"MMT: An Epic Disaster in the Making"
bu Jim Rickards
"If you have not yet heard of Modern Monetary Theory (MMT), you will soon. If you’ve heard of it but don’t know what it means, join the club. There are only a handful of experts who really understand MMT. Those who do understand it fall into two camps – the true believers, who see MMT as the answer to practically every social policy issue facing the U.S. today and the skeptics, who view MMT as intellectual snake oil that will lead the U.S. down a path to financial ruin. I place myself in the latter category. Still, I recognize that you cannot effectively oppose a doctrine unless you understand it better than the advocates.
MMT is now the leading theory driving fiscal and monetary policy in the United States. A failure to understand MMT is equal to a failure to understand what’s driving U.S. economic policy, capital markets and investment performance. In its simplest form, MMT says that money has value because it is issued by a state, and the state will only accept that money in the payment of taxes. Citizens need to earn “state money” because they have to pay taxes. Therefore, the money has value because the state says so.
A state can run unlimited deficits simply by issuing more debt. The state can pay off the debt by issuing more currency, more debt, and so on. There is no limit to the size of deficits, the size of the national debt or interest costs because the state can always print more money to pay the debt and interest.
There is a corollary to the idea that a country can have unlimited debt. The debt must be in the same currency that the country prints. If you borrow money in a currency that you do not print, you can suffer a serious debt crisis. In theory, this would never happen in the U.S. because we borrow in dollars and print dollars. The U.S. can always print the dollars to pay the debt, so it can never go broke.
The MMT advocates take these ideas a step further. They argue that the U.S. Treasury and the Federal Reserve should be viewed as a consolidated entity. The Treasury exists to spend government money and collect taxes. The Fed exists to print government money.By combining operations, the Fed simply monetizes whatever the Treasury spends.
The MMT crowd says individuals and families who spend more than they earn and can go bankrupt. But that same idea does not apply to countries, according to MMT. Individuals cannot print money, but governments can. So, everyday personal finance rules simply do not apply. Every dollar the government spends goes into someone’s pocket. A government deficit is an individual surplus. What if the bond market balks at all the debt issuance? What if interest rates skyrocket?
MMT has easy answers to these concerns. MMT says that the government bond market is practically irrelevant. The Fed can simply put money in the Treasury’s account at the Fed and wire the money directly at the Treasury's instruction. No bonds are needed for deficit finance.
What if individuals lose confidence in the dollar because of money printing and deficit spending? MMT says you need dollars to pay your taxes, so you must keep working for dollars for that reason. Your level of confidence is irrelevant.
Just as the Fed can pay the Treasury’s bills with direct transfers and no bond market, the Treasury can also pay its bills without any tax collections. I repeat, no actual tax collections are needed. If taxes aren’t needed to pay government bills, what is the point of the tax system? MMT gives three reasons.
The first is that it forces you to accept dollars because you need them to pay the taxes. The second is that progressive taxes can reduce income inequality by taking from the rich and giving to the poor. The third is that taxes are a good way to fight inflation if it should emerge. If inflation happens, a large tax increase will cool the economy and end the inflation.
That’s the overview. Once you accept the ideas that spending and money printing can be unlimited (I don’t, but MMTers do), then it follows that there is no social need that has to go unmet. Money is literally no object.
The political class may be plunging headlong into MMT without knowing what it is. But we have to understand MMT to see its impact on markets and our lives and the dangers it may present if it is pursued much longer.
MMT Is a Disaster Waiting to Happen: MMT is the most potentially damaging economic doctrine I have ever encountered, with the exception of communism. Let’s begin with the idea that the Fed and Treasury should be merged in practice so that the Fed will monetize any amount of spending or borrowing the Treasury wants.
The reason markets have any confidence at all in the Fed is precisely because they are perceived as independent of congressional spending plans. MMT takes this confidence for granted and assumes the Fed can just crank up the printing press whenever the Treasury likes. But, as soon as this kind of coordinated effort appears, markets will lose confidence, inflation expectations will soar and interest rates will skyrocket. The plan would collapse before it really began. This is exactly the type of adaptive behavior by investors and markets that MMT academics do not understand.
MMT says that a currency issuer such as the U.S. can never go broke because it can simply print money to pay off the debt (provided the borrowings are in the same currency as the printed money). This may be true in some narrow, literal sense, but it does not mean investors have to wait around for the trainwreck.
The evidence is strong that debt-to-GDP ratios above 90% are a major headwind for growth. Today that ratio is 130% and heading higher. More borrowing does not produce growth; it simply makes the debt problem worse.
At some point, investors abandon the dollar for alternatives, such as land, oil, gold, silver, or alternative assets. Interest rates rise sharply, which only increases the deficit. The fact that the U.S. can print the money to pay the debt is irrelevant if the money itself is being repudiated.
Something like this happened in 1978 when the U.S. Treasury issued bonds denominated in Swiss Francs and West German Deutschmark because investors did not want exposure to U.S. dollars.
