Connect with:
Thursday, November 14, 2019
HomeMarket CommentaryMad Cats, Free Dollars & Monetary Policy Fat Cats

Mad Cats, Free Dollars & Monetary Policy Fat Cats

“To begin with,” said the Cat, “a dog’s not mad. You grant that?”
“I suppose so,” said Alice
“Well, then,” the Cat went on, “you see a dog growls when it’s angry, and wags its tail when it’s pleased. Now I growl when I’m pleased, and wag my tail when I’m angry. Therefore I’m mad.”-Lewis Carroll, Alice’s Adventures in Wonderland & Through the Looking-Glass

You must have heard the term Modern Monetary Theory (MMT) quite a bit lately on pages of New York Times, Wall Street Journal, Bloomberg etc. Whether you spent some time trying to understand it or not, you are in for a real treat, as we will dissect this new alchemy of economics. Is MMT a magic cure for our economic inequality and other ailments? Or is it, as the most successful professional investor or the last decade (Jeff Gundlach), said – ‘it is only good enough for a first grader’. I am not arguing that people who put this theory forward are dumb. Many of them are smart people and are likely intellectually superior to me. However, smart people advocated many insane policies over the years. As Blaise Pascal once said ’a mind is nothing but a workhorse of the heart’ and MMT proponents heart leads into some strange lands. So let’s take a deep dive, shall we? Paradoxically, you will see that despite my believing MMT to be nonsensical, I come to the shocking conclusion that it is actually an improvement over current state of affairs. What, how, why? Read on!

Note of caution and encouragement. Stephen Hawking was once warned that for every equation in his book he will lose half of the readers, so he resolved to have zero equations in his books. I have five simple equations in this post. In my experience readers of Larkspur-RiXtrema blog finish articles with equations at a higher rate than those without them, so we are lucky. Now on to the Modern Monetary Theory, you will be able to explain it to first grader after we are done.

MMT starts with a very radical precept that aims to change everything you know about economics based on experience and common sense. Most people believe that government taxes people in order to raise money, so that the government can spend it on something. Most also believe that government borrows money, because it needs to pay something. MMT says that this is all nonsense. According to MMT the nature of government debt is (we will come back to taxes a bit later):

“Issuing bonds is a voluntary operation that gives the public the opportunity to substitute their non-interest-earning government liabilities— currency and reserves at the central bank—into interest-earning government liabilities, such as treasury bills and bonds, which are credit balances in securities accounts at the same central bank.1

Got that? Issuing bonds has no relation to government finances. It is a kind of a service that government provides to citizens like setting rules for car emissions or some other decision that in theory is not related to finances. Why would that be? The MMT answer is that, strictly speaking, US Government does not need to borrow dollars. It can print (or digitally create) as many as it wants and be done with it without having to deal with issuing, servicing, retiring debt securities. Just. Print. Money. A reasonable comeback woudl be: ‘Why would people value something that can be created in arbitrary quantities with no ties to a reasonable balance sheet?’ Well, Government accepts the money for tax payments for one thing. But in reality taxes (thankfully) do not account for majority of uses of money. We use it for many other things and dollar would not be valued nearly as high based only on ability to pay taxes to Uncle Sam. So the answer must necessarily be that people will accept this money as value, because they believe that someone else will accept it from them. Kind of like a next fool theory. Would we not call that a Ponzi scheme? MMT has the answer and it is a “No”:

“Private debt is debt, but government debt is financial wealth for the private sector. A buildup in private debt should raise concerns because the private sector cannot run persistent deficits. But the government, as the monopoly issuer of its own currency, can always make payments on its debt by crediting bank accounts…Said another way, Ponzi is when one must borrow to make future payments. For government with a sovereign currency, there is no imperative to borrow, hence it is never in a Ponzi position.”

According to MMT the difference between a government and a Ponzi scheme is very technical and it boils down to this. A Ponzi scheme must borrow money or find new participants in a Ponzi scheme, whereas government can always just create money to pay off debts! That is the only difference. At least MMT is honest, that is why I admire it in a way, compared to Milton Friedman’s monetarist economics which is quite dishonest in giving incredible monetary power to the Fed, while hiding behind free market rhetoric.

