Modern monetary theory and pandemic debt Will MMT unlock economic potential or lead to global meltdown? By Mark Yamada August 14, 2020 – Advisor’s Edge

The monetary and fiscal response to the Covid- members such as Italy, Spain and Germany, as 19 pandemic comes with unprecedented well as Canadian and U.S regional costs. The Bank of Canada’s balance sheet governments — have a problem. Such expansion — up to $543 billion in early governments must balance budgets, get federal August — has been stunning compared with its help or have the central bank buy their debt. $81.2 billion response in 2008-2009. In essence, MMT claims that printing money It’s as if central banks wrote the following note to efficiently employ available “resources” is to governments: “To our best customer, we are not inflationary and instead realizes the pleased to triple your credit limit” — only even economic potential of the country. this is a fantasy, since there is no credit limit. MMT “green lights” fiscal spending and “Currency-issuing countries can spend any rejects the need to balance budgets. Its amount of money they want” does not sound proponents — who include former Bernie right, but it underlies modern monetary theory Sanders adviser Stephanie Kelton, which (MMT), a controversial framework for explains some of the criticism MMT has understanding economic principles that’s generated — promote full employment. giving brain-cramps to mainstream economists Excess labour demand can be inflationary, as and investment professionals. can fiscal or private sector action lacking Bridgewater Associates founder Ray Dalio has adequate resources — like trying to produce called MMT “inevitable.” Former Clinton surgical masks and ventilators quickly without Treasury secretary and Obama economic adequate material or manufacturing capacity. advisor Lawrence Summers called it “voodoo But low interest rates and a series of economics.” Nobel laureate in economics Paul quantitative easing since 2008 has not Krugman said he “can’t actually quite make produced anticipated inflation. Federal out what it is.” Former Bank of Canada governments, it seems, can provide unlimited governor Stephen Poloz said last year that funding for aid and stimulus without risking MMT “is offering a free lunch, and most of us real economy inflation if human and natural know there is no such thing.” resources are available. This means that Governments can issue money to fund all pandemic-induced expenditures are not obligations in their own currency. Fiscal necessarily inflationary. spending or central bank initiatives are balance As far as investments go, money created by sheet entries offset by debt issuance and/or fiscal spending and bank lending may bid up increased reserves. Governments service debts prices for real estate, stocks and bonds. For by refinancing or issuing more currency. financial advisors, MMT’s broad adoption The implication is that governments with their could lead to currency volatility, excessive own currency — such as Canada, the U.S., asset valuations and new ways to assess Japan and the U.K. — can’t be forced into inflation risk. default. Governments without currency- Debt, deficits and asset inflation: Who will issuing authority — including Eurozone pay? 2

U.S. Government Debt, 3-Month T-Bill Yields, and Annual CPI (April 1975 to April 2020)

Source: Federal Reserve Bank of St. Louis Mainstream economic thinking says that making. A reserve currency like the U.S. dollar deficit spending funded by government bond demands confidence and economic stability. issuance creates a legacy of debt to be paid by The hyperinflation of Weimar Germany, future generations. Taxation is required to fund Venezuela and Zimbabwe occurred in part and retire debt, while balanced budgets keep because all had large foreign currency debts interest rates low and promote growth. and misused resources. For MMT proponents, debt levels matter less After the Second World War, gross U.S. public than the cash flow to service them. Continuous debt peaked at around 120% of GDP. Some deficit spending has not led to higher interest estimates predict that will be exceeded by rates, inflation or reduced demand for non- 2023. The post-war years proved that with government debt (see figure). nominal GDP growth rates above bond interest The Bank of Canada’s Government of Canada rates, a growing economy can service debt bond and Treasury bill holdings account for faster than the service cost grows, meaning about 15% of all public debt in recent years; budget deficits can be run for extended periods the Fed holds 11.0% of U.S. total debt. of time. Since 1950, only during a period in the According to MMT, not only are there no 1980s when the Fed was in disinflation mode consequences to this amount of debt as long as did interest rates exceed the economy’s growth the spending is productive, but taxes and rate. budget surpluses actually remove cash from Ten-year bond yields under 1% in Canada and the system, drive interest rates higher and the U.S. suggest low expected inflation for the impede growth. The Clinton government foreseeable future. With the exception of surpluses, for example, were followed by periods of stagnation or depression, the recession. economy will likely grow faster than this. This MMT assumes fiscal responsibility will be means massive spending to support the exercised, but politicians and civil servants economy during the pandemic and subsequent often lack the incentives for good decision- stimulus may not be as inflationary as expected, and is certainly more desirable than 3 overburdening our healthcare systems with MMT could be a key to unlocking resource and coronavirus. manpower potential for the next generation; at A conundrum for economists and politicians is risk is a debt burden so large that a future the future value of the balanced budget. If global meltdown is all but assured. MMT is correct, economies have been Mark Yamada is president of PÜR Investing Inc., a handicapping themselves from efficient, full- software development firm specializing in risk management and defined contribution pension employment resource management by strategies. insisting on dancing to a hollow song about a balanced budget.