What's Modern Monetary Theory? Understanding alternative economic theory that's becoming more mainstream
- Modern Monetary Theory is an alternative economic theory that suggests the US government can create more money.
- Modern Monetary Theory claims that because the government is the issuer of money, it can create more since it's no longer backed by gold.
- Proponents think Modern Monetary Theory can counter many economic problems, while opponents fear inflation and increased deficits.
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Modern Monetary Theory (MMT) is an economic theory that suggests that the government could simply create more money without consequence as it's the issuer of the currency, according to the Federal Reserve Bank of Richmond. As part of this theory, the thinking is that government deficits and national debt don't matter nearly as much as we think they do.
Instead of relying on tax revenue or borrowing to support federal government spending, according to MMT supporters, the government can simply create more money instead. This is a big departure from how many economists think about government spending and has become a popular alternative theory as discussions about debt and government spending hit the national stage.
Understanding Modern Monetary Theory
The term "Modern Monetary Theory" was originally coined by Bill Mitchell, an Australian economist, and has become more mainstream over the past few years with politicians like Alexandra Ocasio-Cortez popularising the concept.
"The whole idea of MMT is that since a sovereign entity can borrow in its own currency, it can print more money when it needs to pay off all its debt. The central bank just needs to keep interest rates low," says Robert R. Johnson, professor of finance at the Heider College of Business at Creighton University.
MMT is essentially a paradigm shift when it comes to economic theory and a new way of thinking about governments with fiat currencies.
"In essence, governments like the US, Japan, the UK, and Canada that use fiat currencies are not constrained by their tax revenues when it comes to government spending and can perpetually run a budget deficit. This is due to the fact that the central banks in these counties have a monopoly on the supply of money," explains Ryan Cullen, CEO and founder of Cullen Investment Group.
This differs from the way things used to be with the Bretton Woods System, which started in 1944 and ended with Nixon in 1971. According to FederalReserveHistory.org, the system became operational in 1958 and pegged currencies to the dollar, which were backed by gold.
"This is opposed to when the USD was on the gold standard and we had a fixed number of dollars in circulation based on the amount of gold we had in vaults," notes Cullen. "This was an archaic form of monetary policy because governments with full control of their money supply do not need to confine themselves to a traditional household budget that manages revenues and expenses, because they essentially have an AMEX black card of unlimited money that they do not have to pay back."
Brief history of MMT
- The term "Modern Monetary Theory" was coined by Australian economist Bill Mitchell in the early 90s, however some of the ideas are based on earlier themes in Keynesian economics.
- Ideas around MMT were developed by economists Bill Mitchell, Warren Mosler, and L. Randall Wray as early as 1992 through email listservs.
- In 2019, politician Alexandria Ocasio-Cortez noted that MMT should be a "a larger part of our conversation" as it relates to balancing the federal budget.
- As of 2020/2021 during the pandemic, MMT has grown in popularity and has become more mainstream.
Concerns over Modern Monetary Theory
On the surface, outsiders and those with more traditional beliefs may think that Modern Monetary Theory seems like an idealistic solution to growing economic problems. Though the theory is increasing in popularity, there are also many sceptics and opponents of the theory as well. "It was originally a kind of cult in macroeconomics, it's still somewhat of a cult, except that it's entered the popular press. Basically, what it is is late 1940s Keynesian economics with a wacky theory of money creation tacked onto it," says Mark Kuperberg, professor of economics at Swarthmore.
The primary criticisms and concerns over MMT include:
- Increased inflation. One of the chief concerns of MMT is widespread inflation, though MMT supporters have looked at instances such as the financial crisis, which led to lots of government spending and didn't result in inflation. However, this theory shouldn't set a precedent, as all other factors are not the same and one of the primary indicators of inflation - economic scarcity - has not been part of the equation.
- More deficits. Given the core beliefs of MMT, if implemented, it could lead to even higher deficits. While that isn't a concern for MMT proponents, it's concerning for others, like Nobel Prize winner Paul Krugman, who think that lending and interest rates may be compromised and cause inflation.
- Examples in Venezuela, Zimbabwe, Germany, and more have shown potential downsides, destruction, and hyperinflation. According to the Brookings Institution, previous historical examples show clearly that creating more money can lead to hyperinflation and unrest.
Though inflation is a big concern, there are other ways to manage government spending and taxation to deal with it.
"The government can essentially print as much money as it would like to fund essential services and programmes and also stimulate the economy, and when inflation rises to an undesired level, you can increase taxes to bring inflation back down to your target rate," says Cullen. "It's sort of a seesaw because the government can add money to the money supply when needed, then tax more to take that money back out of circulation and decrease inflation."
In regards to concerns about MMT theories being put in place and having similar results as other countries, that might not be an apples-to-apples comparison, and there's more to the equation to consider.
"The United States is not Venezuela… the US government borrows a lot of money. About a third of the borrowing is from foreigners… it's not a problem in the way that, let's say, if Venezuela borrowed from foreigners, or Argentina, or a lot of developing and less-developed countries," explains Kuperberg. "Because those countries, when they borrow from foreigners, borrow in dollars. They can't print the dollars. So if their currency starts to depreciate against the dollar for whatever reason, it becomes almost impossible for them to pay off their debt. The MMT people totally understand this and they say that for a country that borrows in its own currency, this is not a problem, and they're right."
So while historical examples of hyperinflation and unrest can give us a glimpse into what might happen with MMT policies, it's important to consider all relevant factors and unique considerations with the US government.
Another concern of MMT is the potential transfer of wealth from everyday people to the one percent if the theory turned into actual policy with real-world ramifications.
"Modern monetary policy is the most effective way to transfer wealth from the working class to the elite. When more money is created it generally goes directly to the largest investment banks, which have the closest relationship with the central bank and the Treasury Department," says Shuan Heng, vice-president of operations at CoinMarketCap. "This means that the wealth of the working class, generally stored in cash or bank accounts, loses its purchasing power. Meanwhile the purchasing power of investment banks grows exponentially."
Modern Monetary Theory and investing
MMT policies could have ramifications on investments as well. It could potentially lead to an increase in inflation that could affect investments and lower the overall value. On top of that, it may lead to higher stock prices, which could make it more difficult to get into the market if you have limited means.
According to Heng, MMT-related policies are contributing to the growth of cryptocurrency trading as well.
MMT-related policy "is one of the things driving growth in cryptocurrency. There have been a variety of programmes that go hand in hand with MMT," notes Heng. "The first is the Troubled Asset Relief Program (TARP), which was one of the tools used in the bank bailout following the recent financial crisis. The other is quantitative easing. All of these programs have devalued many assets linked to dollars and have caused many to invest in cryptocurrency."
On top of affecting retail investors, MMT policies would also potentially affect private investment as well, according to Johnson.
"One of the consequences of MMT would be that government spending and debt would rise, and this would crowd out private investment," explains Johnson. "Many advocates of MMT in Congress, like AOC, would use MMT to fund wide-reaching proposals like Medicare for All, Free College, and the Green New Deal. The biggest problem is that citizens ultimately have to eventually pay for these proposals via either higher taxes or by suffering inflation."
The financial takeaway
Modern Monetary Theory is still on the fringes of economic thought but is becoming more mainstream. The theory is still just that - a theory - but with a growing number of proponents and opponents on each side.
Either way, there are potential real-world ramifications for the economy and investors alike to be aware of if the theory is put to the test.
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