A Deep Dive Into Modern Monetary Theory In Contrast To Classical Economics and Supply Side Economics With Historic Examples

Introduction

This is the third post in a series on our National Debt. If you want to read the first one or the second one just click the green links in this sentence.

Let me start this post by saying I am not a fan of Modern Monetary Theory. However, I want to be objective and have attempted to provide objective information and a presentation of both supporters and critics points of view. So, let’s get started.

Modern Monetary Theory (MMT) is an economic framework that has gained significant traction in recent years. It challenges traditional views on fiscal policy and national debt, suggesting that governments with sovereign control over their currency can create money to finance public spending. This theory argues that such governments are not financially constrained in the same way as households or businesses, making national debt a less pressing concern compared to other economic objectives.

MMT’s relevance in current economic discussions cannot be overstated. With global economies grappling with unprecedented challenges, including the aftermath of the COVID-19 pandemic, MMT offers a fresh perspective on how to address fiscal sustainability and economic stability. Proponents argue that prioritizing full employment and inflation control can lead to more equitable and robust economic growth.

In relation to national debt, MMT posits that sovereign governments can manage higher levels of debt without facing insolvency risks typically associated with private entities. This controversial stance has sparked debates among economists, policymakers, and financial experts.

Please Note: All text in green below represents hyperlinks to additional information you might find interesting

Understanding Modern Monetary Theory (MMT)

Definition of MMT and Its Key Principles

Modern Monetary Theory (MMT) states that countries with full control over their currency can never “run out of money” like a household or business might. This is because they have the power to create currency whenever they want. Unlike traditional economic theories that focus on balanced budgets and avoiding debt, MMT advocates for active fiscal policies aimed at achieving full employment and stable inflation.

Key Principles of MMT:

1. Sovereign Currency Issuance: Governments that issue their own fiat currency can always meet financial obligations.
2. Public Spending as a Tool: Instead of relying only on taxes and borrowing, MMT emphasizes the role of public spending in driving economic performance.
3. Functional Finance: Fiscal policy should be directed toward achieving full employment and controlling inflation, rather than balancing budgets.

The Role of Sovereign Governments with Fiat Currency in Money Creation

In an economy based on fiat currency, sovereign governments have the special ability to create money. Fiat currency is money issued by the government that doesn’t have any physical backing like gold but is considered valuable because the government says it is.

Mechanisms of Money Creation:

1. Direct Government Spending: When a government spends more money than it collects in taxes, it essentially creates new money.
2. Central Bank Operations: Central banks can add money to the financial system through different methods like quantitative easing and open market operations.

This power to create money means that a sovereign government isn’t limited by how much revenue it can generate when it wants to spend on public initiatives. It can fund large projects, social welfare programs, and other expenses without having to borrow from foreign sources or immediately raise taxes.

Balancing Act: Emphasis on Inflation Control and Full Employment as Dual Objectives of MMT

One important aspect of MMT is its focus on both full employment and inflation control:

1. Full Employment: MMT supporters argue that achieving full employment should be a main objective of economic policy. They propose using job guarantee programs where the government serves as the employer of last resort.
2. Example: During economic downturns, the government could finance infrastructure projects or other public works to create jobs for unemployed individuals.
3. Inflation Control: While critics often claim that creating too much money leads to extremely high inflation, MMT advocates argue that inflation can be managed through careful fiscal policies.
4. Methods of Inflation Control:

• Taxation: Not just for generating revenue but also as a way to take out excess money from circulation.
• Regulation: Implementing controls on prices and other regulations.
• Monetary Policy Adjustments: Central banks changing interest rates to influence borrowing and spending habits.

Understanding these principles helps clarify how MMT sees the government’s role in handling economic factors. The theory challenges commonly accepted beliefs about debt and deficits, suggesting instead that responsible fiscal management can use money creation for the greater good of society without necessarily causing uncontrollable inflation.

A Closer Look at the Relationship Between Modern Monetary Theory and National Debt

The Controversy Surrounding MMT’s Stance on Government Spending Limits

Modern Monetary Theory (MMT) suggests that sovereign governments can finance their spending by creating money, rather than relying solely on taxes or borrowing. This challenges traditional ideas about fiscal discipline and budget deficits.

