Modern Monetary Theory and the End of History

In his seminal essay “The End of History?”, Francis Fukuyama argues that liberal democracy and capitalism have triumphed over communism and fascism, that it is no longer necessary to consider other political or economic theories. This conclusion appeared self-evident as the Berlin Wall came down. However, the thirty years since the essay’s publication have seen the rise of far-right leaders in Europe, open supporters of fascism in the Americas, communist sympathizers in China and religious fundamentalists in the Middle East. With all of these alternatives jockeying for positions on the world stage, it is safe to say that history has not yet ended: the debate on proper governance lives on.

Fukuyama’s suggestion that the debate on economic theory was over—with capitalism the victor—has also come under fire. China’s mix of Marxism and capitalism has demonstrated that some forms of autocracy, however negligent of human rights, can result in a consumer culture, if business is allowed to develop. Rejected in the West, this form of governance proves that—at least in the short term—individual prosperity and universal freedom need not be part of the same package.

The economic policies proposed during the current US presidential campaign cycle, however, are a different matter. Anti-capitalist calls for higher minimum wages, higher taxes and more discretionary spending are now the norm among candidates, particularly—though not exclusively—those on the left. Many of these policies are premised on Modern Monetary Theory (MMT), an alternative theory that undermines several established beliefs about the role of government in the economy. Most recently, MMT has been suggested as a means to pay for the Green New Deal, the brainchild of Congresswoman Alexandria Ocasio-Cortez and Senator Ed Markey, and has been used to justify a job guarantee policy. Despite gaining some traction in the political sphere, the theory has been subjected to criticism by many notable economists. But what is MMT, and is it a policy on which we should base our economy?

MMT has been thrown around as a solution to everything people think is flawed about capitalism—but these casual uses of the idea are not necessarily representative of the theory. Orthodox economists are biased in favor of established work, while populist politicians look to any alternative that will garner votes. The terrain on which the theory is based seems to shift with each new utterance, making it difficult to define. In an effort to evaluate the theory as objectively as possible, I will rely on James Montier’s summary of MMT, as detailed in his recent paper “Why Does Everyone Hate MMT? Groupthink in Economics.” His summary is not only rooted in a sound understanding of orthodox economics but also addresses some of the concerns that other economists have raised regarding MMT.

Unlike capitalism, which is based on free market principles, MMT is premised on the realization that currency derives its value from the government. As Montier writes, “Anyone can issue money; the trouble is getting it accepted.” Governments have the unique ability to ensure that their domestic currencies remain valuable to their citizens, by lending and taxing in their own money. For example, the US government lends in dollars and requires taxes to be paid in dollars: one cannot buy euro-denominated treasury bonds or pay taxes in yen. This is not true of all governments—some foreign governments issue dollar-denominated bonds—but it is true of that of the United States.

When the government lends currency to banks or private investors, that money is invested in private projects. These projects generate deposits, as entrepreneurs and businesses use the funds to pay for their operations. As entrepreneurs innovate and businesses grow, the economy will expand, providing taxable revenue for the government. According to MMT, the government is essential to driving private investment in this way, and additional investment will yield more taxes to finance public projects. When MMT-ers advocate deficit spending, they are really suggesting that the government invest in private enterprise, so that it can grow the economy and add taxable revenue to the country’s reserves. Inflation worries are quelled by dynamically adjusting lending and tax rates: for example, the government can reduce lending or raise taxes to stymie rising inflation.

Finally, MMT suggests that public policy “be aimed at generating full employment while maintaining low inflation (rather than, say, achieving a balanced budget position).” Not only does this broaden the tax base by providing every participant in the economy with a job, but it will grow private investment, since the country will have more workers to facilitate business expansion. When the economy fails to grow, easy lending policies can provide liquidity to businesses so they can hire workers and produce more goods, generating a cash flow that helps rekindle development. Modern Monetary Theory leverages government spending to take advantage of the economy’s momentum in times of growth and to spur innovation during recessions.

