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My name is Mark B. Spiegel and I'm the Managing Member of Stanphyl Capital Management LLC. I can be reached at: mark (at) stanphylcap (dot) com. My Twitter feed is @markbspiegel
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  • Why "Modern Monetary Theory" is Unworkable in the Real World 8 comments
    Jan 18, 2012 7:07 AM

    An increasing number of Seeking Alpha authors and commentators (perhaps most prominently, Cullen Roche) have recently been embracing the concept of Modern Monetary Theory (NYSE:MMT), with many of them pointing to this explanation of MMT on the Pragmatic Capitalism web site.

    Basically, MMT claims that fiat currency government budget deficits are unlike household budget deficits in that fiat currency governments can cover their deficits by printing as much money as they need, and then if they print TOO much money they can control the ensuing inflation by raising taxes while concurrently cutting government spending, thereby pulling the excess money out of the private sector financial system. However, as with many ivory tower theories, MMT falls apart in the "real world." Here's why:

    In a time of excessively high inflation-- when Americans' purchasing power is being severely eroded-- how many elected politicians will vote to raise voters' taxes enough to stifle that inflation? The answer is: none (at least, none who want to get reelected). Instead, those politicians-- giddy with the vote-buying power of the printing press-- are liable to keep printing and spending the nation into true hyperinflation, by which time MMT would probably require a near-100% tax rate in order to get prices back under control. THAT'S why we need the fiscal discipline of treating the Federal budget as if it *is* a household budget, despite the theoretical differences between the two.

    Furthermore, MMT-ers seem to completely ignore the psychological foundation underpinning a fiat currency. Specifically, the dollar will only be accepted as a way to transact for goods and services if those who accept it believe that they in turn will be able to spend it for a like amount of goods and services themselves. However, if folks begin to believe that the preservation of the future buying power of that currency resides solely with the whims of elected politicians, they're going to demand a substantial "inflation risk premium" before accepting that currency, thereby sparking a self-fulfilling inflationary spiral.

    Thus, MMT-- like many academic theories-- is unworkable in the real world, and thus should be labled as such in economic textbooks and journals before it's able to cause irreversible damage to the American economy.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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  • bob adamson
    , contributor
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    Mark’s SA article appropriately discusses two significant legitimate concerns that need to be addressed when assessing whether Modern Monetary Theory would in fact work in the ‘real world’. I would argue that each of these concerns serves to set limits to the extent and upon the timing of the application of MMT but does not fundamentally preclude such application. If the point being made however is that MMT should become the centre piece of all monetary and fiscal policy, then I would agree that such overreach would end badly.


    An excellent case can be made in the context that arose with the October 2008 meltdown and continues to apply in the challenging circumstances presented by the protracted weakness of the US and global recovery in the face of recession and deflation within the EU that, rather than issuing Federal, State and local government debt for the purpose, simply increasing the US money supply over through the US Fed over the past three years to cover the reflation of the US banking system and economy and to defray the US Federal, State and local fiscal shortfalls caused by the meltdown and recession would have served the twin purposes of
    (a) stabilizing the domestic economy, allowing governments to maintain needed services and economic demand through fiscal policy and leaving traditional credit markets in the private sector free to finance private sector investment and commerce, and
    (b) leaving the Federal, State and local governments free of accumulating additional public debt engendered by doing the things described in paragraph (a) above.
    Given the otherwise deflationary bias in the economy since October 2008 this would not create inflation unless and until the economy recovered significantly but, as Mark asks, does not history show that
    (c) governments and the electorate would not show the discipline necessary to contract the money supply through appropriate monetary and fiscal policies once recovery was under way and inflation was in the offing, and
    (d) would confidence in the currency and monetary system be seriously eroded because of this unorthodox expansion of the money supply thereby destabilizing the economy that expansion was meant to engender?