Key Controversies Include:

1. Unconventional Approach to Budget Deficits: Traditional economic theories say we should limit budget deficits to avoid too much national debt. MMT argues that countries with control over their own currency don’t have the same limits. Critics worry this could lead to irresponsible spending.
2. Inflation as a Primary Constraint: MMT admits that printing too much money can cause inflation, but it believes we can manage this with the right policies. Critics think MMT underestimates how complicated inflation is and how long it takes for policies to work.

Examining the Potential Benefits and Risks of Implementing MMT in Relation to National Debt Levels

MMT’s way of managing national debt has both potential benefits and risks. We need to look at these to understand what it would mean in practice.

Potential Benefits:

1. Increased Fiscal Flexibility: Governments with control over their currency can pay for things without needing tax money or loans right away. This lets them respond quickly to economic problems and invest in long-term projects like building infrastructure. Example: During recessions, governments could create jobs without worrying about their short-term budgets, which might help the economy recover faster.
2. Enhanced Focus on Full Employment: Instead of always trying to balance the budget, MMT says we should focus more on making sure everyone who wants a job can get one. This could make the economy more stable and help it grow.
3. Reduction of Interest Burdens: When governments borrow money, they have to pay interest on it. But if they create money instead, they don’t have that extra cost. This means they can use the saved money for other important things.

Risks and Challenges:

1. Inflationary Pressures: One worry is that if the government spends too much money without thinking about it, prices could start going up really fast. This would make it harder for people to buy things and could hurt the economy. We’ve seen this happen in the past in places like Germany and Zimbabwe. Weimar Germany and Zimbabwe had very high inflation because their governments printed too much money, which made their economies collapse.
2. Market Confidence: If investors think a government is spending too much and relying too heavily on creating money, they might get worried about getting their money back. This could make them ask for higher interest rates on loans to that government or even decide not to invest at all. Insight: It’s important for the economy to keep growing that investors trust the government to spend money wisely, especially when we’re all connected through global markets.
3. Political Misuse: There’s a risk that politicians might use MMT ideas just to win votes now, without thinking about what’s best for the economy in the long run. This could lead to policies that look good at first but end up causing problems later on.

The relationship between Modern Monetary Theory and national debt is complicated. While MMT has new ideas about how countries can manage their debt by using their own currency and investing in important things, it also brings up serious worries about inflation and being responsible with money. People making decisions about how to deal with economic challenges today need to understand these things well.

Comparing Modern Monetary Theory with Other Economic Theories

Overview of Key Tenets

Modern Monetary Theory (MMT) posits that sovereign governments, particularly those issuing their own fiat currency, can create money to fund public spending without the constraint of needing to balance budgets. The theory emphasizes the importance of achieving full employment and controlling inflation through fiscal measures rather than traditional monetary policy tools.

In contrast, Classical Economics operates on principles such as free markets, supply and demand, and fiscal discipline. It argues that markets are self-regulating entities that function best with minimal government intervention. Classical economists advocate for limited government spending and emphasize the importance of balanced budgets to avoid crowding out private investment.

Supply-Side Economics, a subset of classical thought, focuses on boosting economic growth by increasing capital investment. This is achieved through policy measures like tax cuts and regulation reduction. Proponents believe that lower taxes stimulate investment and productivity, leading to overall economic growth.

Critique from the Perspective of Classical Economics Principles

From a classical economics standpoint, MMT’s approach to unlimited government spending is seen as risky and potentially inflationary. Several critiques include:

• Inflation Concerns: Classical economists argue that unrestrained money creation can lead to hyperinflation, as seen in historical examples like Weimar Germany. They stress maintaining fiscal discipline to keep inflation in check.
• Market Interference: The emphasis on government intervention in MMT contrasts sharply with the classical preference for free markets. Classical theory warns that excessive state involvement distorts supply and demand dynamics.
• Debt Accumulation: Classical theorists believe in the principle of limiting national debt to ensure long-term financial stability. MMT’s view on debt is considered overly optimistic about a government’s ability to manage debt without adverse consequences.

