by Jack Sparrow
It’s time to put the smackdown on Modern Monetary Theory (or MMT for short).
To be blunt, MMT is fatally flawed, and someone needs to address those flaws head on. (That is the conclusion of yours truly after investigating in recent months.)
If you aren’t familiar with Modern Monetary Theory, the quotes in the blue sidebar may disturb you a bit. They highlight some rather bizarre assertions made by MMT proponents.
In some ways the MMTers are neo-channelers of Dick “deficits don’t matter” Cheney. (Full quote: “Reagan taught us that deficits don’t matter.”)
In reality, what Reagan taught us is that deficits don’t have to matter for extended periods of time. But then, all of sudden, they can start mattering a great deal.
But we’ll get to that… point being, MMTers think deficit concerns are bunk. In fact, they don’t see much reason to worry at all! Dead wrong, as we shall see…
Let me preface by saying I have great respect for the work of Cullen Roche, who blogs at the excellent Pragmatic Capitalist website.
From what I can tell, Cullen is the most vocal and ubiquitous defender of MMT on the web (next to Waren Mosler himself). Because he is so indelibly associated with MMT, I want to stress that my sharp criticisms here are directed at the theory, not Mr. Roche individually.
Let me also throw in that these are just the thoughts of a humble trader, trying to explain economic reality in layman’s terms. I am no policy wonk. My partner and I are just straight up swing traders looking to book 40% annual returns with reasonably controlled drawdowns. But because my views and communication methods are somewhat unorthodox – and because I’ve picked up a few things in my global macro travels over the years – I feel I have something to add here.
We’ll start with some due diligence… then move into the blunt critiques of MMT… then offer a visuals-and-graphics alternative, closing with a recap.
Before we break out the baseball bats, it’s only fair to let the defenders of MMT speak in their own words. For that reason, I recommend the following resources:
- Understanding the Modern Monetary System. This is the full-bore description of MMT as featured on the PragCap website, with a mix of commentary from Cullen Roche and Warren Mosler.
- Mandatory Readings — Moslereconomics.com. Selections from Warren Mosler, the outspoken senate candidate and father of MMT.
- Chartalism. Wikipedia description of the theory in which MMT is rooted.
- Optional but informative: Money as Debt. A 47 minute video presentation explaining the origin and nature of fractional reserve banking, the means by which modern money is created (as a form of debt), and a closing anti-banker argument that is sympathetic to MMT.
The Big Assertion
The big assertion of MMT is that the United States government is self-funding. (See box at right.)
According to MMT,
- The government does not need to issue bonds to raise money.
- The government does not need to tax to raise money.
- Both of these actions (issuing bonds and raising taxes) are simply policy controls, like plumbers adjusting the pressures and levers on a boiler.
For this reason, MMTers further add, the United States government can never run out of money. How could it? The money Uncle Sam spends does not come from bonds or taxes. He just spends it.
As Cullen Roche says, “[The government] finances new spending by telling men and women to walk into a room and change numbers up and down in a computer.”
Sound crazy? It isn’t – it makes perfect sense.
Believe it or not, this isn’t the part of MMT that is fatally flawed. They are right when they say the government is self-funding. They are also right when they say the government can never “run out of money.” (The disagreements – big ones – will come in other areas.)
As MMT argues, the government could technically fund itself without issuing bonds or raising taxes at all. It could simply spend what it needs to spend.
Under this system, the cost of government waste would come in the form of inflation. To the degree that the government diluted the money supply unproductively, they would be little different than the North Korea regime running off truckloads of $100 bill “supernotes.”
But here is the funny thing. This big assertion of MMT – The government can never run out of money! The government is self funding! – is actually not a very important point in the broader scheme of things.
At the end of the day, MMT’s “eye-opening relevation” is simply a technical observation that Uncle Sam has a printing press… that Uncle Sam can run that printing press whenever he wants… and that, therefore, Uncle Sam can always pay off debts issued in his own legal tender.
