Spinning Straw Out of Gold- Modern Monetary Theory
As we move into the “increase the federal debt limit” season, our minds are naturally drawn to macroeconomics. Well maybe not naturally, but hang in there with me a bit and maybe we can discover what is really going on here.
The United States debt has gone from $49 billion in 1940 before WWII to $11.3 trillion at the end of the Bush administration in 2009. From there, it has skyrocketed during the Obama, Trump, and Biden administrations to $31.4 trillion. What is on the table today is how much more money are we going to pile on.
In the old days…like 2017, the government received money to spend on its projects in only two ways. The first was taxes. Now raising taxes has never been particularly popular (except against the evil rich). Remember, we had a revolution about this 247 years ago over a lot less money. With the inability politically to raise taxes or “revenues” as they are euphemistically called, and being a little short of funds….(well a lot short compared to what our leaders want to spend), the government has to borrow money and purportedly pay it back later.
Actually, the government has no intention of ever paying it back. It merely borrows more money to pay back past debts, a lot like a Ponzi scheme. In fact, it is a Ponzi scheme, but so far there has been no default. However, the problem that arises when we have to refinance too much debt (and borrow more for new deficit spending) is to find new and larger bondholders. Also, if borrowing goes up, it can compete with private lending which otherwise creates real economic growth or finances mortgages. This serves to increase interest costs for everyone.
Beginning in 2020, Congress went on a spending binge. Having closed down the economy because of COVID, denying the people the ability to earn a living, the government sought to make up for its actions by kicking out $2.2 trillion in COVID relief. In addition to individuals and businesses, funds were also doled out to state and local governments as well as public transit agencies to cover their purported losses in revenues.
Like a drunk going on a binge, the government soon thereafter passed the $1.9 trillion American Rescue Plan, the $2.2 trillion Inflation Reduction Act, (which did nothing to reduce inflation), and a $1.7 trillion spending bill in December 2022. Then someone said,… “Whoops, we don’t have the authority to borrow that much money, and we sure aren’t going to raise taxes (except on evil rich people), so we have to increase the debt ceiling.”
Meanwhile in certain academic economic circles (where most bad ideas come from), there arose a theory that government debt didn’t matter. The story was that since the United States can print its own money, the federal government can spend as much as it wants to. We will never default because if we run short on taxes and debt, we’ll just print the money to cover it.
In fact, we don’t even have to issue bonds anymore for the Fed to purchase. We can, with a few keys strokes on the computer, simply create the money and transfer it to the government’s balance sheet.
This is essentially what is known as Modern Monetary Theory (MMT). Modern Monetary Theory developed by academics has been espoused as the new funding model by Bernie Sanders, Elizabeth Warren and Alexandria Ocasio Cortez. It is the ultimate response to the objection that “we don’t have the money” to pay for all of these government programs. If borrowing money no longer has any adverse consequences, we can now pass every utopian progressive scheme that so far has been stopped because of claims that we just can’t afford it. We can now fund Universal Health Care, a guaranteed minimum salary for all, free college, the green new deal and any other governmental program that that anyone wants in order to buy votes in the next election.
The Fed can effectively credit the government’s bank account with an unlimited amount of money without either charging interest or demanding repayment for the government bonds that the Fed has acquired.
We have finally solved the problem that alchemists, Midas and Rumpelstiltskin have struggled with throughout the ages. Free money without work or adverse consequences.
Well… not so fast. One problem with the MMT free money scheme is that it has to be run through central banks and those are, by and large, designed to be independent of political influence. Central banks, in wealthy countries such as the Bank of Canada or the Federal Reserve, may not concur with government requests to fund every whim that can be imagined by its legislature. Of course, this can be simply solved by the politicians legislatively seizing the central banks and altering their charters.
A second objection to MMT is a little more serious. That is that the free money for all policy will lead to inflation, perhaps even hyper-inflation, with devastating consequences for domestic economies and the people in them. MMTers acknowledge the potential for increased government spending financed by the central bank to generate problematic inflation but only in a “full employment” economy.
MMTers think that inflation can result only when money injected into the economy outstrips the aggregate demand (all the purchasing desired in the economy) for the actual products and services available for purchase. If there are a lot of dollars out there trying to purchase products and services and not enough products and services available to be purchased, those products and services become more expensive — so, inflation.
Unfortunately for the academics, the MMT debate occurred during massive COVID spending and resultant work-life balance decisions. These spending policies led to a substantial number in the labor force deciding to retire or deciding they didn’t have to work anymore which created labor shortages throughout all industries. We also had supply chain and regulatory issues creating shortages of goods to buy. We now are experiencing what rational economists had feared and what MMT advocates had thought unlikely, inflation.
But the genie is out of the bottle. Despite these worker shortages and inflationary developments, they were advertised as transitory, and the government, believing that debt does not matter, continues to spend massive amounts of money.
Having experienced what they thought was the free lunch, it is difficult, if not impossible, for these governmental officials to restrain themselves and develop fiscal responsibility and the political courage to cut spending in response to rising inflation.
It’s not like we don’t have examples to learn from. While MMTers proclaimed that the risk of igniting a sustained and relatively fast rate of general price increases was unlikely, there has been relatively recent historical experience in Latin America and Greece where the implementation of MMT did, indeed, result in runaway inflation and a significant decline in the standards of living in those countries.
Not all is gloomy. Since the unlikely event, in the minds of the MMT academics, that inflation has occurred, it has shown the practical bankruptcy (pun intended) of their free lunch economic scheme. But we will have to weather the storm of tax and spend politicians who will claim that we have plenty of money in a “country as rich as ours” (with a $31.4 trillion debt), and that any fiscal conservatism is due to the heartless skin flints who would rather push grandma off the cliff, starve the children who are food insecure, and leave the homeless to freeze in the winter.
Maybe those few folks who still maintain that you can’t create prosperity by borrowing or printing money could use a little support from those of us in the electorate who understand that we can’t afford the price of a free lunch.