Weekender: The Trouble With Modern Monetary Theory (MMT)

December 19, 2010

It’s time to put the smackdown on Modern Monetary Theory (or MMT for short).

To be blunt, MMT is fatally flawed, and someone needs to address those flaws head on. (That is the conclusion of yours truly after investigating in recent months.)

If you aren’t familiar with Modern Monetary Theory, the quotes in the blue sidebar may disturb you a bit. They highlight some rather bizarre assertions made by MMT proponents.

In some ways the MMTers are neo-channelers of Dick “deficits don’t matter” Cheney. (Full quote: “Reagan taught us that deficits don’t matter.”)

In reality, what Reagan taught us is that deficits don’t have to matter for extended periods of time. But then, all of sudden, they can start mattering a great deal.

But we’ll get to that… point being, MMTers think deficit concerns are bunk. In fact, they don’t see much reason to worry at all! Dead wrong, as we shall see…

Let me preface by saying I have great respect for the work of Cullen Roche, who blogs at the excellent Pragmatic Capitalist website (www.pragcap.com).

From what I can tell, Cullen is the most vocal and ubiquitous defender of MMT on the web (next to Waren Mosler himself). Because he is so indelibly associated with MMT, I want to stress that my sharp criticisms here are directed at the theory, not Mr. Roche individually.

Let me also throw in that these are just the thoughts of a humble trader, trying to explain economic reality in layman’s terms. I am no policy wonk. My partner and I are just straight up swing traders looking to book 40% annual returns with reasonably controlled drawdowns.  But because my views and communication methods are somewhat unorthodox – and because I’ve picked up a few things in my global macro travels over the years – I feel I have something to add here.
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We’ll start with some due diligence… then move into the blunt critiques of MMT… then offer a visuals-and-graphics alternative, closing with a recap.

Due Diligence

Before we break out the baseball bats, it’s only fair to let the defenders of MMT speak in their own words. For that reason, I recommend the following resources:

  • Chartalism. Wikipedia description of the theory in which MMT is rooted.
  • Optional but informative: Money as Debt. A 47 minute video presentation explaining the origin and nature of fractional reserve banking, the means by which modern money is created (as a form of debt), and a closing anti-banker argument that is sympathetic to MMT.

The Big Assertion

The big assertion of MMT is that the United States government is self-funding. (See box at right.)

According to MMT,

  • The government does not need to issue bonds to raise money.
  • The government does not need to tax to raise money.
  • Both of these actions (issuing bonds and raising taxes) are simply policy controls, like plumbers adjusting the pressures and levers on a boiler.

For this reason, MMTers further add, the United States government can never run out of money. How could it? The money Uncle Sam spends does not come from bonds or taxes. He just spends it.

As Cullen Roche says, “[The government] finances new spending by telling men and women to walk into a room and change numbers up and down in a computer.”

Sound crazy? It isn’t – it makes perfect sense.

Believe it or not, this isn’t the part of MMT that is fatally flawed. They are right when they say the government is self-funding. They are also right when they say the government can never “run out of money.” (The disagreements – big ones – will come in other areas.)

As MMT argues, the government could technically fund itself without issuing bonds or raising taxes at all. It could simply spend what it needs to spend.

Under this system, the cost of government waste would come in the form of inflation. To the degree that the government diluted the money supply unproductively, they would be little different than the North Korea regime running off truckloads of $100 bill “supernotes.”

But here is the funny thing. This big assertion of MMT – The government can never run out of money! The government is self funding! – is actually not a very important point in the broader scheme of things.

At the end of the day, MMT’s “eye-opening relevation” is simply a technical observation that Uncle Sam has a printing press… that Uncle Sam can run that printing press whenever he wants… and that, therefore, Uncle Sam can always pay off debts issued in his own legal tender.

To which we say: “Yeah, so?”

Monopoly versus Clue

“Well,” the MMTers say, “the fact that the government is self-funding – and could technically fund itself without bonds or taxes at all – means that worrying about deficits is stupid! Deficits don’t matter!”

And this is where MMTers go off the reservation.

Contrary to what MMT argues, deficits still matter, even in a regime where the US government cannot technically default.

A lack of technical default does not preclude DE FACTO default, or default-like degradation by incremental degrees, as investors shift their asset mix preferences over time.

To understand why, consider the game of Monopoly. MMT proponents like to point out that “the banker in Monopoly can never run out of money.” And this is more or less true! We happily concede this point.

The U.S. government is like the banker in Monopoly in that government issuance of currency and debt is a closed loop, with all U.S. debts payable by U.S. currency (which has no limits).

So why are MMTers wrong about deficits? Because there is more than one board game to play.

To wit, if the Monopoly banker grossly abuses his priveleges, investors can go and play some OTHER board game. They can choose to play “Clue” instead. (As in, getting a Clue. Get it? Ha ha…)

Let’s break it down:

  • The Monopoly banker can “never run out of money.”
  • But the Monopoly banker can also abuse the system.
  • In response to this, investors can choose to play a different game.
  • They play a different game by reducing their preference for U.S. liabilities.

Why are top hedge fund managers like David Einhorn, John Paulson and George Soros aggressively long gold? Because they are in effect saying:

“Mr. Monopoly $USD Banker, we do not like the way you are abusing your privileges. We know you cannot technically default,  but we still feel your actions are grossly irresponsible… and so we choose to STOP playing Monopoly and go play Clue (i.e. buy gold) instead.”

Debunking the Chartalist Defense

Still with me so far? MMT crows that the United States government is self-funding, that it can “never run out of money,” and that most people don’t understand this. In this MMT is correct.

But they neglect to acknowledge that, if the government abuses its Monopoly privileges, investors can change their preferences and play a different game, i.e. rotate out of U.S. liabilities (bonds and currency) and into alternatives (hard assets, other currencies, E.M. etc).

“But hold on one minute,” the Modern Monetary Theorists say. “There will ALWAYS be demand for U.S. currency – because we need it for transactions and payroll and taxes!”

This idea extends from the Chartalism school of thought. As a U.S. citizen, you get paid in dollars and have to pay your taxes in dollars. Also, if you want to go down to the store and buy milk or gasoline or shotgun shells, you have to conduct your transactions in dollars. Therefore, hey presto, permanent currency demand.

But consider this:

  • Americans can travel Europe while holding no euros.
  • Brazilians can travel the United States while holding no dollars.
  • Australians can travel Japan while holding no yen… and so on.

How is this is so? Through the power of instant conversion transactions. When you use your major credit card to buy something for sale in a currency other than your own base currency, the bank makes the conversion for you on the spot. This reality makes it possible to limit one’s currency exposure to point of sale only!

The same applies with tax and payroll considerations. What is to prevent a U.S. based business from holding its cash reserves in, say, a mix of Canadian dollars and Swiss francs, then converting the necessary funds to $USD only at the instant point of transaction, i.e. when they pay the tax?

And as for payroll, why couldn’t a company wait until the last second to convert its payroll accounts from, say, Swiss francs to dollars… with employees again making the switch from $USD to something else as soon as the paycheck hits their accounts?

Heck, let’s take this further. Thanks to the modern miracle of ETFs, you could keep 99% of your net worth in copper, crude oil and cotton if you really wanted to. Whenever you needed $USD for a transaction of some kind, you could convert instantly – “point of sale” – and hold no dollars otherwise.

The argument that “there will always be demand” for a currency because of tax, payment and transaction requirements thus seems dubious at best. There is nothing (at least for now) to prevent even U.S.-based investors from

1) shifting their preferences away from $USD liabilities, and

2) minimizing their exposure to $USD to as small a footprint as possible (and hedging even that!).

Let us also note that the “constant demand for the currency” argument in part stems from U.S. hegemony and the use of the $USD as the world’s reserve currency.

But this is a situation that can change – just ask the British Empire! And because world reserve currency status can be lost, slowly and by degrees, it makes sense to show concern at the margins. Like when major players such as Russia and China take concrete steps to remove the middle-man $USD from their trade flows, for example.

The Plucked Chicken Problem

Here is where this MMT stuff gets amusing. These guys don’t understand that a technically correct definition is not the same as a relevant and useful argument.

They crow about how the United States government is self-funding… and they go on about how taxes and transactions create demand for a currency… without realizing that these technical assertions are not relevant to the true problem.

Again, the true problem is that investors can shift their preference away from the Monopoly banker’s closed loop system when the priveleges of that system are abused.

To the degree that this is missed, all the hubbub about a “technically correct” definition is meaningless!

It’s like the old story of sober Plato and the prankster Diogenes (see box). MMTers are like Platonists walking around saying “Man is a featherless biped!”

While the featherless biped definition is technically correct, it is also subject to severe problems (as Diogenes’ plucked chicken so demonstrated).

The same is true of MMT’s big assertions. Their self-funding stuff is technically correct, but irrelevant to the endgame problem of shifting investor preferences when the Monopoly banker goes rogue.

Is this Critique Unfair?