To which we say: “Yeah, so?”
Monopoly versus Clue
“Well,” the MMTers say, “the fact that the government is self-funding – and could technically fund itself without bonds or taxes at all – means that worrying about deficits is stupid! Deficits don’t matter!”
And this is where MMTers go off the reservation.
Contrary to what MMT argues, deficits still matter, even in a regime where the US government cannot technically default.
A lack of technical default does not preclude DE FACTO default, or default-like degradation by incremental degrees, as investors shift their asset mix preferences over time.
To understand why, consider the game of Monopoly. MMT proponents like to point out that “the banker in Monopoly can never run out of money.” And this is more or less true! We happily concede this point.
The U.S. government is like the banker in Monopoly in that government issuance of currency and debt is a closed loop, with all U.S. debts payable by U.S. currency (which has no limits).
So why are MMTers wrong about deficits? Because there is more than one board game to play.
To wit, if the Monopoly banker grossly abuses his priveleges, investors can go and play some OTHER board game. They can choose to play “Clue” instead. (As in, getting a Clue. Get it? Ha ha…)
Let’s break it down:
- The Monopoly banker can “never run out of money.”
- But the Monopoly banker can also abuse the system.
- In response to this, investors can choose to play a different game.
- They play a different game by reducing their preference for U.S. liabilities.
Why are top hedge fund managers like David Einhorn, John Paulson and George Soros aggressively long gold? Because they are in effect saying:
Mr. Monopoly $USD Banker, we do not like the way you are abusing your privileges. We know you cannot technically default, but we still feel your actions are grossly irresponsible… and so we choose to STOP playing Monopoly and go play Clue (i.e. buy gold) instead.
Debunking the Chartalist Defense
Still with me so far? MMT crows that the United States government is self-funding, that it can “never run out of money,” and that most people don’t understand this. In this MMT is correct.
But they neglect to acknowledge that, if the government abuses its Monopoly privileges, investors can change their preferences and play a different game, i.e. rotate out of U.S. liabilities (bonds and currency) and into alternatives (hard assets, other currencies, E.M. etc).
“But hold on one minute,” the Modern Monetary Theorists say. “There will ALWAYS be demand for U.S. currency – because we need it for transactions and payroll and taxes!”
This idea extends from the Chartalism school of thought. As a U.S. citizen, you get paid in dollars and have to pay your taxes in dollars. Also, if you want to go down to the store and buy milk or gasoline or shotgun shells, you have to conduct your transactions in dollars. Therefore, hey presto, permanent currency demand.
But consider this:
- Americans can travel Europe while holding no euros.
- Brazilians can travel the United States while holding no dollars.
- Australians can travel Japan while holding no yen… and so on.
How is this is so? Through the power of instant conversion transactions. When you use your major credit card to buy something for sale in a currency other than your own base currency, the bank makes the conversion for you on the spot. This reality makes it possible to limit one’s currency exposure to point of sale only!
The same applies with tax and payroll considerations. What is to prevent a U.S. based business from holding its cash reserves in, say, a mix of Canadian dollars and Swiss francs, then converting the necessary funds to $USD only at the instant point of transaction, i.e. when they pay the tax?
And as for payroll, why couldn’t a company wait until the last second to convert its payroll accounts from, say, Swiss francs to dollars… with employees again making the switch from $USD to something else as soon as the paycheck hits their accounts?
Heck, let’s take this further. Thanks to the modern miracle of ETFs, you could keep 99% of your net worth in copper, crude oil and cotton if you really wanted to. Whenever you needed $USD for a transaction of some kind, you could convert instantly – “point of sale” – and hold no dollars otherwise.
The argument that “there will always be demand” for a currency because of tax, payment and transaction requirements thus seems dubious at best. There is nothing (at least for now) to prevent even U.S.-based investors from
1) shifting their preferences away from $USD liabilities, and
2) minimizing their exposure to $USD to as small a footprint as possible (and hedging even that!).
