Could Modern Monetary Theory Save America?

7 min read

I Become President For A Day To Apply Modern Monetary Theory (MMT) To The US Economy

Politicians and academics are making dramatic claims about MMT. I apply it to the 2018 US economy and learn that debt isn’t always debt.

Modern Monetary Theory (MMT) sounds dull and morose, but it’s creating quite a stir:

  • Warren Mosler, a leading MMT thinker, apparently fills stadia in Italy. (Well, definitely meeting halls!)
  • Professor Stephanie Kelton, an MMT evangelist, was mobbed in Japan.
  • Alexandria Ocasio-Cortez (NY Rep), who justifies policy using MMT, is the centre of controversy.

Have a look at this, and this, as well.

Why the fuss? It has to do with MMT advocates’ dramatic claims.

“Fiscal policy should be aimed at generating full employment while maintaining low inflation (rather than, say, achieving a balanced budget position).” – James Montier, Why Does Everyone Hates MMT?

“I think the first thing that we need to do is kind of break the mistaken idea that taxes pay for 100% of government expenditure,” – Alexandria Ocasio-Cortez, talking to NPR’s Morning Edition, Feb 2019

“If Congress authorizes a few billion dollars of additional spending, or a few hundred billion dollars, then the Fed’s job is to make sure that those checks don’t bounce,” – Professor Stephanie Kelton of Stony Brook University.

Its critics do not hold back:

“The idea that deficits don’t matter for countries that can borrow in their own currency, I think, is just wrong. We’re going to have to either spend less or raise more revenue.”, Jerome Powell talking to a Senate Hearing in Feb 2019.

Who is right? If it sounds too good to be true, but MMT advocates have impressive credentials. I had to take a closer look.

The Whitehouse (Will Murphy © 2014)

Rather than bore you with a mash-up of MMT musings, I thought I’d get radical. The best way to understand theory is to apply it, so I became a fake US President (FakePrez) for a day. As FakePrez, I tried to understand how MMT would have worked on the 2018 US Economy.

I learned that debt isn’t always debt, and that big government isn’t really that big. Did MMT work for me?

Read on.

I need to get my head around MMT

A crisis in Italy inspired Warren Mosler. He was a Wall Street trader when Italy got into financial trouble in the 1990s. The accepted wisdom was that Italy would default on its loans.

Mosler disagreed, because Italy controlled its currency, and bet big. Italy did not default, and Mosler made US$100 million.

He published a paper in 1993, “Soft Currency Economics”, expounding the idea that a government with a monopoly on a fiat currency cannot run out of money. It is just a number on a computer, and if you need more, change the number.

Why do we use fiat currencies? Because the world economy is too big to be constrained by something physical, such as gold or silver. In 2017, the purchasing power of the world economy was US$127.8 trillion according to the CIA World Fact-book. All the gold ever minted is worth about US$7.5tr.

Let that sink in. The number on the computer is the truth, not physical notes or coins.

Understand that and MMT makes more sense. If a government wants to inject money into an economy, it edits a database record and starts spending. (It feels like cheating!) If the government wants to slow the economy, it raises taxes (not interest rates) and removes money.

A government with fiat currency superpowers can theoretically do amazing things:

  • Clear a national debt in a single bound (if it’s in its own currency).
  • Pay everyone who needs it a living wage. No one will be left behind.
  • Build new national infrastructure to meet, say, a Green agenda.

Such a government does not need to tax anyone to function, which is not unprecedented. There are countries with enough foreign income to avoid the need to tax citizens. The Motley Fool website lists ten here.

There are many who dislike the idea of creating money from air, and refer to the sins of the inflation crisis in the 1970s.

The great inflation was blamed on oil prices, currency speculators, greedy businessmen, and avaricious union leaders. However, it is clear that monetary policies, which financed massive budget deficits and were supported by political leaders, were the cause.

How do MMT enthusiasts address this? The money injected into economies was misspent. It should have been used for investment. Inflation occurs when the economy cannot meet demand, so new money should be used to improve economic efficiency and capacity.

As FakePrez, what do I take from this?

I like the clarity, simplicity and even elegance of MMT. The logic around fiat currencies seems sound. Even fiat money, however, has to obey the laws of supply and demand, and too much of anything is valueless. Isn’t it?

The questions that I’ll have to ask myself are: – How do I identify what will make the economy more productive? – How long will investments take to enhance the economy? – Do I have the courage to raise taxes to fight inflation if and when an investment goes wrong?

I need to understand the US economy.

As FakePrez working on imaginary policies, I should understand the American economy. After some thought, I decided to balance the US’s liabilities and its income streams. Economists often compare national debt with GDP, so I’ll do that.

I’m going to use waterfall diagrams, each with increasing granularity.

2018 US Economy (Will Murphy)

Tax revenues and government spending seem insignificant compared to the national debt. Luckily, we have the size of the US economy (GDP net inflation) to put things in perspective.

Even so, if the US economy were a company, it would be insolvent. Yet the US economy is the strongest in the world, so it can’t be that bad. I need to look more closely.

There are many types of debt.