Some might say the above critique is unfair.

After all, at least in passing, MMT does address the “bad spending and shifting preferences” problem. From the TPC website:

Thus, government cannot just spend and spend and spend or the extra dollars in the system will chase too few goods and drive up prices. It’s important to understand that government cannot just spend recklessly. This is  important so I’ll say it again. This does not give the government the ability to spend and spend and spend. If they spend too much and tax too little they can create mal-investment and inflation.

Well stated by Cullen Roche and quite true! And yet, the opening quote box is now replicated to make a point. MMT pays lip service to the “can’t spend and spend” idea, but then MISSES THE IMPLICATIONS.

To wit, if constraints on the government’s ability to “spend and spend” are truly understood and acknowledged by MMTers at large, then why does Mosler say that “government debt is not true debt” and that There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it?”

And if “spend and spend” has acknowledged  negative consequences, then why does Cullen Roche sharply imply that funding costs are irrelevant?

In a world where the government cannot “spend and spend” willy nilly, funding costs certainly ARE relevant because the printing of currency to service high interest rate debt issues is most assuredly an UNPRODUCTIVE use of funds!

Imagine Uncle Sam printing an extra trillion bucks every month just to cover interest payments. Yeah, he could technically do it… but what effect would that have? Not a small one.

One of the mildly maddening things about MMT, it seems, is that there is a willingness to lightly address certain “mild” critiques in passing without acknowledging that those critiques actually blow a huge hole in the strongly stated assertions of the theory.

‘I am Immortal.’ Really?

Yet another problem with MMT – not stated outright, but heavily implied – is the assumption that the United States government is financially immortal.

MMTers think and act as if deficits don’t matter, no matter how big they get, solely because Uncle Sam can write his own checks in a neat little closed-loop system.

Yet this viewpoint neglects the reality that, given enough abuse of privilege, the entire system can be abandoned to a point of critical threshold collapse – or abandoned to a great enough degree to cause massive problems, even if the baseline system survives.

Longevity and immortality are not the same thing. Present strength can (and often does!) degrade into future weakness.

At this point the MMTers resort to a situational defense. They pooh-pooh the idea that investor preference will ever shift away from $US debt and currency to a significant degree because the U.S. is, at this present point in time, still hegemonic and strong. In part they lean on the chartalist taxes and transactions argument – a leg of the stool we have already kicked out.

But more aggressively they point out the United States is uber-dominant  — 25% of the global economy etc – and that there are no signs (supposedly) this will change. Therefore, why worry about default?

But this argument is extremely weak from a theoretical standpoint. Why? Because saying “the U.S. is too strong to fall” is a long way from saying “the U.S. can never fall.”

Philosophically, the “U.S. can’t fail” argument is comparable to this:

  • Immortals live unceasingly and never die.
  • I too have lived unceasingly and never died.
  • Therefore I must be immortal…

Of course, the individual who assumes immortality is in for a rude surprise.  The same could be said for many an empire…

Here is a more logical approach to the sovereign immortality question:

  • Many (all?)  “too strong to fail” empires eventually do fail.
  • It is possible that this could happen to the United States.
  • If history is a guide, and if it happens, it will be by degrees.
  • Slowly slowly at first… and then, one day, suddenly.

And here is where MMT goes really, really wrong:

Because MMT leans so heavily on the “self-funding” argument, the chartalist “always a demand” argument, and the present economic supremacy of the U.S., they completely dismiss (or hand wave away) the threat that shifting investor preferences could eventually bring down the empire.

In thus so doing, they dismiss the possibility of death by degrees.

Or to put it another way:

  • Only if the U.S. is financially immortal can deficits not matter.
  • If you admit the U.S. is not immortal, you admit the possibility of death.
  • If death happens, it starts incrementally… in small degrees.

Note we are not flat-out predicting the financial downfall of the United States here. (No hyperinflationista or deflationista labels, thanks.) We are merely pointing out that, if downfall is theoretically possible (due to shifting investor preferences), then concern at the margin can be warranted or at least justified.

Or to put it another way, you don’t have to think “the dollar is going to zero” to have legitimate concerns about where it is going! The hyperbole label — everyone worried about the deficit is a hyperinflationist / deflationista — is a sort of subtle ad hominem.

As such, it’s really quite funny to see MMTers snarling at all the “fools” who show concern over U.S. debt levels. Those who show concern are only “fools” if the U.S. is bulletproofl.

But if the U.S. is NOT bulletproof… if the self-funding regime can at least theoretically be abandoned to a critical threshold point… then the small signs of decay are not to be dismissed. Instead of meaningless worries, they are genuine concerns, like the frog in the pot slowly being boiled.

The 5th Dimension Problem

Here is another issue with Modern Monetary Theory. Imagine if I told you that, of all the animals in the animal kingdom, elephants are unique because they live in five dimensions.

All other animals get four dimensions (three physical dimensions plus time). But for some wacky reason, elephants get five. Then further suppose that, when you pressed me on why this is true, I assured you that my theory was sound and you just had to accept it.

The analogy here is to the weird place of self-funding governments in MMT.

All other entities – households, individuals, businesses – are subject to more “normal” economic rules. Yet somehow governments are the magical alchemist elephants… they supposedly have some bizarre fifth dimension factor (born of self-funding elixir) that makes them normality-exempt.

Yours truly argues that the fifth dimension does not exist and there is no call for theorizing it. Elephants (i.e. governments) get four dimensions like all the other mammals.

Why? Because a sovereign governments’ ability to do what it does, within the constraints that it faces,  is wholly explainable by the ‘normal’ laws of economics. We do not need weird or bizarre exemptions.

“But governments are different,” MMTers say. No they aren’t – not really. They are just bigger.

It’s true that the United States government can fund itself, a unique proposition. But you know what? I can “fund myself” too… and so could you if you wanted. The question is, who would accept our paper and why!

An entity’s ability to “fund itself,” then, does not depend on whether it is a government or not. Instead it depends on that entity’s credibility as a powerful force, which in turn depends on access to real productive assets.

The government’s self-funding fifth dimension “magic trick” is thus actually very mundane. The credibility and ongoing acceptance of the government’s self-funded paper is only achieved via the leveraging of the real U.S. economy, i.e. government access to real productive wealth by threat of force!

Economic power flows from the barrel of a gun… the government has the ability to tax and appropriate.

If (as a U.S. citizen) you disagree with your tax bill, or choose not to pay what Uncle Sam asks, you get thrown in jail. Therefore your assets are, in effect, Uncle Sam’s assets for the taking. Your balance sheet is a part of his balance sheet. Uncle Sam self-funds, in part, on the power of leveraging YOU.

Uncle Sam can’t force you to hold your savings in $USD – at least not yet – but he can take an arbitrary chunk of your profits, and in so doing extract some of your productivity for his own doing. This is the key thing.

The only reason any of us play the “Monopoly banker’s game” in the first place is because the Monopoly banker has access to the full scope of U.S. productive assets, the value of which the government can extract and appropriate by force.

It is the perceived value of these assets that keeps faith and confidence alive.

The government relies on collateral

In this, the United States government has a cache of “collateral” at its disposal – in the same manner that individuals and businesses have collateral. Ask yourself:

  • How big a loan could a poor man get with $50 (fifty bucks) in collateral?
  • How big a loan could Bill Gates get with $50 Billion in implied collateral?
  • How big a loan could Uncle Sam get with $50 Trillion in implied collateral?
  • Bigger implied collateral = more leverage and a longer leash. That’s all.

There is no need for a fifth dimension in which governments can fund themselves infinitely, because governments cannot fund themselves infinitely (except in  a meaningless ‘technical’ sense). Credible access to underlying assets constrains them!

The amount a government can leverage itself is linked to its “collateral,” i.e. the size of the economy supporting it. A government’s ability to “self fund” in the MMT-described method, then, is bound by the outer limits of investor credibility… which, in turn, are impacted by the “collateral” of taxable real assets at the government’s disposal.

Consider: An individual, were he rich enough, could “self fund” too. Imagine if Facebook grew to six billion users, putting Mark Zuckerberg’s net worth (as a global social media monopolist) at $6 trillion.

Then further imagine Zuckerberg bought a modest sized country, funded his own army, and began “self funding” with Zuckerbucks and Zuckerbonds. Would these units have perceived value and be accepted as mediums of exchange? Yes they would… because the collateral (and force) would be there to back them.

Governments aren’t so different. They are just big bullies whose “self funding” operations are means of leveraging the collateral credibility built into the asset side of their balance sheets (the economy’s real wealth).

The Productivity Problem

Modern Monetary Theorists have another problem. They don’t properly address productivity, and the productivity issue is extremely important.  

Consider the (true) assertion that the U.S. government could fund itself without taxes or bonds. This highlights that the government’s spending choices are unlimited. But will all choices on the roster have the same impact on the economy?

