I have been trying to organize a decent exchange on MMT on the new financial media platform Real Vision. My first attempt got dropped because the conversation wasn’t forward looking, diving into the issues people care about, namely the likelihood that MMT-oriented policy prescriptions get executed and the ability of MMT-oriented policy prescriptions to deal with inflation, growth, inequality, or full employment. So I am still on the hunt, trying to organize a ‘debate’ around those issues.
Now, this isn’t the newsletter entry I had intended to write today. But as I have been thinking about getting this exchange onto Real Vision, I thought it would make sense to tell you what I’m thinking about the subject.
Hippie punching the MMT crowd
I just looked this term ‘hippie-punching’ up on Urban Dictionary and it says:
The fantasy common among disaffected right-wingers of assaulting people they imagine as the embodiment of treasonous forces afflicting the nation. Rarely if ever put into practice, since in the real world the hippies either went back to real life after 1980 or turned into Silicon Valley libertarians.
I am using the term to describe how MMT gets treated by many mainstream economists and finance professionals. The economists don’t see MMT people as ‘Very Serious People’. They see them as non-mathematical, non-rigorous ideologues with a flawed and shifting economic framework. But, of course, we know MMTers predicted the financial crisis that the mainstream generally did not. And MMT work has held up well in the aftermath of the 2008 Global Financial Crisis in predicting economic outcomes too. The European Sovereign Debt Crisis comes to mind, for example. Most mainstream economists missed that one too.
On the finance professional side, at the extreme, the thinking is that MMT is batshit crazy, far-left, uber-Keynesian Zimbabwe-style socialism. And in Alexandria Ocasio-Cortez as an MMT-receptive politician, many see someone who embodies everything that’s wrong with the ‘Bernie Sanders wing’ of the Democratic Party.
I’m not interested in any of that ideological stuff though. As I was told yesterday by an astute money manager, what matters is what helps me understand the economic system we live in today, what helps me predict economic outcomes, and what helps me make money. When you let ideology take over, you lose money.
So, you have to tune out all of this MMT hippie-punching. That’s politics. Now, you don’t have to agree 100% with the MMT framework. The real question is, first and foremost, what parts of MMT make sense as a descriptive framework. That means understanding the framework and ignoring the policy prescriptions, where all of the vitriol is focused.
One basic thing that works for me: Chartalism
In March, I tried to show you where MMT dovetails with the economics of six economists of repute. I called my piece “MMT for Dummies” – even though it was actually a relatively dense piece. But, the point was to get away from the policy prescriptions and focus on the descriptive side by distilling MMT down into recognized precursors.
One part of MMT that I think was under-appreciated before the European Sovereign Debt Crisis is Chartalism. What Chartalism means is that a state which coerces its subjects into using only state IOUs for transactions and into expunging tax obligations only with those IOUs is different from every other ‘debtor’ within its realm.
For example, the British ten pound note reads “Bank of England. I promise to pay the bearer on demand the sum of ten pounds.” What does that even mean? Think about it. The UK government is telling you that the currency used every day in Britain is simply a promise by the government to repay with more currency in the same or different forms.
It’s basically just an IOU. It has no intrinsic value whatsoever – except via the enforcement of the British government of tax liabilities. That tax liability enforcement gives the government a de facto perpetual source of ‘income’ via its ability to force some portion of all productive work in the UK to be paid over to government in the form of British currency only. No other entity in the UK has that power over British productive assets.
By the way, how much that money is worth depends on how productively those assets are used now and into the future. If the economic policy framework leads to a waste of productive assets like the presence of high rates of un- and under-employment, then we should expect that money to depreciate in value vis-a-vis currencies with better macro efficiency.
And so, state money is the risk free asset in any currency area where the state has that kind of power, namely the ability to create its own IOUs and enforce tax payment in that currency. A government with that IOU-issuing and -taxing power can literally never run out of money because it creates money.
Chartalism in practice
A lot of people like to argue that the central bank and the central government are independent and autonomous powers. And the argument goes that because of this autonomy, central governments like the US aren’t really all-powerful because the central bank can simply refuse to create more IOUs. I think this is a ridiculous argument, though. The central bank is the central government’s agent. And it exists only as a vehicle for executing banking and monetary policies in the government’s interest. The independence it enjoys is entirely at the central government’s discretion – mostly to create the appearance of non-politically motivated policy which would create inflation and debase the currency. If push came to shove, the central government would do whatever it took to issue IOUs to promise to pay the bearer of its money the required sum of fiat currency.
Notice, though, that Euro Zone governments don’t have the same power because they cannot create euros. Sure, they can enforce tax in euros with the coercive power of the penalty of prison as an incentive. But, when their euro taxes fall short, they can’t create euros to make up the shortfall. The euro is not their IOU. They are just like any other debtor in the eurozone.
And the MMT crowd were onto this right from the start. In fact, one of the MMT forefathers, Wynne Godley, predicted the European Sovereign Debt Crisis when the euro was first conceived in 1992. On the other hand, most mainstream economists were caught flat-footed by the crisis. They were operating under the assumption that the bond vigilantes had the same power over all debtors including sovereigns. They said the bond vigilantes just gave sovereigns more leeway. And that’s still their position today despite all evidence to the contrary.
How do you trade that?
For me, I trade that by saying Germany is the de facto ‘sovereign’ in the euro zone because of its size and fiscal rectitude. The euro would have to cease to exist before German sovereign debt came under attack from bond vigilantes. Now, if Deutsche Bank went bankrupt and Germany bailed it out at great cost and went on a deficit binge to boot and government debt to GDP ended up ballooning to 120% of GDP, things would be different.
I would also trade that using MMT by recognizing that the only meaningful default risk for US Treasuries is the unwillingness of the US government to pay because of the debt ceiling or some other banana republic-style political dispute. And that would mean the Treasury curve trades based upon present and expected future overnight rates with a term premium to compensate for asset maturity preferences. Japan is the guide there in that a central bank that can credibly demonstrate its willingness to keeps overnight rates at zero indefinitely will cause the yield curve to flatten and long term rates to fall toward zero.
I would also trade that using MMT by recognizing that a flat yield curve starves the domestic private sector of interest income, making so-called accommodative policy restrictive when left in place long enough to flatten the yield curve indefinitely. The result is a reach for yield domestically or internationally by extending duration or taking on greater risk.
This is how to think about MMT. You analyze what the economics is saying and determine if it makes sense. And if it makes sense, you build a decision tree to weight likely outcomes. The other stuff is ideology.