Expanded National Debt (Will Murphy)

Look at the leftmost side of the new chart:

  • Debt owed to US creditors (US$9.9tr)
  • Debt owed to foreign creditors (US$6.2tr)
  • Debt owed by the US treasury to other departments (US$5.87tr)

The US’s debt includes the value of currency in circulation. Every note and coin creates a liability, but it’s a notional one.

Foreign debt is more worrying. For example, the US owes China US1.3tr, making it the US’s biggest creditor. What if China gets mean? Do I need to panick again?

The Chinese debt represents an imbalance between imports and exports. Say China sells the US a computer for US$1000, and the US sells China US$800 of Californian wine. The US does not hand over US$200 to China. It credits US$200 to China’s account at the US Federal Reserve instead!

No currency leaves America.

Why does China go along with that? It builds products for the Americans, which gives it visibility of the latest technology. It creates jobs within China, and the US is forced to take China seriously.

Intra-government debt is not a threat, because this is money owed to Government departments by the US Treasury. Years ago, for example, the US social security system couldn’t spend its budget, so it had to buy Treasury bonds instead.

The US national debt may seem huge, but when you look closely, it’s soft. I’m going to redraw my waterfall diagram without the intra-government debt.

No Intra-government debt (Will Murphy)

That looks better. Even if MMT advocates are completely wrong about fiat currencies, the US’s debt is not anything like the issue I first thought.

How about the spending?

Do I need to create growth? The economy is slowing in 2018, so the answer is yes. I need to think about creating money if I follow MMT.

Is there an inflation issue? The rate is 2.49%, which is okay but on the high side. If I create money, I need to improve economic productivity. What am I spending money on? How much more do I need to do?

From a budgeting side of things, US$2.5tr of my US$3.3tr spend is mandatory (eg Medicare), and US$325b is a debt interest payment. I only have US$1.3b to play with. The military is getting US$900b of that. How much of the economy will that help?

I’m not feeling confident.

Deconstructing 2018 GDP.

Expanded GDP (Will Murphy)

US GDP in 2018 was US$20.5tr or US$18.6tr adjusted for inflation, which is amazing. Only the EU comes close by combining the economies of 27 countries. How is my deficit of US$795b supposed to make an economy of that size grow significantly? I need a multiplier effect on steroids.

I better unpack that GDP figure.

The star is consumer spending at US$12.89tr with business spending a distant second at US$3.39tr. Oh dear, the government’s impact on GDP is only US$3.18tr.

Hang on, it’s worse than that. US$3.18tr includes State level and local spending. I don’t control that. Federal Government’s GDP contribution is only US$1.23tr.

I’m going to have to create quite a lot of money. I’m aghast.

Bet big on infrastructure?

What can I do?

Consumer spending is just under two-thirds of GDP. I have to do something that affects 127 million households.]Tax cuts sound like the best way to do that, but that means that I lose my only weapon against inflation. I will get results relatively fast though, and it will be popular.

I need to be certain that American productivity continues to grow. What are my options? Big infrastructure projects sound good. Here are five big ones:

  • Dulles Transit Extension (cost US$6.2b; 8 years).
  • Otay Mesa East (US$715m; awaiting okay).
  • O’Hare Modernisation (US$8.8b; 8 years).
  • Crescent Corridor Expansion (US$2.5b; 2030).
  • Alaskan Way Viaduct (US$3.1b; ?).

That totals up to about US$21b, which is small beer. I’m panicking even more. Large infrastructure projects takes years and even decades to complete. I need extra economic capacity now.

Why do they take so long? The federal government cannot do something like that on its own. Funding is needed at a State level and from local business. Worse, I need to get local approvals.

I also need the projects to boost the economy as a whole. I wish good fortune to Dulles and the rest, but I need the whole economy to work better. I need to head off the inflation my federal tax cuts will create.

Where did I put that resignation letter?

MMT is nice in theory.

MMT is praised for its academic rigour, and it is elegant. There are real insights into how money works in a modern economy. Government can treat debt differently to the way an individual or a company treats debt.

It has flaws, because it assumes: – That a central government knows enough about a complex economy to second-guess the market. – That that government has enough influence over an economy to meaningfully change it quickly. – That improved economic capacity aligns with economic stimulus.

Those assumptions are unrealistic, because the US economy is too large and complex to manipulate centrally.

The largest component of US GDP is consumer spend, which admittedly is easy to stimulate with tax cuts. People see money in their accounts, and consumerism does its magic.

The investment spending needed to meet that new demand is almost totally out of my control. I can build bridges and improve roads, but the benefits won’t appear for years. In the meantime, I either reverse my tax cuts or start increasing interest rates.

I wish MMT were as simple as it sounds.

William Murphy I've been in the technology industry for 30 years. I began my career writing code to emulate IBM cluster controllers in the twilight of mainframes. In the early 2000s, I designed provisioning software for British Telecom's national MPLS network, before moving into IP network design. In the last ten years my outlook has become more commercial. My academic training started with a. first in Computer Science, and I received my MBA from Durham. I'm a keen runner and play piano.

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