Playing Calvinball with MMTers

As the US national debt rapidly approaches the $30 trillion mark, a new form of monetary policy, Modern Monetary Theory (MMT) has appeared. High profile proponents of the theory like Representative Alexandria Ocasio-Cortez and Sephanie Kelton have championed the idea as a potential solution to the country’s fiscal concerns.

The idea of no consequence deficit spending is certainly appealing in a time where the harm caused by the pandemic has affected nearly everyone. However, even left leaning economists have called the theory “dangerous” and “obviously indefensible”. If implemented, MMT will likely have devastating results for both the US economy and the world.

Dr. Mike Walden of NC State has explained the concept of MMT simply, saying “government spending financed by newly created money makes the economy more productive – thereby leading to faster economic growth and more jobs and income – then the inflation rate won’t rise. In addition, a larger economy will make debt payments more affordable for the federal government”.

Basically, spending is backed by the assets held by the government. These can include tax revenue, land, mineral rights, as well as many others. As the theory goes, the government cannot go bankrupt by spending because it holds an enormous amount of assets.

Nobel laureate and PdD Economist has been one of the most vocal opponents to MMT. His primary concern with the MMT argument is that it is ever changing, “arguing with the MMTers generally feels like playing Calvinball, with the rules constantly changing: every time you think you’ve pinned them down on some proposition, they insist that you haven’t grasped their meaning”. If a brilliant mind like Krugman cannot understand the theory, how can the rest of us?

In a vacuum, MMT might be a viable option. The federal government can absolutely print an unlimited amount of its own currency. The issue arises when considering that the US is part of a global economy. As such it is subjected to the influence of markets around the world.

One possible outcome would be as the US debt and deficit rises, international concerns about the ability of the US to repay its debts may also rise. If this were to happen, the US could face a drop in credit rating in the form of government bond devaluation leading to an increase in interest rates on debt. This in turn would push the country further into debt, creating a vicious cycle.

Economists are not necessarily opposed to the idea of more aggressive government spending. They are however concerned that at some point, spending will become unsustainable. While there is likely a point up to which spending can continue, that point is unknown and could easily be surpassed. Once surpassed, there could be a large overissuance of currency before the mistake is recognized, and it could be too late to rectify.

Arguably the simplest economic equation is MV=Py, where M is the quantity of money, V the velocity or the number of times a dollar changes hands, P is the price level and y is GDP. Usually, in this equation velocity is held constant. This theory, at least for MMT proponents, begins to break down when there is more money in circulation. As more money is introduced, it is spent faster to offset the future increased price of goods. This, in a word, is inflation.

Inflation is one of the greatest fears of economists. Inflation is not inherently bad. It can be a tool used to control prices of goods and is often used as a tool to control unemployment. At least that is how it has been used in the past. The fear of economists is a rapid rise in inflation leading to hyperinflation.

As more money is introduced into the economy without new assets to back it, the money loses purchasing power. If the trend continues, a dollar is able to purchase progressively fewer goods. As more money continues to be injected into the economy and more money changes hands, both M and V will begin rapidly increasing and the price of goods will skyrocket.

So how does MMT deal with this problem? To paraphrase Mike Walden, “government spending will create a larger economy to fund the government”; taxation. Kind of like taking money out of your left pocket and putting it back in your right pocket. That theory holds as long as the money from the left pocket is worth the same as when it reaches the right pocket. If it loses value in transit, there is a problem.

Ultimately, if the value of the dollar decreases while at the same time taxes increase, the entire theory falls apart. The same people who the spending was designed to help will be left with less purchasing power while at the same time paying more in taxes. This would create a snowball effect that would be difficult if not impossible to arrest.

The US economy is still strong and well backed by assets on the balance sheet. For this reason, there is no real concern that the US would face hyperinflation as was seen in Zimbabwe or Weimar Germany. The concern is that over time the dollar and US bonds could lose value and begin to slide. If this happens, the long held status of the US as the preeminent economic powerhouse would erode, with global ramifications.