Modern Monetary Theory: A Bad Idea Whose Time has Come

There is a growing demand for a new kind of economics – one that can stop deflation, end austerity and benefit the people. Modern Monetary Theory checks all the boxes. It's a bad idea, but as history has shown, bad ideas can still become policy.

Dylan Grice

Deutsche Version

The ongoing debate around the pros and cons of Modern Monetary Theory (MMT) is a strange one. On one level, it feels like the kind of distraction you get when the squabbling between macroeconomists over which faction has the best untestable hypothesis bursts out of the lecture theatre and into the public arena: It’s mildly entertaining, like when brawling drunks spill out of the bar and onto the street, but not particularly enlightening.

Dylan Grice

Dylan Grice is co-founder of Calderwood Capital Research, an investment company specialising in portfolio construction and alternative investments. Prior to founding Calderwood, Dylan was the Head of Liquid Investments at Calibrium, a prominent private investment office based in Zurich. There, he was responsible for the management of the firm’s liquid portfolio, the research underpinning that portfolio, and the teams involved in the effort. Prior to joining Calibrium in 2014, Dylan was a part of the consistently top-ranked Global Strategy team at Société Générale, and was individually ranked first in the Extel Survey of institutional investor opinion in 2011 and 2012. Dylan started his career at Dresdner Kleinwort Wasserstein as an international economist and later prop trader. He is a graduate of Strathclyde University and the London School of Economics.
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On another level though, MMT has clearly sparked something in the collective imagination. I think this is much more interesting.

Although MMT policy prescriptions are probably too radical to be adopted in their entirety, I think MMT’s central tenets will become increasingly influential among the coming generation of voters and investors.

It’s important to understand that financial markets weren’t the only thing that crashed in 2008. The reputation of economists took a hit too. The years preceding the Great Financial Crash were those of the «rock-star» central banker. This was unforgettably captured by the timelessly brilliant 1999 Onion article, «Greenspan, entourage destroy hotel room» (which mock-reported that Greenspan had «once again found himself in legal trouble» after he and Deputy Treasury Secretary Larry Summers had pushed a vending machine off their Beverly Hills penthouse suite balcony onto the swimming pool area below.)

But the years since the Global Financial Crisis have been less kind to central bankers. They’ve been accused of having been asleep at the wheel as the crisis unfolded, of impotency in the face of ongoing deflationary pressures since and of stoking inequality by pumping up asset prices. Detractors argue that thanks to Quantitative Easing the rich got a stock market boom, while the poor got lumped with austerity.

A message people want to hear

Unsurprisingly, there’s a growing demand for a new kind of economics. In the same way that there was a demand for an economic theory which could fix the depression in the 1930s (Keynesianism) or one which could fix the runaway inflation of the 1970s (Monetarism), there is now demand for one which can stop deflation, end austerity and benefit «the many not the few».

This is the context in which I am taking MMT seriously and trying to imagine its potential implications.

For what its worth, I’m no fan of MMT and certainly not advocating it. Intellectually, I find it breaks no new ground, and as a theory it seems little more than a caricature of existing theories, replete with the same flaws which make theoretical macroeconomics the unscientific embarrassment that it is today.

But what I think doesn’t matter. What the public, and therefore the policy makers think, does. And here, MMT is delivering the message people want to hear. So my feeling is that this is an idea whose time has come, and that this in turn has allocation implications. It has the potential to drive a change in the macro regime, from an «economic-deflation and financial-inflation» regime to an «economic-inflation and financial-deflation» one.

What we talk about when we talk about MMT

MMT seems to mean different things to different people, even its luminaries. For example, Stephanie Kelton, one of MMT’s intellectual architects, thinks that Japan has been conducting MMT for some time. But Randy Wray, another intellectual architect and «co-founder», has said that it has not.

I don’t want to get embroiled in this specific debate. Instead I want to talk about MMT as I perceive it. In particular, when I refer to MMT, or of MMT-influenced policy, I will be referring to what I see as its central idea, namely that the notion of currency-issuing governments going bankrupt is plain wrong.

Because unlike private sector actors such as households or businesses or even governments which borrow in foreign currency, the MMT proponents point out that sovereigns with their own currency can always print the money they need.

If you follow the premise of the argument, you end up with some of the other key ideas of MMT, namely that macroeconomic policy should be managed through fiscal rather than monetary policy and that the government should run a «Jobs Guarantee» programme.