Let us also note that the “constant demand for the currency” argument in part stems from U.S. hegemony and the use of the $USD as the world’s reserve currency.
But this is a situation that can change – just ask the British Empire! And because world reserve currency status can be lost, slowly and by degrees, it makes sense to show concern at the margins. Like when major players such as Russia and China take concrete steps to remove the middle-man $USD from their trade flows, for example.
The Plucked Chicken Problem
Here is where this MMT stuff gets amusing. These guys don’t understand that a technically correct definition is not the same as a relevant and useful argument.
They crow about how the United States government is self-funding… and they go on about how taxes and transactions create demand for a currency… without realizing that these technical assertions are not relevant to the true problem.
Again, the true problem is that investors can shift their preference away from the Monopoly banker’s closed loop system when the priveleges of that system are abused.
To the degree that this is missed, all the hubbub about a “technically correct” definition is meaningless!
It’s like the old story of sober Plato and the prankster Diogenes (see box). MMTers are like Platonists walking around saying “Man is a featherless biped!”
While the featherless biped definition is technically correct, it is also subject to severe problems (as Diogenes’ plucked chicken so demonstrated).
The same is true of MMT’s big assertions. Their self-funding stuff is technically correct, but irrelevant to the endgame problem of shifting investor preferences when the Monopoly banker goes rogue.
Is this Critique Unfair?
Some might say the above critique is unfair.
After all, at least in passing, MMT does address the “bad spending and shifting preferences” problem. From the TPC website:
Thus, government cannot just spend and spend and spend or the extra dollars in the system will chase too few goods and drive up prices. It’s important to understand that government cannot just spend recklessly. This is important so I’ll say it again. This does not give the government the ability to spend and spend and spend. If they spend too much and tax too little they can create mal-investment and inflation.
Well stated by Cullen Roche and quite true! And yet, the opening quote box is now replicated to make a point. MMT pays lip service to the “can’t spend and spend” idea, but then MISSES THE IMPLICATIONS.
To wit, if constraints on the government’s ability to “spend and spend” are truly understood and acknowledged by MMTers at large, then why does Mosler say that “government debt is not true debt” and that “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it?”
And if “spend and spend” has acknowledged negative consequences, then why does Cullen Roche sharply imply that funding costs are irrelevant?
In a world where the government cannot “spend and spend” willy nilly, funding costs certainly ARE relevant because the printing of currency to service high interest rate debt issues is most assuredly an UNPRODUCTIVE use of funds!
Imagine Uncle Sam printing an extra trillion bucks every month just to cover interest payments. Yeah, he could technically do it… but what effect would that have? Not a small one.
One of the mildly maddening things about MMT, it seems, is that there is a willingness to lightly address certain “mild” critiques in passing without acknowledging that those critiques actually blow a huge hole in the strongly stated assertions of the theory.
‘I am Immortal.’ Really?
Yet another problem with MMT – not stated outright, but heavily implied – is the assumption that the United States government is financially immortal.
MMTers think and act as if deficits don’t matter, no matter how big they get, solely because Uncle Sam can write his own checks in a neat little closed-loop system.
Yet this viewpoint neglects the reality that, given enough abuse of privilege, the entire system can be abandoned to a point of critical threshold collapse – or abandoned to a great enough degree to cause massive problems, even if the baseline system survives.
Longevity and immortality are not the same thing. Present strength can (and often does!) degrade into future weakness.
At this point the MMTers resort to a situational defense. They pooh-pooh the idea that investor preference will ever shift away from $US debt and currency to a significant degree because the U.S. is, at this present point in time, still hegemonic and strong. In part they lean on the chartalist taxes and transactions argument – a leg of the stool we have already kicked out.
But more aggressively they point out the United States is uber-dominant — 25% of the global economy etc – and that there are no signs (supposedly) this will change. Therefore, why worry about default?
But this argument is extremely weak from a theoretical standpoint. Why? Because saying “the U.S. is too strong to fall” is a long way from saying “the U.S. can never fall.”
