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Modern Monetary Theory: A very bad idea whose time may be coming

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      By Stewart D. Taylor, Diversified Fixed Income Portfolio Manager, Eaton Vance Management

      Boston - A seemingly new theory of money and sovereign debt with significant implications for future inflation is quickly gaining popularity among some politicians as a way to potentially pay for giant government spending programs.

      Modern Monetary Theory (MMT) makes the case that a sovereign government that controls its own printing press can never default or become insolvent (somewhat true). MMT also asserts that deficit spending is necessary for growth (not true).

      Finally, MMT posits that if inflation heats up to uncomfortable levels as a result of spending, then the government can simply raise taxes until supply and demand move back into balance (extremely doubtful). As someone who is admittedly very interested in inflation and its impact on investment and savings, I believe that this is the most dangerous economic idea (for your net worth) in decades.

      Clearly, the logic holds an innate appeal. After all, getting something for nothing is as attractive an offer that a politician can make to his or her constituents. Also, the ability to fund a favored spending program, without bounds or taxation, is incredibly attractive to politicians. While MMT doesn't argue that there should be no bounds on deficit spending, its proponents make the case that the only bound is a lack of resources that creates inflation.

      Unfortunately, there's a catch: While a government can create money with nothing but a printing press, the debasement of the currency does not change the value of the things that we wish to purchase with it. It only changes the quantity of the currency used to purchase those things. In other words, it inflates the value of things by diluting the quantity of the medium of exchange used to pay for them. For retirees, savers and investors, this debasement devalues and potentially imperils years of fiscal effort and future security.

      Many MMT proponents point to the low level of inflation since the end of the financial crisis as proof that utilizing the power of the printing press does not produce inflation. Notwithstanding the fact that one data point is not strong evidence of anything, it is likely that the already high level of debt is the best explanation of why developed economy growth and inflation has been tepid, despite massive global stimulus. Adding debt on top of debt will likely only serve to further inhibit growth.

      Aside from my conceptual inflation worries, there are a number of real world cautionary tales to consider. On my desk, I have both a modern Zimbabwe 100 trillion dollar note, and a 2 trillion mark note issued in the waning days of the Weimar Republic just after World War I. Both countries obviously had control of their respective presses, yet citizens of both suffered almost unbearable consequences. Proponents of MMT present convoluted arguments as to why the two examples are not pertinent, but it intuitively seems to me that they are.

      To control inflation, most monetary systems depend upon either a political process or a strong central banking authority. Because political systems over a thousand years of economic history have such a poor history of reacting to economic threats in a timely manner, modern developed nations have created central banking institutions. Most of these have a central mandate of maintaining price stability, and most are independent from their political leadership. On the other hand, MMT relies on politicians acting against their own self-interest to raise taxes (which damages their popularity with voters) as inflation passes some undefined threshold. History argues strongly against politicians having the will and courage to do so.

      While our current system of an independent central bank controlling the availability of credit has significant drawbacks, I believe the inflationary risks associated with MMT are unacceptable. In my view, MMT is a political rather than economic architecture that simultaneously risks stoking inflation and slowing economic growth for future generations. When a politician offers something for nothing, history says you should beware.

      Bottom line: Despite the recent interest in MMT, it is still an idea that resides firmly on the fringe of political and economic thought. However, in an era of growing populism, fringe ideas can rapidly morph to mainstream ideas. Investors should be particularly wary of this one.