Solving the world’s problems with modern monetary theory (MMT) is easy. Pity, then, that modern monetary theory is quite wrong. I call it the magic money theory.
South Africa could eliminate poverty in three years. So says financial journalist Duma Gqubule in an essay published in the left-leaning New Frame and republished yesterday on Independent Online.
In it, he proposes two transformational economic policies.
The first is what he calls a basic income grant, but which more closely resembles a universal basic income. (I prefer the latter term for a grant for which anyone would qualify, regardless of their income status, while the former term seems more appropriate for a limited grant, available only to those with low or no income.)
The second is a job guarantee, whereby everyone who wants a job would be able to get one, funded by the state, if necessary.
If his claim of eliminating poverty in three short years is correct, these proposals merit sincere deliberation. Indeed, social development minister Lindiwe Zulu champions a basic income grant, and president Cyril Ramaphosa recently said it is ‘being given serious consideration’.
Examining these proposals, however, first requires a look at the economic framework within which Gqubule works, namely modern monetary theory (MMT), which he says corrects ‘false notions of public finance’.
MMT was popularised by’democratic socialists’ in the US, such as Bernie Sanders and Alexandria Ocasio-Cortez.
Although Gqubule says a basic income could be implemented ‘with or without MMT principles’, he clearly favours MMT, as he explains in this Business Day column.
Create and spend
Gqubule cites MMT economist Pavlina Tcherneva, writing: ‘Discussion on how to finance basic income or job guarantees is only relevant for countries that have given up sovereign control of their currencies, she says. According to MMT, a new school of economics within the Keynesian tradition, governments that control their currencies are not like households. They do not have to tax or borrow before they can spend or balance their budgets. They create the money they spend. There are limits to such spending, but they have nothing to do with budgets or deficits. The limit is the availability of real resources or inflation.’
Although Keynesian and neo-Keynesian economists have a lot to answer for in giving governments theoretical cover for excessive deficit spending, I don’t think it’s fair to blame MMT on them.
It did not emerge from any of the great schools of economics. In fact, Warren Mosler, the colourful character who dreamed up MMT in 1993, said it was created ‘entirely independently of prior economic thought’.
It is true, however, that proponents of MMT, like Keynesians and really all monetarists, take issue with Adam Smith’s famous aphorism: ‘What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.’
The basic idea of MMT is that government spending is unconstrained by revenue. As long as a government has the power to print its own currency, budget deficits don’t matter, and neither does government debt. Governments can create and spend as much money as they like to stimulate economic growth or finance social security programmes. Their only constraint is price inflation, but this can be regulated by taxing money back out of circulation.
According to William Mitchell, Martin Watts and L. Randall Wray, who co-authored a recent textbook on MMT entitled Macroeconomics, ‘The most important conclusion reached by MMT is that the issuer of a currency faces no financial constraints. Put simply, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due.’ As a result, ‘for most governments, there is no default risk on government debt.’
In a sense, MMT formalises the notion of government-led redistribution by looking at it in reverse: all wealth in the private sector is created by government spending, ideally directed at the poor and the working class, and taxation mops it up from the wealthy when the economy starts running too hot. In MMT terms, the purpose of money is not to act as a medium of exchange, a unit of account, or a store of value; although it does that, MMT holds that we primarily need money in order to pay taxes.
Critique
Jeff Deist, president of the Mises Institute, has three pointed critiques of MMT. They’re worth quoting in toto:
MMT is not modern. Kings have used seigniorage and currency debasement for centuries to fund their endeavors, always at the expense of their subjects.
MMT is not monetary. It is primarily a fiscal approach to state finance, focused on tax policy as the economic accelerator and brake. Its roots predate the US Federal Reserve Bank, and in fact predate the present notion of “monetary policy.” MMT finds origins in early twentieth-century chartalism, whose proponents opposed gold in favor of paper money issued by government and mandated as legal tender. It is also a genealogical heir to the Greenbackers of the late 1800s, who believed Congress should direct the issuance of unbacked paper currency.