Orthodox economists often fault MMT for using the government, rather than private enterprise, to drive economic growth. While the theory recognizes the benefits of the private sector, it postulates that the government can help facilitate growth by lending in its own currency without limit. Regardless of the state of the economy, more spending would make money easier to come by, likely increasing investment by lowering interest rates on conventional loans. Small businesses would presumably benefit the most from these lower rates, since lower interest rates necessarily mean lower costs on borrowed capital.

Many aspects of this policy sound familiar because the United States has already implemented some of them. Dynamic public spending in the form of quantitative easing (QE)—that is, when the Federal Reserve injects money into the economy by buying government bonds from banks—began after the financial crisis of 2008 and ended in 2014. More recently, President Trump has called for the Fed to restart QE to stave off another potential recession. Although we don’t have 100% employment, we are pretty close, at 96.4%. And, as the economy has grown, some politicians have called for more taxes to combat increased deficit spending. MMT has not been officially implemented here, but it seems to be just around the corner.

Management of currency, additional stimulus for the private sector and full employment all sound as if they should be government prerogatives if they aren’t already. We need to have viable currency with which to pay for goods and services; stimulus for the private sector sounds like a good idea, regardless of the source; and one measure of a thriving society is a low jobless rate. Modern Monetary Theory seems to provide a comprehensive solution to our economic concerns, while ensuring that private industry continues to thrive.

But if MMT provides the solutions that we need, why not continue on the path towards its full implementation? I aim to convince you that the theory contains several flawed assumptions about the economy, which can be exploited by politicians for their own gain and to everyone else’s detriment. These assumptions rely on certain characteristics of our current global environment, whose absence renders the theory’s stated goals, however laudable, unreachable. Furthermore, to allow the government such a strong hand in our economy would further legitimize our polarized state of affairs and provide lasting institutional support to political ideologies not accepted by a majority of the country. With this in mind, I will examine three problems inherent to MMT.

First, let me list some assumptions I’ll make about MMT for the purposes of my analysis. I will assume that government spending is not prone to corruption, and that the money is spent where the economy most needs it. I will also assume that the benefits of government contributions to wages are distributed unequally: that is, that the current salaries of individual workers are multiplied by a constant factor to accurately reflect both the economic realities of different geographical locations as well as wage disparity between jobs. This latter assumption is necessary because we are not discussing a universal basic income, which comes with its own set of preconditions and economic concerns. Finally, I will assume that government cash will supplement private investment—investors will continue to put their money into projects at the current rate—to stave off concerns that private investment will diminish under the theory. I acknowledge that these assumptions are not necessarily realistic, but we should evaluate the theory under perfect conditions before investigating it in reality.

Our first concern is the legitimacy of debt. Many basic economics calculations assume the existence of something called the risk-free rate, even though such a rate does not exist in reality. This assumption simplifies equations and allows us to proceed with valuations of financial instruments and discussions of monetary policy. Since a risk-free rate does not actually exist, however, governments, investors and traders around the world use interest paid on US government bonds as a substitute. Widely considered the safest form of debt (given the country’s lack of defaults and its superpower status), US bonds are used for everything from maintaining government reserves to temporarily holding excess bank funds to hedging complicated financial structures. They are so reliable that foreign regimes often require banks to use them as collateral for certain transactions.

The US dollar is now considered a global reserve currency, but this has not always been the case. Prior to the dollar’s preeminence, the UK’s pound sterling was the global reserve: it formed the basis for international trade. Following World War II, however, the UK realized that “the accumulation of international [foreign currency] reserves required persistent deficits to be run by issuing countries that ultimately undermined confidence in the value of those reserves.” In other words, the UK government had to lend sterling for foreign currencies, the values of which were not guaranteed by their respective governments. The UK deficit was denominated in sterling, but it was backed by unstable foreign currencies, which undermined international confidence in the country’s own economy. A single mass exchange of sterling for foreign currency would push down the value of sterling, which would mean that the Bank of England would have to print more money to cover the deficit. This concern led to investors gradually trading their sterling for dollars in the 50s and 60s. There was a fiscal storm on the horizon, and to stave off potential disaster the UK government decided to work with the international community to complete the exchange in an orderly manner. In the end, investors received their dollars, and the UK avoided economic ruin.

