Monday, August 11, 2014

Modern Monetary Theory is wrong, debt does matter

If the economy was healthy and balanced we would not be experiencing slow growth while massive amounts of money are being printed and poured into the system. The crux of our problem remains in the fact that both people and governments have lived beyond their means by taking on debt they cannot repay. Over the last several decades we have created entitlement societies built on the back of the industrial revolution, technological advantages, capital accumulated from the colonial era, and the domination of global finances. Promises were made on the assumption that the advantages we enjoyed would continue in both Europe and the US. Ever greater prosperity and entitlements were to be sustained through debt financed consumption growth. In that eerie fantasy world, debt-fueled consumption was to be the catalyst to bring about evermore growth.

Now reality has begun to come into focus and it is becoming apparent that this is unsustainable. The entitlements and promises that have piled up have become overwhelming. The world has latched onto and embraced Modern Monetary Theory as the answer to its woes. Referred to as MMT to its many believers it removes much of the risk ahead and guarantees that we will always be able to muddle forward. MMT is also known as neochartalism an economic theory that details the procedures and consequences of using government-issued tokens and our current units of fiat money. Newly acquired tools like derivatives and currency swaps are supposed to allow us to print and control growth going forward thus manipulating our problems away.

Debt is often nothing more than the promise of future payment and is affected by interest rates. It appears debt does matter except in the manipulated land of MMT where what you pay in interest can overnight change everything by redefining the obligations outstanding and coming due. For example, In Europe, the ECB had to step in to halt the economic collapse of Spain, Italy and several other countries that were on the brink. The ECB did this by artificiality lowering and altering interest rates paid on risky debt. It is important to understand the nature of debt and that some debt often is diminished or written off over time. This allows "new debt" to form and become the foundation to pay for future obligations, too often this is the building block of growth. If all debt is treated the same and diminished the value of both savings and future payments will be devalued. Altering the rate paid in interest completely changes how budgets play out going forward and where people invest.

Politicians looking for the "easy way out" and knowing little about business and the economy reach for answers that only delay disaster or spin optimistic messages that reflect well on them. Even as I type this article President Obama filled his time at a conference in New York with African leaders and left touting Africa as part of the answer and the new land of opportunity for American business to go forward and prosper. A place where we can grow creating jobs here at home while making the world a better place. While this happens what appears to be playing out is a scenario where society is being worn down through attrition and we are developing an "almost surreal" feeling of indifference towards reality. We should not forget much of the debt the world faces must be rolled over within a very short period such as the next five years and time has a way of passing very fast.

In recent years the concept of austerity has been given a bum rap The argument by contemporary Keynesian economists that budget deficits are appropriate when an economy is in recession bolster this movement. They claim it reduces unemployment and helps spur GDP growth, and that in an economy one person's spending is another person's income. If everyone is trying to reduce their spending, the economy can be trapped in what economists call the paradox of thrift, worsening the recession as GDP falls. If the private sector is unable or unwilling to consume at a level that increases GDP and employment sufficiently, thus the argument often heard that the government should spend more, and not less.

In truth, an argument can be made that austerity measures do not necessarily increase or decrease economic growth.  All attempts by central governments to prop up asset prices, bail out insolvent banks, or "stimulate" the economy and deficit spending make stable growth less likely.  Often the typical goal of austerity is to reduce the annual budget deficit without sacrificing growth.  Over time, this should reduce the overall debt burden, as the economy grows.  Blaming austerity for the blow-back from governments living beyond its means is more than unfair, we should at all times conduct business and run our government with responsible reigns on spending. If a government spends and runs its business in an austere way the issue of when to start cutting or tightening should never surface.

MMT as a cure to past woes adds a whole new exciting dimension to economics that eliminates any potential of failure and concern that the sun will not come up tomorrow. However, there is a major flaw in the concept of MMT that not only wounds the theory but it is its Achilles heel. What do you do when it becomes apparent the economic efficiency of credit is beginning to collapse? This means that as more money is poured into the system and lower rates are no longer effective in driving the economy forward options evaporate. As the extra GDP growth generated by each batch of loans drops and momentum ends this become the equivalent of pushing on a string and is a sign of exhaustion.

Companies have already ushered savings from interest paid on debt into the earning column and a major reason inflation remains low is they are sitting on a hoard of cash this has lowered the velocity of money. We must remember the artificially low FED controlled interest rates are a massive one-off or onetime tailwind that is mainly behind us.  When rates stop going lower or reverse the positive effect will ebb and become a major headwind. With massive government debt in many countries and the economy still weak this headwind has the potential to become devastating. The collision of MMT, social unrest over inequality, and other destabilizing factors have the potential to create the perfect storm.

The situation that is developing may require a massive shift in future lifestyles over a very short and painful time-frame. The failure for countries to address their long-term debt problems coupled with the number of growing people nearing retirement with little in the way of saving bodes poorly for the economy going forward. Big changes in Medicare that are occurring under the radar also should raise concern. If and when a deep hit to the system takes place we could suffer the triple threat, and as confidence falls the credibility, and the competence of those in charge will be called into question. If this happens the fabric of society may be severely challenged.


  1. Hi Bruce

    Thought I'd take this post to comment that I find the blog really interesting and I appreciate you taking the time to write up these pieces.

    Cheers from Australia

  2. Jimmy,

    Many thanks for the kind words from down under.

  3. I first misread neochartalism for neocharlatanism but when I looked up a definition for neochartalism I saw I would have been no worse off staying with my initial misreading.

    1. spot on - people like my father in law (big on conspiracy theories) will love MMT - he always parks his unicorn out front so the neighbours can see !

  4. I found the error in MMT and after fixing it have a good theory:

  5. the devil is is the detail, and again some hapless souls have found them selves adrift on the deep blue sea of post modernism