Modern Monetary Theory (MMT) has been popping up in the news lately, promoted by some, as a new idea to solve our fiscal dilemmas. Traditionally, economics is defined as the allocation of resources in scarcity. MMT seems to turn this concept on its head because by increasing debt, we can eliminate this scarcity and create abundance. However, MMT is not new, nor is it just a theory. It has been tried by a number of governments in the past and has generally led to tyranny, economic collapse, or both.
MMT begins with the fact that the US issues its own currency. And since the Treasury can print money or destroy money at will, it cannot default on its debt. Consequently, federal deficits are not necessarily bad. In fact, MMTers argue that deficits actually have a positive effect on economic growth because government spending is a form of investment which will increase productivity.
This concept makes sense if money were simply a means of payment. But money has three functions: a means of payment, a unit of account, and a store of value. The value of money is determined by myriads of transactions between two or more individuals, influenced by the supply and demand of the currency. Needless to say, when the supply goes up, it tends to reduce the value. Thus, the supply of money can be controlled by the government, but its value cannot. In the past, governments that have controlled the issuance of their own currency have tried to print their way out of financial problems – Venezuela, Zimbabwe, the Weimar Republic, Revolutionary France – and have failed miserably.
Another problem with the theory is that increasing debt is not cost free. The cost of debt is closely tied to the size of debt. As the size increases, so does the cost. In the US, according to the CBO federal interest payments are set to triple between 2018 and 2028, surpassing Medicaid costs by 2020, defense spending by 2023, and all non-defense discretionary spending by 2025. These interest payments will limit the government’s ability to spend on other projects or services.
To counter, MMTers advocate that the government should buy all its debt and that the Fed Funds rate should be set permanently at zero. This will minimize the cost of borrowing and allow the government to borrow more. On the surface, this seems great for economic activity – more spending more consumption. Needless to say, it would be tough on savers though and entice individuals, not just the government, to borrow more. What about the Great Recession of 2008? Have we already forgotten its root cause? Low mortgage rates encouraged over leveraging, which soon turned into defaults, which snowballed into the great economic collapse.
Assuming this “extended borrowing” never happens again, we still need to consider the effect the abnormally low interest rates have on savings. Since abnormally low interest rates create a disincentive to save, the amount of savings available for investment spending will decrease, which will lead to a collapse in capital spending. This in turn will reduce productivity and lower our standard of living. Again, history is replete with examples of diminished economic activity due to zero interest rates (e.g.: anti-usury laws in the Dark Ages).
Unfortunately, nothing in life is free. Borrowing can lead to productive activity and is often good for economic growth. However, when we start thinking it is free and believe we no longer have to make tough choices, the end is not far away and the outcome is never good. Much to my chagrin, MMT has been tried before and it has never succeeded. I caution all to beware of anyone telling you that this is new and a way have it all.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his MBA at Boston University.