    Addressing questions (c) and (d) above, it should first be noted that the UK, Canada, Australia, the US etc. each expanded their money supply dramatically during and immediately after WW II to fund the war effort and post war recovery and thereafter geared fiscal and monetary policy to keep inflation and public debt costs within manageable limits. Admittedly, while there was a MMT aspect implicit to the policies followed, there were other factors and policies at play. The point being made however that sufficient political discipline is was maintained with the support of the electorate to both expand the money supply to sustain the wartime economy and thereafter to restrain the pace of the post way recovery to prevent unsustainable inflation or growth in public debt. Note as well that the Canadian Government together with the Bank of Canada created (i.e. not borrowed on the open market) and deployed 66 billion dollars with which a substantial portion of the residential housing mortgage holdings of Canada’s private banks were purchased by the Government in the fall of 2008. This was the proverbial win-win-win scenario as the private banks obtained needed liquidity in the face of the global credit crunch following the meltdown, the Canadian Government acquired 66 billion dollars worth of performing mortgages and the stabilization of the Canadian economy and banking system was materially promoted without an increase in the national debt. Inflation in Canada has not ensued and if and when inflationary pressures arise in the future, these will be met by appropriate fiscal and monetary policy because the Canadian electorate will remember that for 12 years preceding 2008 their Federal Government ran an annual budgetary surplus and this, in turn, helped materially to create and maintain the confidence of the markets and electorate in the Canadian economy for those 12 years and, subsequent to 2008, continuing accumulated confidence has given both the Federal Government and the Bank of Canada important added capacity to adopt creative fiscal and monetary policies. There are other examples but this is already too long a comment.


    Put another way, the underlying foundation of a fiat currency (and of the domestic financial and banking systems created on that foundation) is public confidence in the political system and trust between the government and electorate that fiscal and monetary policy will be bounded by the need to maintain that currency as circumstances change. It may be easier to create and maintain that trust under a parliamentary system of government (where the executive is responsible for its day to day actions to the legislative arm and both are accountable to an informed electorate) than under a congressional system where it is more difficult to centre control, responsibility and accountability in as focused a fashion. However, this is a political (in the broader, not partisan, sense) issue and can be addressed under either system.
    18 Jan 2012, 04:19 PM Reply Like
  • Logical Thought
    , contributor
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    Author’s reply » bob,


    Thanks for that detailed comment. I'm not sure, though, how you can have that kind of confidence in our political system in light of Washington's recent inability to get anything done whatsoever that was fiscally responsible.


    As for your example of World War 2 monetary expansion, wasn't that done by borrowing rather than "printing," and wasn't the ensuing fiscal discipline forced by that very concept; i.e., that money borrowed had to be paid back? This, of course, is antithetical to the MMT folks who would "print" rather than borrow, thereby removing the "disciplining concept of debt" from hanging over the heads of voters and legislators. In other words: good luck getting voters to vote to have their taxes raised for the amorphous reason of "fighting inflation."
    18 Jan 2012, 05:20 PM Reply Like
  • bob adamson
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    Thank you.


    There were many aspects to WW II financing within the US and the British Commonwealth countries and it follows that what we would now call MMT was neither the primary focus of public policy nor the rational expressed by national governments during that period to explain what was taking place to finance the war effort. The fact remains that taxation, seizure and sale of share in foreign companies and foreign assets and war bond programs were employed largely to control inflationary pressures created by the diversion of production from civilian goods and services and as a means of reassuring the domestic electorate that everyone would share equitably in the sacrifices. The war was largely financed by deficit financing with only partial support from government borrowing.


    You are quite correct to note that without a broad and informed public consensus concerning the nature and extent that MMT policies would be employed (including a clear recognition from the onset that fiscal and monetary contraction will be a necessary phase in certain circumstances), a broad reliance on these policies will have the problems you describe. Further, it would be dangerous to the role of the legislative arm if the executive arm of government began financing its programs without proper recourse to a legislative approval process. For these reasons I share with you the belief that MMT policies can not and should not become the cornerstone of public monetary and fiscal administration. I am only saying that such policies, employed with moderation and in a appropriate circumstances (i.e. such as addressing the extraordinary circumstances of a major war of financial meltdown) could be the best policy choice provided the necessary mobilization of public and legislative support can be achieved.