  • Imagine a “wise government” scenario in which $100 billion is spent on the new century equivalent of Eisenhower’s highway system.
  • Imagine that this new system contributes dynamically to the healthy growth of the economy in the years moving forward.
  • Now imagine an “idiot government” scenario in which $100 billion is spent on the economic equivalent of hookers and cocaine.

Can we really say that the downstream economic impact of those two scenarios is the same? Of course not. When the government chooses to spend money – be it borrowed, extracted via taxation or created directly – it still matters HOW that money spent.

The importance of wise spending is addressed in passing by MMT, but nowhere near thoroughly enough, and not in consistent fashion with MMT’s main assertions.

Productivity of investment is incredibly key… Why? Because funds spent and invested productively contribute to the health and growth of the U.S. economy, whereas funds NOT spent productively do not.

The importance of this distinction cannot be understated, yet MMT glosses over it. Why? Because Modern Monetary Theory does not properly address the vital linkage between fiat money creation and the real productivity of the U.S. economy.

Productivity – tangible assets and the volume of real goods and services provided – is what counts as genuine wealth. The digital 1s and 0s riding on top are just manipulated transaction mechanisms.This is why it is so important to distinguish between productive spending and unproductive spending. Productive spending adds to the real wealth of the real economy. Unproductive spending does not.

Quality of spending (and borrowing) thus has powerful impact on inflation and deflation, as we are about to see visually…

The Stable Inflation Model

In the most desirable of circumstances for a modern economy, inflation is “low” and “stable.” What does this mean? How can we characterize this favorable situation?

The above compares “total credit flows” – all the credit and debt in the economy, created by various means public and private – with the size of the real economy itself. Total credit flows naturally include currency, loans, bond issuance etc, as they are multiple sides of the same coin. (“Money” is fluid and takes many forms.)

So, as long as there is a dynamic yet stable relationship between credit flows and the ‘real wealth’ of the underlying economy, inflation will be benign. This is due to a match-up in the relative size of the two entities.

Furthermore, if the size of total credit flows and the size of the real economy grow at roughly the same rate, this happy situation will persist – not unlike two cars traveling in parallel at the same speed.

In a perfect world, general price levels would be stable and there would be no inflation at all. But that level of matchup between credit flows and the economy is impossible, because the overall process is too dynamic. Loans are constantly being extinguished and recreated, productive output and profits are fluctuating up and down, and so on.

So rather than zero inflation – which is too close to deflation — central bankers aim for a “stable rate of inflation” instead, a situation where total credit flows are more than required for the real economy to run smoothly, but just by a little bit. (Thus talk of a “stable” inflation rate in the 1 – 2% range.)

The Supernova Boom

Now we see what happens when unproductive debt levels expand and widespread malinvestment kicks in. As the government blatantly attempts to massage credit flows, investor risk appetite increases. As a love of risk comes to dominate, unproductive debt levels rise along with poor choices of investment.

The specific problem with an unproductive debt boom (and gross malinvestment to go with) is that the taking on of such increases the total amount of credit flows, WITHOUT a corresponding increase in the real wealth of the economy.

In practice, this phase of the cycle is marked by lots of folks making lots of dumb decisions:

  • Investors chasing risk assets to nosebleed valuation levels
  • Consumers leveraging themselves beyond prudent levels
  • Aggressive business capacity expansion based on false signals

As more bad debt decisions are made, total credit flows increase well beyond the needs of the real economy (as malinvestment does not create corresponding productivity or real wealth). This leads to a classic supply and demand situation where there are more credit flows on hand than required – and so the extra flows push prices up (i.e. cause inflation)!

Of course, just where this inflation shows up varies from case to case. Sometimes the results of an unproductive debt boom can show up as pure, unadulterated asset inflation. This is the heroin and cocaine of Wall Street – when all those extra flows push up the value of stocks, real estate, junk bonds etcetera while leaving the Fed’s traditional inflation warning gages untouched. Party!

Also of course, paper asset inflation can be just as destructive as any other kind of inflation. Think of the self-reinforcing nature of the housing bubble, as more and more builders and flippers and real estate buyers piled on the leverage in a self-perpetuating orgy of myopia and greed.

Note this process is entirely consistent with the Von Mises prophecy as explained last week. And once the debt boom finally hits critical mass, we get…

Supernova Debt Collapse!

As Walter Bagehot, 19th century editor of The Economist, observed: “at particular times a great deal of stupid people have a great deal of stupid money… At intervals, from causes which are not to be the present purpose, the money of these people — the blind capital, as we call it, of the country — is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone and there is ‘speculation’; it is devoured and there is ‘panic’.”

Though Bagehot died in 1877 – more than 130 years ago – his description of the boom-bust cycle is still accurate in this era of “modern” monetary systems. That is because the boom-bust cycles of today, just like those of yesteryear, are driven by a build-up of malinvestment and unproductive debt.

The key distinction is not between “public” and “private” but “productive” and “unproductive.” This is because productive credit flows facilitate corresponding growth in the real wealth of the real economy, whereas unproductive credit flows do not.

When the artificial boom implodes, the result is dramatic – and deflationary. As with a collapsing star, the relationship of available credit to the functioning real economy goes from “massive overabundance” to “massive shortage” in the space of a market crash. Where banks would lend to anyone before, suddenly they lend to no one. Where investors were brazen before, suddenly they are terrified.

During a supernova collapse, trillions of dollars in private credit flows evaporate into the ether – the result of loans being extinguished in a panic but not replaced. It is this type of situation where the authorities can find themselves helpless, as the size of privately created credit flows is gargantuan compared to what the Fed can gin up on short notice.

False Trend Application

As an added bonus, this model has great utility for traders willing to exploit the false trends of Soros fame.

Note the blue arrows – during the time when the supernova is expanding, you don’t want to be ignoring or fading the false trend… you want to be riding it!

The unproductive debt boom can create excellent opportunities for the trader willing to stay long on the way up, while watching closely for the time to go flat (or even reverse and go short) as the supernova threshold approaches.

Note, too, that this model is consistent with the increasingly feverish waves of investor sentiment as the unproductive debt boom reaches critical mass. The supernova burns at its hottest and most expansive not long before imploding.

It’s the Real Economy, Stupid

Note an important theme running all through this critique: It’s the real economy that matters. Always has been, always will be.

Real wealth is not created by a printing press or punched out by government decree. Real wealth is assets, savings, goods and services – the productive output of the underlying economy itself.

And thus the dog-and-pony show of self-funding government regimes counts as little more than a technicality. The U.S. government never has to technically go into default… fine, so what. The financial power of the United States government is still inextricably linked to the productive power of the real U.S. economy.

And this is why it is the split between productive and unproductive that matters most. Productive investment allows for a corresponding increase in the health and size of the real economy. Wasteful malinvestment does not.

This split also shows why Warren Mosler is wrong in his goofy assertion that “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.”

He is wrong because of the following:


You want 600 billion bucks worth of “da juice?” No problem, Uncle Ben can get that for you.

You want to ensure that the 600 billion bucks is channeled and directed wisely so as to ensure the healthy and productive growth of the real economy? Can’t help you in that department.The government is to efficiency as Britney Spears is to gravitas. And thus when the government malinvests, i.e. borrows or spends unproductively, it does not help things. In fact it only makes matters worse.

And again, the need to spend productively also shows why funding costs actually DO matter. When funding costs reach unacceptable levels, huge amounts of government spending become unproductive, as new credit flows are ginned up to pay off increasingly onerous debt obligations.

When nervous investors shift their preferences as funding costs escalate, creating a self-perpetuating doom loop in the final stages, the “alchemist who never runs out of gold” can still find himself in quite a jam.

Ignoring the Lessons of History

A final irksome point of MMT: In their zeal to embrace a mere technicality (the ability of modern government to pay with a printing press), the lessons of history are forgotten and discarded. Lessons such as these:

  • Over time, every empire has hit a “sell by” date.
  • Boom and bust is in man’s nature… his psyche… his DNA.
  • It is human tendency to ignore problems until the last moment.

That last point is especially important. Through the millennia, we have seen countless collapses at all levels. Individual and family fortunes, business empires, and sovereign empires have all built up over time, then come crashing down with great regularity.

What’s more, the onset of such crisis often looks like a bridge collapse.

For a long time, small stresses and cracks build up in the bridge – but you don’t see them, unless you are looking hard for them.

So for those with a misplaced sense of confidence it is easy to say, “Oh, the bridge is fine. It’s been here for decades… it’ll always be here…”

Until one day the wrong truck drives over the bridge, or the wrong micro-stressor gets impacted – and the whole thing goes down in a flash.

Is this a prediction? No, but it is a call for genuine concern. If the American empire is like a bridge, then today we can see micro-stresses – cracks in the foundation – all around us.

The conditions under which America attained world reserve currency status are eroding at the margins. Players like China and Russia are taking small but meaningful steps to cut the $USD out of their trading patterns. Washington seems to have lapsed into the hands of a quasi-financial oligarchy, bent on preserving stimulative asset inflation policies at all costs (regardless of the damage to the real economy).

