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Thursday, May 9, 2019

MMT: An Instrument of Central Planning

This is a reprint of my article on Modern Monetary Theory (MMT) from Cayman Financial Review, 4th Quarter (issue 53) of 2018. It explains where MMT comes from and its dangerous policy implications.

Modern Monetary Theory
Sven R Larson
Cayman Financial Review, Fourth Quarter 2018 

In its publication Global Sustainable Development Report 2019, the United Nations includes a section called Governance of Economic Transition. Its official purpose is to offer an economic theory for how to make the world economy more sustainable.

In reality, it is a blueprint for endless expansion of government. This is given away in the report on the heels of a superficial commitment to climate-change theory.

First, the authors – a group of Finnish economists – dismiss mainstream economic thinking and the free-market capitalist economy with one swift stroke of the pen. That theory, they say, was “developed during an era of energetic [sic] and material abundance.” Then, on page 2, they reveal what appears to be the real purpose of the report. Nations all over the world, they suggest,
are witnessing rising inequality, rising unemployment, slow economic growth, rising debt levels and governments without workable tools for managing their economies.
The premise is that it is government’s responsibility to “manage” the economy. To further highlight this belief, this UN report explains:
Central banks in the US and the Eurozone have resorted to unconventional measures such as negative interest rates and buying up significant amounts of public debt. ... many commentators are worried about what can be done after these extraordinary measures are exhausted and the next economic crisis hits
It is to remedy this alleged exhaustion of economic policy tools that the Governance of Economic Transition report suggests what is akin to unlimited government spending. Their ambition is to be taken seriously: the report is an “invited background document” to the Global Sustainable Development Report 2019, which in turn is “a United Nations publication aiming to strengthen the science-policy interface at the High Level Political Forum (HLPF) on Sustainable Development.” The United Nations wants the Global Sustainable Development Report to
provide a strong evidence-based instrument to support policymakers in promoting poverty eradication and sustainable development.
It is for this purpose that the UN has included the report Governance on Economic Transition. To eradicate poverty, the report proposes a radical, global expansion of government spending. The first step is a universal job guarantee where everyone who wants a job can get one. All they have to do is go to a government jobs agency and ask.

This is not an idea to be taken lightly. A universal job guarantee means, literally, what it sounds like. In a paper from 2000, University of Missouri, Kansas City economist Randall Wray clarifies that the job guarantee actually means turning government into an “employer of last resort”. The right to a job is “a fundamental prerequisite for social justice”, a point shared by the Democratic Socialists of America.

Taken to a global scale, as suggested in the UN report, this kind of program would have monumental consequences for government finances. As an instrument for funding this largely unlimited spending program, the UN report relies on something called “Modern Monetary Theory” (MMT), the message of which is that governments have nothing to fear from debt monetization.

Modern Monetary Theory has not been given much attention in the broader economic policy debate. Yet as the UN report exemplifies, it is working its way deep into the layers of policy making, nationally and globally. Its message is as simplistic as it sounds: governments should let their central banks pick up where taxpayers run out of money. The fact that the history of the modern welfare state is littered with debt crises goes largely unmentioned in the UN report. The Greek debt meltdown during the Great Recession is ignored entirely.

Here is how the report puts it (p. 4):
The central claim … is that states can never run out of their own currency. Unlike natural, social and technological resources, sovereign currencies are not a limiting factor in collective action such as the transition to sustainability. This has been the case since the gold standard was abandoned and fiat money adopted in the 1970s. The state can always spend and invest in its own currency.
At no point does the report attempt a critical examination of the relationship between excessive money printing and hyperinflation.

Modern Monetary Theory is not just a fringe theory. It did not just randomly end up in a report from the United Nations. Its journey to the heights of the global policy debate runs through the United States Congress, a presidential campaign and even into the gubernatorial race in the U.S. Virgin Islands.

