Policy Makers May Have Already Embraced Modern Monetary Theory
Summary
- Whether the pandemic has forced the issue or Modern Monetary Theory is an idea whose time has come, it is now a factor to be considered.
- Despite massive quantitative easing in the United States and Europe over the past decade, inflation continually undershot the expectations of many financial market participants.
- The inflationary impulse that would be expected to result from massive infrastructure spending might be offset by lower fossil fuel prices as the spending accelerates the switch to electric vehicles.
- Because gasoline is such a visible commodity, energy prices have an impact on inflationary expectations beyond their weight in the consumer price index.
- Policy makers may have already embraced Modern Monetary Theory even as they publicly disparage it.
The discipline of public finance is undergoing drastic change. In 1980, before accepting a vice presidential role, George H.W. Bush referred to the Reagan economic program as voodoo economics. Cut taxes at the top, reduce government’s role in the economy, and growth will soar to the benefit of all. The phrase and the policy have dominated for the past forty years, but it is about to change.
The Biden administration is rejecting the trickle-down theory in favor of a return to the New Deal and Great Society eras of an expanded role for the federal government. Its goal is to lift the socio-economic groups at the bottom end of the income and wealth distribution while asking those at the top to help finance the spending on new programs in order to accomplish this goal.
Until recently there was universal agreement that in times of crisis, whether it be war or pestilence, the government must borrow as much as is necessary to deal with the crisis. However, just as in the case of an individual’s personal finances, there used to be universal agreement that any federal debt incurred because of an emergency should be paid off or at least reduced as soon as possible once the crisis is past.
As we illustrated in our report dated January 17, 2021 The Post Pandemic World: Lion or Lamb, the federal debt incurred as a consequence of World War I was mostly repaid over the next decade. The federal debt rose from about 7.5% of GDP prior to the war to about 35% in 1919. By 1929 it had fallen back to about 16%. Similarly, borrowing for the much more expensive and protracted American participation in World War II pushed the federal debt to nearly 120% of GDP by 1946. A decade later it was at 60.7% and it eventually bottomed at about 31% in 1981.
In the 1980s and 1990s, federal deficits were still deemed to be undesirable. In the mid-1990s, House Speaker Newt Gingrich pushed a Balanced Budget amendment which passed the House and came within one vote of passing the Senate. The sentiment influenced the Clinton administration which not only declared the era of big government to be over, but in 2001 led the President to urge that the country should continue to balance its books and pay off its debt.
But snatching victory from the hands of defeat, since the turn of the century federal deficits have been the rule, both cyclically and structurally. And as a share of the economy, budget deficits have been getting larger and larger while income and wealth inequality became more skewed.
There are several reasons. First, the era of the 1980s and 1990s saw the nexus between deficits, inflation, interest rates and crowding out the private sector totally break down. Despite persistent deficits, interest rates and inflation declined, and growth soared. The second was the pronouncement by then Vice President Dick Cheney that “deficits don’t matter” to justify the deficit spending incurred by the war in Iraq and the concomitant tax cuts that occurred. The third factor was simply the proclivity of law makers of both political parties to spend to please their constituents rather than be concerned with the long-run consequences because as J.M. Keynes was fond of saying: in the long run we are all dead.
Until the pandemic, the extreme example of this was the reluctance of the Trump administration to control spending, even as it passed a big tax reduction in 2017. In 2019 with the economy rolling along at full employment, the federal budget deficit was running at 5% of GDP. The jury is still out, but this may very well prove to have marked the beginning of the demise of “trickle down” economics.
The pandemic is an emergency that all agree demanded a response from the federal government. The response has been huge indeed, with some $4 trillion of federal relief being disbursed in 2020; another $2 trillion being implemented thus far in 2021, and at least another $3 trillion being proposed for 2022 and beyond. The federal deficit soared to about 20% of GDP in 2020-2021; by far the largest since World War II. And the public debt as a percent of GDP climbed to about 100%, also the highest since World War II.
Whether the pandemic has forced the issue or Modern Monetary Theory (MMT) is an idea whose time has come, a form of MMT is being embraced by policymakers. Even current Federal Reserve Chair Powell threw some support for MMT in recent congressional testimony. When asked about the large amount of treasury bonds the Federal Reserve is purchasing on a monthly basis to help finance spending, he responded that the total debt obligations of the federal government are the same whether the debt is treasury bonds held by the public or the obligation of the federal government is in the form of bank reserves. The banks’ reserves are an obligation of the Federal Reserve, which of course is a part of the federal government.
