Updated: Oct 6, 2020
( Italian bond)
Modern Monetary Theory (MMT)
Okay, I will admit that the first time I read about MMT I was dismissive and I shelved the notion to the bookcase of a interesting theory but nonsensical in practice. I had asked myself; you can't just print money without there being dire economical price to pay like rampart inflation. MMT is the economic principal that sovereigns (countries) that control their own fiat (currency) are not constrained by tax revenues and budgets and can simply print more money and put it back into the economic system, which arguably would be taxed as consumption and feed the economy.
Surely no one is taking this seriously?
I could imagine some politicians and policy makers would embrace this theory to appeal to voters without having to show fiscal discipline. However, I couldn't imagine serious economists and critical thinkers would ever embrace this theory. I believed that the principles of most economic disciplines are always built around the levers of supply and demand and it is generally accepted that some inflation is good and rampart inflation is bad. Like most rabbit holes, the information one finds doesn't always correspond with what we have been taught or hold as principles. As Lewis Carrol wrote in his novel about the most famous of rabbit holes: It was much pleasanter at home," thought poor Alice, "when one wasn't always growing larger and smaller, and being ordered about by mice and rabbits. I almost wish I hadn't gone down the rabbit-hole--and yet--and yet--
Economist Warren Mosler in the 70s championed MMT and it was received without much fanfare or notice. Mr Mosler was not only a scholar but also a practitioner who ran a succesful hedge fund. He believed enough in his thesis that he made large bet on Italian bonds for his fund. In the 1990s Italy was struggling to contain internal/external debt while trying to curtail tax fraud. Investors were pricing in a high probability of default due to these seemingly insurmountable issues. Surmising the Italian government wouldn't default, but just print more lira to support their debt, Mr. Moslers' firm was an aggressive buyers of Italian debt. This turned into a 100mm dollar windfall for the firm and provided credence that a central bank could expand its money supply to honor debts rather than defaulting. Ironically, Italy was able to clean up their balance sheet, add austerity and entered the European Union(EU) in 1999.
Just a one off or luck?
Mosler's law states that "[...] no financial crisis [is] so deep that a sufficiently large fiscal adjustment cannot deal with it." Mosler states that governments that have their own currency are not beholden by tax revenue constraints because in essence they don't bounce checks when you can just print more money.This theory is also built into the mathematical models of credit default swaps, which are insurance like contracts on bonds against default. A perfect example of how this already incorporated into mainstream financial thinking would be Japan and their bonds. Japan has the highest debt to gdp ratio in the world, yet its cost to insure it's bond is one of the cheapest in the world. In other words, the market for bond insurance believes Japan can always print more yen to service its debt and avoid bankruptcy.
Further down the rabbit hole: Helicopter Cash and a zero percent world
The Federal Reserve, which controls US monetary policy, has continued to hold an accommodating policy of "quantitative easing infinity"* while holding short term borrowing rates near zero. The goal of the Fed is by having low rates it would induce economic growth and some healthy inflation. What happens when you hold rates at zero and there is no economic rebound? Is the Fed out of tools to spur economic growth? In 1969 famous economist Milton Friedman penned a famous paper " The optimum quantity of money" in which he addressed this problem of zero percent rates and lackluster economic growth. The paper included the quote "Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. " This became know as "helicopter cash", which mentioned the government making direct payments to citizens as a way to increase money supply and to spur economic growth.
Sound familiar? Was Friedman advocating the principles of MMT? Not exactly-as a monetarist Friedman believes that controlling the supply of money by the Federal Reserve could spur economic growth or curtail inflation(growth) by tightening the supply. This is arguably not so dissimilar to MMT when it's put into practice, especially when governments are running large deficits.
How much for a loaf of bread?
The counter argument in traditional economics has been that an over supply of a fiat currency devalues it to the point that it consistently takes more money to buy goods and services, which is the definition of inflation. We have seen this play out in history numerous times in South America and in emerging economies. However currency is a barter for a good or service and is priced relative to other currencies in a global economy. In this world economy the US Dollar (USD) benefits from being a reserve currency and dollars are accepted as barter, which might insulate rampant inflation from greater supply. As a world reserve currency, trade is predominately done in USD to the scope of around 75%. According to macro economist and trader Raoul Pal, this creates around 100 trillion in dollar denominated debt worldwide while there is only 15 trillion dollars in circulation. **This certainly makes the US different than other countries and gives the flexibility to put some sort of Modern Monetary Theory to test.
The printing machine
The United States continues to post record deficits and essentially prints money everyday. Yet we have not seen much inflation as measured traditionally through the consumer price index. Although the relative price of dollars has been generally lower the last several years, it hasn't collapsed compared to other currencies and remains the worlds reserve currency. This begs the questions: is Modern Monetary Theory (MMT) a viable economic theory on a macro scale and can we have our cake and eat it to?