Reconciling MMT with Supply-Side Thinking through a Focus on Long-Term Growth

Despite their differences, certain aspects of MMT can be aligned with supply-side economics by focusing on long-term growth objectives:

• Public Investment in Infrastructure: Both paradigms recognize the importance of infrastructure development. MMT advocates for funding such projects directly through government spending, while supply-side economics supports creating conducive environments for private investments. According to a study by Brookings, robust infrastructure is crucial for economic growth, productivity, and overall well-being.
• Job Creation: Supply-side policies aim to create jobs through business-friendly practices like tax cuts and deregulation. Similarly, MMT emphasizes achieving full employment through direct public sector hiring initiatives.
• Innovation and Productivity: Supply-side economics focuses on enhancing productivity through capital investments driven by tax incentives. MMT could complement this by channeling funds into research and development sectors.

Critically examining these points reveals that while MMT challenges conventional economic wisdom, there are common grounds where its implementation might meet some objectives championed by classical economics and supply-side thinking, differing only in the method of getting there. Effective policy-making may involve integrating insights from all three theories to foster sustainable economic growth while managing potential risks associated with national debt levels.

Exploring Historical Contexts and Real-World Examples of Modern Monetary Theory in Action

Lessons from Hyperinflationary Crises: Weimar Germany and Zimbabwe

Weimar Germany and Zimbabwe serve as cautionary tales for the potential pitfalls of unrestrained money creation. Both countries experienced hyperinflation, offering stark lessons that are frequently cited in critiques of Modern Monetary Theory (MMT).

Note: The link above has some great photos of citizens trying to pay for daily items with (literally) loads of cash.

Weimar Germany

• Historical Context: Post-World War I Germany faced immense reparations payments, economic turmoil, and political instability.
• Hyperinflation Onset: Starting in 1921, the government resorted to printing money to pay off its debts, leading to rampant hyperinflation by 1923.
• Impact: The value of the German mark plummeted, leading to skyrocketing prices and economic chaos. People resorted to barter systems as currency lost its utility.
• Lessons for MMT:
• Inflation Control: MMT advocates emphasize that money creation must be balanced by careful inflation monitoring. However, the usual stance of raising interest rates and reducing government spending to slow the economy are at odds with the basic fundamentals of MMT. This leaves them with raising taxes and instituting price controls.
• Context Matters: The unique socio-political conditions in Weimar Germany underscore that MMT’s application must consider broader economic contexts beyond printing money.

Zimbabwe

• Historical Context: In the early 2000s, Zimbabwe grappled with political corruption, land reform issues, and external debt.
• Hyperinflation Onset: To address its fiscal deficit, the government printed vast amounts of money starting in 2006, leading to hyperinflation peaking at an astronomical rate in 2008.
• Impact: The Zimbabwean dollar became virtually worthless. Basic goods were scarce, unemployment soared, and the economy collapsed.
• Lessons for MMT:
• Economic Stability: Sustainable implementation of MMT requires stable governance and sound fiscal policies. Sound fiscal policies, at least in my view, are at odds with increased government spending well beyond tax revenue received.
• Policy Limits: Excessive reliance on money printing without addressing underlying economic issues can lead to disastrous outcomes.

The Argentine Experience: High Inflation and Debt Defaults

Argentina provides an interesting case study that fuels ongoing debates about MMT. The question is what would be the result of MMT application in a small economy compared to G7-size economies.

Historical Context

Argentina’s economic history is characterized by a pattern of instability, with frequent fluctuations in its economic performance. This South American nation has experienced numerous periods of economic volatility, marked by sharp swings in economic growth and contraction. The country’s economy has been plagued by recurring cycles of boom and bust, with periods of rapid economic expansion followed by severe economic downturns. This economic instability has been exacerbated by frequent debt defaults, which have undermined investor confidence and led to periods of financial crisis. Argentina has defaulted on its external debt nine times in its history, the most recent being in 2020. These defaults have often resulted in severe economic recessions, high unemployment rates, and significant declines in living standards.

In addition to economic volatility and debt defaults, Argentina has also struggled with high inflation rates. The country has frequently experienced hyperinflation, with annual inflation rates often exceeding 100%. This high inflation has eroded the purchasing power of the Argentine peso, leading to a decline in real wages and living standards. The government’s attempts to control inflation through price controls and monetary policy have often been unsuccessful, leading to further economic instability. The high inflation rates have also contributed to the country’s economic volatility, as they have led to uncertainty and unpredictability in the economy.

