Printing Over Problems
In the United States, central banks and governments play a key role in the health of the nation. These institutions have been working in conjunction for many years to determine monetary and fiscal policy in an attempt to grow economies and mitigate inflation and unemployment. However, after the gold standard was abandoned in 1933, and the US moved to a floating currency, everything changed. Under the gold standard, the currency had to be tied to physical gold where it could be exchanged but now, countries like the US have a floating currency where the value of the dollar “floats” with its demand in the global currency markets. This has given banks and governments a lot more freedom with interest rates and policy and has made way for the longest-running bull market in history. However, this has allowed those entities to manipulate markets and push large underlying problems further down the road by embracing new macroeconomic theories, such as modern monetary theory. Unfortunately, since these new theories have never been battle-tested over a long period of time, the economic condition of countries that have embraced these new theories has yet to be fully seen.
What is Modern Monetary Theory?
In simple terms, modern monetary theory or MMT is when governments do not rely on taxes or borrowing for spending, instead, they print as much as they need and are the monopoly issuers of the currency (D'Souza, 2022). This practice is not uncommon and countries such as the U.S., U.K., Japan, and Canada all employ certain aspects of it. Although there are many benefits to the theory such as funding for public programs and the ability to spend more on policy, the theory has downsides that present many risks to even the strongest of economies.
Issues with the Theory:
There is no doubt that MMT has its fair share of criticism, and rightfully so, Nobel Prize-winning economist Paul Krugman warned that the U.S. would see hyperinflation if it was put into practice and that investors would refuse to buy U.S. bonds. Furthermore, the idea that taxes can reduce inflation has been met with much skepticism. Michael R. Strain, a resident scholar at the American Enterprise Institute said that “Raising taxes would only make a downturn worse, increasing unemployment and further slowing the economy.” To prove this point, the Phillips curve which is one of the factors MMT relies on isn’t as perfect as one would like to believe. The Phillips curve argues there is a tradeoff between inflation and unemployment (more of one will lead to less of the other) (Horan, 2020). However, stagflation in the 1970s proved that these things do not have to be mutually exclusive. Another flaw in the theory that poses a significant risk to the current economic standing of the U.S. is that there are not enough safeguards against the risk of excessive public debt and If the US continues to accumulate massive amounts of debt, there is no guarantee we will always be able to easily pay it off (Horan, 2020).
Concerns within the United States:
Although the U.S. is not currently facing the threat of hyperinflation, there is significant inflation and in fact, inflation has just returned to highs at 8.2%, the highest in 40 years. This is happening at a time when excessive borrowing is taking place along with rising interest rates. Very recently, the Biden administration approved 4.8 trillion in additional borrowing at a time when our national debt just exceeded over 31 trillion (Committee for a Responsible Federal Budget, 2022). Even worse, the reconstruction costs from the war in Ukraine will likely keep adding up for the U.S. as it seems unlikely the government will halt spending so the financial balance will have to be achieved in some other way (Bove, 2022). This has all created what Ray Dalio is calling the “perfect storm of economic pain” (Bove, 2022). When looking at the country’s total debt as a percentage of GDP things become even more concerning as it currently sits at approximately 140% (U.S. National Debt Clock, 2022). This is cause for concern as the U.S. could potentially get into a very dangerous cycle of borrowing increasingly more to pay off current debt obligations as interest rates continue to rise, forcing more borrowing and so on.
