of money is also known to fluctuate with business cycles. When an economy is in an expansion, consumers and businesses tend to more readily spend money, causing the velocity of money to increase. . .

Since the velocity of money is typically correlated with business cycles, it can also be correlated with key indicators. Therefore, the velocity of money will usually rise with GDP and inflation. Alternatively, it is usually expected to fall when key economic indicators like GDP and inflation are falling in a contracting economy.[3]

It is entirely possible that money placed into savings or investment will have a different and lesser velocity than money placed in the hands of the general public.  Hazlitt might disagree if the funds being invested were being utilized for capital expenditures, but we are looking at the purchase of stocks (equities) and debt (bonds).  Money placed into both can and normally would have a lower velocity than money dumped onto “Main Street.”

If the velocity of money will rise with GDP and inflation the opposite may also be possible, that the velocity of money can cause or slow inflation.  If this can be demonstrated through competent economic analysis, we have the answer as to why so much deficit spending has not led to significantly higher inflation rates – yet.

There are other factors to consider. The U.S. dollar’s status as the world’s reserve currency has enabled our government to dominate the world economy for decades.  Much of what was done by our government to take advantage of the dollar’s status is regrettable. Installing the Shah of Iran in a 1954 UK and US-backed coup is just one example.

Another possibility is that interest rates have been on the decline since 1979, and have reached negative levels in many cases.  This is an event without precedent.  Zero or negative interest rates are a boon to heavily indebted countries, for there are basically no carrying costs to their debt.  In fact, with negative rates investors pay the government for the privilege of keeping their money for them for ten or even thirty years.

How might low interest rates impact inflation?  Unlike the velocity of money, interest rates often correlate closely with inflation, though not in the sense you might expect.  Paul Volcker was famous for raising interest rates to fight inflation, raising the fed funds rate from 10.25% to 20% in March 1980. He did this to fight inflation, which had risen to an annual rate of 10%.

Since interest rates are largely manipulated today, and not allowed to float freely based upon the creditworthiness of the borrower, there can be no direct cause and effect between interest rates and inflation in either direction, with changes in one leading to corresponding changes in the other.

It is possible that deliberate reductions in certain interest rates, such as those controlled by the Federal Reserve, will influence public perceptions of the actual rate of inflation.  After all, we expect (incorrectly, at least since 1979) that interest rates, like water, will seek their own level.  That is, money in a bank Certificate of Deposit will pay an interest rate sufficient to keep the saver ahead of both inflation and taxes. 

One of the major negative effects of the low interest rates we have experienced since the 1980s is that retirees living on a fixed income have been forced to take their money out of bank CDs and put it into the stock market in the hope that the extra risk will be justified by a greater reward.

Putting it all together

Our original question in this article deals with whether being the world’s reserve currency would immunize the dollar from the effects of money printing. We understand that conceptually Modern Monetary Theory gives issuers of currency a “blank check” to provide enough money to meet the demands of those in government who spend it.

We have discussed the long-standing trend of deficit spending in the United States, which has accelerated and long since gone completely out of control. Our current President constantly reminds us that we are experiencing the greatest economy in American history, and yet we continue to deficit spend as if there were no tomorrow.

The forces of Progressivism, ever strong, are building to hurricane force as they become emboldened by an unbroken string of victories.  There are numerous Progressive assaults on our society underway today, including:

1.      The Green New Deal,

2.      Medicare for All,

3.      Guaranteed national income,

4.      The beginning of a new assault recently seeking to ban homeschooling and private schools in the US, and more.

These programs involve staggering amounts of government spending, far in excess of the current 2020 deficit due to the COVID-19 pandemic.  The case can be made that all of them involve misleading numbers, poor logic, and a strong motive to move the United States into full-blown Socialism.

MMT itself declares that it is all about full employment, as if the government can create and fund jobs out of thin air that will provide the otherwise unemployed or underemployed with meaningful, useful employment.

America also faces a pending employment crisis coming from two related sources: self-driving vehicles and Artificial Intelligence (AI).  Both have the capacity of destroying millions of jobs.  These two concepts alone will in all probability change the face of our world forever.  No one today can accurately detail all the consequences of these developments.

We should always remember that the Socialists are now “out of the closet.”  Candidates for public office now feel free to demand that we abandon capitalism and adopt Socialism.  They remain undaunted by the fact that Socialism and its companion Communism have brought about more death, destruction, and misery than any philosophy, economic system, or form of government in human history.

Is it a coincidence that MMT, the supposed solution to all our financial woes, is being touted just as we teeter on the edge of national bankruptcy and have massive, unfunded spending proposals waiting in the wings? We do not think so.

We have a Constitution which is, or at least was meant to be, the supreme law of the land. The Constitution specifically limits and restricts the authority of Congress and, by extension, the President, to certain enumerated powers. Direct taxation of incomes and wealth redistribution are not among those powers. The fact that our government has seen fit to ignore its mandate, and virtually all of its members have failed to uphold their oath of office to the Constitution, must give us pause in considering giving them a “blank check.”

We have discussed some possible reasons why the United States has not experienced significant inflation as a result of the massive money printing and Quantitative Easing carried out by the Federal Reserve. Despite Dick Cheney’s famous statement “Deficits don’t matter,” we must acknowledge that throughout human history deficits have mattered.

Is it conceivable that in our “post-modern era,” after the date when Francis Fukuyama declared that history had come to an end, that we can deliberately cast off the entire mass of human experience and announce that “this time it’s different?”

Let’s consider a few other points:

1.      In our era of globalization and very significant international trade, can we reasonably expect the United States dollar to retain its dominance as the world’s reserve currency if we adopt MMT? Those promoting the theory themselves acknowledge that other nations, Japan among them, are already engaged in something remarkably similar to MMT. Will the Japanese (or any other nation) be disqualified from utilizing this theory as it regards their own currency?  Who will make that decision?  Can all nations practice MMT?