*: this is where the Federal Reserve is the buyer of debt and adds liqudity (cash) into the market
** further reading on why the US may have an advantage to print money without severe inflation
Updated: Jan 11, 2021
Thursday 5PM
Two economists walk into a bar. A big sign out front says, “Happy Hour! Half off for all drinks except top shelf whiskies.” One of the economists, a Mr. Keynes, clearly looks disturbed. He worries that a 50% discount is a sure sign of financial distress and intervention is the only sensible solution. Keynes buys a full bottle of top shelf whiskey and puts on his credit card. The other economist, a Mr. Hayek smiles, seemingly realizing that this price dislocation can't last for long and he better take advantage of it. So what does he do? He orders two half-price beers and pays with Bitcoin.
Move over Keynes and Friedman-the Austrians are coming back
Keynesian economics has been one of several schools of the economic and financial thought leadership over the last century . Centered around Jonathan Maynard Keynes, these economic principles believe in the role of central banks and governments to induce economic behavior by controlling money supply through interest rates. Keynesian economics lost some of its influence in the 1970s pressured by economic unrest of stagflation and a new school of thought called Monetarism which was championed by Milton Friedman*. Monetarists believe in controlling the supply of money as a way to keep price stability. Anyone who has taken a econ 101 class has been exposed to several different theories which mostly conclude to having a central authority to manipulate the supply/demand equilibrium to try to get the optimum output or desired result. Less renowned and often glossed over, is the Austrian Economic school of thought. While it's existed for much longer, it remains much smaller, arguably less renowned and certainly less followed. However, Austrian economics has seen a resurgence and large growth over the last 10 years as the world recovers from the worst economic times since the great depression. The Reliance on central banks to control interest rates, Austrians would argue ,has caused greater dislocations in the market place. Austrians also believe in market forces to correct themselves towards an equilibrium and that these cycles are shorter and less extreme when left to auto-correct.
Rise of decentralization
Keynesian and Monetarism have dominated economics and central bank thinking since the second world war. It is fair to suggest that they have been extremely successfully in helping bring economic expansion and improving the quality of life. However we have seen great boom/bust scenarios and arguably a greater amount of wealth inequality than ever. The last boom/bust scenario brought on the "great Recession" which led many to question some of previous and prevailing ideas of economics. This economic crisis and the response of sovereign/central banks to this, has brought about much distrust of central banks and a simmering move of looking for a better way. From the crisis rose" occupy wall street" and a distrust of institutions like banks, the media and government rule of law. One interesting and possibly seminal response was Satoshi Nakamoto's (anonymous creator of Bitcoin) white paper on peer to peer transactions and a decentralized currency without a sovereign backing. In fact, I believe you could argue the phoenix from the crisis is Bitcoin, blockchain and decentralized ledgers as a way reduce the dependence of middlemen such as banks and the influence of central banks. We have also seem a rise in interest in the Austrian economic school of thought whose principles align with decentralization and yes, perhaps even an alternative, mathematically based form of fiat.
What does this mean if you’re not an economist?
Most people carry on with their daily lives without much worry over economic schools of thought. However, their buying power in a local currency is arguably their biggest issue day-to-day ,especially if those people are living in less developed countries. Throughout history, fiat currencies have suffered over time from severe devaluation. Even the US dollar, has lost 90 percent of its value over the last century while it’s functioned as the currency of international trade. Meanwhile, central banks continue to explode their balance sheets while sovereign treasuries around the world continue to print money, which in turn, puts further pressure on currencies. 70 percent of the worlds GDP is at zero or negative interest rates and more debt will likely be issued by sovereigns at these low levels. No matter which school of thought you adhere to, you’d be hard pressed to find an economist who believes this sort of thing is sustainable. If you’re in doubt, just ask a Venezuelan.
Technology and Economic crisis leads to change
Computing power along with encryption has brought about about the possibility of new solutions to economics. Cryptography has been around since the ancient Greeks and cryptography in machines was pioneered by Alan Turing during WWII. Forty years ago Fredrich Von Hayek of the Austrian economic school wrote about denationalized and decentralized forms of currency to compete with fiats. In the 90's Monetarist economist and free marketer Milton Friedman predicted "e cash" and internet transfer of payments. One could argue Hayek and Friedman not only had foresight, they may have come to the same conclusion given time. The good news is, the advancement of technology and computing power has made these ideas possible Like the beginning of all great movements, more than just one catalyst was needed. The means to make it happen–in this case technology in the form of computing power–and a catalyst, the great recession of 2008, created the perfect storm. Perhaps we are finally at the confluence of a desire for a decentralized, transparent market based approach and the technology to support it. And perhaps that new economic system of measure is best theorized in Austrian economics.