Taken to the extreme, if the Federal Reserve is on board with financing the deficit, MMT would argue that there is not anything priced in dollars that the U.S. cannot “afford”. And because everything is priced in dollars domestically, and most everything can be priced in dollars globally, the U.S. can “afford” to buy anything it wants. And no, the government does not need to tax or borrow to do it. Recent history should dispel the notion of inflation; but were it to erupt, MMT adherents argue that it need not be addressed urgently. Even treasury secretary Yellen is espousing this view.
Proponents of MMT argue that their model better describes the manner in which the post-war world works in terms of central bank operations. Indeed, Japan is often cited as a successful experiment as it has encountered huge deficits, low interest rates, and no inflation. The trillions of Sovereign debt that trades at a negative interest rate is also cited to support the MMT position that something is amiss with mainstream economics.
Of course, MMT proponents fail to address the struggles Japan and other countries have had in achieving economic growth. But the world faced the same problem in the 1930s which the macroeconomics developed by J.M. Keynes failed to solve. The MMT assertion that deficit spending can drive down interest rates, encourage investment, and thus crowding in economic activity is exactly the opposite of Keynesian economics.
One can only imagine what J.M. Keynes and others of his time would think of negative interest rates and Bitcoin with a market capitalization of over one trillion dollars. He might think that if Satoshi Nakamoto could create $1 trillion of Bitcoin out of thin air, without any sovereign backing or legal status, then central bankers like Jerome Powell can indeed create an unlimited amount of its own fiat currency.
This proposition is about to be tested by the implementation of the American Rescue package, which has passed the congress, and the American Recovery Plan, which is proposed but not yet law. Contained within the recently enacted $1.9 trillion American Rescue Plan are several categories of transfer payments. Aside from temporary aid to airlines and restaurants to name a few, there are payments to individuals earning up to $150K per household and $3,600 per child to families with children.
The child payments can be paid in the form of monthly $300 checks. The progressive wing of the democrats has stated that its major goal will be to make the $3,600 per child payment permanent and refer to it as guaranteed basic income. Whatever one thinks about the efficacy of guaranteed payments to everyone below a defined income threshold – which of course would be adjusted annually like Social Security – it is an effective way to redistribute income and thus presumably reduce inequality.
Until 2020, universal basic income (UBI) was mostly considered a fringe idea proposed by Milton Friedman as early as the 1960s; presidential candidate George McGovern in the 1970s; and more recently by presidential aspirant and currently New York mayoral candidate Andrew Yang.
MMT is gaining acceptance within the Biden administration but the inflation bogeyman is still looming as an issue in the financial markets. To this day the inflation process is not well understood, so proclamations about its course run the gamut. Milton Friedman is famously quoted as saying inflation is always and everywhere a monetary phenomenon. But Friedman’s crucial assumption was that money velocity is stable. Velocity has been anything but stable in recent decades. Japan has printed yen like crazy beginning in the 1990s with little success in fending off deflation. Despite massive quantitative easing in the U.S. and Europe over the past decade, inflation continually undershot expectations.
During these periods, the economy has undergone several commodity cycles. Oil has arguably behaved most violently in these cycles, peaking at over $100 per barrel on several occasions, and actually falling below zero in the pandemic-induced global demand collapse. Former Fed Chair Alan Greenspan often said that oil is more important than all other commodities combined. But on balance, history shows no reliable correlation between oil and inflation nor commodity cycles and inflation.
The inflation of the 1970s was an outgrowth of Lyndon Johnson’s "guns and butter" economy of the 1960s – a forerunner to MMT? But intertwined with this was the twin oil embargoes of 1967 and 1973 which triggered a quadrupling of the oil price. At the time, oil usage was intricately linked to economic activity. And because gasoline is such a visible commodity, energy prices were believed to significantly affect inflationary expectations.
But as fossil fuel usage became more efficient, its role in influencing economic activity and inflation was seen to be the opposite of conventional wisdom. Periods of rising prices came to be seen as positive for economic growth as industry profitability would bolster capital investment, while being deflationary because it sapped discretionary incomes of households and thus weakened prices for other goods and services.