Philosophically, the “U.S. can’t fail” argument is comparable to this:
- Immortals live unceasingly and never die.
- I too have lived unceasingly and never died.
- Therefore I must be immortal…
Of course, the individual who assumes immortality is in for a rude surprise. The same could be said for many an empire…
Here is a more logical approach to the sovereign immortality question:
- Many (all?) “too strong to fail” empires eventually do fail.
- It is possible that this could happen to the United States.
- If history is a guide, and if it happens, it will be by degrees.
- Slowly slowly at first… and then, one day, suddenly.
And here is where MMT goes really, really wrong:
Because MMT leans so heavily on the “self-funding” argument, the chartalist “always a demand” argument, and the present economic supremacy of the U.S., they completely dismiss (or hand wave away) the threat that shifting investor preferences could eventually bring down the empire.
In thus so doing, they dismiss the possibility of death by degrees.
Or to put it another way:
- Only if the U.S. is financially immortal can deficits not matter.
- If you admit the U.S. is not immortal, you admit the possibility of death.
- If death happens, it starts incrementally… in small degrees.
Note, we are not flat-out predicting the financial downfall of the United States here. (No hyperinflationista or deflationista labels, thanks.) We are merely pointing out that, if downfall is theoretically possible (due to shifting investor preferences), then concern at the margin can be warranted or at least justified.
Or to put it another way, you don’t have to think “the dollar is going to zero” to have legitimate concerns about where it is going! The hyperbole label — everyone worried about the deficit is a hyperinflationist / deflationista — is a sort of subtle ad hominem.
As such, it’s really quite funny to see MMTers snarling at all the “fools” who show concern over U.S. debt levels. Those who show concern are only “fools” if the U.S. is bulletproof.
But if the U.S. is NOT bulletproof… if the self-funding regime can at least theoretically be abandoned to a critical threshold point… then the small signs of decay are not to be dismissed. Instead of meaningless worries, they are genuine concerns, like the frog in the pot slowly being boiled.
The 5th Dimension Problem
Here is another issue with Modern Monetary Theory. Imagine if I told you that, of all the animals in the animal kingdom, elephants are unique because they live in five dimensions.
All other animals get four dimensions (three physical dimensions plus time). But for some wacky reason, elephants get five. Then further suppose that, when you pressed me on why this is true, I assured you that my theory was sound and you just had to accept it.
The analogy here is to the weird place of self-funding governments in MMT.
All other entities – households, individuals, businesses – are subject to more “normal” economic rules. Yet somehow governments are the magical alchemist elephants… they supposedly have some bizarre fifth dimension factor (born of self-funding elixir) that makes them normality-exempt.
Yours truly argues that the fifth dimension does not exist and there is no call for theorizing it. Elephants (i.e. governments) get four dimensions like all the other mammals.
Why? Because a sovereign governments’ ability to do what it does, within the constraints that it faces, is wholly explainable by the ‘normal’ laws of economics. We do not need weird or bizarre exemptions.
“But governments are different,” MMTers say. No they aren’t – not really. They are just bigger.
It’s true that the United States government can fund itself, a unique proposition. But you know what? I can “fund myself” too… and so could you if you wanted. The question is, who would accept our paper and why!
An entity’s ability to “fund itself,” then, does not depend on whether it is a government or not. Instead it depends on that entity’s credibility as a powerful force, which in turn depends on access to real productive assets.
The government’s self-funding fifth dimension “magic trick” is thus actually very mundane. The credibility and ongoing acceptance of the government’s self-funded paper is only achieved via the leveraging of the real U.S. economy, i.e. government access to real productive wealth by threat of force!
Economic power flows from the barrel of a gun… the government has the ability to tax and appropriate.
If (as a U.S. citizen) you disagree with your tax bill, or choose not to pay what Uncle Sam asks, you get thrown in jail. Therefore your assets are, in effect, Uncle Sam’s assets for the taking. Your balance sheet is a part of his balance sheet. Uncle Sam self-funds, in part, on the power of leveraging YOU.