The challenges faced by Argentina’s economy have been compounded by economic mismanagement and external shocks. The country has often pursued economic policies that have exacerbated its economic problems, such as unsustainable fiscal deficits, over reliance on external borrowing, and protectionist trade policies. These policies have often led to economic imbalances and crises. Furthermore, Argentina’s economy has been vulnerable to external shocks, such as fluctuations in global commodity prices and changes in international financial conditions. These external shocks have often triggered economic crises in the country, further exacerbating its economic volatility and instability.

Political corruption has further exacerbated Argentina’s economic woes. The country has a long history of corruption scandals involving high-ranking officials, which have undermined public trust in the government and hindered economic development. Corruption has led to the misallocation of resources, with funds intended for public services and infrastructure often diverted for personal gain. This has resulted in inadequate public services and a lack of investment in critical sectors of the economy, further stifling economic growth.

Moreover, corruption has created a climate of uncertainty and unpredictability, discouraging both domestic and foreign investment. The lack of transparency and accountability in government operations has also fostered a system where government officials are typically immune from legal consequences of their actions, further entrenching corruption and its detrimental effects on the economy. Thus, political corruption has not only compounded Argentina’s economic challenges but has also posed a significant obstacle to the country’s economic recovery and development. However, the election of a new President whose goal is to implement classic economic principals gives hope for an economic recovery, albeit with a likely painful journey to reverse decades of wrongs.

Argentine President Javier Milei’s Economic Policies and Results in Argentina

Javier Milei, the recently elected president of Argentina, has implemented several bold economic measures since taking office. These measures have sparked both support and opposition, and their impact on the Argentine economy has been a subject of debate.Economic Measures Implemented:

• President Milei has announced a sharp devaluation of the Argentine currency and cuts to energy and transportation subsidies as part of shock measures to address the economic emergency in the country
• His economic policies have been described as radical, involving wholesale deregulation of the economy, and have faced strong opposition from trade unions and left-leaning parties.
• The government’s performance has been praised by the International Monetary Fund, which stated that its economic program was “better than expected” and “firmly back on track”.
• President Milei’s administration has been implementing a dual approach to stabilizing Argentina’s economy, focusing on fiscal reform to eradicate the large fiscal deficit.
• The early results of these efforts have shown a significant drop in the monthly inflation rate, from 25% in December to 11% in March, indicating promising outcomes and bolstering confidence among citizens and investors.

Public Reaction and Protests:

• The announcement of far-reaching economic measures by President Milei has led to thousands of protesters pouring onto the streets of Buenos Aires, with some comparing his actions to those of an absolute monarchy.
• The radical economic policies have triggered a general strike organized by the CGT, resulting in the cancellation of hundreds of flights and reflecting the significant opposition to the proposed policies.
• Critics fear that President Milei’s broad-based austerity program could trigger mass unemployment and lead to an unpredictable and potentially turbulent future for the Argentine economy.

Assessment and Outlook:

• The government’s economic program has been praised by the International Monetary Fund, indicating that it is on track and performing better than expected.
• President Milei’s shock therapy approach, deeply rooted in free market principles and fiscal restraint, has shown promising early results, with a significant drop in the monthly inflation rate 4.

Economic Turmoil

• High Inflation: Persistent high inflation has plagued Argentina for decades. Efforts to stabilize the currency often involve controversial measures such as price controls or forex restrictions.
• Debt Defaults: Repeated defaults on national debt have strained Argentina’s ability to secure international financing.

MMT Debate

• Pros:
• Fiscal Space Creation: Proponents argue that MMT could allow Argentina more fiscal space to fund public services and infrastructure without immediate risk of default.
• Employment Focus: By prioritizing full employment over debt servicing, MMT could address structural unemployment issues.
• Cons:
• Inflation Concerns: Critics highlight Argentina’s susceptibility to inflation spikes as a significant risk factor. Implementing MMT without stringent inflation control measures could exacerbate existing problems.
• Debt Sustainability: Skeptics argue that leveraging MMT principles might not adequately address Argentina’s chronic and consistent pattern of defaults.