    Put another way, the "disciplining concept of debt" in a truly modern advanced nation with sound legal and political institutions is really subsumed within the broader “disciplining concept of public confidence founded upon well functioning and realistic political institutions and process”. As my earlier comment suggested, there are implicit indications evidenced by wartime economic management (and the adjustments with the return to a peacetime economy), the monetary expansion program of Canada’s central bank during the mid to late 1990s to mitigate the steep fiscal austerity program of Canada’s Federal Government at that time (I didn’t fully explore that in my earlier comment) and the 2008 program that provided liquidity to Canada’s otherwise sound banks that such MMT like interventions can work and will receive support by both the public and markets if properly deployed.
    18 Jan 2012, 06:59 PM Reply Like
  • Logical Thought
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    Author’s reply » bob,


    Re. WW2 financing: certainly war bonds were a form of debt. You do make a fair point about the tax increases that also provided financing, but again, it's one thing to get people to vote for higher taxes right after Japan bombs Pearl Harbor and Germany invades Europe, but you'll NEVER get that to happen to "fight inflation," epsecially when peoples' paychecks are already not letting them make ends meet.


    Re. your Canadian example: can you please steer me to some articles or papers that explain exactly what you're saying happened there?


    18 Jan 2012, 07:56 PM Reply Like
  • bob adamson
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    Unfortunately published reports about the 1995 Canadian Federal budget are generally incomplete and often designed to advance some political agenda in Canada or some other country. The following reports together will at least give a general flavour of the challenges and how they were met. The challenges in question were quite daunting but, as I hope you will see from the following reports, the circumstances in 1995 offered a unique opportunity which the Liberal Party Federal Government was wise enough to discern and act decisively upon.














    It should also be noted that
    (a) The Provincial Government of Alberta (the most conservative government in the Canadian context at the time) had implemented a deep austerity program during the early 1990s and the Federal Minister of Finance (of the Liberal Party, which is a centre party in the Canadian context, was then in power nationally) was encouraged by the fact that, after initial public opposition, the Alberta Government actually gained public support by sticking to its policies despite the resulting curtailment of many popular programs;
    (b) The main challenger to the Liberal Party nationally at the time was a conservative party that itself was advocating deep austerity while the Parties representing left wing opinion had recently lost public support.
    (c) It followed from points (a) and (b) that the Federal Liberal Minister of Finance had an opening to pursue a “Nixon goes to China” opportunity.
    (d) International markets for Canadian exports were reasonably secure and the global economy was improving so a combination of fiscal restraint and monetary easing (easing that would both serve to devalue the Canadian dollar and promote growth in the domestic private sector to offset contraction in the public sector) would both improve the Federal balance sheet and not result in a serious domestic downturn.


    I should add that I opposed several important details of the Federal austerity program and of the austerity programs that most of the Provinces were forced to adopt in the wake of major reductions in transfers by the Federal Government to the Provinces. It was my view then and remains my view now that the wrong targets (i.e. important social programs) were chosen and the cuts to these programs were too deep and achieved too rapidly with consequent unnecessary disruption to services upon which many people relied. That said, the fact remains that Canada experienced 12 years of surplus Federal budgets resulting in significant reductions in the national debt and, just as importantly, the general public within a couple of years became quite supportive of the budget surplus
    19 Jan 2012, 01:37 AM Reply Like
  • Logical Thought
    , contributor
    Comments (5485) | Send Message
    Author’s reply » bob,


    Thanks for the links, but I'm not sure that I understand your point. As I thought, the Canadian austerity was forced into place by that country's debtload! Here's the "money quote" from your first link:


    >>...the Liberals were confronting grumbling provincial governments, a tax-choked populace and a road of foreign-owned debt that extends all the way around the world, with stops at the major money markets in Tokyo, London and New York City. Forty-six per cent of the federal government's $546-billion debt - which climbs at the rate of $85,000 per minute - is in foreign hands.<<


    And your second article (the Reuters link) is ALL about the debtload.


    My point (the point of this entire article of mine) is that given the power of the printing press, if debt in a fiat currency is allowed to be rendered meaningless, this kind of austerity will NEVER happen.
    19 Jan 2012, 07:21 AM Reply Like
  • bob adamson
    , contributor
    Comments (4560) | Send Message
    Mark –


    I can understand you confusion. The fact is that no country has employed MMT as such and, even where elements associated with that school of thought have been employed, this (I have been suggesting) has been as an ad hoc response to exceptional circumstances such as a major war or under a broader Keynesian aegis. Essentially my comments were addressing the two impediments your article identifies that you suggest make it impractical to adopt MMT in practice (whatever its theoretical merits) but, and this may well be the source of the confusion, the examples I gave to support my contention that the impediments you cite might well not be as great as you suggest don’t presuppose the ongoing adoption of MMT practices.