But with all this logic you may have missed something else that is astounding in that quote!

”…government debt is financial wealth for the private sector.”

Get that? Debt is… wealth. We just need to add a few more thoughts to this declaration like War is Peace, Freedom is Slavery, Ignorance is Strength, but I digress.

How can government debt be private sector wealth, you ask? It comes about through few simple equations from a sophomore economics class. Here they are

GDP = C + I + G + (X- M)                                                        (1)

where:

C (Consumption), I (Private Investment), G (Government Spending), X (Exports), M (Imports)

But GDP is also:

GDP = C + S + T                                                                      (2)

where:

S (Private Saving), T (Taxes)

Therefore:

C+S+T= C+I+G+(X-M)                                                        (3)

After doing some fourth grade math we get:

(I-S)+(G-T)+(X-M)=0                                                          (4)

and finally let’s assume that imports and exports are equal for simplicity.

G-T=S-I                                                                                    (5)

It is this final equation that MMT uses as a main theoretic justification. Government Spending minus the Taxes is equal to Private Saving minus the Private Investment. Now some sleight of hand is done and this equation is (strangely) summarized as

Government Deficit = Net Private Saving

Therefore to increase Net Private Saving, government must run a deficit. Don’t yet ask how Private Saving minus Private Investment turned into Net Private Saving. That is kind of like saying that we will now call Net Income the amount you ‘earn’ above what you spend and save combined. Similarly, in order to have savings, I have to be able to invest more than I save? Logical person would say, no, in order to fulfill those definitions I need to rob a bank or…. well, print money. Exactly, says the MMT.

So. Without government spending more than it takes in (bad word Deficit), you or me cannot have what is called (good word) ‘Net Saving’. This is just a marketing trick to be sure. Government deficit (left hand side of the equation 5) is not a very popular term, so play with equations and turn it into Net Saving (left side of equation 5), which sounds a lot better. And converse is true. It sounds bad not to have net private saving. Therefore it is bad not have deficits. This is logical if you suspend disbelief and forget that all this is simply a definition trick, because Net Private Saving is defined as what you save MINUS what you invest. Since you cannot invest more than you save just by laws of logic (which admittedly don’t always matter to economists), then to invest more than you save there must some external source of money. It cannot come from your friends or family, because we are talking about aggregate private economy. It has to come from the government. Or it could come from the Martians. See, I told you it will get spooky. So the old saving and investing paradigm is thrown out the window, we need government to give us some money, so we can invest more than we actually save.

Why would we do that? The answer is simple, to eliminate unemployment. MMT believes that unemployment is artificial and arbitrary; it exists because those who run the economy with not enough deficit spending are not smart enough to use MMT. Or else they are evil and want to keep people in poverty. This government deficit can be spent on public projects, it could be given directly as a Job Guarantee from the government (yes, that is official term from the MMT theory). If you say that government can end unemployment by increasing private investment beyond saving, it just sounds better than simply giving out free crap by running a deficit or printing money, though the two are essentially equivalent.

Great, we gave everyone a guaranteed job by ‘printing lots of money’. This is where most of the critics start asking a simple question. If you just create money for everyone, would it not cause inflation. And to their credit MMT proponents acknowledge this and spell out exactly how this inflation will be fought. It will be fought with… taxation. Remember, I wrote that taxation does not exist to fund government expenditures. Government expenditures are funded by creating money, because the government can. No, tax collection is just an instrument to control the amount of money people have out in the economy (try to argue with that for a second). So, in the view of MMT government borrowing and taxation are just mechanical actions for the upkeep of the economy, no relation to budgeting at all. In fact, the term budget is a complete misnomer, MMTers only use it to appease old fashioned people (like me). Because debt is wealth and debt can be created at will, so wealth can be created… at will. And you thought economic problems of humanity were hard and all toil, sweat and tears. Poof and they are gone. Too bad nobody realized this much sooner, a few hundred or thousand years earlier.

Typically, critics of MMT ask the following questions of this inflation fighting with taxation.