Cautionary Insights

All three historical examples caution against unchecked money creation. They underscore the importance of robust fiscal policies and strategic planning when considering Modern Monetary Theory. While Weimar Germany and Zimbabwe illustrate extreme outcomes due to hyperinflation, Argentina presents a complex scenario where the debate over MMT’s viability continues amidst persistent economic challenges and evidence that newly implemented classic economic principals may produce the desired results but with pain in the process.

Global Perspectives on the Feasibility of Adopting Modern Monetary Theory

Japan’s Longstanding Battle with Deflation and its Relevance to MMT’s Policy Prescriptions

Japan’s economic landscape offers an intriguing context for evaluating Modern Monetary Theory (MMT). For decades, Japan has wrestled with persistent deflation and stagnant economic growth. Its approach to these challenges shares some parallels with MMT, particularly in terms of monetary policy.

• Monetary Easing: The Bank of Japan has implemented extensive quantitative easing programs to inject liquidity into the economy.
• Fiscal Stimulus: The Japanese government has also used significant fiscal stimulus measures to spur demand and investment.

Despite these efforts, Japan continues to grapple with low inflation and sluggish growth. Proponents of MMT argue that Japan’s situation exemplifies how a sovereign nation with its own fiat currency can sustain high levels of public debt without triggering inflation. Critics, however, point out that Japan’s unique economic conditions—such as strong domestic savings rates and a relatively insular financial system—may not make it a representative case for broader application of MMT principles.

The European Union’s Stance on MMT during Periods of Crisis: A Delicate Balancing Act between Fiscal Integration and Discipline

The European Union (EU) presents a complex scenario when considering the feasibility of adopting MMT. Unlike sovereign nations with their own currencies, EU member countries share a common currency—the euro—which introduces several unique challenges:

• Fiscal Constraints: Member countries must adhere to strict fiscal rules under the Stability and Growth Pact, which limits their ability to run large deficits.
• Monetary Policy: The European Central Bank (ECB) controls monetary policy for the entire eurozone, reducing individual countries’ control over their own monetary tools.

During periods of crisis, such as the 2008 financial meltdown and the subsequent Eurozone debt crisis, these constraints have often led to contentious debates over fiscal policy. Some economists argue that a more flexible approach akin to MMT could help member states address economic downturns more effectively. However, others contend that such flexibility would undermine fiscal discipline and could jeopardize the stability of the eurozone.

The case of Greece and its economic collapse during the European Debt Crisis exemplifies the ECB – and Germany in particular – in action.

The Economic Collapse of Greece and Implementation of Austerity

The European Debt Crisis, which followed the global financial collapse of 2008, had a profound impact on Greece. The country’s economy was already fragile due to high levels of public debt, and the crisis exposed the structural weaknesses in its economy. In 2010, Greece was on the brink of bankruptcy, and in order to avoid a default, the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF) – collectively known as the “Troika” – stepped in with a bailout package. However, this financial assistance came with strict conditions, primarily in the form of austerity measures.

The austerity policies imposed on Greece were multifaceted and included a combination of tax increases, spending cuts, and structural reforms. The Greek government was required to implement severe cuts in public spending, including reductions in public sector wages and pensions. Taxes were increased across a range of goods and services, and the retirement age was raised. Additionally, the government was required to undertake structural reforms aimed at improving the competitiveness of the Greek economy, including labor market reforms and privatization of state-owned assets.

Initial Impact of Austerity Policies

The initial impact of these austerity measures was severe and led to a deep recession in Greece. The economy contracted by more than a quarter between 2010 and 2016, and unemployment soared to over 27% at its peak. The spending cuts and tax increases reduced household incomes and led to a sharp decline in domestic demand. The austerity measures also led to widespread social unrest, with frequent protests and strikes against the government’s policies.The austerity measures were also criticized for making the economic downturn worse. Critics argued that the sharp cuts in public spending led to a decline in economic activity, which in turn reduced tax revenues and made it more difficult for the Greek government to reduce its budget deficit. Furthermore, the austerity measures were seen as having a disproportionate impact on the most vulnerable sections of society, particularly the poor and the elderly.