An even more extreme version happened in 1922-23 in the German Weimar Republic. The Weimar Republic could print Reichsmarks to pay off bonds denominated in Reichsmarks, but nobody wanted the bonds or the currency. The printing press is not the answer when it’s used promiscuously. The printing press is the problem.
The MMT claim that U.S. citizens cannot repudiate the dollar because they need it to pay taxes is also nonsense. Nothing is easier than the legal avoidance of taxes. For example, take any one of Silicon Valley’s tech billionaires. A company founder, such as Mark Zuckerberg of Facebook or Larry Page of Google, can issue shares tax-free. After years of hard work and success, that stock may be worth $100 billion. How much tax do you owe? The answer is zero. As long as you do not sell the stock, you do not owe any tax no matter how much the stock goes up in value.
Not everyone is a co-founder of Google, but the analysis is no different if you’re just an everyday investor with 100 shares. As long as you don’t sell the stock, you don’t owe any tax. Americans who contribute funds to 401(k)s or IRAs also avoid taxes on those amounts until they take distributions, which can be decades later.
The list of tax avoidance methods goes on. I was formerly International Tax Counsel to Citi, so I know exactly how the game is played. Only an academic sitting in a faculty lounge would believe that taxes force anyone to use any particular currency. Once the currency becomes debased, citizens will drop it like a hot rock.
Who Needs the Bond Market?: Another baseless claim of MMT is that government bonds are not needed to finance government spending. The Treasury can just spend what it wants by ordering the Fed to send funds to suppliers and contractors. In fact, the government bond market is the benchmark for every fixed income market in the world. Interest rates on government bonds are a critical signal of whether government policies are working (or not), whether inflation is gaining a foothold, and whether monetary policy is too tight or too loose.
The existence of a liquid government bond market signals that private investors regard the government as creditworthy. The idea that the Treasury market is an unnecessary frill shows how out of touch the MMT academics are and how little monetary history they have absorbed.
One of the more bizarre MMT claims is that “a government deficit is an individual’s surplus.” The idea is that the government is the sole source of money, and if the government didn’t spend it, you wouldn’t have any. The corollary is that the more the government spends, the more money you have. But if the dollar becomes dysfunctional, as has happened with many currencies in the past, people abandon it for a better substitute.
Gresham’s Law, “bad money drives out good,” is an explicit recognition that citizens are always ready to dump one type of money and hoard another when they are being shortchanged by the former. So, just because the Treasury spends money, it does not mean citizens have any confidence in the money being spent.
What About the Banks? The idea that government is the sole source of money is just wrong. This ignores the role of the banking system. In fact, the literature on MMT focuses almost exclusively on the government and individuals while largely ignoring the banking system. But, banks are the intermediaries between the government and individuals and businesses. Banks create money just as surely as the Fed by making loans. That money comes out of thin air in a manner similar to Fed printing in the conduct of open market operations.
The Treasury may be the creator of the dollar, but they are not the sole issuer of the dollar. The dollar is continually issued by both the Fed and the commercial banks without involving the Treasury. Money is issued by various financial intermediaries in various forms. The dollars in our wallets and purses are liabilities of the Federal Reserve System. (Read the fine print on a twenty-dollar bill, and you’ll see the words “Federal Reserve Note.” The Fed is the issuer, and a note is a liability). It is true that the Treasury borrows money, receives taxes and spends money. But it’s just another user of money, not the sole source. MMT’s understanding is exactly backward.
The Role of Taxes: Perhaps the most pernicious idea from the MMT crowd is that taxes have nothing to do with spending. MMT says government can just spend what it wants. The purpose of taxes is not to balance the budget or even pay for anything. Taxes exist solely to cool down inflation and redistribute income from rich to poor.
If taxes are just another monetary safety valve (to reduce inflation) or a redistributionist tool, there is no reason for any American to support any level of taxation. Central banks have other ways to cool inflation, such as raising rates.
The idea that the tax code is nothing more than a cattle prod to fight inflation is exactly the kind of mindlessness one expects from academics whose business or real-world experience is practically nil. This view of the tax code treats citizens like Pavlov’s dogs. We’re not Pavlov’s dogs. We understand the monetary and tax systems better than any MMT proponent because we live with them every day.
In conclusion, MMT proponents ignore human nature, adaptive behavior and unintended consequences. MMT will fail and cause great economic hardship in its wake. That’s a recipe for disaster."
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Related:
"Demystifying Modern Monetary Theory"
by New Economic Thinking
"In a challenge to conventional views on modern monetary and fiscal policy, Professor Bill Mitchell of Newcastle University in Australia has emerged as one of the foremost exponents of Modern Monetary Theory (MMT), a heterodox challenge to the prevailing paradigms which dominate how mainstream economics is taught and economic policy implemented. In his works, and the interview below, Mitchell presents a coherent analysis of how money is created, how it functions in global exchange rate regimes, and how the mystification of the nature of money has constrained governments, and prevented states from acting in the public interest."