But these other variants flow from this central idea, which is that raising taxes and issuing debt are not necessary from any kind of revenue or solvency imperative because a currency-issuing sovereign can print the «revenue» it needs (Yes, MMT proponents would say, taxation and bond issuance are important levers for aggregate demand management, and taxation is necessary anyway to guarantee an end demand for the currency printed by the government, but they are not needed for any traditional «housekeeping» sense).

The government can print as much (or as little) money as it needs so long as inflation doesn’t pick up. Therefore, government spending is not constrained by any kind of budget constraint, like that which constrains the private sector. Inflation is the constraint.

So for me, MMT, or MMT-influenced policy, is any policy idea which is based on the argument that «government can afford it since it's non-inflationary».

And here is the first problem MMTers run into. Saying «governments can’t go broke because they can always print money» naturally conjures images of wheelbarrows in Weimar in the mind’s eye.

And here is also where one of the MMTers' main frustrations with non-MMTers rests. Although they readily admit that the insight is not a new one, they feel the full power and potential of it has not been fully understood by mainstream economists, or realised by policy makers.

Therefore the whole debate around, for example, the cost of Bernie Sanders’ «Medicare for All» plan in the US, and whether it is affordable, misses the point – from an MMT perspective, it’s all affordable so long as paying for it doesn’t trigger inflation.

Of course, the application of this logic is endless; the Green New Deal, the rebuilding of roads, new schools, new hospitals, all or any of the above. And the way current discussions around these policy ideas are framed – in terms of it not being affordable because government debt is already «dangerously high», or the deficit already unsustainably big – is all wrong according to the MMTers.

The correct question for them is whether or not there is the capacity in the economy to produce those things. If there is, there will be no inflation. And if there is no inflation, there is no problem. The current low and falling rates of inflation across the world economy is a strong signal to MMTers that governments should be pumping money into the economy.

The soft-money zeitgeist

To repeat, I really don’t like this and find it a terrible idea on many, many levels. Primarily, I don’t buy the premise that we are all better off because central bankers and government officials have some clever way of managing the macroeconomy. To me prosperity, wealth, job creation are micro, not macro phenomena.

But bad ideas can still become policy, as examples like imperialism, eugenics and socialism have shown. And if I was a host to the macroeconomic meme, and I believed that my judicious interventions could make the world a more prosperous and harmonious place, I’d be looking at MMT's idea that government spending should only be constrained by the economy’s inflation speed limit, and I’d be excited.

I’d be thinking, «Globally inflation is low and falling. Economists have been warning about the dangers of deflation for years now, and we’re getting closer. Surely, that can only mean ... we’re not spending enough money fiscally!»

«People believe what they want to believe in proportion to how desperate they are.»

Alternatively, if I were a megalomaniac politician living for votes and seeing myself as some kind of wise benevolent dictator, I’d be rubbing my hands and salivating.

If I was on the right, I could finance enormous tax cuts. If I was on the left, I could fund New Deals, more doctors and nurses, more teachers, rail system upgrades, affordable housing, a shorter work week, and so on.

And that is one of the reasons why I think it’s going to happen. People believe what they want to believe in proportion to how desperate they are. During the next economic downturn the idea that only old-fashioned thinking about fiscal responsibility is preventing us from building a better, fairer economy will have strong appeal.

There’s another powerful reason which I think will see MMT inspired ideas gain traction in the coming years. It is that central banks suffer all too obviously from Charlie Munger’s «man with a hammer» syndrome, i.e. for a man with a hammer, every problem is a nail. There is no problem a central banker sees that cannot be fixed with an adjustment in interest rates.

But rates are at zero, and QE «hasn’t worked». The hammer box is empty. So how are they going to continue doing the only thing they know? Answer: with a new hammer. The next downturn will see us move into a more serious discussion about the «need» for additional policy levers.

So that’s how I think we’ll get politicians and central banks on the same page, and that’s how MMT-inspired policy will happen. We may not see MMT in its purest manifestation, with public Job Guarantees and near-abandonment of government bond issuance. MMT’s influence might not even be officially acknowledged.

But for better or worse (worse in my view, but what do I know?) the next generation of stimulus designs will have the fingerprints of Wray and Mitchell all over them.

An MMT regime is coming

During the last UK election, Jeremy Corbyn proposed a «People’s QE», in which printed money would be used to invest in housing and public transport. Since then, Oxford economist Simon Wren-Lewis and macro hedge fund manager Eric Lonergan have publicly urged the government to adopt the same policy. Frances Coppola has published a clearly articulated and succinct book outlining a detailed rationale for a similar policy.