MMT is not a theory. It is accounting. In fact, it relies on an accounting subterfuge which bizarrely claims government deficits represent private (societal) surpluses. Because government is the font from which currency springs, all financial assets (denominated in that currency of issue) exist thanks to government! Thus, under “national accounting,” the more government spends, the richer we the people get. When tax revenue is $100 but government spends $120, Americans are richer by $20. And so on. This is not a theory; this is accounting gimmickry almost purposefully designed to obscure what’s really going on.
Deist says we should not underestimate the allure of MMT, because it appears to make possible every left progressive programme: unlimited public works and government jobs, useless and uneconomic green energy schemes, slavery reparations, healthcare for all, free tertiary education, free housing, and whatever else your socialist heart might desire.
Indeed, Gqubule also promotes ‘universal public services’, including ‘free education and healthcare, and subsidised public electricity, transport and mass housing’.
After all, if money is no object, the government can fund anything, can it not?
Our little Rand
It clearly is true that some governments can print extraordinary amounts of money, without much by way of short-term impacts on consumer price inflation. These are big countries, however, with currencies that are, or approach, global reserve currency status – like the US dollar, the British pound, or the Euro. Their economies are broad and deep, and can absorb fairly large currency shocks.
Even if you assume some form of MMT could apply to governments issuing major currencies (which would be wrong), the notion that a minor currency like the Rand gives the South African government the same sort of power is preposterous. We can’t even defend our little currency against a handful of coked-up 20‑something speculators from boutique foreign investment banks.
That governments, especially those who claim a monopoly on major currencies, can indeed print money to pay debts does not mean they can do so without constraint. While MMT proponents think inflation is a distant threat that merely requires increased taxation if and when it happens, inflation is a far more acute problem than that.
Money supply, in neo-Keynesian theory, is supposed to keep track with the amount of money needed in the economy. Roughly, this translates to the value of transactions, multiplied by the velocity of money (or how many transactions there are). The more underlying economic activity there is, the more money is needed to keep everything running smoothly.
Inflationary monetary policy
Inflationary monetary policy goes beyond this, however. It creates more money than can be justified by a simple value times velocity calculation, in an attempt to stimulate the economy. Initially, the Keynesian idea was to do this only on cyclical downturns in the economy, to cushion the blow, so to speak, while during upturns, the screws would be tightened, in preparation for the next downturn. The intended effect was to dampen the amplitude of cyclical booms and busts.
Monetary inflation, or monetary easing, has become an almost permanent fixture of monetary policy, however. And as you’d expect when more money chases the same limited set of goods and services, it inevitably causes price inflation.
The thing is, price inflation as a consequence of monetary inflation does not turn up first in consumer prices. Widely quoted consumer price indices, therefore, are not early warning systems for overheating economies. Conversely, pointing to a lack of consumer price inflation as evidence that inflating the money supply is harmless, is mistaken.
Newly-printed money first shows up in asset price inflation, and of that, we have seen plenty in recent decades.
Thanks to easy money, the ‘dot com boom’ in stock prices became a bubble which burst, as all bubbles must. In response to the crash, central banks lowered interest rates, which began to blow up yet another asset bubble, not only in stocks, but also in fixed property. That bubble burst in 2007/8. And again, governments responded to ‘prop up’ the economy.
Because interest rates were nearing zero, which central banks described as ‘running out of ammunition’, they began to print money through bond buy-back programmes, or quantitative easing. Governments also injected money into the economy through fiscal stimulus spending, and through direct payments to individuals.
This persistent inflation of the money supply is why the world’s stock markets hardly blinked at the Covid pandemic. If investors bet on the real underlying economy, a worldwide pandemic (even without catastrophic lockdowns) would have warned them to expect lower returns on their capital, depressing stock prices. Yet the markets kept right on flying, as if nothing was the matter, buoyed entirely by the knowledge that governments would print enough money to keep the asset price bubble from bursting.
Party on
MMTers think this party can continue indefinitely. They think that instead of moderating monetary inflation and restricting fiscal spending, governments have plenty leeway to print far more money, and, ignoring budget deficits, spend far more.
All they want is that governments, instead of funneling new money to the banking sector and its wealthy clients, pour it directly into the real economy, to alleviate poverty and fund grand projects favoured by the left like green technology, smart cities and electric cars.
