Why Modern Monetary Theory Won’t Work

This post Why Modern Monetary Theory Won’t Work appeared first on Daily Reckoning.

San Francisco, California
November 5, 2019

Editor’s note: We’ve discussed Modern Monetary Theory, which is essentially money printing on a colossal scale, in The Daily Reckoning before. Today Charles Hugh Smith gives you an objective account of MMT and arrives at a disturbing conclusion.

Dear Reader,

We’ve heard a lot about Modern Monetary Theory (MMT) for several months now. The Daily Reckoning has been on top of it the entire time.

MMT is presented as a means to painlessly fund the large-scale infrastructure/alternative energy spending the nation needs to rebuild and modernize.

While most people support the goal of useful fiscal stimulus (as opposed to paying people to dig holes and fill them), the question remains: Will MMT work as advertised?

Rather than dismiss it out of hand, I’m trying to approach the subject without ideological bias.

What exactly is MMT?

The basic idea of MMT (as I understand it) is that the economy is not running at 100% capacity — there are capital, equipment, people and resources that could be put to work to better society, and the chief impediment to making full use of our capacity is a lack of funding for projects that would benefit society.

In other words, the only thing standing in the way of broad-based, socially beneficial spending/ progress is a lack of money (funding).

In the view of MMT advocates, a blindingly obvious source of funding is already available: The federal government can issue however much new currency it wants, so the government could fund large-scale socially useful projects if the political will to do so were present.

We have to pause at this point and distinguish between borrowing money to fund projects, which is the current model, and issuing (printing) new currency.

In the current model, the federal government sells Treasury bonds and uses the proceeds to fund government spending.

The Treasury pays interest on the bonds, and this mechanism — interest due on borrowed money — creates a “governor” on spending: As borrowing rises, so do interest payments, and as interest payments rise, this crimps other government spending.

The other mechanism in the current model is the central bank (Federal Reserve) can create currency out of thin air and buy Treasury bonds. This is a form of monetary stimulus, i.e., a way to inject new money into the financial system.

When the central bank creates money out of thin air to buy newly issued Treasury bonds, this is called “monetizing the debt”: In effect, the central bank creates money out of thin air and transfers it to the government by buying Treasury bonds.

The basic idea of MMT (as I understand it) bypasses both paying interest on newly issued money and the artifice of central bank monetization. Instead, the Treasury issues new currency directly.

This removes the “governor” of interest payments, freeing the Treasury to issue cost-free currency in virtually unlimited quantities.

But here are the arguments against MMT…

Various historical studies have concluded that hyperinflation does not occur when governments must pay interest on their debt; the danger with rising interest and debt is default, not hyperinflation.

Hyperinflation arises when the supply of goods and services — the output of the economy — remains roughly the same while the supply of currency skyrockets.

As money increases but the sum of goods and services available for purchase remains flat, the value of existing money declines accordingly.

Read on to sort this all out. Will MMT trigger the collapse of money itself?

Regards,

Charles Hugh Smith
for The Daily Reckoning

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