Possible Repercussions:
One thing that needs to be made clear is that true MMT has never really been tried and tested in the long term. Certain aspects of it have been applied to policy but it was throughout the pandemic is when MMT began to creep into the U.S. government. John Mauldin, the former CEO of the American Bureau of Economic Research is one of the most respected macroeconomic minds in the field and he is sincerely worried about this. Mauldin wrote an article after discussing the feasibility of MMT with the Shadow Open Market Committee or Shadow Fed, where he ended by stating “I predict an unprecedented crisis that will lead to the biggest wipeout of wealth in history. And most investors are completely unaware of the pressure building right now” (Mauldin, 2021). This is a very bold statement and although no one can say for sure whether or not this man is correct, it is worth mentioning that he is not the only one. Every day more and more highly respectable and credible individuals in the financial markets are warning of a very serious economic recession. There are even similarities to 2008 with banks like Credit Suisse and Deutsche Bank that are speculated by some to be on the brink of collapse (Knight, 2022). It’s also worth noting that the U.K. employed similar MMT tactics and is now facing one of the most troubling economic periods in its history. To illustrate the severity of the situation, nearly 3⁄4 of pubs in the U.K. are currently facing permanent closure (Rowsell, 2022), citizens are purchasing generators and torches as they anticipate blackouts in the coming winter (Ziady, 2022), and police are preparing for an incredible surge in violent crime and civil unrest as the cost of living will make for a very tough winter for the country (Anderson, 2022).
Needless to say, one must tread very carefully in these next few months.
*Edited by Andy Colando
Works Cited
Anderson, N. (2022, September 4). Police 'prepare for tidal wave of violent crime and public disorder' as cost of Living bites. Daily Mail Online. Retrieved October 18, 2022, from https://www.dailymail.co.uk/news/article-11177455/Police-prepare-tidal-wave-violent-crime-public-disorder-cost-living-bites.html
Bove, T. (2022, October 13). 'ridiculously stupid' economic policies have the U.S. hurtling toward a 'perfect storm' of economic pain, Ray Dalio says. Fortune. Retrieved October 17, 2022, from https://fortune.com/2022/10/12/ray-dalio-says-us-headed-for-perfect-storm-economic-crises/
Committee for a Responsible Federal Budget. (2022, September 13). The Biden administration has approved $4.8 trillion of new borrowing. Committee for a Responsible Federal Budget. Retrieved October 17, 2022, from https://www.crfb.org/blogs/biden-administration-has-approved-48-trillion-new-borrowing
D'Souza, D. (2022, October 6). Modern monetary theory (MMT): Definition, history, and principles. Investopedia. Retrieved October 14, 2022, from https://www.investopedia.com/modern-monetary-theory-mmt-4588060
Federal Reserve Bank of St. Louis. (2022, September 29). Federal debt: Total public debt as percent of gross domestic product. FRED. Retrieved October 17, 2022, from https://fred.stlouisfed.org/series/GFDEGDQ188S
Horan, P. (2020, April 17). 5 problems with MMT. Mercatus Center. Retrieved October 14, 2022, from https://www.mercatus.org/bridge/commentary/5-problems-mmt
Knight, R. D. (2022, October 7). Credit Suisse and Deutsche Bank on the brink of collapse. BeInCrypto. Retrieved October 18, 2022, from https://beincrypto.com/are-credit-suisse-and-deutsche-bank-on-the-brink-of-collapse-and-what-does-it-mean-for-crypto/
Mauldin, J. (2021, January 6). Modern monetary theory could destroy this nation. Forbes. Retrieved October 18, 2022, from https://www.forbes.com/sites/johnmauldin/2019/08/21/modern-monetary-theory-could-destroy-this-nation/?sh=2ae1ec5f1dd3
Roswell, J. (2022, August 24). 70% of pubs could shut down due to soaring energy costs. Supply Management. Retrieved October 18, 2022, from https://www.cips.org/supply-management/news/2022/august/70-of-pubs-could-shut-down-due-to-soaring-energy-costs/#:~:text=Soaring%20energy%20costs%2C%20a%20shortage,pubs%20at%20risk%20of%20closure.
U.S. National Debt Clock . (2022). U.S. National Debt Clock : Real Time. Retrieved October 17, 2022, from https://www.usdebtclock.org/
Ziady, H. (2022, October 7). Facing risk of blackouts this winter, the UK will drill for more oil | CNN business. CNN. Retrieved October 18, 2022, from https://www.cnn.com/2022/10/07/energy/uk-power-cuts-oil-gas/index.html
