Investors are captive to Modern Monetary Theory (MMT) and its convenient non-answers to the vexed issues of economic stagnation, unsustainable public finances and debt. People’s savings are underwritten by high asset prices, courtesy of this novel brand of economics.
A state, MMT argues, does not finance its spending out of taxes or borrowing but by creating money. Nations cannot go bankrupt when it can print its currency. Therefore, a country with its own currency can run deficits and accumulate debt at almost whatever level deemed necessary.
Little about MMT is new. Keynesian deficit spending has 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 via quantitative easing has been used extensively by Japan since 1990 and globally since 2008.
MMT advocates that in the face of inadequate demand, governments spend to move the economy to full employment. This is the job guarantee which requires everyone who is willing to work to have one. An alternative, unpopular among MMT advocates, is for government-funded universal basic income (UBI), providing every individual an unconditional flat-rate payment irrespective of circumstances.
MMT ignores several issues. First, it is unclear where useful, well-paid work will come from and how jobs will be created. Government influence over the productive sector that produces actual goods and services is limited. The impact of employment-reducing technology and competitive global supply chains is glossed over. It is unclear whether the deficit spending needs to be productive or how it will achieve an acceptable financial or social rate of return.
Second, critics point to the risk of inflation. Large deficits financed by money creation exceeding economic production changes can lead to hyperinflation. MMT acknowledges the risk but only where the economy is at full employment or there is no excess capacity. Government, MMT-ers argue, can raise taxes or reduce spending to control inflationary pressures.
Third, the idea only applies to states able to issue their own fiat currencies. It could not be applied to the European Union, where individual nations have ceded currency sovereignty to the European Central Bank. It is also unavailable to private businesses or households, unless the state underwrites private debt.
Fourth, the exchange rate may be a constraint. Where a country borrows in its own currency from foreigners or engages in cross-border trade, investors must have confidence in the government, monetary authorities and the stability of the exchange rate. As periodic U.S. dollar DXY, +0.20% weakness shows, excess deficits and money printing may cause financial markets to lose confidence and force a devaluation,. Businesses may not be able to import goods at affordable cost or service foreign currency denominated debt.
Fifth, there are operational challenges. In addition to creating the right jobs, it is necessary to set the natural rate of employment or the UBI level and structure. Measures used to set policy, such as unemployment, inflation rate, money supply statistics or output gaps, are complex to calculate.
Finally, the transition to MMT may create instability. An exchange-rate or inflation shock would affect existing investors and trade. Policymakers may be unable to control the process once set in motion. Where supply constraints are reached, excessive deficit-financed spending would result in inflation, higher rates and a currency correction. As with all policy, lags in the availability of data, which may be ambiguous, make management difficult. It is uncertain what would happen if MMT failed. The road back from any experiment is problematic and the difference between theory and practice is larger in reality than in concept.
Governments and central banks have adopted elements of MMT by stealth. It underwrites elevated asset prices which, in turn, secure unprecedented levels of borrowing.
Unfortunately, if printing money and deficit spending was all it took to ensure prosperity, then it is surprising that it hadn’t been thought of and enthusiastically embraced earlier. Whether they recognize it or not, investors are now unwitting participants 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 we’re in and why we need to act now’ (Penguin 2021).
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