    I, like you, doubt that MMT could be adopted in the foreseeable future as the mainstay of a nation’s monetary and fiscal affairs. My reason is that the concepts underlying MMT are counter-intuitive to the thinking of a large majority of people at present and this is not likely to change within the foreseeable future. Given that the application of MMT depends upon political and market support for ever-changing decisions to expand or contract the money supply (even where such shifts might well entail short term pain), I therefore doubt that public policy guided by MMT would enjoy the necessary public confidence that both support of a fiat currency and democratic governance require. On the other hand, I do see both the utility and public and market acceptance potentially occurring for MMT inspired measures in exceptional circumstances (i.e. wartime economic circumstances, response to a financial collapse such as that occurring in 2008 etc.).


    With regard to the fiscal and monetary policies of the Canadian Federal Government and the Bank of Canada between the 1995 Federal Budget and the October 2008 global economic meltdown, we need to remember that Canada had run an annual Federal budget deficit during each of the 27 years prior to 1995 and faced serious political challenges in the form of struggles between the National Government and the Governments of several of the Provinces (the strong separatist movement within Québec being only the most pressing). In fact, it was this political fragility (in the broader and not partisan sense) that called for a response and limited the possible scope of that response.


    While Canada was in 1995 emerging from domestic recession a good case could have been made under MMT to simply begin monetizing a significant portion of the national debt in stages and allow the exchange rate of the Canadian dollar to devalue. There simply were no grounds to assume that a general understanding, let alone a consensus in favour, of such an approach was possible at that time; I highly doubt that such an approach was ever raised for discussion. The Federal Government simply (and, to give them credit, audaciously) seized control of the political agenda by shifting fiscal policy 180 degree by imposing deep austerity. The Bank of Canada ameliorated the domestic impact of this austerity by monetary easing which also had the added benefit of speeding up the expansion of exports through depreciation of the Canadian dollar internationally. In a global economy that was in recovery mode this all worked like a charm.


    As I said in my earlier comment, commentaries about the 1995 budget are often coloured by the political objectives of the person doing the commentary and this can be confusing to the reader. The fact is that the seize of the accumulated national deficit was a legitimate issue (but not necessarily a pressing one of the moment nor by any means the only one); however, the Liberal Minister of Finance in 1995 and following years used dire warning about the national debt to great effect as his rallying cry. We must be careful to distinguish the spin, past and present, surrounding the motivation for the 1995 budget.


    I only raised the 1995 Canadian budget in our discussion as an example of my contention that a large measure of political consensus can be created for austerity measures. I could equally have described the consensus for austerity that was created within the Province of Alberta during the late 1980s and 1990s in response to the collapse of oil revenues to the Provincial Treasury.


    Specifically to the point made in the concluding paragraph of your latest comment: While in some sense "debt in a fiat currency is allowed to be rendered meaningless" under MMT, this is not the same thing as saying that currency exchange rates and inflationary pressures are also "rendered meaningless". I would argue that concerns about falling exchange rates and inflation would become the focus of calls for slowing or even reversing growth in the money supply if MMT applied and, for the reasons I discuss earlier, political consensus could be rallied around such issues in place of around concern for the national debt.
    19 Jan 2012, 02:59 PM Reply Like
  • Logical Thought
    , contributor
    Comments (5485) | Send Message
    Author’s reply » >>I would argue that concerns about falling exchange rates and inflation would become the focus of calls for slowing or even reversing growth in the money supply if MMT applied and, for the reasons I discuss earlier, political consensus could be rallied around such issues in place of around concern for the national debt.<<


    And I've yet to have anyone show me an economy that was able to thrive (and thus control its inflation when necessary) by printing money at will rather than borrowing said money, and I assume that if you had such an example I assume you would have shared it. On the other hand, throughout history there have been many, many, many economies that were able to "accomplish" just the opposite (i.e., destroy themselves by printing money at will).
    19 Jan 2012, 06:13 PM Reply Like
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