Current Situation

Today, the situation in Greece has improved, but the country is still dealing with the aftermath of the crisis and the austerity measures. The economy has returned to growth, and unemployment has fallen, although it remains high by European standards. The government has also made progress in reducing the budget deficit and stabilizing the public debt.

However, the recovery has been slow and uneven, and many Greeks are still struggling with the effects of the crisis. The austerity measures have left deep scars on Greek society, with high levels of poverty and inequality, and a significant proportion of the population is still at risk of social exclusion. Further, the structural reforms required by the Troika have been implemented slowly and with difficulty, and there are ongoing concerns about the competitiveness of the Greek economy

By examining these global perspectives—Japan’s deflationary struggles, the EU’s balancing act between fiscal integration and discipline, Greece’s experience with austerity, and Venezuela’s multifaceted collapse—we can gain an understanding into the feasibility and limitations of adopting Modern Monetary Theory and Classic Economic Principals across diverse economic circumstances.

The Future of Economic Policy in Light of Modern Monetary Theory

Evolving Macroeconomics: From Stagflation to Moderate-Inflation Environments to Changes in the Global Reserve Currency

Modern Monetary Theory (MMT) is gaining traction as economic thought shifts. Historical periods like the 1970s stagflation, characterized by high inflation and unemployment, contrast sharply with today’s moderate-inflation environment – moderate compared to the 1970’s.

• Stagflation challenged traditional Keynesian economics, prompting a reevaluation of the balance between fiscal and monetary policy.
• Interest rates became a critical tool for central banks to combat inflation. Central banks like the Federal Reserve adopted policies aimed at controlling price stability through interest rate adjustments.

MMT proposes an alternative approach where sovereign governments with fiat currency can prioritize full employment without being constrained by traditional funding mechanisms. This shifts the focus from managing interest rates to directly addressing economic output and employment.

The Dollar as the Global Reserve Currency – At Least For Now

Impact of Dollar as Global Reserve Currency on Modern Monetary Theory

The U.S. dollar’s status as the global reserve currency has significant implications for Modern Monetary Theory (MMT) and the global economy.

1. Importance of the Dollar as a Reserve Currency: The U.S. dollar is the most commonly held reserve currency, making up 59 percent of global foreign exchange reserves 

-Central banks held around 58.4% of their allocated reserves in U.S. dollars as of the fourth quarter of 2023 

• – The dollar’s dominance in the international reserve system remains significant, although it continues to cede ground to nontraditional currencies 

2. Implications for Modern Monetary Theory:

Reliance on the Dollar: MMT relies on the U.S. Dollar continuing as the world reserve currency. The reserve currency status could be challenged by the rise of Central Bank Digital Currencies (CBDCs) or by China’s rise to global economic leader by 2028 and their goal of making the Yuan the reserve currency (more below).

• Potential Challenges: Real concerns have emerged about the longevity of the U.S. dollar as a reserve currency, with proposals for an overhaul of the global financial system that would eventually replace the dollar with a CBDC.

3. Potential Shifts in the Global Monetary Order:

• Challenges to Dollar Dominance: There are indications that a parallel financial system led by stablecoins is starting to jeopardize the greenback’s status as a reserve currency.
• Impact on Global Economy: The transition to a new monetary order, potentially involving decentralized finance using a stablecoin as its reserve currency, could significantly impact the global economy.

The Reserve Currency and Petrodollar

The history of the dollar as the global reserve currency and the petrodollar system is crucial in understanding the dynamics of international finance and trade.

The Dollar as Global Reserve Currency: The U.S. dollar’s status as the global reserve currency was solidified in the aftermath of World War II by the 1944 Bretton Woods Conference, where forty-four countries agreed to the creation of the IMF and the World Bank 

This agreement laid the foundation for the dollar’s prominence as a major reserve currency post-World War II and the Bretton Woods agreement in 1944  The dollar’s central role in the global economy confers benefits to the United States, including easier borrowing abroad and extending the reach of U.S. financial institutions 

Petrodollars and the Dollar’s Role: The term “petrodollars” refers to U.S. dollars that have been exchanged for crude oil exports. The petrodollar system rose to economic and political prominence in the mid-1970s amid growing interdependence between the U.S. and crude oil exporters 