Against this backdrop, I believe, Modern Monetary Theorists come down on the wrong side of history. They ignore all the micro-stresses in a quaint belief that “self funding” is akin to immortality, neglecting the impact of shifting investor preferences as credibility and confidence ebb.

“Bah!” the MMTers say. “Deficits don’t matter – the U.S. government will ALWAYS be able to fund itself!”

This attitude is not helpful. Technical default may be an impossibility, yes. But de facto default, or a long slippery gradient to such as bad debts and malinvestments mount? That is certainly a possibility – one that MMTers claim not to see.

Final Recap

So now let’s wrap this up with a recap:

  • MMT says it’s important to understand the government is self-funding and can’t run out of money. We say “meh” – this is true but not that big a deal. It’s the functional equivalent of saying Uncle Sam owns a printing press with no “off” button.
  • MMT says (or strongly implies) deficits don’t matter because the Monopoly banker can’t go broke. Again we say “meh” – not the critical point. If the Monopoly banker (i.e. the Federal government) abuses his priveleges, investors can shift their preferences. They can walk away from the Monopoly board and go play “Clue” instead, moving their assets into fiat alternatives.
  • MMT verbally acknowledges that governments cannot “spend and spend” unproductively, but fails to pursue the implications of this truth. The overwhelming message of MMT (and especially of Mosler!) is that the United States government is “unconstrained” in all the ways that matter – a serious inconsistency.
  • MMT says there will always be a demand for currency because of taxes and payments and transactions. We rebut this by pointing out how easy it is to avoid holding a currency, even your own local one, by conducting all necessary business solely at the point of transaction. There is no reason a U.S. based business couldn’t hold its cash reserves in Swiss Francs or crude oil if need be, converting to dollars for payment purposes on a just-in-time basis. A U.S. employee paid in $USD can do the same thing, converting dollars to something else the moment they hit the account.
  • MMT implies that U.S. government self-funding equals financial immortality. We say no, the ability to avoid technical default does not translate to a free pass. Even a self-funding monetary system can experience severe decline if investors lose faith and shift their preferences at an escalating rate.
  • MMT suggests that governments are special economic entities worthy of their own 5th-dimension-like rules. We say no, governments are faced with implied collateral requirements and leverage credibility restraints just like anyone else. It is the wealth of the real economy that gives a government leverage, little different than the leverageble and accessible wealth within a household or a business.The ability to write blank checks against one’s own IOUs is great, but not a qualifier for special treatment above and beyond other economic entities.
  • MMT glosses over the importance of productivity and prudent investment — paying lip service to such, but then promoting contradictory assertions. Another MMT aphorism, “the gold alchemist can never run out of gold,” shows the deeply misguided psychology that MMT cultivates. The United States government is not an “alchemist.” It cannot conjure up gold. It can simply expand or contract credit flows to good or ill consequences, depending on the soundness of its choices… and a successive chain of ill choices can lead to disaster.
  • MMT does not fully account for the role that bad spending, unproductive debt build-up, and malinvestment surges have in fueling Austrian style boom-bust cycles, which have been around for centuries (or even millennia). The supernova model demonstrates these effects quite clearly.
  • MMT fails to acknowledge, let alone give proper weight to, the fact that THE REAL ECONOMY IS WHAT MATTERS. This negligence is shown by the wackiness of “Mosler’s law,” which assumes that all spending can be beneficial by decree, regardless of whether such spending translates productively to real economic benefit or no. The short-sightedness of MMT is also shown by the “Monopoly banker” and “alchemist can’t run out of gold” memes, which de-emphasize the importance of real economy impacts in favor of playing up a trivial point.
  • MMT ignores the lessons of history in its general smugness as to the U.S. financial position. Once again, lip service is paid – “yes we must be responsible” etc – but the main assertions of MMT sing a much more cavalier tune and are thus all wrong. We should not think of the United States government as an all-powerful entity that is financially immortal. We should perceive it for what it is – a facilitator of overextended empire, making a semi-alarming series of unproductive spending choices, with all the latent dangers that such a profile entails.

Forrest Gump: “And that’s all I have to say about that.”


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56 Responses to Weekender: The Trouble With Modern Monetary Theory (MMT)

  1. Mitch83 on December 19, 2010 at 3:15 pm

    I just read the first few breaks (short in time atm) and have to say:
    Reserves (Dollars spent into existence) can't "escape" in aggregate. If you buy Gold with Dollars, somebody else has to sell Gold and switch to Dollars. The same with other currencies. If you buy Euros with your Dollars, somebody else has to sell Euros and holds your Dollars now. Maybe Dollar goes down and Euro (Gold) goes up, but that's no problem. The Dollars still exist, you can't "escape them".
    This is closely related to the "cash on the sideline" myth.
    Ok, will try to read the full article later.

    • Jack Sparrow on December 19, 2010 at 2:25 pm

      Thanks for the comment. I don't disagree, but don't see how this dilutes the point.

      As an individual, I can certainly be shed of $USD in respect to savings, as can millions of other individuals.

      In "aggregate," if a large enough body of $USD holders wishes to sell, then yes someone else must wind up as a buyer somewhere — but the value of the $USD then falls until it hits the clearing threshold at which the other parties wish to buy.

      The fact that there is "no escape" does not counter the fact that an undesirable asset in high abundance can be marked down in value as sellers dominate…

  2. Mitch83 on December 19, 2010 at 3:27 pm

    To be clear: With "ecape" I mean that the public sector can't destroy or remove the Dollars (reserves) in aggregate.

    • Mitch83 on December 19, 2010 at 3:22 pm

      Arrgh, of course I mean the private sector, not the public sector.

      • Jack Sparrow on December 19, 2010 at 7:14 pm

        Though dollars can technically be "destroyed' by the private sector via the net reduction of loans in the system — a greater balance of loans being extinguished than recreated leads to a contraction in total credit flows, i.e. a reduced a supply of money as the compounding effects of the fractional reserve system get reversed.

        • Mitch83 on December 20, 2010 at 5:49 am

          That's true. But deposits created through loans are not cental bank money, but CLAIMS on central bank money.
          The private sector can't remove CENTRAL BANK MONEY = RESERVES (Dollars spent into existence). This can only be done by taxation / issuing of Tbonds (by the government) or by (P)OMOs / reverse repos (by the Fed).
          This means the private sector can't shift out of Dollars in aggregate. Perhaps the value of the Dollar declines if they TRY to. So what?

          Btw: Banks don't lend out reserves. We don't have a "fractional reserve system" but more of a "fractional capital system". Banks just lend and look for reserves later, if necessary. Some countries even don't have reserve requirements (Australia, Canada, Mexico, NZ, Sweden, UK). Of course banks still have to hold reserves for settlement etc.

          • Jack Sparrow on December 20, 2010 at 6:19 am

            The "central bank money" is a very small portion of the total compared to the credit flows created by the private sector. Like a jockey riding an elephant. This is why the Fed was at such a loss in 2008. When trillions of dollars worth of private sector credit flows are suddenly vaporized, it is not an easy thing to push a button and get them going again.

            An important point, one I believe that is generally overlooked, is that the free-functioning U.S. economic system has a valuation multiple attached to it that cannot be maintained by force. The government may be able to "do what it wants" to a large degree, but the government cannot create or maintain economic franchise value by dint of fiat or decree.

            This is why free markets and wise decisions are so important. Bad decisions tend to dilue the real wealth value of the economic franchise, and there is no magic dust to get that value back up other than acting logically and productively in the sustaining and enhancing of real productive output.

            • Mitch83 on December 20, 2010 at 7:03 am

              I'm with you. Don't get me wrong.

              What I want to say: The system is much more stable than most think.
              Of course it is built on confidence. But which confidence, on what level? If you look sharply, it is the confidence in the US as military power that e.g. can prevent foreigners to enforce redeemability of their Dollar reserves (in gold or land etc.) or protect the status of the FRNs as "legal tender".
              Of course there are limits, if the US government would spend 100 trillion Dollars tomorrow (remember government spending is the only operation that adds net financial assets to the private sector, the Fed can't) this would create immense geopolitical tension, inflation (fears), instability or actually even war.
              But if it is done reasonably, the government can help the distressed economy by offsetting the reduction in private (credit) demand by reducing taxes or increasing government spending (again, of course not by "building bridges to nowhere").

              • Jack Sparrow on December 20, 2010 at 7:08 am

                Yep, it sounds like we're on the same page. I agree that wise policy decisions can have a beneficial impact on the real economy (the thing that matters most). In challenging MMT, my main concern is with slippery slopes and gradient effects born of accidentally cavalier thinking — in order to maintain the health and stability of the system, we need to recognize that bad choices have consequences.

