Investors are caught up in modern monetary theory (MMT) and its convenient non-answers to the tricky issues of economic stagnation, unsustainable public finances and debt. People’s savings are guaranteed by high asset prices, thanks to this new form of economy.
A state, MMT argues, does not finance its expenditure through taxes or loans, but through creating money. Nations cannot go bankrupt if it can print its currency. Therefore, a country with its own currency can have deficits and build up debt at almost any level it sees fit.
Little about MMT is new. Keynesian budget deficits have been used since the 1930s. A country’s ability to print its own currency has been accepted since the end of the gold standard in the 1970s. Central bank-financed government spending through quantitative easing has been widely used by Japan since 1990 and worldwide since 2008.
MMT is advocating that, given insufficient demand, governments spend money to bring the economy to full employment. This is the job guarantee that requires anyone who wants to work to have one. An alternative, unpopular among MMT proponents, is for government-funded Universal Basic Income (UBI), where each individual receives an unconditional lump sum payment regardless of the circumstances.
MMT ignores several issues. First, it is unclear where useful, well-paid work will come from and how jobs will be created. The government’s influence on the productive sector that produces actual goods and services is limited. The impact of employment-decreasing technology and competitive global supply chains is being obscured. It is unclear whether the deficit spending should be productive or how it will yield an acceptable financial or social return.
Second, critics point to the risk of inflation. Large deficits financed by money creation that exceed changes in economic output can lead to hyperinflation. MMT recognizes the risk, but only where the economy is running at full capacity or there is no overcapacity. According to MMTers, the government can raise taxes or cut spending to contain inflationary pressures.
Third, the idea only applies to states that can issue their own fiat currency. It cannot be applied to the European Union, where individual countries have ceded currency sovereignty to the European Central Bank. It is also not available to private companies or households unless the state underwrites private debt.
Fourth, the exchange rate can be a constraint. When a country borrows from foreigners or trades across borders in its own currency, investors must have confidence in the government, monetary authorities and exchange rate stability. If periodic US dollar DXY,
weakness, excess deficits and money pressure can cause financial markets to lose confidence and force a devaluation. Businesses may not be able to import goods at an affordable cost or pay off debt denominated in foreign currencies.
Fifth, there are operational challenges. In addition to creating the right jobs, it is necessary to determine the natural employment rate or UBI level and structure. Measures used to determine policy, such as unemployment, inflation, money supply statistics or output gaps, are difficult to calculate.
Finally, the transition to MMT can create instability. An exchange rate or inflation shock would affect existing investors and trade. Policy makers may not be able to control the process once it is set in motion. Where supply constraints are met, excessive deficit-financed spending would lead to inflation, higher tariffs and a currency correction. As with any policy, data availability delays, which can be ambiguous, make management difficult. It is uncertain what would happen if MMT failed. The way back from any experiment is problematic and the difference between theory and practice is greater in reality than in concept.
Governments and central banks have covertly adopted elements of MMT. It guarantees high asset prices which in turn creates unprecedented levels of lending.
Unfortunately, if printing money and spending deficits was all about ensuring prosperity, it’s astonishing that it wasn’t conceived and enthusiastically embraced before. Whether they recognize it or not, investors are now unknowingly taking part in an economic experiment that will affect the value of their investments and savings.
Satyajit Das is a former banker. He is the author of “A Banquet of Consequences – Reloaded: How We Got Into This Mess & Why We Need To Act Now’ (Penguin 2021).
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