The reliance of foreign oil exporters on the U.S. dollar as the principal means of exchange and store of value reflected the dollar’s already established role as the global reserve currency, which continues without serious challenge to this day 

This process, known as petrodollar recycling, helps finance the U.S. government’s budget and trade deficits, and it also increases the demand for U.S. dollars, thereby helping to maintain its value and status as the world’s primary reserve currency 

China’s Goal of Making the Yuan the New Reserve Currency and MMT’s Perspective

China has been actively pursuing the goal of making the yuan a new reserve currency. The country has sought to increase cross-border transactions in the Chinese yuan and has signed deals with several countries to achieve this. China has also maneuvered the yuan as an alternative or replacement reserve currency by conducting more international trade using the Chinese yuan and negotiating deals to allow the purchase of Saudi Arabian oil in yuan. 

From the perspective of MMT, there is speculation about whether China could turn to Modern Monetary Theory (MMT). Should China adopt the MMT regime, there is likely to be a bull run on sovereign bonds. However, the currency outlook is uncertain because the yuan has not yet attained the same reserve currency status as the US dollar, known as the “exorbitant privilege.”

Impact on the US Economy if the Dollar Was No Longer the Reserve Currency

If the US dollar were to lose its status as the world’s reserve currency, it could have significant implications for the US economy.

Decreased Demand for the Dollar: Currently, many countries hold large amounts of US dollars as part of their foreign exchange reserves. This demand helps to keep the value of the dollar high. If the dollar were no longer the reserve currency, these countries might decide to diversify their reserves, leading to a decrease in demand for the dollar. This could potentially lead to a depreciation of the dollar, making imported goods more expensive for American consumers.

Increased Borrowing Costs: At present, the status of the dollar allows the US government to borrow at relatively low interest rates. If the dollar were no longer the reserve currency, investors might demand higher interest rates to compensate for the perceived increase in risk. This could lead to an increase in the cost of government borrowing, which could in turn lead to higher taxes or cuts in government spending.

Potential Decrease in Economic Growth: The ability to borrow cheaply has allowed the US to invest in its economy and stimulate growth. If borrowing costs were to increase, this could potentially lead to a slowdown in economic growth.However, it’s important to note that these are potential impacts and the actual outcome would depend on a variety of factors, including how the transition away from the dollar as the reserve currency was managed.

Current Market Conditions and Their Implications for MMT’s Viability as an Economic Framework

The current economic landscape, marked by moderate-interest rates and moderate inflation, presents both opportunities and challenges for MMT.

We have been in a Secular Bull Market since recovering from the 2008 economic collapse, with intermittent cyclical bear markets along the way – the 2020 Covid Collapse and the January 2022 to October 2023 bears being two examples where we had dramatic drops in stock prices followed relatively quick recoveries to new stock price highs.

A secular bull market is a long-term upward trend in the stock market, typically lasting for many years. It is driven by broad economic and market forces, and it is characterized by positive conditions such as low interest rates and strong corporate earnings that contribute to the rise in stock prices  In a secular bull market, investor confidence is high, economic conditions are favorable, and there are optimistic expectations for continued earnings and economic growth  This type of market is influenced by large-scale national and international trends, and it reflects a backdrop of positive economic conditions and optimistic expectations for the future 

