Highlights:

  • Big Foot, the Loch Ness Monster, and Modern Monetary Theory are all delusions with an ardent following among otherwise clear-thinking adults.
  • Modern Monetary Theory asserts that the government can and should spend as much money as is needed to solve societal problems.
  • Unfortunately, the law of supply and demand dictates that if a government engages in unchecked deficit spending over the long term, the value of its currency will be devalued, resulting in hyperinflation.

“… [F]or it is a habit of mankind to entrust to careless hope what they long for, and to use sovereign reason to thrust aside what they do not fancy.” – Greek historian Thucydides.

My grandfather was a factory worker who operated a drop forge at night and a farmer by day.  He was a hard worker for sure.  He was also a bit hard headed.  Once he believed something, it was rare for him to change his mind, regardless of evidence to the contrary. 

Psychologists have demonstrated in a litany of academic studies that many of us have a deep-seated and powerful emotional need to believe in theories or ideologies that are consistent with our existing opinions and beliefs, even in the face of strong evidence to the contrary.  Psychologists refer to a partiality for theories and arguments that support our own beliefs and predilections as “confirmation bias”.  The rest of us call it wishful thinking.

Economists are not immune to wishful thinking, and as a result brilliant economists have been known to persuade themselves (and others) that what they would like to be true is in fact the case, even if the desired belief contradicts fundamental economic principles.  Modern Monetary Theory (“MMT”) is an example of when an economist’s predisposition trumps logic.

MMT is an economic theory that has been around for years, but has been enjoying a surge in popularity as of late as a result of the recent endorsement by Representative Alexandria Ocasio-Cortez and Senator (and presidential candidate) Bernie Sanders.  In simplest terms, the core tenants of MMT are:

  1. Monetary sovereign countries (that is, countries such as the U.S. whose debt is payable in their own currency) can never go broke because such countries can always print more money with which to pay off their debts.
  1. As a result, there is no reason for the government to shy away from printing as much money as is needed to provide free housing for the poor, free healthcare and college education for all, and to protect the environment.

The first of these principles is, technically, irrefutable.  Technically, the U.S. can never go bankrupt because it can always print as many dollars as it needs to pay off its debts so long as those debts are payable in U.S. dollars.

The second tenant of MMT is where wishful thinking runs afoul of perhaps the most fundamental concept in economics: the interplay of supply and demand.  Stated simply, price is determined by the intersection of demand and supply.  Water is in high demand but there is a lot of it and so it’s cheap (unless you buy it at a professional sporting event or a concert).  Diamonds are both treasured and rare and so the price is high.  

All other things equal, value falls as supply increases.  As a result, if the U.S. prints currency to pay its bills, the amount of currency in circulation – the “monetary base” – increases.  However, simply printing more money does not increase the amount of goods and services that are produced in the U.S. 

The law of supply and demand mandates that all else equal, if the monetary base grows faster than GDP, and as a result there is more money chasing the same number of goods, it will take more money to buy those goods.  In other words, the value of money will decline, which in turn causes inflation, which in turn means the government will have to print more money to pay its bills, and so on, and so on.

The link between the monetary base and inflation can be seen in many historical cases.  

Germany.  During World War I, Deutschmarks in circulation skyrocketed from 13 billion to 60 billion.  In the aftermath, Germany printed more currency to repay war reparations.  By the end of 1923, the inflation rate was 20.9% a day.

U.S. Civil War.  During the U.S. Civil war, the Confederacy could only raise 46% of the money it needed to finance its war effort from taxes and bonds so it printed more money.  At the same time, the South’s output of goods and services plummeted, causing inflation to peak at over 5,000% by the war’s end.

Venezuela.  The most recent example of hyperinflation is in Venezuela.  At the beginning of 2013, more than 90% of the country’s export earnings came from oil.  These export earnings enabled Hugo Chavez ‘s government to pay for popular (and expensive) social programs.  In 2014, the global price of oil dropped and the Venezuela’s oil production fell.  In other word’s Venezuela’s GDP fell but the amount of currency in circulation didn’t.  To make matters worse, in 2017, the government increased the money supply by 14%.  By 2018, inflation in Venezuela reached an estimated 80,000%.

Proponents of MMT argue that our modern U.S. economy is different and immune from inflation.  As proof, MMT theorists mistakenly point to the U.S. inflation rate remaining very low even though the Federal Reserve has pumped trillions of dollars into the economy in its effort to combat The Great Recession of 2008-2009.

There are three reasons why the Fed’s “quantitative easing program” has not caused inflation. 

  1. The U.S. economy was deflationary when quantitative easing began.
  1. The Great Recession led banks and financial institutions to hoard money instead of lend it, which kept the amount of currency in circulation (the “money supply”) relatively constant; and
  1. As the economy has recovered, banks have increased their interest payments on the debts the Fed purchased as part of the quantitative easing, and the federal government has begun repaying the Treasury bonds the Federal Reserve purchased. The result has been the monetary base has not spun out of control.

In short, a short-term spike in the monetary base will not necessarily result in inflation, but printing money indefinitely to pay for long-lasting, expensive government-entitlement programs (as MMT prescribes) almost certainly will.

The goal to help the less fortunate is a worthy one.  Human nature being what it is, the strong desire to accomplish this goal can cloud one’s judgment.  In the words of William Reville, University College Cork professor emeritus:

And so, the take-home lesson for today is that the ability to think analytically is a very fine thing but it’s not enough – you must also have the inclination to do so.[1]

Thank you for reading,

Mr. Market Commentator

[1] Why we believe what we want to believe, The Irish Times, May 3, 2019.

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