Is it politically feasible that elected representatives, freed from any prejudices such as a budget, will actually raise taxes when inflation starts to tick up?

This would require a clockwork operation on the part of our elected representatives, not to mention that they have enough warning about impending inflation.

But there is another (more important) question that is asked less frequently. What about these guaranteed jobs that would incentivize employees to actually do a good job? It is guaranteed, after all. More importantly, a job is not just a job (it only seems like that for people who toy with equations in ivory towers (at a guaranteed tenured job, ironically) without ever having to build a real business. Someone has to be a janitor and someone has to be a manager. Who decides? And what about pay grade differences? What would be the quality of such labor?

This is an insane scheme because economy is not just a set of numbers. I grew up in a Soviet Union and recall the phenomenon of forcing people to buy goods produced under ‘guaranteed jobs’. Some store has some sneakers that you want. But in order to buy them you have to wait in line and when your turn comes, you actually have to buy another pair of shoes that nobody wants. But that is a condition of buying the desirable pair. The thing is, people were paid the same to produce both goods. But because in a communist system the pay did not correlate to performance, prudent risk taking or ingenuity, lots of crappy goods were produced (despite a highly educated population).

So, no incentives to do a good job. And how to determine who does what and at which paygrade? The old Marxist slogan suggested that: “”From each according to his ability, to each according to his needs” as a way of determining that.

But as one of Alexander Solzhenitsyn’s heroes noted in paraphrase: “They decided that I have ability to work 18 hour days in freezing temperatures and as to my needs… One bowl of watery oatmeal a day will do”. I am definitely not saying that MMTers want to bring us Gulag, but to thing that a government will decide who gets paid how much en masse is just not compatible with a free society. Moreso, it is not compatible with a productive and vibrant economy.

MMT literature is full of missing forest behind the trees types of arguments that make anyone who actually worked in real world finance smile. Here is one quote from an IMF paper nonetheless:

“The paper builds on other analyses that link the recent financial crisis to demand for safe assets (see Acharya and Schnabl (2009), Caballero (2010), and Bernanke (2011)). According to these views, the financial crisis was driven by an insatiable demand from the rest of the world for safe, high-quality (that is, AAA) debt instruments, which the U.S. financial system produced through the securitization of lower-quality ones.”

https://www.imf.org/en/Publications/WP/Issues/2016/12/31/Institutional-Cash-Pools-and-the-Triffin-Dilemma-of-the-U-S-25155

Ehhh. Really? This crisis was driven by the demand for US Treasury. Maybe it occurred because of all those junk loans creating with infinite supply of cheap credit? And when those went bad then people rushed into Treasuries? But no, there you have it. Desire to own Treasuries drove the crises and we outlaw US Treasuries or make them abundant (which is what the author ultimately advocates), such crises will not happen. And most people hit brakes before a car accident. Therefore car accidents seem to be driven (pun intended) by a very strong desire to hit brakes.

I will close the first part of this blog with a quote from someone who is a strong advocate from of MMT. This person is not an economist, but he is highly educated with Ph. D. from US Berkeley and is a a Research Scholar at the Global Institute for Sustainable Prosperity, which is headed by two economics professors.

Here is how Dr. Scott Ferguson (very succinctly) summarized MMT:

“Money is an infinite public reserve that has been choked off at its source. Unlike money’s private users, moreover, only government wields the capacity to furnish all persons with meaningful employment and sufficient access to the common store of wealth. To choke off this power, MMT insists, is not a de facto consequence of a money economy—there is no such thing as a natural rate of unemployment, for instance—but, rather, a political decision to maintain populations in conditions of poverty, violence, and despair…

In contrast to this frenzied and inadequate supplementation, MMT’s Job Guarantee aims to endow local councils with funds to furnish every market reject with living-wage employment (say $25 per hour plus health care, to start).

https://arcade.stanford.edu/content/unheard-center-critique-after-modern-monetary-theory

Money is an infinite public reserve indeed. Don’t say I didn’t warn you.

Part 2 to follow…

1  Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems by Randall Wray

leave a comment