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Dismiss Modern Monetary Theory at Your Peril A reprinted article from November/December 2019 Dismiss Modern Monetary Theory at Your Peril By Chris Brightman, CFA® ® © 2019 Investments & Wealth Institute®, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE 2019 Dismiss Modern Monetary Theory at Your Peril By Chris Brightman, CFA® on’t dismiss modern monetary theory (MMT) as unlikely to KEY POINTS Dinfluence policy. This heterodox economic doctrine advocates sharply 1. MMT argues that governments with fiat currencies should coordinate treasury increased fiscal expenditures backed by and central bank actions to fund government programs by directly printing money creation. An alluring promise money, unconstrained by tax receipts or borrowing capacity. of MMT is that it directly confronts a 2. Progressive politicians embrace MMT because the doctrine allows them to perceived flaw in today’s conduct of advocate substantial increases in social spending without imposing the taxes monetary policy by pumping liquidity traditionally assumed necessary to fund such spending. into financial markets as the standard 3. MMT is attracting a growing following because it also promises to reverse the response to stock market and economic contribution to wealth inequality of today’s conventional monetary policy. turbulence. But this inflates asset price 4. Historical experience with policies similar to MMT has resulted in periods of bubbles and thereby exacerbates income high and volatile inflation, which depresses the real returns of mainstream inequality. stocks and bonds. 5. Savers and investors may wish to revise financial plans to allow for the height- Recognize that monetary policy-fueled ened risk of inflation given that policies influenced by MMT appear to be bull markets only benefit the few who increasingly likely. own stocks. Three U.S. billionaires are now collectively worth more than the 160 million Americans in the bottom half of the wealth distribution. A dra- government spending to fund European have become accustomed to the recent matic increase in social spending as levels of social benefits by cutting taxes stable inflation rate achieved through prescribed by MMT advocates may well and raising deficits when in power, and independent central banks may not help alleviate some of this inequality. then demanding austerity to remedy appreciate the misery inflicted by high the accumulating debt when Democrats and volatile inflation. I’m old enough Investors, however, should be aware that are in power. Having learned from this to remember. When I began my first MMT-inspired policy raises the risk of gambit, prominent members of the pro- college economics course, the U.S. infla- inflation. Unexpected inflation shocks gressive wing of the Democratic party tion rate was racing at double digits, cause the prices of stocks and bonds to are now turning the tables. MMT allows while the unemployment rate was plummet. Proponents of MMT may them to promote a massive expansion headed to nearly 11 percent, its post- interpret destruction of financial wealth in government spending without admit- World War II high. Diagnosing the as necessary and beneficial because few ting that a corresponding tax increase cause of that miserable inflation disease of the bottom 160 million hold any (likely a European-style value-added and administering a cure was the most stocks or bonds. A burst of inflation will tax) will become necessary to offset that important practical problem for eco- help level the playing field. spending. nomic policy of the time. Many prominent politicians currently The frightening problem with this polit- In this article, I summarize the past six embrace MMT more as political strat- ical game of chicken is that we may end decades of monetary policy in the egy than economic policy. Over recent up with a rerun of the Great Stagflation United States to remind readers of the decades, Republicans have successfully of the 1970s and its dismal capital cause of the Great Stagflation of the prevented an expansion of U.S. market returns. Younger readers who 1970s and the pain of repairing the 48 INVESTMENTS & WEALTH MONITOR © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER FEATURE | DISMISS MODERN MONetarY THEORY at YOUR PERIL DECEMBER 2019 damage in the early 1980s. I note that Figure U.S. FISCAL POLICY, 1960–2018 technological advances have since 1 Over the past half-century, tax revenues largely have failed to cover spending rendered the rules of monetarism obso- and control the inflationary impact of fiscal policy. lete. I discuss why today’s complex 4.00% 30% econometric models invite unorthodox 2.00% new theories. I briefly touch upon a 25% potentially