Modern Monetary Theory: The World’s Biggest Bullshit Sandwich (Part 1)

For those of you who are even 1% informed about economics - did you ever know that one person in school who’d ask “why don’t we just print money to solve the world’s problems?”? You, being knowledgeable enough to answer the question, would respond: “Because money printing leads to inflation”, and if you really knew your stuff, you’d then say, “look at the Weimar Republic - they printed money because they were so poor after the war, and look how bad things got”. You probably didn’t understand exactly why there was this relationship between the growth of the money supply and increase in the price level. But it’s just something you took for granted, and thought it was something no rational person would ever question.

Well, you’d be wrong. Modern Monetary Theory is a relatively young economic discipline which states that so long as governments operate a fiat currency (which isn’t linked to anything intrinsically valuable, like gold), they can basically borrow and spend as much as they like. This is because, prominent MMT-ers like Stephanie Kelton tell us, whenever countries which enjoy fiat currencies get into fiscal trouble and teeter on the brink of a sovereign debt crisis, they are simply capable of producing that very currency in which government bonds are denominated, any time they like, and - hey presto - they can escape trouble by paying back nervous bondholders. Moreover, the MMTers argue, a fiat currency reduces the inherent risk of a sovereign debt crisis, which is triggered by investors believing that a government can’t pay the interest on their debts, so begin selling off bonds, driving up interest rates and further reducing its ability to pay off debt, perpetuating a self-fulfilling prophecy. This is because if investors know that a government can - quite literally - bring money out of nowhere, their inherent confidence in its ability to pay off debt won’t be shaken. 

Because of these beliefs, MMT is an incredibly attractive ideology to those who think society can spend its problems to death. Think of what governments could do without any fiscal constraints? Kelton herself supports a universal jobs guarantee, but with MMT, you could fund many more goodies: a Universal Basic Income, infinite monetary resources to combat climate change, and for the more right-wing types, vast military spending.

But the second argument has quite obviously been brought into question by fairly recent political events (recent enough for me to remember). A certain British Prime Minister, by the name of Lizz Truss, succeeded in spectacularly wrecking the nation’s currency in a mere 50 days. In large part, she did this through proposing a fiscal plan which would enlarge the deficit by £40 billion. Yields on government bonds rose by 50%, essentially overnight. Clearly, therefore, investors aren’t religiously trustworthy of debts issued in fiat currencies, as MMT-ers suggest. 

But more importantly, back to the first - fiat governments can produce as much money as they want, so spend yourselves till the cows come home, no? This, really, exposes us to the debate at the heart of MMT. Fundamentally, it's to do with the causes of inflation. Governments which operate fiat currencies are certainly able to handle debts better than their non-fiat counterparts. By producing the currency, they can ‘monetise’ debt and pay off holders of government bonds, typically banks. But this begs the question - what happens to that money, now transferred into the hands of banks and other private sector agents? As economist Paul Krugman has explained, this money doesn’t just sit there. It is lended out by banks, channelled into speculative ventures by buying up property and securities, and ultimately leads to higher consumer spending. The result of this, given no adjustments in supply chains? That’s right, inflation. 

But, MMTers retort, this assessment is wrong. This is because of what they claim is a shortage of empirical evidence that monetary policy actually does cause inflation. A popular explanation among them for inflationary surges is resource constraints. In other words, economic investment only ever leads to an increase in the price level when there arise shortages of capital, labour and materials to effectuate projects. But a hell of an obstacle to this theory comes from Rafael Guthmann on Twitter (not ready to call it X, sorry): From 1865 to 1920, the US experienced net deflation. To suggest that there were no fluctuations in the breadth of supply chains during this period would be nonsense. So, the only real explanation for the behaviour of prices is monetary policy - the US existed on the Gold Standard throughout the period, making it very difficult for institutions to expand the quantity of money in circulation, as you needed a concordant stock of gold to cover any liabilities (that’s not a defence of the Gold Standard BTW - more on that in a later post). 

In other words, would the implementation of an MMT regime lead to massive inflation? Yes, because, like it or not, there is a huge monetary component to inflation. As there was in the Weimar Republic. As there always has been.

Interestingly, though, MMT-ers contest that textbook case studies of hyperinflation have been down to ‘money-printing’. In the case of the Weimar Republic, the argument goes, Germany was forced to pay off large sums of post-War debt denominated in Francs. This basically sucked all value out of the German currency, resulting in exorbitant price increases. MMT-ers make this argument with no hint of irony. By doing so, they basically admit that there are profound monetary forces which can determine inflation, and that the value of the currency is dictated by supply and demand. And so, in a hypothetical MMT world, the mass monetisation of debt to satisfy bond holders and allow extravagant spending programs would bring a large rise in the supply of the currency through the interaction with banks described earlier, depressing its value and summoning an inflationary beast.  

Stay tuned for part 2, folks.