Hopefully, you read Part 1 and now have a strong grasp on the foundations of our financial system. Part 2 builds on that foundation. It’s all about Modern Monetary Theory (MMT). MMT is the modern evolution of our financial system and pretty accurately describes the philosophy to which Central Banks and governments have ascribed for the last twenty years. As you’ll come to understand, and as Epsilon Theory so aptly states: We’re All MM'ters Now.” The consequences of this will reach beyond the dollar to cryptocurrencies, financial markets, and politics.
In a few words, MMT is founded on the understanding that as long as a government is printing and managing its own money and doesn’t have debt issued in the currency of another country (more on this later), the country won’t ever have to worry about running out of money. It can just print more. MMT’ers asserts that the focus should not be on the deficit, but rather on managing inflation. If inflation can be kept in check, the government can engage in whatever spending it wants. This is MMT’s diagnosis.
Armed with this understanding – that if we eliminate the conventional debt concerns, then we unlock a whole pool of underutilized money, MMTers ask:
This is the question guiding MMT's key proposal
Why is this important? Because if MMT'ers are right, then we’re artificially constraining our growth and limiting our ability to do good. If they’re wrong, either in their diagnosis or in their proposals, inflation could skyrocket.
Imagine national debt in terms of credit cards. Credit card debt is debt in a currency that you do not control. You can’t just print more dollars, euros, or yen to pay off the debt. If you don’t make your payments, you’ll default, ruin your credit, and struggle to get loans in the future. It works like this for some governments, but not for all of them.
If a government has debt in its own sovereign currency, then it can’t “default.” It made the money in the first place. If it needs to pay off debt, it can just print more money.
Only governments that have debt in foreign currencies (AKA foreign-currency denominated debt) are at risk of defaulting.
Why would a country want to take on debt in a foreign currency? Good question. Imagine that a country like Angola wants to build infrastructure and purchase oil to encourage growth. No country or investor will lend to Angola if they’re going to be paid back in Angola Kwanzas. Investors would worry that Angola’s inflation could spiral out of control so they’d likely be unwilling to buy debt in kwanzas. Inflation is bad for investors since it means that by the time they get paid back, the money is less valuable. That 100 kwanzas an investor is owed becomes a lot less valuable after dramatic inflation.
Thus, Angola must borrow in dollars. Because this is debt denominated in dollars, the debt must also be paid back in dollars. This protects investors and gives Angola financial liquidity, but it’s risky for Angola. Eventually, Angola will have to pay back this money and, in order to do so, it will have to obtain the dollars on the Forex (foreign currency exchange) market. If their currency has devalued significantly, it makes the debt much more expensive. If they can’t purchase enough foreign currency to satisfy their debtors given the current exchange rate, they’ll either have to borrow more to pay their current debt (a bad, bad cycle of doubling down), or they’ll default on their loans (also really bad). They can’t just print more dollars since they don’t have control over the American dollar printing presses. The list of defaults is long.
Angola isn’t the only country to do this. Debt in foreign currencies is most common with developing countries since they have the most volatile economies and thus, the highest risk of inflation. This is what is meant when it’s said that the American dollar is the Global Reserve Currency. In fact, 61.69% of all foreign currency reserves are in dollars.
Easy access to capital (friendly monetary policies) makes it very easy for foreign countries to borrow dollars to finance development. This is great, but it’s enormously risky for these emerging markets. If they can’t develop (build their national economic value) in pace with the value of the dollar, the debt can become crushing. This is what happened to Turkey in 2018 as the Lira’s value collapsed.
Some countries even “peg” their currency to the price of dollars. This is known as a Fixed Exchange Rate. This is in contrast to currencies with Floating Exchange Rates. Most first-world fiat currency values are determined through floating exchange rates, meaning that the currency's value is determined simply by the supply and demand for their currency on Forex markets (Foreign Exchange Markets).
With a Fixed Exchange Rate, a Central Bank will manipulate the supply and demand of the national currency to keep it closely tied to the price of dollars. For example, Angola might peg the kwanza to the value of the dollar. In this case, the Central Bank of Angola would purchase and hold large reserves of dollars. If the kwanza began to drop in value compared with the pegged currency (i.e. the dollar), Angola would flood the market with dollars by buying back kwanzas. This would drive up the price of kwanzas in comparison to the dollar.