The UK’s rationale still holds true today. QE has resulted in a large fiscal deficit, which has started to inadvertently undermine global confidence in the US economy, prompting concerns that international trade is too heavily premised on the economic well-being of the United States. Unlike in the postwar UK, however, no other proposed currency has proven a viable alternative to the dollar: the pound sterling is adversely affected by Brexit; the euro is still reeling from the effects of the 2008 financial crisis; renminbi lacks the necessary trust. In our current global environment, the US government can reliably run fiscal deficits without fear of a mass exodus from dollars to another currency.

However, it would be naïve to assume that this scheme can last forever. Any number of global events can prompt foreign countries to rewrite their laws or convince international investors to sell US currency. If this happens, the US government will be stuck with large deficits in an illiquid market, prompting another domestic—and possibly global—recession. This is the situation the UK feared in the postwar era. Since Modern Monetary Theory encourages the government to maintain even larger deficits, the problems associated with a recession would be compounded. These larger deficits would need to be covered by increasing taxes, by printing more money, or by issuing more debt, all of which would scare away potential investors. Thus, the concern isn’t just that MMT encourages the government to issue more debt. It is that the theory encourages the government to issue more debt while also assuming that the US dollar will forever remain the sole global reserve currency, even as the country runs higher deficits. We cannot risk becoming complacent.

This brings us to our second concern, that the Federal Reserve cannot add unlimited cash to the system. Let’s pretend for a moment that we don’t have to worry about global events, and that the dollar will continue its reign for a long time. As we discussed earlier, MMT suggests that the Fed can pay for federal spending by buying government debt, with future cash flows paid for by taxes and economic growth. As Montier writes, “when a government spends, it simply tells the central bank to credit the government’s account with funds (created by keystrokes). Similarly, when a government taxes, these funds eventually end up as a credit to the government in its central bank account.”

The most common criticism of this policy is that spending begets hyperinflation. As the government prints more money to pay for its spending, currency in circulation devalues at an ever-increasing rate. As money devalues, we can expect prices to rise and consumer purchasing power to weaken. This is true from an economic perspective, but comparisons with Venezuela and Zimbabwe push the economic envelope. Montier dismisses the concern that MMT’s spending will inevitably lead to hyperinflation by analyzing “three traits: 1) large supply shock; 2) big debts in a foreign currency; and 3) distributive conflict” in a separate paper. Modern Monetary Theory will lead to some inflation, but we cannot conclude that the US will experience hyperinflation of titanic proportions. Our current policies already generate inflation; a nominal amount is considered healthy for a growing economy.

If we can ignore inflation worries, then what is the concern with this scheme? Here, we must distinguish a growing economy from an economy in a recession. During periods of growth, private investors put their capital to work in productive enterprise, fostering innovation and development. Under MMT, this private capital is supplemented by government funds; more money in the economy means more money for innovation and development. Private investors would be encouraged to take more risks since less of their money is on the line, and workers would have more money to spend since corporations would have more money to pay them.

In a growing economy, government deficits as suggested by MMT would not harm economic output—and might even improve it—because the additional spending could add a small boost across the board (remember our assumptions earlier). Tax revenue generated from increased profits would help keep the deficit at reasonable levels, and the government would issue additional bonds to make up the rest. This is similar to current monetary and fiscal policy.

Our problems with the theory’s dismissal of deficits begin when our period of growth gives way to recession. Since private investment falls during a recession, government spending would need to progressively increase to encourage the innovation and development we discussed earlier. The additional spending would widen the deficit, but, unlike during the period of growth, we cannot expect higher taxes to cover the difference. The government would thus need to issue additional debt to make up for the spending shortfall. Investors tend to flock to safety by buying government bonds in times of recession, so in the short run the government can issue these bonds without worrying about potential economic backlash. But investment in government debt does not drive economic growth, which means that federal spending would continue to supply innovation and development. Spending would need to increase every year as more people lost their jobs, raising government debt levels. At some point, people would stop buying government bonds simply because they didn’t have any money left to buy them—leaving us stuck in a prolonged recession with the government driving the economy. Note that we ignored potential global events at the beginning of this discussion: introducing them into consideration would only add kindling to the fire.

