MMT: The case against modern monetary theory

MMT: The case against modern monetary theory

The author is HSBC's Senior Economic Adviser and author of "Grave New World".

In a world where national debt is rising rapidly, it is not surprising that investor interest in modern monetary theory is growing. Finally, one of its central claims is that budget deficits are irrelevant from a financial perspective. As long as increased public debt doesn't lead to inflation – and there really isn't much of it around right now – we can all afford to relax.

As Stephanie Kelton points out in her book The Deficit Myth, governments with access to a printing press are “currency issuers” (the exceptions are clearly members of the euro zone). As such, all of their expenses could in principle be funded through the creation of cash. Taxes can serve other purposes – redistributing income and wealth, discouraging "sinful" behavior – but they do not play a useful macroeconomic role in the world of MMT.

In the real world, however, taxes are vital. The fundamental difference between public finances and those of companies and households is not access to a printing press, but the compulsion to raise taxes. A company that makes a heavy loss cannot reduce that loss by imposing taxes on everyone else. A government can. An employee who receives a wage cut cannot force others to make up the difference. A government can.

Knowing this, creditors are understandably prepared to accept lower returns on government bonds than on other investments. Put simply, the risk of sovereign default in the face of an adverse economic shock is lower than that of other potential borrowers.

Granted, there are limits, largely determined by a government's political ability to generate revenue in difficult circumstances. Instead, emerging markets often resort to devaluation, default or inflation. In anticipation, the cost of borrowing will rise.

Still, imagine for a moment that governments embrace MMT. Also imagine MMT proponents suggesting that control of the printing press be removed from unelected central bankers and given to “accountable” elected finance officials. Would we be better off

Far from it. Giving elected representatives the keys to the printing press is equivalent to giving the keys to the casino to a gambling addict. For many politicians, the main goal is to stay in power. As such, they are too often stimulated to obtain instant gratification at the expense of longer-term stability. In the early 1970s, thanks to the efforts of the Conservative Chancellor of the Exchequer Anthony Barber, Britain began the 1974 election, known as the "barber boom". As it turned out, the Tories lost and Britain shamefully had to accept an IMF bailout two years later. Central bank independence provides a useful bulwark against such behavior.

More importantly, inflation and taxes are, in many ways, simply two sides of the same coin. Governments with no access to tax revenue can instead "degrade coinage". MMT supporters claim this will never happen, but history suggests otherwise: after all, it has been a tried and true policy of kings and queens for hundreds of years. Too often, those with press access are willing to take inappropriate risks in the hope that "this time it will be different".

In truth, inflation is helping solve the funding problems that MMT proponents claim no longer exist. Negative real interest rates, which are the result of unexpectedly high inflation, are used to redistribute assets from private creditors (e.g. pensioners) to public borrowers. Something similar could be achieved through a wealth tax. At this point things come full circle: the distinction between printing press and control begins to disappear.

Thanks to Covid-19, the national debt is increasing quickly and appropriately. In the face of recurring lockdowns, it is better to allow businesses and workers to enter a period of economic “hibernation” in the hopes that once the virus is under control, they can thaw. The alternative of multiple company failures and mass unemployment is of no use to anyone. In doing so, however, we are actually borrowing from our collective economic future. At some point, some of us will be presented with an invoice that we will have in an appropriate payment position if the hibernation policy is successful. The political process will decide whether this bill is in the form of higher taxes, more austerity measures, rising inflation or possible insolvency. I fear that is the reality of the deficit.