Uncle Sam can’t force you to hold your savings in $USD – at least not yet – but he can take an arbitrary chunk of your profits, and in so doing extract some of your productivity for his own doing. This is the key thing.
The only reason any of us play the “Monopoly banker’s game” in the first place is because the Monopoly banker has access to the full scope of U.S. productive assets, the value of which the government can extract and appropriate by force.
It is the perceived value of these assets that keeps faith and confidence alive.
The government relies on collateral
In this, the United States government has a cache of “collateral” at its disposal – in the same manner that individuals and businesses have collateral. Ask yourself:
- How big a loan could a poor man get with $50 (fifty bucks) in collateral?
- How big a loan could Bill Gates get with $50 Billion in implied collateral?
- How big a loan could Uncle Sam get with $50 Trillion in implied collateral?
- Bigger implied collateral = more leverage and a longer leash. That’s all.
There is no need for a fifth dimension in which governments can fund themselves infinitely, because governments cannot fund themselves infinitely (except in a meaningless ‘technical’ sense). Credible access to underlying assets constrains them!
The amount a government can leverage itself is linked to its “collateral,” i.e. the size of the economy supporting it. A government’s ability to “self fund” in the MMT-described method, then, is bound by the outer limits of investor credibility… which, in turn, are impacted by the “collateral” of taxable real assets at the government’s disposal.
Consider: An individual, were he rich enough, could “self fund” too. Imagine if Facebook grew to six billion users, putting Mark Zuckerberg’s net worth (as a global social media monopolist) at $6 trillion.
Then further imagine Zuckerberg bought a modest sized country, funded his own army, and began “self funding” with Zuckerbucks and Zuckerbonds. Would these units have perceived value and be accepted as mediums of exchange? Yes they would… because the collateral (and force) would be there to back them.
Governments aren’t so different. They are just big bullies whose “self funding” operations are means of leveraging the collateral credibility built into the asset side of their balance sheets (the economy’s real wealth).
The Productivity Problem
Modern Monetary Theorists have another problem. They don’t properly address productivity, and the productivity issue is extremely important.
Consider the (true) assertion that the U.S. government could fund itself without taxes or bonds. This highlights that the government’s spending choices are unlimited. But will all choices on the roster have the same impact on the economy?
- Imagine a “wise government” scenario in which $100 billion is spent on the new century equivalent of Eisenhower’s highway system.
- Imagine that this new system contributes dynamically to the healthy growth of the economy in the years moving forward.
- Now imagine an “idiot government” scenario in which $100 billion is spent on the economic equivalent of hookers and cocaine.
Can we really say that the downstream economic impact of those two scenarios is the same? Of course not. When the government chooses to spend money – be it borrowed, extracted via taxation or created directly – it still matters HOW that money spent.
The importance of wise spending is addressed in passing by MMT, but nowhere near thoroughly enough, and not in consistent fashion with MMT’s main assertions.
Productivity of investment is incredibly key… Why? Because funds spent and invested productively contribute to the health and growth of the U.S. economy, whereas funds NOT spent productively do not.
The importance of this distinction cannot be understated, yet MMT glosses over it. Why? Because Modern Monetary Theory does not properly address the vital linkage between fiat money creation and the real productivity of the U.S. economy.
Productivity – tangible assets and the volume of real goods and services provided – is what counts as genuine wealth. The digital 1s and 0s riding on top are just manipulated transaction mechanisms.This is why it is so important to distinguish between productive spending and unproductive spending. Productive spending adds to the real wealth of the real economy. Unproductive spending does not.
Quality of spending (and borrowing) thus has powerful impact on inflation and deflation, as we are about to see visually…
The Stable Inflation Model
In the most desirable of circumstances for a modern economy, inflation is “low” and “stable.” What does this mean? How can we characterize this favorable situation?
