The Inconvenient Truth About Modern Monetary Theory


First of all, there is nothing “modern” about modern monetary theory (MMT). It’s nothing but Chartalism, founded by German economist Georg Friedrich Knapp in 1905, renamed presumably to sound more, well, modern and appealing for marketing purposes. The basic premise of Chartalism is simple: the government supplies money to stimulate economic activity and creates demand for money through its sovereign power to tax economic activity.

By this principle, it follows that a sovereign government issuing its own money can never “go broke” as it can simply print more money to repay outstanding debts. In other words, national debt is nothing to be concerned about as it’s simply an accounting representation of surplus credit issued to the private sector. Taking this one step further, the government doesn’t even need tax revenue to spend, it can theoretically print all the money it needs to provide public services without taking a dollar from the private sector. Taxes are therefore only levied to regulate spending and prevent excessive inflation.

As crazy as it may seem, all of this is true. When Chartalism was first conceived, the world was largely on a monetary (gold) standard. Chartalism offered an alternative financial system based on an interest-free form of credit that bypassed gold, and thereby avoided the limitations (deflationary pressure) of the gold standard. This, however, was not the financial system adopted. If it were, everything proposed by the MMT community would be true.

Instead, we got Central Banking, also a credit based financial system, but one that is distinct from Chartalism in that it’s the Central Bank, not the government, that originates credit. Furthermore, under the Central Banking system, the vast majority of credit in the economy is created not by the Central Bank but by “regular” banks such as JP Morgan, Citi Bank, Deutsche Bank, HSBC, Barclays etc. The central premise of MMT is therefore false in the context of today’s financial system: governments do not issue money, they issue interest-bearing credit through a Central Bank, and the vast majority of credit in circulation is issued not by the Central Bank but by the banking system.

MMT conflates Chartalism with Central Banking, and in doing so it ignores the implications of a government issuing interest-free credit versus the banking sector issuing interest-bearing debt:

In the former, the government truly controls the money supply, and banks work the way most people think they do i.e. classic “3-6-3” banking: pay 3% on a pool of deposits, lend the rest (minus a small reserve to service withdrawals) at 6%, and hit the golf course by 3pm!

In the latter (what we have today), the government has limited control over the money supply. It perpetually borrows from a Central Bank that literally creates “money” out of accounting entries (it’s not actually money, but rather credit), and charges interest for it! The government then spends this credit, and as it flows through the economy, banks mark up the interest and issue even more credit. In doing so, banks multiply the credit supply by far more than the original credit injected by the government, which it in turn received from a Central Bank that whipped it up out of thin air!

To be fair, MMT does advocate for 0% interest on credit created by the central bank. This would be closer to the paradigm in which the government issues interest-free credit, but still fails to address the reality that retail and commercial banks create most of the credit in the economy. The Central Bank does in fact issue interest-free credit, but only during periods of extreme financial distress. This is commonly known as Quantitative Easing or “QE”. During the 2008 financial crisis, QE funds were used to buy financial assets (mainly government bonds and mortgage backed securities). Over $3.6 trillion of these assets were purchased between 2008 and 2017 yet the “money” (credit) supply increased by more than double this amount.

Where did the additional “money” come from? Banks. The end result? Inflation. But not the type of inflation you’ll see in the consumer price index. Rather, inflation has been largely confined to financial assets: stocks, bonds, and real-estate. Not surprising at all given QE funds were injected into the financial system!

What if QE funds were given directly to consumers? This would be akin to “helicopter money”, a term coined by Milton Friedman to describe a scenario in which the government gives money (credit) to its citizens to stimulate economic activity. MMT folks call it “people’s QE”, and excitedly claim it will solve the private debt bungle that is plaguing most western economies. This idea is dangerously naïve and demonstrates a complete lack of understanding of today’s financial system.

In terms of reducing private debt, People’s QE would be like giving penicillin to a cancer patient. Give everyone a thousand bucks and the banking system will gobble it up, issue two thousand bucks of credit, and before you know it, the private debt bubble would be even bigger. The real issue (the cancer) is the banking and monetary system itself. MMT doesn’t recognise this fundamental issue at all (to be fair, neither do most other economists), and therein lies the problem.

The principles behind MMT are sound, but applying them in today’s complex financial system is irresponsible. In the words of Thomas Jefferson, 3rd President of the United States:

“If the American people allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the people of all their property until their children will wake up homeless on the continent their fathers conquered.”

Sure enough, The Federal Reserve now owns nearly $2 trillion in US property through its holdings of Mortgage Backed Securities – depriving the people of their property. Applying MMT thinking to the current system will only make this problem worse by accelerating the creation of debt.

Instead of misinforming the public that “deficits don’t matter”, MMT advocates would better serve their cause by promoting structural changes to the monetary system that would support their philosophy. A good example would be the Quasi-Gold Standard – a truly modern monetary system that embraces the valid principles of MMT and describes the structural framework necessary for implementation.

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