more sensible cousin to 0.00% 20% MMT, the fiscal theory of the price level –2.00% (FTPL). I note where MMT departs from –4.00% 15% economic orthodoxy and highlight the –6.00% harsh assessment of prominent econo- 10% mists, notably including those from the –8.00% 5% political left. I conclude by referencing –10.00% the terrible capital market returns of –12.00% 0% the 1970s. In that decade, cash and 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 0 2 4 6 8 6 6 6 6 6 7 7 7 7 7 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1 1 1 1 1 bonds provided negative real returns, 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 and stocks provided a real return of ■ Surplus/Deficit % of GDP ■ Federal Expenditures % of GDP ■ Federal Receipts % of GDP about zero. Source: Research Affiliates, LLC, using data from Economic Data, Federal Reserve Bank of St. Louis (FRED) KEYNESIAN POLICY AND INFLATION DURING THE 1960s STAGFLATION OF THE 1970s President Jimmy Carter instituted volun- The fiscal and monetary policies of my AND THE FAILURE OF WAGE tary wage and price controls, which childhood foreshadowed MMT (see AND PRICE CONTROLS proved as futile as Ford’s WIN buttons figure ).1 In 1964, Congress cut income Republicans made a bad situation worse. (Farnsworth 1978). tax rates by approximately 20 percent to In 1971, President Richard Nixon ended boost growth and raise employment, convertibility of the U.S. dollar into gold, Through the latter half of the 1970s and enacting a policy originally proposed by imposed wage and price controls, and into the early 1980s, high and volatile the recently assassinated President John raised tariffs (Ghizoni 2013). In 1972, inflation coincided with rising unem- F. Kennedy. This tax cut, paired with Nixon pressured Fed Chairman Arthur ployment. The unemployment rate rose large increases in government spending Burns to ease monetary policy in order from less than 4 percent in 1969 to for the moon shot, the War on Poverty, to boost the economy heading into the nearly 11 percent by 1982. Whether the and the undeclared (but nonetheless all election of 1972 despite the elevated Great Stagflation was caused by rapid too real) war in Vietnam, fueled an eco- inflation rate. The economy duly expansion of money or by oil price nomic boom along with a jump in the strengthened and Nixon was re-elected shocks remains a subject of debate. inflation rate (Federal Reserve Bank of in a landslide. Beyond debate was the human suffering; Cleveland 1970). From 1963 to 1966, to quantify it at that time, Arthur Okun unemployment declined from 6 percent This episode teaches us about the risks invented the “misery index,” or the sum to below 4 percent, while inflation more of politicizing conduct of monetary pol- of the inflation and unemployment rates, than doubled from less than 1.5 percent icy. Nixon’s wage and price controls which peaked at more than 22 percent in to 3 percent. paired with politically motivated easy the early 1980s. money propelled inflation much higher. Can tax policy control the inflationary The Consumer Price Index (CPI) dou- VOLCKER TAMES INFLATION impact of a too-aggressive fiscal policy, bled from 3 percent in 1972 to 6 percent WITH MONETARISM as asserted by today’s MMT proponents? in 1973. The next huge step-up in Milton Friedman famously stated: In an explicit effort to control the rapidly prices coincided with the oil price “Inflation is always and everywhere a rising inflation rate following the fiscal shocks of 1973 and 1974 (Corbett 2013). monetary phenomenon …” By the time I stimulus of the mid-1960s, Congress CPI soared to 11 percent by 1974. began my study of economics, events reversed course to enact a large tax proved Friedman and his collaborator increase, the Revenue and Expenditure Following Nixon, President Gerald Ford Anna Schwartz prescient. Following Control Act of 1968. Although this led tried to control the then-raging rate of Friedman and Schwartz, I was taught to a tiny and temporary budget surplus, inflation by urging patriotic, voluntary that excessive growth in the money sup- as discussed at length by Arthur Okun action to reduce consumption and ply caused the inflation of the 1970s. (1971), the effort to control inflation increase savings, passing out WIN The growth rate of money, as measured through taxation utterly failed. (Whip Inflation Now) buttons. In 1978, by M2, rose from 1.5 percent in 1960 to INVESTMENTS & WEALTH MONITOR 49 © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. © 2019 Investments & Wealth Institute, formerly IMCA. Reprinted with permission. All rights reserved. NOVEMBER DECEMBER FEATURE | DISMISS MODERN MONetarY THEORY at YOUR PERIL 2019 Figure U.S.
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