Modern Monetary Theory Delusions

A reprinted article from November/December 2019

By Charles Lieberman, PhD

Modern Monetary Theory Delusions

By Charles Lieberman, PhD

hot debate has erupted over “modern monetary theory” A (MMT), which promoters allege With one notable exception, every time governments have justifies an increase in government printed money copiously to pay bills, the result was rising deficit spending to pay for the Green inflation and, in the extreme, hyperinflation. New Deal and other programs. The government would issue as much debt as needed to raise funds, and the Federal Reserve (the Fed) would buy by Keynesians and has been mainstream With one notable exception, every time the debt by printing the money. MMT for many years. But Kelton goes further governments have printed money copi- proponents claim there would be no by maintaining there is no limit to the ously to pay bills, the result was rising adverse consequences because the debt size of the budget deficit that can be run inflation and, in the extreme, hyperinfla- is denominated in dollars and the Fed as long as there is no inflation problem— tion. Two egregious examples are the can print as many dollars as required. and she sees no link between too much Weimar Republic and its hyperinflation federal spending and inflation. She calls in Germany in the 1920s and Zimbabwe One vocal and visible MMT promoter is such a link “hard to believe.” Others, in 2008–2009. Both printed vast, seem- Stephanie Kelton, former chief econo- however, believe that MMT misses the ingly unlimited quantities of money to mist of the Senate Budget Committee for inevitable link between too much federal finance government spending, but they the Democratic minority staff, a former spending, printing money, and inflation. paid for this behavior with runaway senior advisor to Bernie Sanders, and a inflation. Recently, Venezuela, which is professor of economics at Stony Brook THE SOMETIMES TRAGIC experiencing eroding oil revenues, has University. Kelton has argued that any HISTORY OF DEFICIT FINANCE managed its deficits by printing more country engaged in MMT doesn’t have a The legal ability to print money has long money, and its inflation rate has risen deficit problem unless it has an inflation been held exclusively by government, from around 800 percent annually in problem; she states that running very despite the best efforts of counterfeiters. 2016 to an estimated 1-million percent large deficits does not lead to rising Economies need currency with which in 2018. These are the extreme examples inflation (Helfand 2019; Malter 2019). to conduct business transactions. In trotted out to explain why printing Kelton notes that because the U.S. gov- supplying money to their economies, money is economically dangerous. ernment can print its own money to governments enjoy seigniorage, which meet any obligation (the Fed would do is the difference between the face value More moderate versions are more com- the printing and buy the Treasury’s of money, such as a $10 bill, and the mon, with lesser but still problematical newly issued debt), it is not possible for cost to produce it. Governments can results. When Italy and France had their the U.S. government to ever become print currency at little cost and use it to own currencies, both economies contin- insolvent. This is true, but others believe buy goods and services for the govern- ually suffered from higher inflation than that dire consequences will ensue. ment beyond whatever tax revenues the rest of Europe. They found it difficult they can impose on their economies. politically to pay for their high level of Kelton’s argument stands on the basic And for the most part, governments government spending with taxes, so view that increased government spend- have handled this ability to print money they made up the difference by printing ing is desirable to fight high unem– fairly responsibly. But they can and have money and tended to have higher infla- ployment, even when that spending gone overboard with severe adverse tion than their neighbors. These higher creates a deficit. This basic view is held consequences. inflation rates weakened their currencies

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to offset the rise in domestic prices Figure CIVILIAN UNEMPLOYMENT RATE and to maintain competitiveness. 1 11 Neighboring governments resented that the French and Italians were always 10 weakening their currencies in order to maintain their competitiveness to sell 9 goods. So, the Europeans pressed to 8 adopt a single currency that would make competitive devaluations a thing of the 7 past. Indeed, when the Italians and 6 French pegged their currencies to the Percent rest of Europe, their higher rates of infla- 5 tion killed their competitiveness and 4 they suffered high unemployment even when they chose to run larger govern- 3 ment budget deficits. 2 1950 1960 1970 1980 1990 2000 2010 Some Latin American countries, such ■ U.S. recessions as Argentina and Brazil, also have cho- sen to fund budget deficits by printing Source: U.S. Bureau of Labor Statistics, fred.stlouisfed.org money to pay for their spending. These episodes also ended badly. Bonds issued growth for more than two decades. It Inflation results when demand for goods in their own currencies required ever also has a shrinking population as well and services exceeds supply, so rising higher interest rates to compensate as a highly acquiescent population that prices are required to offset the differ- investors for rising inflation, so these seeks order and favors existing institu- ence. For example, consider an economy governments resorted to issuing bonds tions. Workers don’t strike for higher with $19 trillion in demand that is pro- in foreign currencies, such as the wages in Japan. Redundant workers ducing $19 trillion in goods when the U.S. dollar. But the international invest- aren’t fired; they0 are givendead -end government chooses to increase its ment community’s appetite for Latin jobs with nothing to do. It isn’t clear spending by $1 trillion financed by American bond issues in the U.S. dollar that any other–10,000 nation could mimic the printing money. There is now demand was sated when foreign investors wor- Japanese economy, assuming it wished for $20 trillion of goods and services, ried they’d never be repaid. A buyer’s to do so. Regardless,–20,000 we haven’t yet seen but only $19 trillion is being produced. revolt resulted in a financial meltdown in how Japan’s huge budget deficit will There are two possible outcomes. The –30,000 Latin America in the 1980s, because play out. first is that the economy expands more those governments could no longer fund quickly so output increases to meet that –40,000 their deficits.1 THE CASE FOR AND higher level of demand. This is feasible