• MMT & Bull Markets
• In a bull market, where investor confidence is high and market indices like the S&P 500 are performing well, MMT suggests that government spending can continue to fuel economic growth. This is particularly relevant if there are concerns about the underlying health of the economy despite the strong market performance.
• As discussed earlier, MMT states that government spending, funded by the creation of more money, can stimulate demand and support businesses, thereby sustaining economic growth. This could be especially beneficial if market confidence starts to wane, as government spending could help to offset any potential decrease in private sector investment. In the aftermath of our Covid experience, the massive increase in government spending kept the secular bull going, unfortunately we did get the inflation that comes along with it.
• Cyclical Bear Markets
• In a cyclical bear market, where the economy is in a downturn, MMT advocates for proactive fiscal policies to mitigate the impact of the downturn. Traditional economic theory might suggest fiscal restraint during these periods to avoid increasing public debt. However, MMT argues that this could exacerbate the economic contraction by reducing demand and slowing economic activity.Instead,
• MMT suggests that the government should increase spending during a downturn to stimulate demand and support economic activity. This could involve investing in public services, infrastructure, and other areas that can create jobs and stimulate economic growth. When we enter the next cyclical bear – and it is likely coming our way sooner rather than later, we will see whether our government implements MMT or Classical Economic policies to combat a coincident economic recession.
• Secular Bear Market
• A Secular Bear Market is a prolonged period of generally falling stock prices, typically lasting between 10 to 20 years. This type of market trend arises due to a confluence of factors such as high inflation, weak economic growth, and negative investor sentiment.
• Historically, there have been several instances of secular bear markets. For example, the period from 1966 to 1982 in the U.S. stock market was characterized by low returns due to high inflation and stagnant economic growth. Another example is the Japanese stock market from 1990 to the early 2000s, which was marked by a prolonged downturn following the burst of the asset price bubble.
• Depending upon when our next secular bear market occurs, Modern Monetary Theory (MMT) may still be in fashion – any economic theory that gives politicians of any party the go-ahead to spend beyond the country’s means will have a hard time becoming unpopular. The build up of government debt due to that spending and the more trillions than we can count might even be the cause of the next secular bear market. The growth of the debt is the biggest economic problem on the horizon that I see, and if we don’t curb it, the consequences will be severe when the market for our debt collapses.

Conclusion

Balancing fiscal sustainability with economic stability requires integrating insights from multiple economic theories, potentially including certain parts of Modern Monetary Theory (MMT). Policymakers should consider the basic ideas behind MMT while being mindful of its limitations. A multi-faceted approach can offer a more resilient strategy for managing national debt, especially in volatile economic climates.

The post-pandemic world presents unique challenges and opportunities for national debt management. The viability of MMT as an economic framework hinges on its ability to address these complexities effectively:

1. Economic Recovery: Can MMT provide the tools needed for sustainable recovery without triggering runaway inflation?
2. Fiscal Policy Innovation: Will governments adopt innovative fiscal policies that align with MMT principles while ensuring long-term economic stability?

If I were in charge, I would combine the MMT concept of government spending with the Supply-Side concept of using that spending to incentivise the private sector to accomplish the goal of increased and sustained economic growth. Things like:

– A focus on government spending on hiring private contractors to fix our crumbling infrastructure, bridges, highways, and airports;

-An investment in a national high speed train system built and managed by private companies that would spark commerce much like the Eisenhower Interstate Highway System did in the 20th Century – just imagine the research possibilities if all the Big 10 universities were within an easy commute to each other, the research into technological and medical advances that could be had by the University of Illinois and the University of Michigan being just 90 minutes apart;

-Bringing back manufacturing that has moved out of the country through tax incentives to private companies to build new factories, education programs to prepare workers for these high paying jobs, housing incentives tfor developers to build new neighborhoods for the workers;

Anything that leads to government spending with the goal of advancing economic growth and raising the average wage levels of workers organically would bring in additional tax revenues that could be earmarked to lower the national debt and further invest in the future of the country. Unfortunately, I don’t see anyone in power in any branch of government or in either party with a vision for the future anything like this. So we have to play with the hand we are dealt and I have to manage client investment portfolios accordingly.

Last week I briefly outlined our investment strategy, so I’m not going to repeat that here – but it does look like the consolidation in the Magnificent 7 stocks I mentioned is fully underway with many of them dropping below their 50-day moving average on thee way to the 2300-day moving average. This is setting up some nice entry points to add to positions and to invest new client money. We are not entering a secular bear market – that is a few years off, I think. We may not even be entering a cyclical bear market. But we are in a consolidation and rotation bringing some short-term pain but ultimately healthy for our stock market and investment portfolios.

If you are not a client, don’t panic and sell everything just because the markets are pulling back – in my experience most that do this end up missing the point to buy back in and end up buying back in at a point higher than they sold. Be patient, and if that doesn’t work, contact Karen Sharp at (217) 351-2870 or [email protected] to discuss having us manage your investment portfolio.

Thanks for reading,

Mark