Even if the Fed were able to add unlimited cash to the system, it’s not clear that the economy would experience a real benefit. Private investors often require a connection to the projects to which they contribute their money. They want their investments to grow and return a profit: they will not invest in a project if they think it is going to lose money. Money thus flows towards a (relatively) productive use. If the government supplies an increasing amount of capital, as would be the case under MMT, people will be incentivized to take unnecessary risks, creating an environment in which money is not necessarily directed towards its most productive use. Rather than spurring innovation and development, public capital would be routed to projects that produce no real benefit to the economy.

Public spending thus brings us to our third concern: it is really difficult for politicians to reverse government spending programs. Millions of voters receive government benefits that they are reluctant to lose, and politicians who even suggest cutting these programs run the risk of losing out on reelection. As former Treasury department economist Bruce Bartlett wrote for Forbes in 2009, “there is no evidence that it is politically possible to cut spending enough to make more than a trivial difference in our nation’s fiscal problems.” Since we cannot meaningfully cut our budget, we have to be smart about how the government spends our money. This means finding the true costs of political initiatives and ensuring that they are products of real societal needs and not simply political projects designed to garner votes. Modern Monetary Theory runs the risk of giving politicians a blank check that they will inevitably use to promote their own self-interest, but that cannot be rolled back at some later date.

MMT’s potential to be used as a political blank check is not our most pressing concern, however. The real problem is the economic distortion that appears as a result of government spending where it is not necessary. A thing is necessary when people need it and the market cannot, will not or should not, produce it. Federal safety nets, some medical research programs and police forces are just a few examples of government spending that are beneficial to society but that the market will not, or should not, produce. This is not to say that these and other, similar programs cannot be privatized effectively in the future, or that the government runs them inefficiently. Rather, the point is that the market did not produce them in an effective way and that government intervention was required to ensure their benefits were applied to as many citizens as possible.

However, when the government spends our money on unnecessary projects, private companies are forced to compete with a monolith not constrained by financial incentives. The additional influx of money (and often special interest groups) distorts the market by making competition more expensive for private industry. Regulatory efforts produce the same effect: mandating higher minimum wages or implementing a jobs-for-all policy adds additional costs to the private sector. Larger companies edge out smaller ones, driving up compliance costs and driving down innovation, thus solidifying the status quo. Consumers then get hit with higher prices and a smaller selection of products. Note that this scenario does not contradict our assumption earlier, that private industry would still invest in projects at the same rate under MMT as it does under our current system. Rather, investors would simply avoid putting their money into industries dominated by the government. The inevitable result would be stagnation, which is the enemy of progress.

I don’t think proponents of MMT would like to see any of these economic scenarios actually materialize. Support for the theory seems to be political: it quells the widespread dissatisfaction with our current system resulting from changing societal values (e.g. the wish for a move away from fossil fuels), increased automation and renewed focus on benefits such as healthcare and college tuition. We do have problems under our current system, but we cannot rely solely on the government or our politicians to solve them for us. Instead, we must focus on ourselves as individuals and strive to compete in the national and global marketplace with the unique talents that we have. The government should provide a safety net as an option of last resort, for use when people inevitably find themselves in difficult situations health-wise and financially. It should also drive investment in places ignored by the market, slowly pulling back as private industry grows in those areas. MMT seems to promise solutions, but in reality it will only leave our nation worse off in the long run.

Conventional economics, which advocates low tax rates, low government spending, light regulation and a focus on interest rates has helped propel the United States to the position of the strongest economy in history. This is not to suggest that any of these individual components are static; rather, conventional wisdom suggests that economic management is a delicate balancing act, governed more by market forces than by politicians. Modern Monetary Theory attempts to control the market economy by encouraging the government to print more money and to issue more debt.

Francis Fukuyama was wrong when he suggested that the debate on capitalism was over. Capitalism alone is not perfect, and we need to evaluate some of its shortcomings and fix them where necessary. The government needs to provide solutions when the market refuses to, but it should not seek to control the market. We should not think ourselves so powerful that we try to force the goose to give us more golden eggs: instead, we just need to keep the goose alive and healthy, and more eggs will follow.