They believe that increases in aggregate demand due to monetary inflation, instead of leading to price inflation, can easily be absorbed by economies in which there is spare productive and labour capacity.
‘Conflict theory situates the problem of inflation as being intrinsic to the power relations between workers and capital (class conflict), which are mediated by government within a capitalist system’ write Mitchell, Watts and Wray, betraying their philosophical stomping ground of Marxism.
The solution to this problem, they believe, is government intervention in the form of wage and price controls.
Most people, however, would recognise that the party cannot last forever. As the money supply continues to diverge from the underlying value created in the economy, and aggregate demand increases beyond the productive capacity of the economy, something has to give. There are already worrying signs of the coming price inflation.
‘Indeed, there is likely a Laffer curve for seigniorage,’ says Harvard economist Greg Mankiw in A Skeptic’s Guide to Modern Monetary Theory, referring to the idea that there is an optimum tax rate, above and below which tax revenues decline. ‘A government that acts as if it has no financial constraints may quickly find itself on the wrong side of this Laffer curve, where the ability to print money has little value at the margin.’
Mankiw distinguishes between the natural level of economic output and employment, which is the level to which the economy gravitates without external stimuli or constraints, and the optimal level of output and employment that maximises the social welfare, for which MMT aficionados aim.
Economic calculation problem
It might be possible for a government to intervene to push the economy towards this optimal level, but that would cause price inflation, the answer to which, in MMT, is higher taxation and price controls.
However, that it is even possible to control wages and prices to achieve something resembling optimum economic output and employment is a theoretical pipe-dream.
It runs into the classic economic calculation problem, first formulated by the great Austrian economist Ludwig von Mises, and later developed by his most prominent follower, the Nobel Laureate, Friedrich Hayek.
In a free market, the price mechanism determines how to rationally distribute resources in an economy, based on millions of individual decisions about the relative scarcity of resources and relative desirability of products and services. The economic calculation problem says that it is technically impossible for any central authority to know all the information that the price mechanism encompasses, and without this information, it is impossible for such an authority to rationally allocate resources.
Therefore, any attempt to control prices and wages, due to insufficient information on which to base such decisions, inevitably leads to shortages or surpluses, with none of the rapid correction mechanism that free-floating prices provide.
In essence, proponents of MMT deny the basic law of supply and demand, as mediated by the price mechanism. No wonder Mosler described MMT has having been conceived ‘entirely independently of prior economic thought’.
Not cogent
Not being an economist myself, I’ll lean on Mankiw’s conclusion: ‘In the end, my study of MMT led me to find some common ground with its proponents without drawing all the radical inferences they do. I agree that the government can always print money to pay its bills. But that fact does not free the government from its intertemporal budget constraint. I agree that the economy normally operates with excess capacity, in the sense that the economy’s output often falls short of its optimum. But that conclusion does not mean that policymakers only rarely need to worry about inflationary pressures. I agree that, in a world of pervasive market power, government price setting might improve private price setting as a matter of economic theory. But that deduction does not imply that actual governments in actual economies can increase welfare by inserting themselves extensively in the price-setting process. Put simply, MMT contains some kernels of truth, but its most novel policy prescriptions do not follow cogently from its premises.’
Mankiw, as befits an academic, is admirably restrained here. I don’t have to be.
MMT is popular with socialists because, if it worked, it would achieve almost everything socialists love: practically unlimited government spending, a well-funded welfare state with free everything, systematic redistribution of wealth from the rich (via taxation) to the poor (via government spending), and extensive government control over the private sector through elaborate price and wage controls that make it hardly relevant who actually owns the means of production.
Perhaps most importantly for socialists, MMT claims that wealth is not created by private industry and productive work, but is bequeathed to the private sector by the government.
‘If you’ve got a business, you didn’t build that’, former US president Barack Obama once said. That’s the core belief of MMT.
MMT is a deeply socialist doctrine, and an absurd pipe-dream. It posits a magic money tree, which governments can harvest to fund whatever it desires.
Understanding this is a pre-requisite for addressing Gqubule’s ideas about basic income and guaranteed employment, which I’ll do in my next article.
[Image: Suzy Hazelwood from PxHere]
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