( 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
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