Across the political divide, there is a strong demand for new types of stimulus. The idea is not going to go away.

MMT might seem too radical right now, but «crazy» things do happen. Monetary regimes change. The idea that the gold standard would ever be abandoned must have seemed pretty radical to anyone who was contemplating it in the early 20th Century. But by the 1920s, following the disaster of World War I, the idea was gaining ground. By the 1930s it had happened.

Similarly, the idea that currency would be unbacked by anything real would have seemed ludicrous after World War II, which is why the Bretton Woods regime was built in the first place. But by the 1970s, that «preposterous» policy had become normal. Indeed, today the idea that we’d go back to a gold standard is seen as loony by most.

And not too long ago, the idea that the central banks of the world would be printing money to buy government bonds, corporate bonds, equities and/or ETFs would have been laughable!

So how radical is MMT, really? True, the theory might offend the sensibilities of certain theoretical economists. But economists are notoriously thin-skinned and are always offended by the theories of anyone outside their faction. Do politicians and voters care about the hurt feelings of such notorious squabblers?

What to do differently, and when?

So I think we are drifting into a new policy regime. Does that mean we’re moving into a new market regime too?

The end of the gold standard certainly ushered in a new financial market structure, reflecting the era’s new inflationary environment. Real assets were in, basically, while nominal assets were out.

The rediscovery of monetarism in the early 1980s did too. During the «Great Moderation» of 1981-2008, everything went up: real, nominal, liquid, illiquid, levered, unlevered, complex and simple.

What did the post-2008 era of QE bring in? Not much really. In financial market terms it was more of the same, and everything has continued to go up since. So policy regime changes don’t necessarily bring in changes to financial market regimes.

Ultimately, I do believe a shift to an MMT inspired policy regime will change the market regime. I think everything which has done well in the prior regime (bonds, credit, public and private equity) will do badly in the next one.

But I don’t think there’s much to do differently right now because this all remains too distant. The «People’s QE», or some variant thereof probably won’t be a story until the next recession, during which there isn’t likely to be a whole lot of inflation.

But ultimately, the «good old-fashioned» consumer price inflation will come. The key MMT idea that government spending will be limited not by some maximum deficit, but by inflation implies that someone somewhere in one of these government departments is able to precisely and reliably forecast inflation. I don’t think that person exists.

Therefore, the new target for central banks will effectively become sharply rising inflation. Inflation will become volatile. Policy responses will be clumsy, unpredictable and difficult to time. This will be reflected in higher risk premiums in asset markets.

And, if MMT, even by stealth, is ultimately CPI inflationary in a way that QE was not, MMT will be market deflationary in a way that QE was not.

Here is an example of some of the asset classes I’m exploring in preparation for this regime change:

  1. Gold, which is an obvious one, the problem being that it’s difficult to model. For example, if the expected return of a bond, or an equity is some variant of its yield, then a decline in prices implies an increase in yield, and therefore a higher expected return, all else equal. But gold has no yield. So how should we think about expected returns? If we say expected returns are the rate of expected inflation, which I think isn’t a dumb way to approach the question, we still have no way to know how to link that to a movement in the gold price. So what happens when the gold price doubles over a few months or years when inflation expectations have remained unchanged? What is our expected return now? Still the rate of expected inflation? If so, it means that the current price has no relation to the expected return, which can’t be right.
  2. Inflation linked securities. Again, obvious.
  3. Real estate, also obvious, though less straight forward. As inflation accelerates, the replacement cost of real estate rises too. Since most rental agreements are indexed to inflation, real estate has various layers of inflation protection built in (indeed, I believe the data shows real estate actually did OK in the 1970s). On the flip side is that real estate is typically a levered asset, and as higher inflation pushes up rates, the more extended borrowers are shaken out, becoming forced sellers and depressing prices as the process plays out.
  4. Asset backed structures. Less obvious because they are clearly nominal assets, but related to the above because a big category of ABS are real estate backed securities. They’re typically floating rate, and are collateralised by real assets. So as inflation picks up, your coupon will be increasing while your credit risk will be decreasing (since collateral values will be pushed up by the inflation). The negative is that your principal is non-indexed, and in a steeply rising rate environment, you might still suffer defaults (although the extent of this exposure depends on which tranche of the structure you’re in).