“Trillions of dollars of debt! This is what Republicans stand for?”
Kentucky Senator Rand Paul, reacting to his own party’s proposed stimulus legislation in July.
“Now is not the time to worry about shrinking the deficit.”
Treasury Secretary Steven Mnuchin, on September 15 2020.
“If you elect me, your taxes are going to be raised.”
Vice President Biden at a campaign rally in South Carolina.
The ongoing stalemate in Washington over the need for further fiscal stimulus to combat the pandemic induced recession presents an especially opportune moment to explore the nature of money and the federal budget.
You’ve probably never heard of Modern Monetary Theory (MMT). In some economic circles it is a form of heresy; the equivalent of Copernicus and Galileo placing the Sun rather than Earth at the center of the universe. The book’s author, Stephanie Kelton, is a professor of economics and public policy at the State University of New York at Stonybrook and a rigorous scholar. Hopefully she will avoid Galileo’s fate and not spend the rest of her life under house arrest.
What is MMT?
What is MMT and why should we try to understand it? Very simply, MMT posits that the government’s deficit (spending more than it takes in either via taxation or borrowing) is not a fundamental barrier to utilizing fiscal policy either to counter economic crises or to fund programs for the benefit of the people. Kelton argues forcefully that current economic orthodoxy is myopically limiting our ability to use money for the benefit of all Americans -and indeed the world. Her purpose is to marshal political change to reform the federal budget process to achieve democratic accountability.
The book consists of eight chapters. Chapter one introduces the subject and provides the fundamental underpinnings of MMT. The succeeding chapters refine the theory and provide policy prescriptions for utilizing MMT to bring the economy closer to full employment and to solve a number of our problems that naysayers suggest we can’t afford to solve.
Don’t Think of a Household
The foundational chapter Don’t Think of a Household is so counterintuitive you may have to read it several times. I did. The author even admits to being skeptical of these ideas when she first encountered them. Following are the basic principles:
- The United States is a monetary sovereign; a constitutionally empowered monopoly issuer of the only currency accepted as legal tender. And since leaving the gold standard in 1971, can issue as much as it wants.
- Contrary to economic orthodoxy, government spending must precede taxing or borrowing. How could it be otherwise? Where would the money come from that would be taxed or borrowed?
- Since the government doesn’t need to borrow or tax to spend, the purposes of these activities is not to raise money. The purpose of taxation is to redistribute wealth and to encourage or discourage certain behaviors. The purpose of government borrowing is to create a risk-free investment vehicle and as a tool to manage interest rates.
- Of course, we still can’t spend our way to prosperity. But our real resources (hard work, ingenuity, food and energy supply), economic productivity and inflation are the true constraints to how much money the economy can absorb before getting into trouble.
What Does This all Mean?
First, by so obsessively targeting the unlikely prospect of hyper-inflation the Federal Reserve has been settling for an inhumane level of unemployment under its so-called “dual mandate.” Kelton recommends implementing a federal job guarantee program to maintain full employment. Government spending should be modulated not by whether the budget is artificially balanced, but by whether it posed an inflation risk. At which point taxes would be raised to suck inflationary demand out of the economy. And some of these buffers could be on a form of autopilot to take politics out of the equation.
Second, there’s no need to worry about the national debt. Congress could pay it off in a minute. Of course, that would eliminate US treasury obligations, which Congress otherwise loves.
Speaking of US Treasury securities, in Chapter 4, Kelton dispels the myth that government deficits “crowd out” private borrowing by competing for investment dollars. US government deficits actually create private surpluses and vice versa. Fiscal deficits don’t deplete savings, they actually enlarge them. Selling bonds to private investors gives the illusion that the government is dependent on savers to finance its operations.
Winning at Trade
MMT completely reimagines how to manage international trade. Instead of focusing on the deficit – importing more goods and services as measured in dollars than we export – the focus should be on a fiscal policy that maintains full employment. Kelton lays out the tautological three-sector accounting: US Government + Private Sector + Foreign Sector = 0. A private sector deficit (which is the worst of all deficits for the economy) is the inevitable result of allowing the government deficit to fall below the trade deficit.
There is a great discussion of the problem faced by developing countries who are not monetary sovereigns and must borrow in foreign currencies – typically dollars – to survive. Here, Kelton calls for an end to trade wars and instead using our dollars to promote “trade peace” and worldwide full employment.
Implications for Entitlements
Nowhere is the cause of fiscal conservatism more prevalent than in a discussion about the future of entitlements, such as Social Security, Medicare and Veterans benefits. Why are these programs called entitlements? Very simply, because a federal program or provision of law requires payments to any person or unit of government that meets the eligibility criteria established by law.
Some people will be almost shocked to learn that the deficit myth (we are running out of money) applies to social security; a program under attack from its inception as being “unaffordable.” But this is true only because it has been structured from the beginning as being “paid for” by those “entitled” to receive it. Congress could change that structure. Benefits have been “cut” in various ways: raising the retirement age, taxation of benefits for some and changing the inflation adjustment benchmark.
Excess collections in any given year from payroll taxes are held in the so-called Social Security Trust fund or “lockbox”- which is scheduled to be depleted around 2034. But this is an artifice established by FDR to make the program politically palatable. Kelton suggests the trust-fund approach has impeded a grown-up discussion. Perhaps we need to stop asking the question: How will we pay for it? And start asking the question: How will we resource it?
Cri de Coeur
In the final two chapters Dr. Kelton gets to the questions of what do we do with the money that is available to spend, now that we know that taxes and borrowing are not limitations. Rather we are constrained by actual resources and potential inflation. She identifies seven “deficits” (i.e., social problems) that need to be addressed:
Good Jobs, Savings, Health Care, Education, Infrastructure, Climate and Democracy
As economic theory, MMT is policy neutral. It is neither liberal nor conservative. The “fiscal space” created could – without threatening national bankruptcy – fund either Medicare for All or military spending. So, we are faced with political questions: How do we trust Congress to be responsible with MMT? And how do we achieve the right balance between spending too much and spending too little.
Kelton envisions an economy where private enterprise and public investment combine to raise living standards for everyone. According to Kelton, the two most important policy objectives are the federal job guarantee – with the goal of near zero unemployment targeted at caring for an aging population – and combating climate change. Your vision may be different.
Are You MMT Curious?
I was privileged to be part of an online book club – consisting mostly of several hundred financial advisors – that read and studied this book together. We were able to ask the author and her MMT colleagues numerous questions about the content of the eight chapters. As you read the book, you can watch the recordings of the Q & A sessions here.
Unsurprisingly, MMT has encountered criticism from both the academic and investment communities. You’ll have to decide for yourself the extent to which these are well founded or the product of some sort of anchoring bias.
At a moment when the Federal Reserve is running out of monetary policy tools to support the economy and looking to Congress for more spending, every American who chooses to be an informed citizen and is “worried” about the deficit should read this book to test whether those worries are justified.