Oftentimes, this fixed exchange rate policy is coupled with restrictions on how much foreign currency citizens are permitted to hold. If Angola is artificially propping up the price of kwanzas, it certainly can’t have Angolan citizens selling kwanzas for dollars at every opportunity. Between 1870 and 1914, every currency was tied to a fixed rate (that of gold) – the United States maintained this until 1971. And true to form, the U.S. indeed banned private gold ownership between 1933 and 1974: one more example of how economic policy is intrinsically connected to individual freedom.
No currency’s value is solely determined by fixed or floating rates. The kwanza is vulnerable to the impact of supply and demand and the U.S. Fed intentionally manipulates rates to adjust the value of the dollar. Fixed v. Floating simply refers to the primary means in which a currency’s value is determined.
The advantage of a fixed rate is that it creates currency stability in the short term. But as everyone eventually learns, it’s hard to maintain an artificial value that heavily contradicts the free-market value. If a country props up the price of the currency too dramatically without the support of underlying economic value, then the currency will eventually bubble and collapse. Oftentimes, black markets emerge that price the currency according to the free-market exchange rate, well below the official rate. For example, tourists to the Soviet Union in the ‘80s describe how one could get close to a 4x better rate of dollars to rubles on the black market than was obtainable through official exchange locations.
Why? Because the free-market is the house and the house always wins…
The U.S. benefits from having the dollar serve as the global reserve currency because it allows the U.S. to only ever need to accrue debt in dollars. Everyone wants dollars so everyone is happy to have America pay back the debt in dollars.
Issuing debt in one’s own currency (like the U.S.) presents a whole class of great benefits. Enjoying those points your credit card company offers? Well so does America. America can rack up charges on their credit card while also having a money printing press at home. Time to pay the bill? Just print more! In fact, unlike in the above example, inflation actually makes existing debt cheaper for America.
However, MMT’ers do understand that while debt in ones’ own currency can easily be paid off, it’s not without consequence. MMT’ers understand that the risk for America is not defaulting. It’s hyperinflation.
If a country accrues debt in a foreign currency, it is vulnerable to default because debt becomes more expensive if its native currency loses value in comparison to the foreign currency.
If a country accrues debt in its own currency, there is no real risk of default since the country can just print more money. The only danger is that it will create inflation.
Now we can get to the good stuff. I’m going to try to present this as fact-based as possible. I appreciate making my own opinions and I assume you do too. The opinions will be in the next article.
MMT points out that everyone today is essentially an MMT'er. Governments spend and spend without any tax raises or concern over funding those expenditures. MMT defines this reality by pointing out that given today’s economic reality, we only need to offset spending to control inflation. We don’t need to balance the budget.
And if this is true, and modern Central Banks absolutely do believe this, then we should disregard the old financial policies built upon the importance of a balanced budget (i.e. Treasury bonds and monetary policy). We should open up the federal pocketbook.
MMT holds that Fiscal Policy is better than Monetary Policy. Fiscal Policy can be used in essentially the same way as Monetary Policy. Higher tax rates lower cash liquidity in the same way that higher interest rates do. If this doesn’t make sense to you, return to Part 1 to review those concepts.
This belief is rooted in the understanding that one major consequence of monetary policy is unemployment. If you remember from Part 1, contractionary monetary policy makes it harder for companies to access capital. Thus, they end up laying off employees and decreasing their expansionary operations.
MMT believes that since the government is creating unemployment, it has an obligation to solve unemployment.
Since Fiscal Policy includes government spending, MMT'ers believe that the government can kill two birds with one stone. It can print money to stimulate the economy AND use that money to finance bills that solve social problems such as unemployment.
Come on baby, don’t fear the deficit
Baby take my hand, don’t fear the deficit
We’ll be able to fly, don’t fear the deficit
No one really fears deficits anymore. We’re actually printing trillions of dollars on encouraging economic prosperity. Whether it’s Trump or Sanders, both are committed to spending money with little concern for financing such expenditures. Yet when Trump proposes large spending plans, the Left criticizes it by asking how we’ll pay for it. When the Left proposes the Green New Deal, the Right asks how we’ll pay for it. The reality is that we won’t pay for it.
So MMT asks, why don’t we accept this reality and put some of that money towards public-good expenditures? We spend trillions of dollars buying corporate debt, but we’re not willing to spend money on healthcare and a guaranteed jobs bill?
MMT’ers would argue that because unemployment is a consequence of federal monetary policy, employment should also be a guaranteed policy.
So MMT’ers say, “let’s stop doing all this debt financing.” In fact, we don’t need to finance the debt. Let’s (as the U.S. Government) stop selling debt on the open market. Let’s get rid of Treasury Bonds. Since we don’t actually care about financing government spending, let’s stop pretending we do.
