Saturday, January 7, 2017

MMT and the US economy

In my post Modern Money Theory Thought Exercises I walked through some scenarios using my rudimentary grasp of Modern Money Theory (MMT), which is a field of economics that promotes the notion that governments that issue their own fiat currency operate in a way that is not intuitive when considered in terms of standard household budgets. A few of the more surprising outcomes of those thought exercises, and of MMT in general, are:
  • The government collects taxes not to raise funds for itself, but to give the money it issues value.
  • A national debt is necessary to maintain a liquid money supply.
  • Bond financing is necessary to maintain a liquid money supply. (my conclusion)
  • A fiat money system is not inherently inflationary.
  • Fractional reserve banking is not inherently inflationary (in the long run).
In my exercises I attempted to create scenarios that proved the latter two were false, but I was unable to do so. I was hoping my thought process would lead to conclusions that invalidated the premises of MMT but that did not occur. However, just because I wasn't able to show that catastrophe is inevitable is in no way an assertion that catastrophe is impossible, or even unlikely. If driven incompetently the safest automobile in the world will still crash. Also, I mentioned in my conclusions that I've not confirmed how similarly the US operates to the theory. The practical deviations could be important.


I showed that simply holding a national debt is not inflationary. The effect of the debt is that the government must effectively reduce spending to make interest payments. Currency would be redistributed from government programs towards bond holders. While this may have undesirable consequences (plenty of people state that bonds are a form of corporate / oligarchic welfare, but then again anyone can buy them) this does not drive some infinite debt spiral.

Those scenarios were simple and short-term, all just one or two years, and mostly assumed a steady national debt. They did not assume a continuously increasing national debt. They did not assume a debt that doubles roughly every 8 years. MMT suggests that it is okay to have a national debt, but says nothing about exponential debt growth!! National debts may not matter, but deficits definitely do matter. (Reagan and Cheney are not vindicated by MMT).

When the national debt grows, the government must either reduce spending to accommodate debt growth, or it must increase the money supply to cover the debts. If the economy is growing fast enough they can safely issue extra money to cover the interest payments, otherwise inflation occurs. In our situation everything is at odds. The money base is growing fast, spending is increasing fast, the economy is growing slowly. Only one of those can be true at the same time for sustainability. 

The strongest counterargument to this is that we are not actually witnessing a lot of inflation based on consumer price indexes. However it may very well be that the inflation is hidden from those metrics. They don't account for some of the fastest growing expenses, like education. Also, I suspect that much of this excess currency is being sponged up by the soaring stock markets. I don't quite understand the mechanisms for this right now so I'll save that for another post. But the fundamentals are there: money base expansion is outpacing economic growth. From basic macroeconomics there must be inflation.

Foreign Interest Payments

If bonds are held domestically then the interest payments still trickle through our economy towards the government tax sinks. As mentioned before they cause a transfer of wealth towards bond holders. But as I showed in my previous post, if the bonds are foreign-held then the interest paid amounts to a transfer of wealth out of the country. The money still must come back to the US tax sinks, but in exchange we send them goods and services - some percentage of our economic output.

Foreign financing amounts to a tax on the domestic economy. Policy proposal: the percentage of debt that can be foreign-held should be capped. Right now we're at a about 33%, which seems high. Interest payments consume 6% of the US budget (which isn't that terrible). This indicates that an amount of wealth equal to 2% of the US budget is sent overseas every year, simply for the sake that they hold bonds that we need to give our currency value for our system to work, with nothing of material value offered in exchange. 

As an aside, I don't understand how being the world's reserve currency favors typical Americans. Many people act as if we have some great benefit because of it, but I don't know what that is. We are paying out our wealth to other countries in return for doing them the favor of providing that stable reserve currency! I've heard this argument before, from smart people. The example often provided is that gas is much cheaper here than in Europe. But they had to convert the local currency to dollars to make that comparison. There is nothing stopping the Europeans from converting their currency to dollars to make the purchase! Surely the difference can be explained by the high gas taxes over there, and that the US is a large oil producer.

But I would like to hear some compelling argument as to how the US dollar as a global fiat currency benefits me as a citizen economically. There are benefits of course to the US government, many of which are purely political.

Fractional Reserve Banking

I found that reserve banking is not inherently inflationary, which is in line with what the MMT people say. In fact getting this point across seems to be a constant struggle for them, as there are many blog posts dedicated to the notion. Many of us have watched videos such as this one that tell us the government and banks create money out of thin air, thus inflating the currency as a secret tax. But they ignore the part where the debt is repaid and the money is destroyed. 

However, there are two ways catastrophe can occur:

Unsound money

Bank credit relies on so called high-value money, or money that is directly issued by government spending, as a reserve. Bank credit is created by leveraging high-value money and I've shown that it seems to be a sound practice. But what if the reserve was not high-value? If bank credit was used as the reserve, the could lead to an infinitely expanding money supply. Banking is regulated, of course, but so is the financial industry, and the 2008 crisis was caused because Wall Street crooks were using dirty tricks to sell high-risk instruments as low-risk. High-value money carries less risk than bank credit because it is backed by the US government. Surely there is great incentive for those same crooks to find ways to leverage the difference. The question is really how much of that is going on?

Debt bubbles

I've shown that fractional reserve lending is not inflationary in the long run, but it does expand the money supply. This should balance out into a steady state. Loans are created and settled every day. But what happens when the debt all collapses at once? If that occurs, there could be massive deflation, which can be even more devastating than inflation. (Economic planners strive for a small inflation). There are all kinds of reasons a debt collapse can occur, and MMT doesn't change any of that. So in light of all this I still advocate that people prepare for deflation. Inflation is likely to be gradual, and we aren't even suffering the consequences of that for some reason. But deflation could be truly drastic. At this point I am more worried about the collapse of an already over-inflated credit supply than I am about runaway hyperinflation from government spending.

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