              • Mitch83 on December 20, 2010 at 7:36 am

                Yes, but the momentum is clearly on the austerity / deficit hysteria side. This is very dangerous. So I'm absolutely with MMTers even if they sometimes sound like there is no downside risk to anything spending related. Of course there is (and if you read carefully, they say so), but we are far away from such a point atm. Imo MMTers are absloutely correct about this.

              • Jack Sparrow on December 20, 2010 at 7:51 am

                Well, I would disagree with you there. Look at the tax cut deal that just went through, and look at how much operational room the Fed continues to get.

                Fiscal discipline is a political football. Politicians like to pay lip service to it, but then they go ahead and spend anyway. I think a lot of austerity talk has to be discounted as blow-dried pols trying to look good on the TV screen. Consumers do the same thing too — they voice the importance of fiscal prudence whenever an interview mic is shoved in their faces, then they whip out the credit card and go buy a big screen TV.

                Again, "Mosler's law" encapsulates what is so frustrating to me about MMT. It is one thing to point out that the asset side of the U.S. balance sheet is stronger than many assume. That is a true statement. It is another thing to promote the "no constraints" idea so aggressively.

                At the end of the day I think we have similar goals and are trying to reach the same destination — more a question of which route to take. But your point is a fair one that the debate would be better served by more education (re the technical aspects that MMT is correct on).

              • Mitch83 on December 20, 2010 at 8:40 am

                If you like it or not, "Mosler's Law" is (theoretically) true. But of course it has downside risks.
                One downside risk (geopolitical tensions) would be decreased dramatically if politicians around the world understood the current monetary system we live in / had a little foresight and implemented it on their own economies.
                The other downside risk (high inflation) is decreased heavily If fiscal stimulus / tax reduction is implemented correctly / reasonably.
                Imo it is especially far smaller than the downside risk of a deflationary death spiral like the one we experienced in the Great Depression.

                The Fed can't add net financial assets to the private sector. Therefore in this balance sheet recession QE2 (QEn) is not sufficient to offset debt deflation imo. There has to be additional fiscal stimulus (as Bernanke often mentions).

              • Jack Sparrow on December 20, 2010 at 11:42 am

                This has a notable similarity to the tenets of Keynesianism. There is a difference between the theory of Keynesianism as it is designed to be applied — by wise and responsible politicans — and as it is actually applied — by the political types who exist in the real world. To a certain degree the merits of a ruleset or policy proscription have to be weighted by how realistically and effectively they apply in harsh real world conditions. If a system of great technical merit requires an unrealistic helping of self-discipline to implement, it might be inferior to a cruder yet more pragmatically robust system in terms of actual results.

              • Mitch83 on December 20, 2010 at 1:03 pm

                Ok, no offense meant, but I think you didn't know how modern monetary systems REALLY operate just a few short months (weeks, days) ago. Neither did I.
                My estimation is over 99% of policy makers around the world also don't know (this is the no.1 irresponsibility). So it is very important they understand in order to implement responsible policies.
                Before the crisis it wasn't of much importance, but now it is.
                We have the tools to fight the recession, so let's use them!

              • Jack Sparrow on December 20, 2010 at 1:14 pm

                No worries, no offense taken. The central ideas of MMT were not new to me — I mentally walked through the idea that the government could fund itself without taxation many years ago for example. The impossibility of a technical default has also long been apparent.

                But I will happily admit my general familiarity with these ideas may be uniquely due to my global macro background, that the concepts are not at all widespread, and that I had never gathered together the self-funding conclusions as aggressively and succinctly as MMT has.

                Part of the reason the debate is interesting, I think, is precisely because of where it takes the policy discussion – that is to say, where the implications of the "operational realities" lead.

                That is one reason I instinctively come down on the "restraint" side of the equation, because my feeling is that in spite of their tough fiscal talk, the majority of politicians are still inclined to do too much, not too little, and the Keynesian mindset has plenty of weight behind it as it is. I also remain unconvinced that the path from theoretical soundness to positive real results is a straightforward one. Government is very good at screwing things up and making a hash of best intentions.

                But this kind of thing is exactly why discussion is good and useful — if the answers were cut and dry there would be little to talk about…

              • Mitch83 on December 20, 2010 at 7:13 am

                So I think the worst thing to do now is to go the way of austerity just because most people/politcians/economists don't understand the monetary system and think the US can go broke on its deficit or believe in other myths.

              • Jack Sparrow on December 20, 2010 at 7:28 am

                And you may in fact be right about that. Austerity sure ain't working for Europe!

                The place we want to get to, in my opinion, is one where three things are recognized:

                1) All monetary policy decisions have potentially serious consequences
                2) It's important to make wise, prudent decisions
                3) The wise course is neither obvious nor easy to determine from here.

                I'm not sure where we go from this point. I do strongly feel that the polar extremes are both wrong — the Andrew Mellon style liquidationists on one hand, Paul Krugman hyper-Keynesians on the other. (With "Mosler's law" putting him in the Krugman camp…)

                Extreme austerity and extreme profligacy are just different roads to hell. Both sides make the mistake of playing down what's at stake if their course of action fails.

              • Mitch83 on December 20, 2010 at 9:28 am

                You see, I'm from Germany, my (grand)grandparents lived through WW1, Weimar hyperinflation, WW2, currency reform of 1948 and this fear of inflation / deprivation is deeply anchored in the German thinking. The older people still tell stories about these traumata.
                You can hardly expect rational thinking from the Germans regarding this matter, objective arguments (the ones I seek) are hard to put about. Germany dominates the Eurozone, so until there is a "United States of Europe" with central EU treasury and true monetary souvereignity (I hope it will come as soon as possible), transforming Germany to a state like California in the US, there will be strong austerity forces.
                It is ridiculous, but true. Although I'm German I have to acknowledge our politicians/economists understand NOTHING about the monetary system and I would rather sooner than later see them give away monetary power.
                Don't count on the Europeans in the short term. They would enforce another Great Depression if they were the only ones in the world.
                My hopes are on the rest of the world, especially the US, to avoid such terrible outcomes.
                So imo we are far closer to the "extreme austerity" scenario than the "extreme profligacy" scenario.

              • Jack Sparrow on December 20, 2010 at 9:37 am

                My take on the Germany situation is similar in respect to lip service — Germany and by extension the ECB would much prefer to maintain a Bundesbank mentality, but ultimately they will not follow that road to its conclusion. The potential pain of a eurozone breakup is too great to contemplate, whether it be a periphery country or Germany itself leaving… net result, in the end, being some sort of monetization option (eurobonds etc.)

                Politicians like to talk a tough austerity game, but when the deflation monster puts hot breath on their neck they cave in. Just ask Trichet…

  3. Mike C on December 19, 2010 at 8:29 pm

    Phenonemal article. Just absolutely phenonemal. I first encountered MMT some months ago, and I understood that some of their technical points seemed correct, yet intuitively knew something was off. Your note here did a great job of explaining exactly what if off (the connection between total flows and the productive economy).

    Interestingly, by coincidence I happened to start reading the book When Money Dies this weekend, which chronicles the German hyperinflation, and the effect it had on society. Hopefully, the U.S. never ever gets close to that point, but I wonder what happens when the Social Security and Medicare entitlements really ramp up the next 10 years. How will the government/society respond? After all, the MMT is right that the government simply can print up the nominal dollars needed to pay those "promises".

    What you write in this piece dovetails nicely with a Hussman piece that the key ingredient of inflation is unproductive government spending:

    To the extent that real goods and services are being appropriated by government in return for an increasing supply of paper receipts, whatever the form, aggressive government spending results in a relative scarcity of goods and services outside of government control, and a relative abundance of government liabilities. The marginal utility of goods and services tends to rise, the marginal utility of government liabilities of all types tends to fall, and you get inflation.

    This is important, because it means that the primary determinant of inflation is not monetary policy but fiscal policy .

    Seems like we are headed down a road where unproductive government spending is really going to ramp up. At the same time, private credit creation is imploding so you have massive deflationary forces offsetting that.

    On a different note, this blog is going to the top of my reading list. I'm someone who considers macro, fundamentals, chart analysis, and sentiment for investing/trading decisions. For some reason I can't understand very few people seem to want to use all tools and want to use just one. I like how you integrate them all.

    Lastly, thanks for making me some money last week. Saw the NFLX post, did my own chart analysis, agreed and sold the 185 calls for December expiration last Monday. Nice one week gain. I'm looking to sell the Jan 185 calls. Looks like 185 is resistance in the short-term. Would be interested to see updated thoughts on NFLX.

    Keep up the awesome work!

    • Jack Sparrow on December 19, 2010 at 7:36 pm

      That reminds, I actually owe a large hat tip to John Hussman… been reading him for years, love his stuff, and he has definitely had an influence on the thinking in this piece.

      Thanks for the kind words!

  4. Mike C on December 19, 2010 at 8:38 pm

    Heck, let’s take this further. Thanks to the modern miracle of ETFs, you could keep 99% of your net worth in copper, crude oil and cotton if you really wanted to. Whenever you needed $USD for a transaction of some kind, you could convert instantly – “point of sale” – and hold no dollars otherwise.