MMT’ers believe that we should pretty much abolish Monetary Policy and set interest rates to 0%. Instead, we should use Fiscal Policy to manage inflation AND put people to work. A trillion dollars spent on a guaranteed jobs bill will accomplish the same thing as lowering interest rates, with the added bonus of putting people to work and helping facilitate economic wealth.
And since we don’t have to worry about America (or other countries) “defaulting” on its debt, provided that they only have debt in dollars (which we do), then the deficit is only bad when it causes inflation.
The government can spend as much as it wants as long as it keeps inflation under control. Inflation hasn’t increased in years even with massive government expenditures. So let’s put those massive government expenditures to some good.
Fiscal policy has lagged significantly behind monetary policy in recent years. MMT would have it the other way.
MMT bases its ideas on several key economic understandings. If you want to save time, you can just read these conclusions here. For a deeper explanation, continue below.
MMT'ers hold that money is endogenous. It’s ok, I didn’t know what that meant either. Endogenous means “having an internal cause or origin.” Like a centralized currency. The Central Bank creates its currency and destroys it pretty much at will.
So the idea that the U.S. won’t be able to pay off its debt is absurd. It could pay it off tomorrow by just buying assets from the public and crediting the accounts of those banks (remember Expansionary Monetary Policy?). Deficit Crisis solved. There is zero chance that the U.S. defaults on its debt.
MMT Tenet #1: Money is Endogenous. The U.S. government will never default.
MMT’ers ascribe to something known as Sectoral Balances which divides the global economy into 3 sectors: Government (Public), Private, Foreign.
Imagine that I am transacting with you and only you. If I had a deficit (spent more than I made) you would — by default — have a surplus (since you’d be receiving my excess money without any way of creating a deficit for yourself).
Thus, MMT'ers hold that the government must always encourage a private sector surplus (saving more than it spends) since a deficit in the private sector is almost by definition a bubble (people taking on more debt than they can pay off). To encourage this private sector surplus, the government sector MUST run a deficit. In other words, if the government wants people to save more than they spend, the government needs to give them the funds with which to save. The only exception to this is if the government has a trade surplus (they export more than they import) since the large international demand can support a surplus in the government sector AND the private sector. America does not have a trade surplus.
There’s a lot of truth to this. Bill Clinton balanced the budget during his presidency. Between the years of 1997 and 2001, the Federal Government even maintained a surplus. But the saving rate for the private sector (i.e. household savings) dropped while household debt rose. In other words, the private sector operated at a deficit to accommodate the public sector surplus.
But it’s unsustainable for the private sector to always operate in a deficit. Because, unlike the government, the private sector can default. And if it’s spending more than it makes year after year after year, it will default, and it did. In 2008 we saw the bubble pop.
The build-up to 2008 was partly because of the Clinton surplus. Because the government had a surplus, it didn’t need to issue debt. It stopped selling Treasury Bonds. But people still wanted to invest in something safe. Without the availability of T-Bonds, people turned to other investment bonds in the safest place they could find: real estate. As the availability of T-Bonds dropped, demand for mortgage-backed securities from Fanny Mae and Freddy Mac skyrocketed. If you saw “The Big Short,” you know what happened next. This article brilliantly outlines the effects of Clinton-era budget balancing. However, recognize that there are many conflicting theories and it’s incredibly hard to establish direct cause from any single theory.
MMT Tenet #2: The government must run a deficit if it wants the private sector to run a surplus.
MMT'ers don’t believe that governments need to finance spending. They just need to offset spending. That’s a big difference. The goal is not to raise taxes to accrue debt in order to finance public spending, but rather to raise taxes to keep inflation down as spending happens. Remember, traditional economics believes that removing capital liquidity lowers inflation since there will be less circulating money.
So when the government decides to spend money, it needs to make sure that it’s offsetting that spending somehow. It can offset it by raising taxes to remove money from circulation. It can also issue bonds to accomplish the same thing. It can also build economic value to meet the greater cash supply. For example, it could improve infrastructure so that production will increase to meet the increased money supply. It could create jobs with the money as well. In other words, MMT'ers hold that governments should spend, but they must spend wisely to keep inflation under control.
MMT Tenet #3: The government must offset spending, not fund spending. It can offset it with tax increases and with government spending in targeted areas. The government can pay for everything it wants (technically). Its only constraint is inflation.
MMT’ers believe that Fiscal Policy, not Monetary Policy, is the best way of managing inflation. They see an outdated, archaic system and question why we need to still play by these (largely ignored) laws. Why influence interest rates when we could just keep interest rates at 0% and manage inflation through taxes and government spending?
