Welcome to 2019! The depths of winter have arrived, and with them temperatures in the US that are literally colder than Antarctica. But fear not dear readers! We have prepared this January newsletter with you in mind, and hope you will find the content stimulating enough to keep you warm.*
Have you heard of Modern Monetary Theory? If not, you just did. And you’ll probably hear more of it soon, because it’s like an Acme Portable Hole for the government’s Wile E. Coyote. It just can’t help itself.
A Brief History of Economic Theory in the US
In the interest of expediency and not boring you all to death, we’re going to use a fairly broad brush to paint this picture. Let’s start with the industrial revolution and the advent of modern day “industry”. Economic theory was dominated by the Austrian School (so named because it originated in, wait for it...Austria). Austrian economic theory is all about small “l” liberalism, free markets, and limited government intervention. The business cycle is driven by supply-side dynamics and is naturally self-correcting; bubbles happen when interest rates are kept artificially low, leading to over-production of goods (supply side dynamics). Too many goods in the market leads to falling prices and a slowing economy until supply comes back into equilibrium with demand (naturally self-correcting).
This was all well and dandy - alles ist gut, as the Austrians would say - but then the Great Depression happened.
The Great Depression gave rise to the Keynesian School (named for John Maynard Keynes), whose insight was basically twofold: 1) the economy might not have time to wait for supply to equalize with demand while in the middle of a depression. What if that takes multiple years? What if the economy falls into a deflationary spiral in the interim? And 2) demand disappears when you have a populace that is scarred into saving every possible penny. Saving is, and continues to be, the bane of central banks everywhere.
Basically, Keynes said that supply-side is the wrong focus, you need to actively pull the demand-side lever to have an impact. And by “actively pull the demand-side lever”, we mean large-scale government spending to act as a fiscal stimulus in order to hurry up that supply-demand equilibrium and keep some kind of base level to demand in the economy so that things don’t completely shut down. When not in a depression, government should cut back on the spending and ideally even run a budget surplus.
This was all well and dandy, but if you give a mouse a cookie, as they say… The government started used Keynesianism to as justification for profligate spending any time there was a slight economic hiccup, because that “reining in spending” bit seems to be especially hard for politicians.
Which led to the massive inflation of the '70s. At which point, some guys from the University of Chicago showed that such government spending outside of an actual depression didn’t have any effect on growth, and that controlling the money supply was the best way to regulate business cycles. This came to be known as the, wait for it...Chicago School of economic thought, and that controlling-the-money-supply thing is known as monetary policy.
All of which brings us to where we are today. Mostly Chicago-style monetary policy (run by the Fed), with some bastardized Keynesianism government spending (fiscal policy) thrown in when things get especially bad - remember that “shovel-ready” stimulus package back in 2009?
So which theory is most correct? Hard to say. At the moment and in a nutshell, we’re still keeping interest rates artificially low while tightening monetary policy in a stubbornly low inflation environment and simultaneously running record government deficits 10 years into an economic expansion. That counts as “doing it wrong” no matter which school of thought you subscribe to, so it’s a little hard to make any kind of objective judgement.
(Geek’s note tangent: Monetary policy is governed by the equation MV = PQ, where M is money supply, V is something called the velocity of money, P is price and Q is quantity. So with a constant V, increasing M (money supply) will increase the prices of goods, the quantity of goods, or both, and vice versa. Thus employment is filled and prices are “stabilized”. The Fed uses (used - QE and extraordinary monetary policy of the last decade has blown this up a little bit) three main policy tools for controlling M - the reserve ratio, the discount rate, and open market operations. The only issue, and we’re not joking here, is that nobody knows what controls V. Why didn’t inflation show up with the Fed pumping $3.5 trillion into the economy in the last decade? Because V basically dropped to zero. Why? Who knows. That’s right, the one four-variable equation used to manage the economy and it isn’t even understood how the variables interact with each other. That’s economics for you.)
A Brief Tea Leaf Reading of Economic Theory in the US
Okay, you’re all caught up. That wasn’t too bad, right? Well, looking into the not-so-distant future, next up in the progression of “doing it wrong” will be Modern Monetary Theory (MMT).
Austrianism, Keynesianism, and the Chicago School all frame economic and monetary policy within the context of supply and demand. The key insight of MMT is that the laws of supply and demand are irrelevant because there are no constraints on the supply of money for a government that issues its own currency. For you or us or a corporation or a state, yes, there are absolutely limits on money supply and debt is a huge drag on finances that can lead to bankruptcy. But on a national scale (excluding the nations of Europe’s monetary union, of course), there is no limit to the money supply because you can print money. Therefore, budgets and debts don’t matter since you can never go bankrupt because you can just print more money to pay them off.
You’ve essentially combined fiscal and monetary policy and authority - government spends however much money on whatever it wants to spend money on and then prints however much it needs to cover said spending. Naturally, flooding a system with unlimited money like that would lead to inflation, so the way that you remove money from the system and thereby keep inflation in check is through taxation. Under MMT, taxes are not government “income” that gets allocated to various spending projects; rather, taxes are a means of removing money from the economy in order to control inflation.
So you’ve given government the green light to spend literally everything - Medicare for all, free college tuition, universal basic income...or a massive border wall and fancy schmancy Space Force program (depending on which party is in power - hence the earlier Acme Portable Hole reference: instant justification for bad fiscal behavior regardless of party affiliation). And when prices start rising and individuals feel the pain caused by inflation, government is going to….raise taxes on them? We’re sure that will go swimmingly.
In all seriousness though, there is a sound theoretical basis here. Not necessarily what we would call rational, but sound...ish. Money, if you’ll recall from an early-days newsletter, has no intrinsic meaning or value. It is entirely a societal construct. Under MMT, there would probably be a push to link the value of a dollar to labor output; a dollar is worth 4 minutes of labor, say. That’s a $15/hr minimum wage, and the government would guarantee a job, and healthcare, and education to everyone. The issue with a universal income is that the benefits disappear if the income is truly universal, so you’d still have to contend with inflation and income inequality from specialized labor unless! there were price controls. A gallon of milk is pegged to ten minutes of labor, a pound of meat costs half an hour of labor, etc. Conceptually, one could imagine a labor-based society like this dominated by central planning in which MMT is a perfectly descriptive framework.
As Ms. Ocasio-Cortez has said, it’s a question of what kind society we want to live in. In a present-day society that has seen suggestions of a mildly redistributive 70%+ marginal tax rate, an entirely confiscatory 2% “wealth tax”, and increasingly prevalent suggestions that wealth is immoral, we think it probable that MMT will continue to edge its way into mainstream conversation, especially as primary elections draw near.
Just keep in mind as you hear about this magical utopia that there has been maybe one successful case study of central planning in history. Maybe. And regardless of any sound theoretical basis, the transition from our current economic system to an MMT-descriptive system would bring another polar vortex with it - just of the economic kind rather than the temperature kind.
*Or you could just print it out and start a fire. Economic theory is, as a general rule, quite dry and well suited for such endeavors.
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