Modern Monetary Theory – or alchemy?
* For centuries governments have taxed, borrowed or created money to pay for public spending. All carry risks. Heavy taxes dampen growth and upset voters. Excessive public borrowing triggers financial crises. Printing money to pay for public spending can look tempting. But, as rulers from Henry VIII to Venezuela’s Nicolás Maduro have discovered, creating money out of thin air and spending it tends to destroy confidence and send inflation rocketing.
* In economics, as in investing, if something looks too good to be true, it generally is.
* So, imagine finding a way to increase spending without borrowing, taxing or creating inflation.
* Yet, in simplified form, this is pretty much the promise of a policy getting a lot of airtime in America at the moment – Modern Monetary Theory or MMT.
* MMT asserts that a government that prints and borrows in its own currency cannot go bankrupt, since it can always print more money to pay back debt. The argument runs that since it can print money to pay off its debts such a government can also do so to pay for public services. This is a truly radical idea.
* Supporters of MMT argue that government should print money and spend it as long as the economy is operating with spare capacity, i.e. it has unemployed workers or underused factories. Once spare capacity is used up, and the economy risks overheating, proponents of MMT say the government should stop spending and raise taxes to dampen activity and inflation.
* To its supporters MMT avoids many of the disadvantages of traditional forms of economic policy. Voters get better public services with unchanged taxes. There’s no extra public borrowing to alarm deficit-hawks. And it won’t push up private borrowing and asset prices in the way QE (quantitative easing) has in the last ten years.
* Now, it’s worth noting that both MMT and QE involve the government creating money electronically – or, more graphically though incorrectly, printing it. But with QE a central bank creates money to buy assets, such as government bonds. This injection of new money into the system drives down interest rates and bolsters asset prices. Under MMT, by contrast, the government spends the money directly on public services.
* That’s one crucial difference, and from it a second follows. With QE, as practised in the US and Europe, central banks have promised to reverse money creation. They can do so because, unlike under MMT, the money that has been created has been swapped for assets which can be sold. The idea is that central banks will, in time, sell these assets, withdrawing money from the system and dampening asset prices and activity. This has so far convinced investors that the new money created will eventually be absorbed back into the system. The message from central banks is that QE does not represent a permanent expansion in the supply of dollars, euros and pounds.
* By contrast, the money created under MMT will be spent on public services and not in purchasing assets. And, since there are no assets to sell in future, the money creation is permanent.
* These are important differences. They explain why so many prominent US economists, from Fed chair Jay Powell to former treasury secretary Larry Summers, have raised concerns over MMT.
* The most obvious danger is of runaway inflation. If investors think a central bank would print money at the whims of the government they are likely to get rid of money and buy other assets to protect against inflation. That could cause the currency to collapse and inflation to soar.
* A related concern is that government, with its infinite spending power, could hoover up people and resources and crowd out the private sector. This would reduce the tax take and could tempt the government to print more money to fill the gap.
* More fundamentally, the state could end up with a far greater role in allocating capital in the economy. The market has flaws and limitations. But it tends to be better at allocating capital and raising efficiency than the government. A worry, therefore, is that MMT could enfeeble the private sector.
* With numerous critics and few true believers among politicians MMT is unlikely to see action in the US. Even on the political left its support is qualified. While Stephanie Kelton, one of MMT’s leading proponents, worked as an adviser to Democrat presidential hopeful, Bernie Sanders in 2016, Mr Sanders has never explicitly endorsed the policy. MMT’s most high profile advocate is Democrat congresswoman Alexandria Ocasio-Cortez though she is not committed to it, saying MMT needs to be, “a larger part of our conversation”.
* Yet the debate sparked by MMT highlights a willingness to push the boundaries of policy in pursuit of faster, more inclusive growth. Critics of the status quo point out that ten years of easy money have not stoked inflation. Nor has a soaring federal budget deficit, and vast issuance of US treasury bills, unsettled investors. This is an environment in which radical economic ideas, such as MMT, are attracting attention. To me MMT sounds rather like alchemy, the age-old search for ways of turning base metals into gold. Given the damage caused by the last recession I shouldn’t be surprised. It has reinvigorated the eternal search for new and faster paths to prosperity.
OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 1.0% at 7,158 as global equity markets retreated on trade concerns.
Economics and business
* President Trump threatened to apply tariffs on all US imports from Mexico unless the country improves its efforts to stop illegal immigration
* China’s planning body, the National Development and Reform Commission, suggested Beijing could restrict the export of rare earth minerals to the US as the trade war between the countries intensifies
* Huawei ordered its employees to cancel technical meetings with US workers at its Shenzhen headquarters
* Chinese manufacturing activity contracted in May, according to official PMI data, with the employment sub-index falling to a 10-year low
* The FT reports that President Trump is to threaten reducing intelligence-sharing with the UK if the UK allows Huawei to build part of its 5G infrastructure
* The German 10-year bond yield hit its lowest level on record as investors snapped up safe assets amid growing concerns over the trade war and global growth outlook
* Vice chairman of the US Federal Reserve Richard Clarida struck a dovish note saying that the central bank must be “nimble” to sustain the US expansion
* The German unemployment rate rose for the first time since 2013 last month, edging up to 5% from 4.9% in April
* One in four small and medium-sized businesses in the euro area said the biggest challenge they face is attracting skilled labour
* US consumer confidence hits a six-month high in May
* Israel prime minister Benjamin Netanyahu engineered a fresh general election, which will take place later this year, just six weeks after the last one
* A review of the UK’s higher education system says more funding should be given to vocational training and university tuition fees in England should be cut to £7,500 per annum
* An economist hired by UK chancellor Philip Hammond to look into the country’s minimum wage signalled his recommendations would include a big increase in the statutory rates
* Norway’s largest pension fund will divest from “sin stocks”, companies which derive more than 5% of their revenue from alcohol or gambling
* Brazil’s economy contracted for the first time since 2016 in the first three months of the year
* New Zealand revealed a “wellbeing” budget which outlines mental health and child poverty amongst other spending priorities for the coming year
Brexit and European politics
* The CBI warned contenders vying for the Conservative Party leadership that a no-deal Brexit would cause “severe” damage to businesses
* UK chancellor Philip Hammond said he could run for the Conservative Party leadership if his views are not “properly represented” by the other candidates
* Financial donations to the Conservative Party fell sharply in the first quarter
* More than 750,000 of the 3.6 million EU citizens living in the UK had applied for the government’s settled status scheme that secures their legal rights post-Brexit by the middle of May
* The European Commission has written to Italy’s populist government saying “Italy is confirmed not to have made sufficient progress towards compliance with the debt criterion for 2018”
* UK foreign secretary Jeremy Hunt said he could negotiate a better Brexit agreement and avoid the “political suicide” of attempting to get a no-deal Brexit through parliament
* Speaker of the House of Commons John Bercow said the next UK prime minister will not be able to force through a no-deal Brexit against the will of parliament
* President of the European Council Donald Tusk said the UK Brexit situation had acted like a “vaccine” across Europe against populist campaigns
And finally… Belgian monks in the Grimbergen Abbey, north of Brussels, are reviving the site’s ancient tradition of beer making. The brewery is being resurrected after more than 200 years of lying dormant – stale ale