The most recent example was the 2010-2016 period when crude prices rose from a low of about $30 per barrel in 2008-2009 to about $130 per barrel in 2015 with no impact on inflation. But it supported an industry-wide capital spending boom that was augmented by the introduction of dynamic fracking. Ironically, the Obama administration and the Biden administration are considered to be anti-fossil fuel, but it was the fossil fuel boom that bolstered the Obama administration’s otherwise weak economic rebound from the 2008-2009 financial crisis.
The world is currently awash in oil. Global excess capacity is estimated at about eight million barrels per day. Prices have nevertheless been rising over the past year to about $60 per barrel currently. This reflects an expectation of a post-pandemic demand recovery as well as the success OPEC plus Russia is enjoying in controlling output. Russia is profiting handsomely from this year’s price rise. Saudi Arabia is too, but because estimates are that Saudi needs about $85 per barrel to balance its budget, the perception is that prices will continue rising.
Once again, the U.S. is along for the ride as industry activity is on the rise even as the Biden administration throws roadblocks in the way of domestic exploration and production. Meanwhile, the price of gasoline is rising as well. But as yet there is no evidence that it is having an effect on inflationary expectations or household purchasing power.
Evaluating oil’s importance in the inflationary deflationary debate could again undergo a transformation as renewables, particularly vehicle electrification, gains in popularity. A centerpiece of the Biden administration’s Green New Deal Economic Recovery proposal is the electrification of America with vehicle charging stations being erected from coast to coast, and an extension of generous tax credits for solar and wind power, and for the motor vehicle industry.
To be sure, electrification requires a major upgrade and expansion of the electric grid and this is not a small endeavor, physically and financially. California has demonstrated this in spades as its power industry encounters the wrath of both environmentalists and regulatory authorities which push back on rate increases.
Even assuming a successful transition from fossil fuel, there still may not be a discernible impact on overall inflation. The price of both electricity and fossil fuel would likely rise, but fossil fuel’s overall weight in the household budget would shrink as the weighting of electricity rises. Since relative and not absolute price changes are what matter for inflation, the net impact could be negligible.
In the short run, post-pandemic euphoria could well be accompanied by a recovery in money velocity. And if as expected, the measured rate of inflation gains momentum, some will undoubtedly blame the energy industry, and many will undoubtedly proclaim that the chickens of past excess money printing are finally coming home to roost. MMT would thus be culpable. But remembering Milton Friedman, it is also conceivable that such a recovery is in the context of a long-term downtrend in velocity.
This would be driven by a secular global slowdown in population growth; aging societies which tend to save more and spend less; and perhaps, most importantly, the continued emergence of new labor-saving technologies which would boost productivity and hold down labor cost specifically, and overall business cost generally.
Finally, even the most ardent MMT supporter would agree that its effectiveness is dependent on a country’s success in managing its currency. Over the past few decades, all countries have been engaged in money printing so the impact on exchange rates has been insignificant. The principal beneficiaries have been speculative assets, precious metals, and more recently cryptocurrencies. But the outcome could become significantly different if policies begin diverging.
There is no question that the U.S. has benefited from its status as having the world’s reserve currency. The Treasury has had no problem financing huge deficits with the private sector not being crowded out of the capital market and interest rates declining. The U.S. economy seems to be recovering faster than other countries except for China, further easing the burden of its public debt. But there is also no question that China is emerging as a formidable competitor as it embarks on a strategy to achieve political and economic dominance.
China is beginning to disengage from unbridled monetary expansion, the U.S. may not be far behind, while money printing is likely to continue unabated elsewhere. This could eventually strengthen the renminbi versus other currencies, making the holders of these currencies less enthusiastic. If so, this might put even more pressure on central banks to enlarge balance sheets. This would necessitate an acceleration of the long-term decline in money velocity or acceptance of a structural upturn of inflation. The result would be a decline in competitiveness and more inequality. Then MMT would be relegated to the dustbin of failed experiments.
Please note that this article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by BEACH INVESTMENT COUNSEL, INC. and is used with the permission of both.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Please note that this article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by BEACH INVESTMENT COUNSEL, INC. and is used with the permission of both.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (23)