    The argument that “there will always be demand” for a currency because of tax, payment and transaction requirements thus seems dubious at best. There is nothing (at least for now) to prevent even U.S.-based investors from

    1) shifting their preferences away from $USD liabilities, and

    2) minimizing their exposure to $USD to as small a footprint as possible (and hedging even that!).

    Let us also note that the “constant demand for the currency” argument in part stems from U.S. hegemony and the use of the $USD as the world’s reserve currency.

    This seems key. What about political risk? What about the potential for the government to put some type of onerous restrictions on holding alternative assets/currencies for the "store of value" function? Making hard asset ETFs illegal, no holding of foreign currencies. In other words, they would force all holdings to be in U.S currency or bonds. I think it was some South American country that basically confiscated retirement accounts and forced holding 100% government bonds.

    One of the interesting things I read about in the book I mentioned is that some of the German people understood what was happening and raced to convert currency into anything else, land, art, pianos, you name it and it was bought with the rapidly depreciating currency. It seems to me on one level the key would be to keep the process slow enough, insidious enough, so 99.9% of the populace has no idea what is going on.

    Perhaps I'm being paranoid, but I suspect this decade 2010-2020 is going to have some difficult choices that need to be made. I'm not confident government will make the tough but right choices that involve collective self-sacrifice. I'd rather be a wolf then a lamb.

    • Jack Sparrow on December 19, 2010 at 7:56 pm

      Yep, what's that saying: "Just because you're paranoid doesn't mean they're not after you…"

      Currency controls and other clampdown measures are a frightening prospect — though one line of defense against such is that their implementation might stoke the flames of fear to an even greater degree. Kind of like the policy equivalent of the President on all TV stations: "Please be calm, there's no reason for alarm…"

      I don't see a currency control / investment lockdown scenario for the U.S. in the next few years (knock on wood), though at the far end of the bad scenario bell curve it probably can't be ruled out…

    • Jack Sparrow on December 20, 2010 at 5:07 am

      More on capital and price controls — the more I think about them the less I consider them even a halfway viable solution. At this point they would essentially be an admission that the most prosperous country on earth has failed.

      The below contains some of my points in a message board debate with someone who argues MMT's ultimate strength is the government's ability to implement capital and price controls (in the name of maintaining a "free and prosperous democracy"):

      I think what you are describing sounds like the kind of talk coming out of Maoist China or the GDR prior to the fall of the Berlin Wall. Have you ever studied socialist / communist propaganda? It's full of lofty, noble sentiments about how the system is designed to free man rather than enslave him, how it represents the purest and fairest of ideals, blah blah blah.

      If MMT's main plank is the notion that a government can temporarily suspend free markets to save itself, then it is an even more frightening doctrine than I thought. The type of thinking as you just described could be used as justification to eventually throw dissenters in prison for challenging the "free and prosperous democracy."

      And not only that, but it is crazy to assume that the United States could simply "decide" to implement new capital and price controls at this time. Political decisions have roadblocks (some formidable), all decisions have consequences, and such a series of maneuvers are less likely than a man coming home to his conservative wife and saying "honey, let's have a threesome." Just think about some of the obvious problems:

      — U.S. based assets have a "freedom premium" built into their valuations (i.e. part of their value comes from the openness and stability of at least quasi free markets, free flow of capital and an open political system). Trash that and you give these assets a major markdown

      — To implement capital and price controls in the most prosperous country in the world would be a potential admission of economic policy failure so great as to possibly incite global panic

      — Political opposition would be huge and ferocious, including from yours truly: You want to saunter in and tell me at gunpoint that I can no longer invest in foreign currencies or foreign markets? F*CK YOU

      — The status of the $USD as a world reserve currency would go straight into the toilet (A world reserve currency that is subject to flow restrictions and price controls at home? WTF?)

      — America's trade relationships all over the world would be jeopardized to the point of potential catastrophe

      — There is no guarantee such measures would work in the first place, and might even instigate a new round of economic collapse

      — Look at the riots that went down (and are still taking place) in Iceland and Greece and Ireland. Newsflash: Americans are more belligerent than Europeans and many of them still like guns… there are limits to what a government can do to a free people.

      Those are just a few very quick points off the top of my head. Again, to the degree you defend MMT simply on the basis of a government being able to use fascist-style force to bleed its citizens dry without limit, your ace in the hole is actually a very weak deuce of clubs.

    • Jack Sparrow on December 20, 2010 at 5:54 am

      p.s. More from yours truly in the same message board debate:

      To quickly add a further point — I do find it irksome to hear it said that "a dollar isn't worth anything except what we think it is."

      The belief is widely circulated that fiat currencies have no intrinsic value, that they are faith and faith alone. I don't think this is accurate.

      To the extent that a government has access to a nation's productive output — the ability to tax it and harness it WITHIN REASON — the currency issued by that government represents a claim on the same pool of assets.

      By this analogy we can think of fiat currency like shares of stock. $US dollars are shares in America Inc…. Japanese yen are shares in Japan inc., and so on.

      The "currency as a share of stock" analogy captures the notion that a nation's currency is a representation of that country's economic output and productive strength, just as a share of Microsoft stock is the same for Microsoft.

      But then think about something else. What would happen if Microsoft decided to issue 100 billion extra shares overnight? Or what would happen if Microsoft made a series of internal decisions that wound up killing the business franchise?

      Even though a currency unit is like a representational share of a nation's output (to the degree the government has the power to tax), currency units can also be debased and degraded in the same way that over-issuance of shares can dilute value. And the other key point is that IT ALL GOES BACK TO THE REAL VALUE OF THE UNDERLYING ASSETS.

      That for me is what's so frustrating about MMT. They pretend governments have some magic ability that comes from the ether, some free pass that allows them to bypass rational application of the laws of supply and demand. They do not. To the extent a government is economically powerful, it is like the board of a corporation with the ability to issue shares of stock in that corporation.

      But the government cannot do whatever it wants and assume the value will always be there. The idea that the U.S. could simply issue capital and price controls in a pinch, for example, overlooks the fact that such a decision might actually completely trash the value of the underlying assets. If Microsoft's board starts thinking "we are invincible and can do what we want," they will be inclined to start making bad decisions that destroy the perceived value of the underlying assets on the whole.

      There is no magic, no free lunch, and no mystery as to where value comes from. A unit of currency has value to the degree that it is a representational share of the economic output of the host country. But also like company shares, over-issuance can dilute this value and the board (i.e. the government) can make bad decisions that destroy the underlying value of the franchise.

      This is all very basic, straightforward stuff and we don't need a theory like MMT — which imputes a sort of magical immunity to governments that does not exist — in order to explain it all.

      • mmtdebtkiller on August 6, 2014 at 4:03 am

        I think MMTers tend to assume that our economy is generally functioning OK. I don’t see them encouraging governments to fund any and all things uncritically. Do we always elect idiots to run our governments? Not for long. Remember MMT focuses on the realities of a specific banking system, while trying to relate that to a general theory of sovereign fiat money systems. Hyperinflation usually results when a nation’s debts are in a currency other than its own, and it is trying to create new money and then exchange it for the foreign currency before the rates are adjusted not in its favor and use that to pay its debt. For the most part MMTers do not say that it would be desirable to have a sovereign fiat money system, when our system already is a specie of that. What they focus on pointing out is that the public seems totally ignorant of how our monetary system is already a fiat money system, and that many policies advocated do not take advantage of the powers of that kind of system, which we already have. We don’t necessarily need new legislation to accomplish what we want. The legal basis already supports a fiat money system. We just need to use it according to what it can do. For example, the national debt doom-sayers just do not realize that the debt is already being managed by Treasury rolling over the securities to the banks with swaps of new securities for mature ones. It has been doing this almost since the beginning of the nation and in principle can do this perpetually. But it isn’t always the only way to manage debt. Or the Fed is actually redeeming the government’s debt for deficit spending when it buys securities from banks and investors used to cover that spending. The Fed buys with money it creates out of thin air. The Fed owes no one for this money. It is what must be done in a sovereign fiat monetary system. The Fed is a government agency independent within the government. It attempts to keep Treasury at arms length by being prohibited from buying securities directly from the Treasury or of lending money directly to the Treasury. That the Treasury has to borrow money means banks and investors can be intermediaries between the Fed and the Treasury, and the Fed can buy from these banks and investors the securities used to fund by borrowing the Treasury’s deficit spending needs. That fulfills the need to show that our system is compatible with a general and simplified ideal fiat money system. Once the Fed buys the securities from banks, etc. used to fund deficit spending, that redeems the government’s debt to these banks and investors. That makes the deficit spending money debt-free, as if it had been created and spent directly by the Treasury and is new money. The latter follows from the fungibility of money. Although the Fed is seen to be creating new money and injecting it into the reserves of banks or hands of private investors to cancel loans to the Treasury. That can also be seen as simply restoring the banks and private lender’s reserves and accounts to their original condition. Since the deficit money spent by Treasury equals the money used to buy the securities and is now debt free, it is fungibly equivalent to it, and so deficit money can be regarded as if it is the new money injected into the economy, raising the levels of money circulating in the economy.

