MMT likely will influence the amount the US can spend and borrow before crisis begins.
We have long planned a post about Modern Monetary Theory (“MMT”) as part of our intermittent series analyzing the issues in the 2020 election. The coronavirus epidemic has added a palpable sense of urgency to plumbing the depths of MMT because the untold trillions in new money being created by the government in response to Covid-19 will provide an acid test of MMT much sooner than contemplated. This post focuses on explaining and analyzing MMT – a daunting task even for us.
Our next post May 10th is among the most consequential of the 600 posts we have written over the past 13 years! It presents an up-to-the-minute projection of the US Debt-to-GDP ratio incorporating the multi-year impact of the mammoth new debt and deficits that result from the effects of coronavirus. The analysis in the May 10th post is new and different than anything we previously have written about the spending crisis. This truly is a blockbuster and one you definitely don’t want to miss.
Just What is Modern Monetary Theory?
First off, MMT is not so modern; the accepted origin is a book “Soft Currency Economics” by economist Warren Mosler published in 1993. However, as with most economic theories, its underpinnings can be traced back for centuries.
The main tenet of MMT is that any government that issues its own fiat currency can create and spend unlimited amounts without the need to finance it via either tax revenue or debt instruments. Such a government can never be forced to default on debt denominated in its own currency. Further, any such monetization does not compete with the private sector or cause higher interest rates. The only problem acknowledged by MMT proponents is that inflation can get out of hand under some conditions.
In layman’s terms, MMT asserts that the USA has much more leeway to spend money than previously thought; it can’t ever go broke; and the debt to GDP ratio is immaterial – provided inflation is managed. Progressives like Sanders, Warren and AOC believe MMT is the Holy Grail of economics which can be used to finance the green new deal and the rest of the progressive wish list – all at once. Beware however, MMT makes for strange bedfellows and it also has many conservative adherents.
Is MMT Valid and Does It Work?
The strongest case against MMT is millennia of human experience. From Rome to today, many countries with their own fiat currency have defaulted or suffered other terrible economic fates, MMT notwithstanding; the lengthy list includes, inter alia, Weimar Germany, Argentina and Zimbabwe. Logically, MMT defies understanding; how can we create and spend money ad infinitum without adverse consequences? If MMT works, why doesn’t every country use it? It appears to be pie-in-the-sky or like finding a unicorn at the end of a rainbow. Many top economists and businessmen including Bill Gates, Jerome Powell and Warren Buffet believe MMT is claptrap.
To its credit, MMT explains certain economic phenomena better than classical economics. The USA and Japan among others have seen budget deficits skyrocket and bond markets respond in accord with MMT; yields on government bonds decreased despite sluiced up supply and trillions of dollars of quantitative easing. Massive government borrowing has not crowded out corporate debt or raised interest rates. Simply, some markets are acting in ways that can best (only) be explained by MMT. The chief economists for Goldman Sachs, Pimco and Nomura believe MMT is valid. The top investor of our era, Ray Dalio, attributes much of his success to MMT.
So, how can such diametrically conflicting theories, logic and data be reconciled? Economic principles that have stood for millennia are not going to be replaced by MMT nor will countries be able to borrow unlimited amounts. Nonetheless, thanks to MMT nations may be able to borrow more – much more – than previously thought possible. Moreover, the recent behavior of bond markets and interest rates can’t be reconciled with other economic theories. MMT provides much better explanations for what is happening. In short, MMT works in certain areas where other theories don’t.
Although MMT may permit more borrowing, this is a double-edged sword. The increased debt will make the resultant crisis deeper and longer. Another disastrous result of MMT is that it vastly diminishes the power of markets and central banks to allocate money and credit and to control the money supply and interest rates. To a corresponding degree, MMT increases the power of politicians. Progressive politicians could use such power to control the entire economy and spend the USA into oblivion.