“The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” - Alan Greenspan, former Federal Reserve Chairman
If you have been paying attention to the current political landscape, chances are you have heard the acronym MMT or the phrase Modern Monetary Theory thrown around. According to Google Trends, the search frequency for the phrase “Modern Monetary Theory” has increased dramatically since the end of last year (see chart below) thanks in part to all the media attention surrounding Congresswoman Alexandria Ocasio-Cortez including her support of MMT. But what exactly is MMT? A quick Google search will return plenty of results explaining what MMT is and why it will or will not work but most of them are very technical in nature, so in today’s post we will try to answer this question by boiling it down to its foundational substance.
At its core, MMT states that a sovereign nation which 1) controls its own fiat money supply & 2) only holds debts denominated in its own currency can never go broke because it can always print more money to pay their debts. The logical next step from this foundational belief is that deficits don’t matter, because unlike a household, the government has unlimited resources (e.g. the so called printing press) at its disposal to pay its debts. Therefore, the government should spend money to create jobs and bring voluntary unemployment down to zero.
The next question to ask is, “If deficits and a balanced budget don’t matter, why do we need taxes?” MMT views taxes as a control rather than a revenue source. First off taxes create an embedded demand for the government’s currency. No matter how popular an alternative “currency” like Bitcoin might become or how many dollars the US Treasury might print, at the end of the day if you live in the USA you will need US dollars in order to pay your federal taxes. The second role taxes play in the MMT universe is a lever to control inflation, which is the only thing the government needs to worry about since inflation has the potential to “confiscate the wealth of the people.” In theory, if inflation starts running high, the government can cool the economy down by raising taxes, which drains money out of the system.
Proponents of MMT point to the actions taken by the Federal Reserve during the Global Financial Crisis as proof that MMT works since a tremendous amount of “money printing” never led to inflation. I’m not entirely convinced whether MMT would work or not, but I have given some thought to potential pitfalls.
As the old saying goes, “If it sounds too good to be true, it probably is” and “There is no such thing as a free lunch.” Both of these idioms should be heeded when exploring the idea of MMT. One thing I firmly believe when it comes to something as complex as macroeconomics is that “we don’t know what we don’t know,” so there could be a number of unintended consequences from making such a dramatic shift in economic policy.
Favoring the Few
Very few countries actually qualify as candidates for MMT because they either 1) have yielded control of their currency to a larger governing body like the European Central Bank, 2) they lack the economic stability to have a free floating currency that isn’t pegged to another currency, or 3) they have sovereign debt that is denominated in a foreign currency such as the USD (see the Weimar Republic for a case study on printing local currency to pay debts denominated in a foreign currency). Other than the United States, the only other countries that come to mind as potential candidates would be the UK, Japan, Canada, and Switzerland. So right out of the gate, I would question an economic theory which only applies to a handful of wealthy, developed countries.
Out of all of the countries who do qualify, only the United States has the distinct advantage of controlling the world reserve currency because so much international trade is denominated in USD. The advantages of being the issuer of the world’s reserve currency is beyond the scope of this post, but we can confidently say that they are vast. But what would happen if the US were to adopt MMT and potentially devalue the dollar against other forms of currency? Would the US dollar still be considered the world’s reserve currency and if not, what would be the cost?
Does the Government Know Best?
The biggest issue I have with MMT is the fact that it is predicated on the idea that the government will always act in the best interests of its citizens. This may come across as callused, but I have a hard time buying off on that premise. For example, will politicians actually raise taxes when inflation starts to overheat? Raising taxes and taking money out of people’s paycheck is a fairly unpopular political move which can cause someone their job/re-election. If the current political environment is any indication of whether politicians are willing to make hard choices for long-term gains, I would venture to say that they will not. Another foundational belief of MMT is that the government will engage in “wise spending” because without it, you increase the risk of inflation with no real benefit to the economy. Again, call me cynical, but I’ll take the under on that bet too.
To be fair, no developed economy has ever tried MMT so it is impossible to say whether or not it would actually work. As many have contented, economics is more art than science so the only real way to test something like MMT is to actually try it. There are aspects of it that make perfect sense and are rooted in sound economic theory, but there are also some very large potential risks. Unfortunately, in the age of Twitter and social media, everything is boiled down to tweets and sound bites, which does a great disservice to MMT because the vast majority of those who support it haven’t taken the time to truly understand it. As a disclaimer, you can put me in the camp of those that don’t completely understand it either, but hopefully today’s post has provided some food for thought on what has become a front-and-center discussion on the economic future of our country.
Author Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.
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