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Oxford Financial Group, LTD


Oxford Financial Group, LTD


Expert Perspective

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Investment e.Perspective

Current Issue | May 15, 2019

Modern Monetary Theory?

By: Marcos Nogués, Chief Investment Officer & Oxford Investment Fellow

A drop kick is a technique used in rugby whereby a player drops the ball and kicks it immediately after it hits the ground. This is the visual that comes to mind when I think how investors will react to the US Dollar (USD) and dollar-denominated assets should Modern Monetary Theory (MMT) be implemented to its full extent. So, what is MMT and why should we be concerned about it?

The challenge in discussing MMT is that it isn’t really a formal theory supported by econometric models such as those studied in mainstream economics. MMT is a set of ideas that challenges conventional economic wisdom and generally endorses the following tenets:

  • A government that borrows in its own currency cannot be forced to default
  • A government can simply print money to pay its debts
  • A government deficit creates a “non-government” surplus
  • Deficit spending doesn’t matter until there is evidence of inflation
  • If inflation begins to rise, it can be curbed with a tax hike (or cut in government spending)

The logic described in these statements is of particular consequence to the US because of its status as the primary reserve currency. Proponents of MMT suggest that the government could easily increase its deficit financing in order to pursue policy goals. This thought process is now influencing economic policy prescriptions for some politicians in the US and abroad.

On the surface, the MMT statements above appear to be reasonable. So why be concerned about MMT? Let me start by asking the following rhetorical question: if economic goals of full employment and output gaps can be solved with unconstrained deficit financing, why hasn’t anyone tried before? The answer, of course, is that it has been tried many times. It was tried by the U.K. in the 1970s, France in the 1980s, Germany in the 1990s, and many others. The world champion of this strategy is Argentina. In all cases, the policy had to be reversed through the political system or its hand was forced by a market-driven collapse.

The first tenet described above is in fact false. A government that borrows in its own currency can indeed print more money to pay its debts, BUT under certain circumstances it may be forced to do so at a cost of high inflation. The erosion in purchasing power can be considered a partial (if not total) default on the government’s obligations.

The argument that the US could engage in unlimited deficit financing because it borrows in dollars and prints the world’s reserve currency is upside-down. The opposite is true: the USD is the reserve currency in part because the US has NOT abused the value of its currency. If the US were to grow its deficit to the point where inflation begins to rapidly accelerate, in effect devaluing its liabilities, that would deal a catastrophic blow to confidence in the currency.

Why has this concept, which has been discussed in the fringes of academia for decades, resurfaced in the political mainstream now? Part of the answer lies in the fact that populism has resurfaced across the political spectrum and across the world. This can be seen in the spheres of international trade, immigration and (anti-)globalization. Populist movements are much more willing to remove policy-making authority from technocrats (Federal Reserve) and give it to politicians (Congress).

Another reason is that a particular version of MMT was implemented in the throes of the financial crisis in the form of Quantitative Easing (QE). A naïve view would contend that authorities used deficit financing to buy assets (bonds in the QE program) in order to “save the banks and bail out the wealthy shareholders.” Ten years later, some are observing that this experiment 1) didn’t cause inflation, 2) produced a long economic expansion, and 3) didn’t materially devalue the dollar. So if we used QE to “save the banks,” why not use it for healthcare for all? Or universal employment? Or minimum income?

The devil is in the details, and the details sometimes are nuanced. When QE was implemented, the economy was in the first innings of what is normally described as a debt-deflationary spiral. This means that economic agents (individuals, companies, etc.) had a good deal of leverage on their balance sheets. As their assets (homes, property, etc.) dropped in value, they tried to dispose of them in order to lower their debt ratios. The selling pressure in turn caused the aggregate value of assets to drop at a faster rate, creating more selling pressure, and so on and so forth. I believe QE did in fact create inflationary pressures which resulted in a low observed inflation during the past decade instead of deflation if QE had not been implemented. If we were to implement QE in today’s economy (for whatever political purpose) it would likely cause inflation to accelerate.

I trust the Federal Reserve to fine tune our economy through Monetary Policy (the real thing) much more than I trust Congress to do it via modifications to the tax code and spending policies. Despite a less-than-perfect track record, the Fed has the know-how, the expediency and the political independence to manage our economy toward the dual objectives of full employment and price stability. The policy prescription suggested by MMT could lead us down the wrong path and be met with a rugby-style tackle.

The above commentary represents the opinions of the author as of 4.24.19 and are subject to change at any time due to market or economic conditions or other factors.