2.      All 50 states are required to balance their budgets. The Constitution prohibits them from issuing their own currency. Will the argument be made that states obtain their sovereignty under the Constitution and, if the federal government is free to detach itself from the Constitution the states should have the same privilege? Could the U.S.  end up having 51 entities (50 states plus the federal government) issuing their own currency under Modern Monetary Theory?

3.      Will other nations succumb to the siren song of the “blank check” and embark upon a program of MMT even though their economies and their currencies are not sufficiently strong or internationally credible to enable them to do so? After all, all currencies throughout the world today are fiat currencies; what’s to stop any nation from taking the next step?

4.      MMT almost certainly must assume that the United States dollar will remain the world’s reserve currency. What will happen when this changes?

5.      Is it not possible that Congress will take advantage of this spending opportunity and “invest” trillions of dollars in new welfare programs and the Green New Deal? Will this not significantly increase the risk that MMT will fail? Keep in mind that money that finds its way into Main Street, which is to say, to corporations that will actually produce things and to people who will spend the money to meet their own personal needs, will almost certainly have a higher velocity of money than that which ends up on Wall Street invested in stocks and bonds. If the velocity of money is a key to inflation, the adoption of MMT could quickly become disastrous.

6.      MMT suggests that the velocity of money could be slowed by taxation. It assumes that every dollar spent by government will be monetized, though it acknowledges that on occasion government debt may be issued. There is far too little clarification on these important points.

7.      It is probably safe to assume that institutions currently considered “too big to fail” will remain so classified. Now, however, the big banks will be able to greatly expand their reckless spending, knowing that the government will be happy to bail them out by creating an unlimited supply of money. What will this do to the concentration of wealth among the 1%?

8.      What does MMT do to the old notion of “dollars chasing goods?” Inflation may have been restrained so far despite our enormous deficit spending because most of the money has ended up on Wall Street, as we discussed previously. When those extra dollars are being used by individuals and families to purchase items at retail, how will our entire system of manufacturing, marketing, and distribution be affected? Remember that under MMT income taxes will be largely eliminated. That alone will free up a significant percentage of personal income. It will effectively add trillions of dollars of consumer spending. Is it possible that those trillions of dollars will not simply raise consumer prices?

If we sound skeptical in these “talking points,” it is because we believe there is great cause for skepticism. MMT will not repeal human nature; Congress will not abandon its spendthrift ways nor adopt any semblance of fiscal responsibility. Individuals will most likely stop saving because they will know that the government will always be there to bail them out when they get into trouble.

Without a doubt, Modern Monetary Theory assures us into a brave new world. In the 2020 election, many promises will be made that we cannot afford to fulfill. There is more than fiscal responsibility at stake here; history and human experience are on trial. If we can print unlimited currency and convince people that it has value we will have abandoned one more principle, the idea of sound money.

Conclusion

Modern Monetary Theory draws its impetus from recent history. Its proponents can rightly claim that the type of spending MMT authorizes differs only in degree to our experience with a fiat currency. Just because the nations of the world have not experienced serious inflation or even hyperinflation in recent years as a result of their huge amounts of deficit spending and accumulation of national debts does not mean that inflation has forever disappeared. Just because no fully adequate explanations have been put forth as to why inflation has been delayed does not justify the adoption of a theory which flies in the face of the economic history of the world.

It is our position and the position of the Constitution Party that the United States needs to return to fiscal responsibility, and the acknowledgment that debts must be repaid. Deficit spending must be reduced and ultimately eliminated. As Milton Friedman famously said, “There is no such thing as a free lunch.” Modern Monetary Theory proposes that there is. The adoption of MMT will put this nation and the entire world economy at serious risk of collapse at the very moment when individuals, corporations, and governments have taken on more debt than at any time in human history.

Do we dare abandon both established principles and all human experience and roll the dice on one grand-sounding, unproven, illogical theory?

The choice will soon be made – and it will be out of our hands.  The decision will be made by members of Congress, whose primary purpose in life seems to be getting re-elected, and by our President. Even if President Trump is re-elected he will be under enormous pressure to go along with MMT.  If any of the Democrat candidates is elected, they will readily embrace MMT,

Footnotes

  1. ^ Shadowstats.com is the website for John Williams’ Shadow Government Statistics," an electronic newsletter service that exposes and analyzes flaws in current U.S. government economic data and reporting, as well as in certain private-sector numbers, and provides an assessment of underlying economic and financial conditions, net of financial-market and political hype. It is well worth looking at when examining official government data. Shadowstats’ Alternate Inflation Charts, for example, show two different methodologies utilized by the Bureau of Labor Statistics in 1980 and in 1990.  These charts indicate that current CPI inflation is either 7.5% (1980 method) or 3.75% (1990 method).
  2. ^ Congress went much further in destroying Americans’ confidence in their currency. The PATRIOT Act, just renewed by Congress, contains provisions enabling local, state, and federal governments to perform “asset seizures,” stealing without legal recourse cash, precious metals, precious gems, houses, boats, aircraft, vehicles, and much more.  The repeal of Glass-Stegall helped enable the casino-like investment banks to draw on the reserves of the FDIC when they inevitably got themselves into trouble.  More recently, Congress has worked on legislation permitting banks to solve their problems internally by literally stealing their customers’ funds.  This is called a “bail-in,” and after Cyprus used it successfully it was adopted by the G20 at their Brisbane meeting in 2015.  The United States is a G20 member.
  3. ^ Investopedia, Understanding the Velocity of Money, https://www.investopedia.com/terms/v/velocity.asp.