AGAINSTMillions of Dollars MMT when unemployed workers can be hired –50,000 Even the United States has succumbed Kelton’s argument seems to be based on to increase output. In this case, deficit to this temptation. In the 1960s, when the observable–60,000 fact that the U.S. govern- spending may be desirable. Indeed, this Lyndon Johnson sought to finance ment is running a large budget deficit is precisely when Keynesians argue that “guns and butter” spending on Great today without–70,000 experiencing worrisome fiscal stimulus should be used to help Society programs and also pay for a war rising inflation. MMT advocates1995 don’t2000 the2005 economy get2010 back to full2015 employ- in Vietnam, inflation surged. The Fed seem to offer any■ U.S. explanation recessions of what ment quickly following a recession. imposed historically high interest rates does cause inflation, and Kelton rejects in order to squeeze inflation out of the outright the possibility that inflation The second possibility is that the excess U.S. economy and bring down federal may increase in response to large budget demand drives up inflation. The gap deficits. deficits albeit with a lag. MMT adher- between $20 trillion in demand and ents also claim that if inflation were to $19 trillion in supply can be closed by The notable exception to large budget increase, then government could prevent a 5-percent price increase across the deficits without rising inflation is Japan, a surge by raising taxes. That may be board, so that the $19 trillion in supply is where the debt to gross domestic prod- true in theory, but in practice, govern- repriced to cost $20 trillion. This situa- uct ratio is about 2.5, well above the U.S. ments raise or lower taxes when such tion arises when the economy is already ratio of about 1.0. Yet Japan has been in action is politically expedient, not when at full employment, hiring is difficult recession or experienced rather little it is most appropriate for the economy. because unemployed labor is scarce, and

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© 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 | Modern Monetary Theory Delusions 2019

Figure SHORT-RUN PHILLIPS CURVE injected incremental spending into an 2 economy already enjoying low unemployment. Most economists expected the 8% tax cut to prove inflationary. The very fact that it has not resulted in a surge in inflation has been taken up by MMT proponents as evidence to suggest it won’t 5% and shouldn’t be expected to do so.

Phillips curve Proponents of MMT probably take com- Rate of Wage Inflation of Wage Rate fort from the fact that government deficit spending has increased and inflation has not increased significantly, as yet. 0% Indeed, it is the breakdown in the histor- 2% 4% ical relationship between unemployment and inflation, known as the Phillips Unemployment Rate Curve, that has provided some credibil- Source: Stylized Phillips Curve courtesy of the author ity to their claims that printing money to finance debt need not result in rampant the effort to hire drives up labor costs prices will keep rising. The simple fact inflation (seefigure ).2 But this is a very and inflation, as suggested byfigure .1 that the government chose to print more weak reed on which to build the case for But the story does not end with this sim- money doesn’t increase the actual supply MMT. For one thing, MMT advocates ple outcome. Demand was at $20 trillion of goods and services. Those goods and offer no alternative theory or explanation before the 5-percent increase. Once services simply get repriced to cost more for what causes higher inflation and prices rose, buyers paid $20 trillion, but to equate supply with demand. none of them would argue explicitly that only got $19 billion in inflation-adjusted the laws of supply and demand have goods and services, and the government So, what determines which of the two been repealed, which happens to be the got $1 trillion of that total. Consumers outcomes may occur? (In reality, some of underlying economic foundation for the were frustrated in their effort to buy both is likely to occur, but to simplify the Phillips Curve. Implicitly, if growing the goods they wanted. Before the analysis, only the two extreme outcomes labor scarcity does not cause rising labor government added that $1 billion to the are being considered.) The key determi- costs and higher inflation, supply and spending stream, consumers were spend- nant of whether printing money to pay demand don’t matter. Now that’s really ing $19 trillion and getting $19 trillion. for new government programs creates hard to believe. Once the government stepped in to buy inflation is whether the economy has the $1 trillion worth of goods, consumers got capacity to increase output. When unem- Moreover, nothing in economic theory only $18 trillion of goods, because infla- ployment is already low and labor is suggests that inflation must surge tion squeezed them out of the market for scarce, printing money causes inflation immediately in response to larger the $1 trillion of goods bought by the because the economy is constrained from government budget deficits. Market government. Even so, the increase in producing more goods and services. reactions and adjustments to changing inflation almost certainly increased That condition exists today. An increase economic conditions can take some wages as well as prices. With more cash in U.S. government deficit spending now time. So, the risk today is for inflation to in their pockets, consumers might now would add to demand, but because labor increase because of this deficit spending. try to buy $20 trillion instead of $19 tril- is scarce, increasing the supply of goods And this would occur whether or not lion. But adding in the government to meet that higher level of demand the increased supply of bonds is bought spending, we now have $21 trillion in likely would run into bottlenecks. In this by the Fed. There’s simply too much demand chasing a higher-priced $20 tril- case, excess demand can be met only by demand chasing goods, and if the Fed lion in supply. Rinse and repeat and we marking up the price of supply—infla- printed more money, the Fed would be get recurring, accelerating inflation. tion—so that supply can match up with pouring gasoline on the fire. That’s how 5-percent inflation turns into demand once again. 10 percent and 20 percent and hyperin- WHY HAS INFLATION flation, unless spending retrenches. As This economic theory and historical BEEN MUTED? long as the government provides more experience are precisely why many Some of the credit for keeping inflation money to pay for its own spending, it val- economists criticized the Trump admin- contained surely goes to the Fed, which idates the general rise in demand and istration’s late 2017 tax bill, which has been vocal about keeping inflation