  5. Mike C on December 20, 2010 at 12:00 am

    Not sure if you've seen this note. Hits on some of the macro themes you've discussed:

    • Jack Sparrow on December 20, 2010 at 5:04 am

      Hadn't seen that, but I definitely like Howard Marks. Thanks!

  6. Scott Fullwiler on December 20, 2010 at 8:53 am

    Allow me to add a few things to Warren's fine comment, since, as he says, you haven't really offered a critique as much as setting up a straw man and knocking it down. No MMT'er will actually take this critique very seriously, at least.

    Regarding the first two points of your "summing up," good for you that you understand. I would agree with you that it's a "meh" if our policymakers actually understood as much as you do on this. Obama thinks we can run out of money.

    Regarding holding non-$US and converting as needed, that in no way contradicts MMT. We've written about this many times. The size of the demand for "cash" is irrelevant. The point is, there will always be a "non-trivial" demand as long as tax liabilities can be enforced (of course, that's an "if" that relies on some of the points both you and we have made above). Same goes for the "special rules" for the govt–as long as it is the issuer of the currency necessary to settle a tax liability, and the tax liabilities are enforeceable, it's "special." If not (and there are many reasons why it might not be, as again you and we have noted above), then not special.

    Regarding the "boom-bust cycle," apparently you haven't seen the volumes of research we've done on cyclical and secular financial fragility/instability, a la Minsky. Or the research of Bill Black. Or the fact that Rob Parenteau, an MMT'er, writes the Richebacher Letter, which at its core takes an Austrian view of the boom-bust cycle, again blended with Minsky.

    As Warren pointed out, ALL WE EVER SAY is that it is the REAL ECONOMY that matters. The operational ability to create full employment is given. The REAL ability to do so is not. If you haven't seen us say this, you haven't been paying attention at all.

    Again, Warren addressed the others, which are generally misinterpretations of MMT or overlooking things MMT'ers have already said in general agreement with your points.

    We invite you to keep reading and discussing, given that MMT must have struck a chord with you if you would spend the time writing something of this length for or against.

    • Jack Sparrow on December 20, 2010 at 9:19 am

      I look forward to continual discussion — the debate is most interesting…

      Re, "No MMTer taking the critique seriously" — I would amend that to no high level MMTer with a sufficient quantity of nuance and subtlety such as yourself, since my critique was largely fashioned under the influence of, and in direct response to, vocal MMTers in the financial blogosphere who have repeatedly and aggressively underscored their (incorrect) belief that the government can operate without policy constraints. Whether or not these individuals are false ambassadors of MMT, they should be taken seriously as emissaries of the conceptual idea imho. I imagine we would agree the important thing is a higher level of general understanding in all areas, from the MMT perspective to the Austrian one.

  7. Scott Fullwiler on December 20, 2010 at 9:23 am

    When are you going to approve the comment I made at Weekender? Or respond to Mosler. Are you trying to avoid discussion on this with real MMT'ers? Could be, given that the vast majority of what you've written here is just a straw man.

    • Jack Sparrow on December 20, 2010 at 8:39 am

      Not sure what you're talking about — comments are not held for moderation unless the filter marks them as spam. This is the first of yours I've seen.

      • Scott Fullwiler on December 20, 2010 at 8:42 am

        OK. Thanks. Sorry for the tone. It just appeared.

  8. Scott Fullwiler on December 20, 2010 at 9:38 am

    From Warren Mosler

    Glad to see you consider MMT important enough to be addressed 'head on' thanks!

    First, MMT/Mosler Economics is about the operational realities and not policy recommendations per se. So it can't be 'fatally flawed' in the sense you are writing about.

    Second, and along the same lines, we emphasize that the risks of excess spending are inflation rather than insolvency.

    Third, Wikipedia is not a reliable source. In fact, it's currently quite the opposite with regards to MMT.

    Regarding your further comments. I fully agree govt can and does get abusive, can and does cause inflation, and can implement policy that's destructive to our well being as citizens.

    So we agree those are the risks, not insolvency or social security running out of money, etc.

    And I completely agree on and focus on what I call shifting 'savings desires' with regards to the level of the currency, inflation, etc. Just read my blogs over the last several months with regard to portfolio preferences shifting between currencies, commodities, etc. In fact, I was perhaps the first to write about the significance of our pension funds allocating to passive commodity strategies, etc.

    I also more than agree with the fact that taxes need to be coercive to function as they do. Again, it's central to my discussions. The 'collateral' govts have is their taxing authority. Take that away and the value of their currency goes to 0. And I carry no assumption of national immortality.

    Lastly, reads like you haven't read my '7 Deadly Innocent Frauds' book at http://www.moslereconomics.com

    • Jack Sparrow on December 20, 2010 at 9:10 am

      Thanks for stopping by and encouraging a stimulating discussion.

      I agree with the operational realities of MMT within the context of real economic constraints. My problem comes in the policy-influencing assumptions born out of the technical assertions of the theory.

      I now realize that the assumptions that irk me may not in fact be your direct assumptions. But they apply to a great many followers of MMT, and those outsiders investigating MMT with an inquiring mind (such as yours truly and others I know) have come across these aggressive assumptions repeatedly.

      I also find it hard to separate operational realities from policy recommendations in the real world, because the worldview facilitated by one naturally shapes opinions of the other.

      It's definitely a "shades of gray" thing here too, because not only can dangerous assumptions flow from correct technical assertions, true statements can be interpreted in a way that is more false than true by many who hear them.

      Take the flat statement "the government cannot run out of money," for example. While I again agree with this statement technically, I think the nature of the statement is so ambiguous as to allow many indiviudals with less nuance to interpret it the wrong way, e.g. as an invitation to believe the government can operate with no policy constraints. Again, if this were only a theoretical concern it would not have been a large enough point to warrant a rebuttal. But many MMTers have reiterated it to me…

      p.s. You are right, I haven't yet read the 7 Frauds book. I owe you that and will give it a read…

  9. Johnny Depp on December 20, 2010 at 11:54 am

    Why Jack Sparrow and not Willy Wonka? I've always preferred Willy myself. Pirates are so dirty. Ewwwww.

  10. Johnny Depp on December 20, 2010 at 12:22 pm

    Well played.

  11. charliebrown on December 20, 2010 at 2:17 pm

    Per Cullen the one flaw of the roman empire was the use of a gold backed currency which is by definition constrained. If romans had the roman fiat dollar they would still be ruling the empire. Because anytime you offer the us is a drunken fool in spending cullen says the us has $15T in productive capacity. Well in their time I am sure the roman empire had the most productive capacity and hence without a constrained fiat could always fall back on their economy as backstop to run multiple wars , have a corrupt political class, and just extend themselves in far too many ways. Just like the US today.

    • Jack Sparrow on December 20, 2010 at 12:55 pm

      I think blaming the fall of Rome entirely on the gold standard is a bit rich.

      Also, in saying Romans would "still be ruling the empire" if they had a fiat dollar — thanks for underscoring my point on the implicit belief in financial immortality…

  12. Jack Sparrow on December 22, 2010 at 3:21 am

    Another telling exchange (via the Seeking Alpha repost of the piece):

    Asbytec (the commenter) struck me as fair, reasonable, logical and informed over the course of our entire MMT discussion on the SA thread. He patiently explained how, even though he didn't like it at first, the "operational realities" convinced him that MMT was true.

    So I'm thinking okay, fair enough… and again the "technical" aspects are not what was disputed, but the wacky assumptions… and then the guy goes and says this!

    "The days when consumers and entrepreneurs created the wealth of nations are long past. Today, the government does. Sad, but true."


    Those kinds of responses — from seemingly logical people!!! — are exactly why my strong instincts are to be very wary of MMT, again even though the "operational realities" are technically true… this and the "Roman Empire" comment show EXACTLY how MMT can be like a bad acid trip.

    • Investor on December 22, 2010 at 11:22 am

      I agree.

      Here is a list of strange statements from TPC, which I am afraid are the result of too much contact with MMT:

      – The Fed should exist only to provide lender of last restor lending at the natural IR of zero
      – EUR is bad, because it is like a gold standard for the poor Greeks (cannot print money)
      – Fiat currency is better than gold standard, as the latter is too inflexible for intl. trade
      – The Japanese avoided a dpression, so their fiscal policy worked miracles
      – Huge wealth creation in the USA in the last X years proves that there is no problem with the fiat system

      I do not know where to start. Not that I fully disagree on all points, but the self-certainty (and alleged self-evidence) of statements like these makes me shiver

  13. Schofield on January 3, 2011 at 10:35 am

    A preference for getting out of US liabilities (playing another game) can be the result of other factors than a supposed MMT lack of fiscal responsibility. It could, for example, be the awareness that a Disney-World arbitrage process exists in the USA whereby, for example, wages are held down, taxes are too easily evaded, too many goods and services out-sourced and environmental sustainability ignored all leading to dismal prospects for the economy. So whilst your argument might not be exactly a "straw-man" argument it is a far too narrow "can't see the wood for the trees" argument.