And that’s why when two economists with opposing monetary views walk into a bar, it’s never going to just be about drinking.**
* Keynes basically looks for the central role of government policy to drive demand side while Monetarist believe in manipulating money supply for price stability.
** I write this as a feedback loop and always appreciate any opinions and thoughts. My intention here is not to get into any deep analysis of economic theories but on the role that technology may also be influencing the way economic policy may look evolve in the future.
We Love volatility but...
One thing we have learned for certain is that you get a full plate of volatility with crypto currencies. For trading, volatility is welcome , especially after so many years of volatility suppression at the hands of central banks. However, volatility is a hindrance when it comes to currency transactions. What exactly does that mean? Volatility, in foreign exchange, is described by how much the price of a currency in a percentage terms move from its average. This is interesting for a currency trader but not practical in everyday life because a price swing for consumer goods and staples would be hard to stomach for the average person. Many have argued that digital assets need a way to manage the price volatility to become practical in application and as a medium of exchange (MoE).
Stable Coins and Smart Contracts
The internet has been powerful in the way its democratized information and changed commerce. Rich sources of information can be harvested by anyone with a internet connection. Ironically, as information became widely available, the internet itself and all the data became centralized. Large internet companies own or control swaths of personal and historical data. The technology of blockchain provides an opportunity to remake the internet and change the way data and privacy are handled. Blockchain and embedded smart contracts allow a way for individuals to control the personal data and share it with who they like. A smart contract, which is a specific use of blockchain technology, is a computer protocol that automatically executes and enforces a specific set of criteria without using a third party. Through decentralization, individuals can connect peer to peer or business to consumer without necessarily using a centralized intermediary, which is why many people have have described this technology as the internet 2.0. Stable coins, which are tokens whose value will not fluctuate in price, have garnered attention as a way of bridging digital assets and fiat in a way that reduces volatility. These coins could provide scalability and help transform to a decentralized internet were transactions are friction-less and in real time, wringing out inefficiencies in commerce across the globe.
Navigating Protocols
What might the internet look like in the future with more decentralization and what does a stable coin have to do with it? Joel Monegro seminal paper "Fat Protocols" describes the inverse relationship between the current internet, where protocols are benign and apps are king, to where blockchain technology makes the protocols valuable and apps are the second layer. So what will this new internet look like? First we have to make a few assumptions. Tokens will become commonplace for a companies as well as decentralized organizations where you are participating in their particular community through a utility or native token. Secondly, people want to be able use their own tokens freely and across all or many applications without the inconvenience of being a currency trader. Stable tokens might well be the bridge of decentralization which allows one to seamlessly move community to community or protocol to protocol while maintaining your identity and data.
Internet 3.0-the internet of things
I first looked up the word Interoperability assuming it was a new crypto phrase to describe something technical. While the word is worthy of a William Safire muse, it is a central ingredient to tying the web together. Interoperability describes the extent to which systems and devices can exchange data, and interpret that shared data. If you search for "the internet of things" (IoT), surprisingly you will get many different definitions of what this actually means. The best definition, in my opinion, was put forth by the SAS institute which is " It's a concept of everyday objects- from industrial machines to wearable devices- using built-in sensors to gather data and take action on that data across the network".
For two systems to be interoperable, they must be able to exchange data and subsequently present that data such that it can be understood by a user. This function is critical to the evolution of the "internet of things" (IoT), in which separate computers or systems communicate with one another to perform tasks. So your car tells you it time to change the oil (not if you have a Tesla), search the web and find the best price, check your schedule and book an appointment. Your refrigerator will make a list of groceries, order them online and have them delivered to your front door. Wearable devices can monitor health and report data directly to your doctor for analysis. Supply chain management will become automated as the IoT's communicate using secure, transparent, immutable time stamped smart contracts and blockchain. The mind boggling possibilities are endless once tech and protocols start interacting with fluidity across distributed ledgers.
What Currency is in my electronic wallet?
There are over 400 different fiat currencies in the world and the majority of these are characterized by high volatility and a lack of trust. This is salient because it is at the heart of why the USD is a reserve currency. This is not to say Bitcoin is going to replace USD as the reserve currency or even the euro, yen or remibi as a medium of exchange. Bitcoin however because of it's unique immutable and mathematical structure makes it a compliment for a reserve, a medium of exchange as well as a store of value. While I believe digital coins, native tokens and stable coins will all have a place in this new and evolved ecosystem perhaps known as internet 3.0, the engine of this system is still the internet of money, which is Bitcoin.
Perhaps a smart stable coin gains traction or a digitized US dollar becomes the bridge to connect everything across the internet, time will tell. What seems clear is that blockchain technology and Bitcoin will bring more decentralization to the web. In turn there will be more connectivity worldwide between people, communities and "things".