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6 Percent

2 1950 1960 1970 1980 1990 2000 2010 ■ U.S. recessions

NOVEMBER FEATURE | Modern Monetary Theory Delusions DECEMBER 2019

around its 2-percent target and main- Figure TRADE BALANCE—GOODS AND SERVICES, BALANCE OF taining its high level of credibility. But 3 PAYMENTS BASIS Fed officials understand perfectly well 0 that an unemployment rate that is already below full employment could –10,000 cause higher inflation at any time. In this politically charged environment, –20,000 Fed officials are reluctant to raise interest rates until higher inflation becomes –30,000 visible. If they raise rates to prevent rising inflation, critics will argue they are –40,000 preventing growth from continuing.

Indeed, President Donald Trump has Millions of Dollars –50,000 criticized Fed Chair Jerome Powell for raising rates over the past year, and –60,000 MMT proponents are also critical because they’d like to finance their –70,000 social programs. The Fed gets little 1995 2000 2005 2010 2015 credit for inoculating the economy ■ U.S. recessions

against a problem that isn’t visible, as Source: U.S. Bureau of Economic Analysis, fred.stlouisfed.org yet. So, the Fed has acquiesced and will tolerate some rise in inflation at least until everyone sees higher inflation as value of the dollar and increase the price ENDNOTE an emerging problem. of imported goods to U.S. consumers. 1. see https://en.wikipedia.org/wiki Latin_American_debt_crisis. The Fed also is operating within the Looking ahead, standard neoclassical context of a U.S. economy that is per- economic theory suggests that the ongo- REFERENCES forming quite well, while many foreign ing decline in the unemployment rate will Helfand, Zach. 2019. The Economist Who economies are struggling. Strong become an ever-greater bottleneck in the Believes the Government Should Just Print More Money. The New Yorker (August 20). demand here can be satisfied, at least in economy that will lead to higher inflation. https://www.newyorker.com/news/ substantial part, by importing the differ- Theory is extremely clear on this point, news-desk/the-economist-who-believes- the-government-should-just-print-more- ence. Using the example above, if there’s even if it is incapable of providing much money. $20 trillion in demand but only $19 tril- insight with regard to timing. Assorted Malter, Jordan. 2019. Bernie Sanders’ 2016 lion being produced in the United pressures are likely to keep the Fed from Economic Advisor Stephanie Kelton on Modern Monetary Theory and the 2020 States, we can always import $1 trillion acting in anticipation of such an out- Race. CNBC (March 3). https://www. to make up the difference, at least for a come. And the fact that some Fed officials cnbc.com/2019/03/01/bernie-sanders- economic-advisor-stephanie-kelton-on- while. For a global economy struggling would prefer a period of inflation above mmt-and-2020-race.html. to grow, it is simply a godsend for those 2 percent to make up for a period of infla- struggling economies to be able to sell tion below 2 percent ensures that the Fed Advisors Capital Management, LLC (ACM) is a provider of privately more products to the United States. In will not react either pre-emptively or managed portfolios for industry professionals and their clients. Although the information included in this report has been fact, the overall U.S. trade deficit has quickly to a rise in inflation. MMT lacks obtained from sources ACM believes to be reliable, we do not increased even as the United States has a sound basis in theory and there is guarantee its accuracy. All opinions and estimates included in become an exporter of crude oil and nat- plenty of historical precedent to indicate this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for ural gas after many years of being a that it is bad policy. If adopted by the informational purposes only and is not intended as an offer or major importer, as shown in figure .3 government as policy, it is likely to lead solicitation with respect to the purchase or sale of any security. ACM is a registered investment advisory firm. Web Address: www. the nation to experience more inflation advisorscenter.com. Rising imports can delay our domesti- than we would otherwise. cally brewed inflation pressures, but they can’t overcome them. As the United Charles Lieberman, PhD, is chief investment States runs larger trade deficits, we are officer at Advisors Capital Management. supplying the global economy with He earned a BA in economics from the Massachusetts Institute of Technology and ever-larger quantities of dollars. Sooner a PhD in economics from the University or later, this dollar supply will turn into of Pennsylvania. Contact him at chuck@ a dollar glut, which will drive down the advisorscenter.com.

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