    • Jack Sparrow on January 3, 2011 at 10:42 am

      Given the length, it felt comprehensive enough without rabbit trailing into environmental sustainability issues.

  14. Schofield on January 3, 2011 at 11:29 am

    Dysfunctional arbitrage isn't just about environmental sustainability it's about the whole bag of issues that prevent a stable economy serving a common good. Shifting from playing "Monopoly" to "Clue" because a majority are ignorant of how the monetary system works may well result in a further contribution to dysfunctional arbitrage.

  15. KGP on January 29, 2011 at 4:30 pm

    Cullen Roche of The Pragmatic Capitalist responds:

    • Jack Sparrow on January 29, 2011 at 9:01 pm

      Thanks — I saw that response quite some time ago when it was initially created as a post.

      There was extensive discussion on the Seeking Alpha thread for this article — 244 comments pro and con MMT, with many entries from yours truly. The debate has been extensively (perhaps exhaustively) aired out there and I don't much feel the need to revisit it.

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  17. joe462 on November 7, 2012 at 6:08 pm

    I’m new to MMT, but it doesn’t sound very crazy to me. You point out that they recognize that the government can not spend with reckless abandon, but you say that is just lip service. My understanding though is that they advocate using market indicators, like inflation/deflation and such to dictate how much spending they can get away with and ignore debt itself as a sign to curb spending. Isn’t that better than putting undo significance on the national debt?

  18. Jim Nazyum on December 20, 2012 at 6:19 pm

    All you really need to know about this mmt is that we didn’t start hearing about it until the democrats got in power. They needed the intellectual firepower to borrow and spend. And so it was provided.

    I know many of the people spouting it were screaming about republican deficits before, and i’d be willing to bet that the chief developers of the theory were doing the same.

    If a cockamamy theory is needed to justify ridiculous policy, you can be assured that the universities are overflowing with people who will give the progressives what they want.

    • mmtdebtkiller on August 6, 2014 at 3:19 am

      MMTers for the past 6 years have emphasized the need for deficit spending as the proper response to a deep recession. Money has gone out of circulation, banks gambling with money with derivatives, collaterlized debt obligations, deficit default swaps, exhaust their reserves when bad debts come due, and bank customers also reach the end of the Ponzi scheme in housing as mortgage debtors discover that prices are beyond most buyers ability to pay and they cannot flip their houses and hold a massive mortgage debt their incomes cannot sustain. So, the economy is running with not enough money in circulation to play a full-fledged game. The sovereign needs to inject more new money into circulation by spending newly created money on something useful. In our system Congress needs to start the ball rolling by large deficit spending on infrastructure and other generally useful items.
      But if we shift into a rising inflation, MMTers will be calling for raising taxes, cutting govt spending, encouraging buying imports, encouraging savings (non-consumption with income), urging the Fed to raise interest rates and start selling Treasury securities to banks to drain their reserves of excess money to constrain lending.

      So, MMT is not necessarily politically liberal or motivated by nurturant tendencies. But it recognizes that deficit spending leads to money creation, and this is needed during recessions and depressions, if the general welfare is to be sustained.

  19. ThomasW on December 9, 2013 at 10:15 pm

    Thank you for an excellent review of MMT and its problems. I’ve been following MMT and reading much of their material for close to three years and you’ve hit the major issues.

    The scary thing is that MMT and related concepts (e.g. the US government cannot go bankrupt) have been hitting mainstream media more and more. If this continues we’ll learn the hard way whether MMT is right or wrong.

    I’ve also notice, especially in the last few months, that MMT advocates (at the blog New Economic Perspectives) have moderated some of their tone, though not a lot.

    One MMT assertion you missed is that inflation cannot occur from large deficits unless the economy is at full employment. I’ve heard all sorts of reasons for inflation (e.g. oil price rises in the 1970s, etc) but a general denial that too much money will raise prices unless the economy is overheating, which to MMT means full employment. I haven’t seen an explanation of the inflation of the early 1970s (before oil prices rose, when Nixon applied wage and price controls).

    The other concept entwined with MMT is the “job guarantee” (JG) or “employer of last resort” (ELR). In this the government will give anybody willing to work a job at some fixed wage (generally well above minimum wage, influenced by “living wage” concepts). The program is viewed by glasses of a deep rose color.

    Thanks again for a strong, well written critique.

  20. John on April 3, 2014 at 8:55 pm

    As someone who thoroughly enjoys reading your trading articles, I am extremely disappointed in this post and you may have lost relevance with me after reading this. Scott said it accurately, this is not a critique that will be taken at all serious among MMT’ers or economists in general trying to understand MMT. You have greatly misinterpreted what MMT is and given your critique, it seems as though you have done minimal due diligence on the subject matter. It may seem a bit harsh and I really do enjoy your other posts, but I lose respect for those who criticize or form an opinion without thoroughly understanding the topic they are writing about. I would love to write more about what you have gotten so wrong, but it would be much more effective if you read the work done by the pioneers of MMT(Mosler, Wray, Kelton, Fulwiler, Forstater etc.). If you still disagree after you’ve done this, then please write another critique that more accurately describes this school of thought. Then it will be taken seriously. Until then, this post extremely undermines your ability to write on the topic and is a great injustice to those trying to understand economics and form their own opinions of MMT.

    Again, I enjoy your work and this post should be taken in isolation. Please do your due diligence and then if you still disagree, write a post explaining why instead of presenting a straw man. Then knowledgeable MMT’ers would be happy to engage in a constructive discussion.

    • Jack Sparrow on April 4, 2014 at 1:09 pm

      Though this post was written years ago, and much in respect to the debate has changed, the broad sweep of criticism is still accurate. If anything MMTers believe even wackier and more dangerous things than was noted here (e.g. the jobs guarantee), part of why Cullen Roche has left them entirely. I don’t have the time or inclination to revisit this subject any time soon — if you judge our body of work based on how well we do or don’t comply with an ideological framework, there may not be a lot of common ground. With that said, we really don’t focus much on monetary policy at all, that’s a very small fraction of what we’re about. Cheers and here’s hoping you are happier with our work in future if you choose to stick around.

  21. mmtdebtkiller on August 4, 2014 at 3:58 am

    Just my first impressions. It seems you have not abandoned the camp of monetary theorists; you have
    just extended its application with greater emphasis on the private sector. MMT can be modified as any theory can by adding other features and aspects to it. But the key idea of MMT is ‘monetary aggregates’ of possibly non-homogeneous individuals’ behavior.
    But your remarks on transforming at the point of sale your assets into one monetary unit to another, seems to ignore as Mich pointed out the dollars were not extinguished in the sale but someone else possessed them. I find theories and theorists frequently lose account of that which fades into the background, and new theories are always trying to bring into focus overlooked aspects of the phenomenon. You have attempted to to that with your essay, and I commend you for it.

  22. mmtdebtkiller on August 6, 2014 at 2:55 am

    Sparrow said: “In a world where the government cannot “spend and spend” willy nilly, funding costs certainly ARE relevant because the printing of currency to service high interest rate debt issues is most assuredly an UNPRODUCTIVE use of funds!”
    To what extent is Sparrow taking costs of ‘printing money’ literally? Actually printed paper money is a very, minuscule portion of the dollars exchanged. Most dollars today are represented electronically by digits in spread sheets, and transferred electronically. The cost of those representations of dollars are much less than the printed kind. The Fed, for example could buy Treasury bonds from banks sold to them to raise money for the interest on the national debt. The Fed, in the act of buying would create the dollars out of thin air added to bank reserves. That would redeem the government’s debt to the banks for the interest dollars. (The same thing goes for dollars raised with Treasuries for deficit spending). Or Congress could revamp the banking system by allowing the Treasury to create any needed money to spend, out of thin air.
    Lincoln did this to win the Civil War. The requirement passed in 1917 that the Treasury had to borrow money instead of simply create it is what gave the banks a perpetual cash cow in interest payments. That’s not a very productive use of dollars, other than it creates extra money that can go into the economy making it possible for enough money to be in circulation to cover the borrowers’ principal plus interest debt. But deficit spending by a Treasury empowered with money creating powers would accomplish the same thing.
    Here I note as most MMT theorists do, the private banks also create money as does the Fed. But the private banks create debt when they create money. The Fed creates debt-free money when it buys and spends. (Debt here is in the sense of money used to represent specific debts between parties. The government’s obligations to exchange dollars for dollars, to recognize taxes and fees as erasing a citizen’s obligations to the government is a different kind of debt, an obligation of all sovereign-created money, whether or not it is fiat money or commodity-based).

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