This is especially true since they see that Monetary Policy hurts people since it creates unemployment. The government should spend more to guarantee jobs to its citizens which will, in turn, spur economic growth.
MMT Tenet #4: Monetary policy should maintain a 0% interest rate. The government should guarantee a job for everyone.
MMT'ers point out that we can see the economy in relation to its total capacity: i.e. how many people are employed and is all the demand for goods being met? If the economy is under capacity, government spending will not cause inflation. Under capacity is synonymous with deflation. So at that point, government spending is just counteracting deflation. Only when an economy is at full capacity (total employment) can the government spending create inflation. This isn’t a new view; Keynes saw this too. But MMT'ers have returned to this principle.
Bramley, Maurice (Department of National Service)
In a recession, the economy is far below capacity. Recessions are defined by less available jobs than available workers and by a decrease in demand for goods because of economic stagnation. At this point, it’s critical that the government begins spending more to offset this below-capacity production. Look at WWII (MMT literature loves this example). With a world war on its hands, America was far below capacity. It had tanks and planes and bullets to make. It could afford to fund huge military and civilian spending while incurring little inflation.
MMT Tenet #5: The government can only cause inflation if it spends when the economy is at full capacity. When the economy is under capacity, government spending is crucial for a quick recovery. This is true for unemployment since unemployment means the economy is under capacity.
The reality is that the only problem we’ve really encountered in the last 40 years in developed countries is deflation, not inflation. We’ve cut taxes, lowered rates, spent enormous amounts of money, and we still haven’t spurred inflation.
America’s inflation rate since 1930
So when Alexandria Ocasio-Cortez proposes a Green New Deal with its estimated cost of tens of trillions of dollars (accurately estimating the cost is difficult), she’s not expecting us to pay for it. She’s expecting the same pattern of the last forty years to continue. The government spends, the economy improves, the government keeps spending, and the economy keeps improving. Until happily ever after.
And she’s expecting that the Green New Deal will encourage more economic progress which will further protect against inflation.
MMT Tenet #6: We worry too much about inflation and about deficits. As long as we’re being smart about how we spend money and how we offset inflation, we’ll be fine.
To see an inflationary benefit, taxes must target the middle and lower class. This is where I see some of the logic in AOC’s Green New Deal breaking down.
The rich spend a lower percentage of their income than the lower classes in food and essential items. They probably “spend” all they
have by investing, expanding or starting businesses, and just general purchases. To see an effect on inflation rates, one must tax the people who are spending money. Thus, both tax breaks and tax hikes must target the middle and lower class if they’re to influence inflation. A 70% tax on $10 million dollars and up isn’t really going to have nearly as large an impact on inflation as would taxing the lower class.
Additionally, high taxes on the rich incentivize them to find loopholes or to move to new tax regions. When governments levy taxes against the rich, they’re competing competitively with taxes offered by other countries (or states). When corporate taxes are raised in New York, companies go to Delaware. All this further reduces the ability of these taxes to offset government spending and prevent inflation.
MMT Tenet #7: Raising taxes on the rich raises money, but it’s a poor way of offsetting spending. Thus, to offset spending and prevent inflation, taxes must be raised on the actual people spending large percentages of their income: the middle and lower class.
MMT is basically saying that we’ve been living in a contradiction for a long time. We’ve pretended like the deficit matters but our actions show that we don’t actually care. So we should accept that the only constraint the government has on its spending is inflation. We should do away with federal debt since there never was any need to finance anything anyways. Let’s focus only on controlling inflation.
And you know what? Inflation hasn’t been a problem for a long time— even when the economy was exploding (like during the last ten years). So let’s keep spending money in smart ways so that the economy grows and we can control inflation through taxation if we need to.
There’s also a reason that the biggest advocates for MMT are also the biggest advocates for government spending. MMT is the narrative that not only permits, but encourages enormous government spending. The motive driving this narrative, regardless of whether the narrative is accurate or not, is that there are problems that can be solved by increased government spending in the right areas.
This article is less about asserting whether MMT is right or wrong and more about understanding what MMT proposes and what it says about our economy. Part 3 will look at the potential consequences of MMT: for America, for our global economy, for Bitcoin. It will explore whether MMT’s principles are founded on an accurate understanding of the financial system and it will analyze to what end MMT might be taking us.
A thank you to Giuseppe Gori for the helpful edits and contributions.
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I love getting questions or suggestions, so comment away! I do my best to respond to all thoughtful comments.
I received no compensation for this article.