The above compares “total credit flows” – all the credit and debt in the economy, created by various means public and private – with the size of the real economy itself. Total credit flows naturally include currency, loans, bond issuance etc, as they are multiple sides of the same coin. (“Money” is fluid and takes many forms.)
So, as long as there is a dynamic yet stable relationship between credit flows and the ‘real wealth’ of the underlying economy, inflation will be benign. This is due to a match-up in the relative size of the two entities.
Furthermore, if the size of total credit flows and the size of the real economy grow at roughly the same rate, this happy situation will persist – not unlike two cars traveling in parallel at the same speed.
In a perfect world, general price levels would be stable and there would be no inflation at all. But that level of matchup between credit flows and the economy is impossible, because the overall process is too dynamic. Loans are constantly being extinguished and recreated, productive output and profits are fluctuating up and down, and so on.
So rather than zero inflation – which is too close to deflation — central bankers aim for a “stable rate of inflation” instead, a situation where total credit flows are more than required for the real economy to run smoothly, but just by a little bit. (Thus talk of a “stable” inflation rate in the 1 – 2% range.)
The Supernova Boom
Now we see what happens when unproductive debt levels expand and widespread malinvestment kicks in. As the government blatantly attempts to massage credit flows, investor risk appetite increases. As a love of risk comes to dominate, unproductive debt levels rise along with poor choices of investment.
The specific problem with an unproductive debt boom (and gross malinvestment to go with) is that the taking on of such increases the total amount of credit flows, WITHOUT a corresponding increase in the real wealth of the economy.
In practice, this phase of the cycle is marked by lots of folks making lots of dumb decisions:
- Investors chasing risk assets to nosebleed valuation levels
- Consumers leveraging themselves beyond prudent levels
- Aggressive business capacity expansion based on false signals
As more bad debt decisions are made, total credit flows increase well beyond the needs of the real economy (as malinvestment does not create corresponding productivity or real wealth). This leads to a classic supply and demand situation where there are more credit flows on hand than required – and so the extra flows push prices up (i.e. cause inflation)!
Of course, just where this inflation shows up varies from case to case. Sometimes the results of an unproductive debt boom can show up as pure, unadulterated asset inflation. This is the heroin and cocaine of Wall Street – when all those extra flows push up the value of stocks, real estate, junk bonds etcetera while leaving the Fed’s traditional inflation warning gages untouched. Party!
Also of course, paper asset inflation can be just as destructive as any other kind of inflation. Think of the self-reinforcing nature of the housing bubble, as more and more builders and flippers and real estate buyers piled on the leverage in a self-perpetuating orgy of myopia and greed.
Note this process is entirely consistent with the Von Mises prophecy as explained last week. And once the debt boom finally hits critical mass, we get…
Supernova Debt Collapse!
As Walter Bagehot, 19th century editor of The Economist, observed: “at particular times a great deal of stupid people have a great deal of stupid money… At intervals, from causes which are not to be the present purpose, the money of these people — the blind capital, as we call it, of the country — is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone and there is ‘speculation’; it is devoured and there is ‘panic’.”
Though Bagehot died in 1877 – more than 130 years ago – his description of the boom-bust cycle is still accurate in this era of “modern” monetary systems. That is because the boom-bust cycles of today, just like those of yesteryear, are driven by a build-up of malinvestment and unproductive debt.
The key distinction is not between “public” and “private” but “productive” and “unproductive.” This is because productive credit flows facilitate corresponding growth in the real wealth of the real economy, whereas unproductive credit flows do not.
When the artificial boom implodes, the result is dramatic – and deflationary. As with a collapsing star, the relationship of available credit to the functioning real economy goes from “massive overabundance” to “massive shortage” in the space of a market crash. Where banks would lend to anyone before, suddenly they lend to no one. Where investors were brazen before, suddenly they are terrified.
During a supernova collapse, trillions of dollars in private credit flows evaporate into the ether – the result of loans being extinguished in a panic but not replaced. It is this type of situation where the authorities can find themselves helpless, as the size of privately created credit flows is gargantuan compared to what the Fed can gin up on short notice.