One of the most frequent proponents of MMT is Stony Brook University economist Stephanie Bell (married Kelton). In a recent interview with Financial Times, she summed up the scholarly foundation for MMT: one man’s debt is another man’s asset. Therefore, more debt only means more assets, and more interest paid by governments means more income for those who own that debt.

In MMT, we see public debt as private wealth and the interest payments as private income. The outstanding public debt is really just an expression of the accumulated budget deficits that have been run in the past. These budget deficits have added financial assets to the private sector, providing the demand for goods and services that have allowed us to maintain income growth.
Contrary to what Mitchell seems to suggest, debt-ridden welfare states typically drift into a state of long-term economic stagnation. Their piles of debt correlate with slower growth, not faster, suggesting that more of government spending, and more of government debt, would accelerate the global economy into a serious economic crisis.

The fact that MMT adds nothing of substance except a reiteration of the millennia-old understanding of debt and credit, has not stopped its proponents from reaching steadily new heights of influence. Stephanie Kelton has served as chief Democrat economist with the U.S. Senate budget committee, and she was an economic advisor to Senator Bernie Sanders during his presidential campaign.

Another passionate MMT proponent is Warren Mosler, an entrepreneur and the man behind the highly regarded supercar Mosler MT900. Mosler has suggested an MMT-based method to do away with government debt:
  • Let governments indebt themselves until they can no longer honor their debt;
  • At that point, let them default on the debt;
  • When they default, owners of treasury bonds can use those bonds to pay taxes.
Mosler has proposed a similar model for the U.S. Virgin Islands, where he is running for governor.* It is unclear what the government of the Virgin Islands would do once it has reached the point of default where owners of government bonds would be allowed to use them as tax payments. Once all the debt has been converted into tax payments, government will have little chance of borrowing more money, leaving unanswered the question of how it moves forward without very drastic spending cuts.

The practical side of MMT becomes increasingly important as its proponents get closer to defining economic policy. To take one example, an expansion of the U.S. government debt, based on MMT, would require a fundamental shift in household portfolios. After all, the central macroeconomic tenet in MMT is that the interest government pays on its debt is a stimulus for the economy.

The problem is that facts are not on their side. Despite U.S. government debt already being abundantly available to the public, it has not become a major asset in their portfolio choices. According to the Bureau of Economic Analysis, only 15.7 percent of personal income in the United States comes from assets of any kind. Of that, 6.5 percent is from dividends, leaving 9.2 percent as interest.

Already before anyone has attempted to use MMT to fund government spending in the United States, the Treasury is having problems competing with other assets. In fact, of the $1.6 trillion in personal income that comes from interest, only a small portion is from U.S. government debt. According to the Federal Reserve, U.S. government debt accounts for only 2.3 percent of all financial assets held by the U.S. general public. Even if this debt paid a three-percent average interest each year - a very generous assumption – it would only amount to $56.6 billion per year.

This means that the income effect that MMT proponents suggest, accounts for a bit more than 0.2 percent of personal income in the United States.

Barely even a blip on the macroeconomic radar.

Households in the United States own ten times as much corporate equity as they do government debt. They have almost six times more money in time-savings deposits as they have in government debt. They own five times as much in mutual-fund shares as they do government debt.

These numbers give a clue to what would happen if just the U.S. government went all-out with what MMT proponents want. Other investment forms are clearly more attractive than sovereign debt; to raise its attractiveness, the U.S. Treasury would have to significantly increase the interest rate.

At the same time, a massive expansion of government debt inevitably erodes government credit. Greece, again, demonstrated this with chilling clarity. During the Greek government’s most prolific borrowing streak, the rate on their ten-year bond went from five to 25 percent.

The result, which included the loss of one quarter of the nation’s GDP, remains a compelling challenge to MMT proponents.

While this is a drastic outlook, it is not irrelevant in the context of the United Nations report “Governance of Economic Transition”. It advocates significant expansion of government spending, based on a social-justice ideology and motivated by an economic argument that essentially removes all prudence in global monetary policy.
*) Mosler, an independent, came in fourth with 4.7 percent of the vote.

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