False Trend Application
As an added bonus, this model has great utility for traders willing to exploit the false trends of Soros fame.
Note the blue arrows – during the time when the supernova is expanding, you don’t want to be ignoring or fading the false trend… you want to be riding it!
The unproductive debt boom can create excellent opportunities for the trader willing to stay long on the way up, while watching closely for the time to go flat (or even reverse and go short) as the supernova threshold approaches.
Note, too, that this model is consistent with the increasingly feverish waves of investor sentiment as the unproductive debt boom reaches critical mass. The supernova burns at its hottest and most expansive not long before imploding.
It’s the Real Economy, Stupid
Note an important theme running all through this critique: It’s the real economy that matters. Always has been, always will be.
Real wealth is not created by a printing press or punched out by government decree. Real wealth is assets, savings, goods and services – the productive output of the underlying economy itself.
And thus the dog-and-pony show of self-funding government regimes counts as little more than a technicality. The U.S. government never has to technically go into default… fine, so what. The financial power of the United States government is still inextricably linked to the productive power of the real U.S. economy.
And this is why it is the split between productive and unproductive that matters most. Productive investment allows for a corresponding increase in the health and size of the real economy. Wasteful malinvestment does not.
This split also shows why Warren Mosler is wrong in his goofy assertion that “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.”
He is wrong because of the following:
- THE GOVERNMENT CAN SPEND AT WILL, BUT IT CANNOT SPEND PRODUCTIVELY AT WILL.
You want 600 billion bucks worth of “da juice?” No problem, Uncle Ben can get that for you.
You want to ensure that the 600 billion bucks is channeled and directed wisely so as to ensure the healthy and productive growth of the real economy? Can’t help you in that department.The government is to efficiency as Britney Spears is to gravitas. And thus when the government malinvests, i.e. borrows or spends unproductively, it does not help things. In fact it only makes matters worse.
And again, the need to spend productively also shows why funding costs actually DO matter. When funding costs reach unacceptable levels, huge amounts of government spending become unproductive, as new credit flows are ginned up to pay off increasingly onerous debt obligations.
When nervous investors shift their preferences as funding costs escalate, creating a self-perpetuating doom loop in the final stages, the “alchemist who never runs out of gold” can still find himself in quite a jam.
Ignoring the Lessons of History
A final irksome point of MMT: In their zeal to embrace a mere technicality (the ability of modern government to pay with a printing press), the lessons of history are forgotten and discarded. Lessons such as these:
- Over time, every empire has hit a “sell by” date.
- Boom and bust is in man’s nature… his psyche… his DNA.
- It is human tendency to ignore problems until the last moment.
That last point is especially important. Through the millennia, we have seen countless collapses at all levels. Individual and family fortunes, business empires, and sovereign empires have all built up over time, then come crashing down with great regularity.
What’s more, the onset of such crisis often looks like a bridge collapse.
For a long time, small stresses and cracks build up in the bridge – but you don’t see them, unless you are looking hard for them.
So for those with a misplaced sense of confidence it is easy to say, “Oh, the bridge is fine. It’s been here for decades… it’ll always be here…”
Until one day the wrong truck drives over the bridge, or the wrong micro-stressor gets impacted – and the whole thing goes down in a flash.
Is this a prediction? No, but it is a call for genuine concern. If the American empire is like a bridge, then today we can see micro-stresses – cracks in the foundation – all around us.
The conditions under which America attained world reserve currency status are eroding at the margins. Players like China and Russia are taking small but meaningful steps to cut the $USD out of their trading patterns. Washington seems to have lapsed into the hands of a quasi-financial oligarchy, bent on preserving stimulative asset inflation policies at all costs (regardless of the damage to the real economy).
Against this backdrop, I believe, Modern Monetary Theorists come down on the wrong side of history. They ignore all the micro-stresses in a quaint belief that “self funding” is akin to immortality, neglecting the impact of shifting investor preferences as credibility and confidence ebb.
“Bah!” the MMTers say. “Deficits don’t matter – the U.S. government will ALWAYS be able to fund itself!”
This attitude is not helpful. Technical default may be an impossibility, yes. But de facto default, or a long slippery gradient to such as bad debts and malinvestments mount? That is certainly a possibility – one that MMTers claim not to see.
So now let’s wrap this up with a recap:
- MMT says it’s important to understand the government is self-funding and can’t run out of money. We say “meh” – this is true but not that big a deal. It’s the functional equivalent of saying Uncle Sam owns a printing press with no “off” button.
- MMT says (or strongly implies) deficits don’t matter because the Monopoly banker can’t go broke. Again we say “meh” – not the critical point. If the Monopoly banker (i.e. the Federal government) abuses his priveleges, investors can shift their preferences. They can walk away from the Monopoly board and go play “Clue” instead, moving their assets into fiat alternatives.
- MMT verbally acknowledges that governments cannot “spend and spend” unproductively, but fails to pursue the implications of this truth. The overwhelming message of MMT (and especially of Mosler!) is that the United States government is “unconstrained” in all the ways that matter – a serious inconsistency.
- MMT says there will always be a demand for currency because of taxes and payments and transactions. We rebut this by pointing out how easy it is to avoid holding a currency, even your own local one, by conducting all necessary business solely at the point of transaction. There is no reason a U.S. based business couldn’t hold its cash reserves in Swiss Francs or crude oil if need be, converting to dollars for payment purposes on a just-in-time basis. A U.S. employee paid in $USD can do the same thing, converting dollars to something else the moment they hit the account.
- MMT implies that U.S. government self-funding equals financial immortality. We say no, the ability to avoid technical default does not translate to a free pass. Even a self-funding monetary system can experience severe decline if investors lose faith and shift their preferences at an escalating rate.
- MMT suggests that governments are special economic entities worthy of their own 5th-dimension-like rules. We say no, governments are faced with implied collateral requirements and leverage credibility restraints just like anyone else. It is the wealth of the real economy that gives a government leverage, little different than the leverageble and accessible wealth within a household or a business.The ability to write blank checks against one’s own IOUs is great, but not a qualifier for special treatment above and beyond other economic entities.
- MMT glosses over the importance of productivity and prudent investment — paying lip service to such, but then promoting contradictory assertions. Another MMT aphorism, “the gold alchemist can never run out of gold,” shows the deeply misguided psychology that MMT cultivates. The United States government is not an “alchemist.” It cannot conjure up gold. It can simply expand or contract credit flows to good or ill consequences, depending on the soundness of its choices… and a successive chain of ill choices can lead to disaster.
- MMT does not fully account for the role that bad spending, unproductive debt build-up, and malinvestment surges have in fueling Austrian style boom-bust cycles, which have been around for centuries (or even millennia). The supernova model demonstrates these effects quite clearly.
- MMT fails to acknowledge, let alone give proper weight to, the fact that THE REAL ECONOMY IS WHAT MATTERS. This negligence is shown by the wackiness of “Mosler’s law,” which assumes that all spending can be beneficial by decree, regardless of whether such spending translates productively to real economic benefit or no. The short-sightedness of MMT is also shown by the “Monopoly banker” and “alchemist can’t run out of gold” memes, which de-emphasize the importance of real economy impacts in favor of playing up a trivial point.
- MMT ignores the lessons of history in its general smugness as to the U.S. financial position. Once again, lip service is paid – “yes we must be responsible” etc – but the main assertions of MMT sing a much more cavalier tune and are thus all wrong. We should not think of the United States government as an all-powerful entity that is financially immortal. We should perceive it for what it is – a facilitator of overextended empire, making a semi-alarming series of unproductive spending choices, with all the latent dangers that such a profile entails.
Forrest Gump: “And that’s all I have to say about that.”
Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.