Disclosure: Yes; I understand that these types of articles aren’t the most fun to read (nor write), but we’ll try to make this as easy as possible
Last year, about this time, the topic of Modern Monetary Theory (MMT) was being widely discussed by the media, and largely disavowed by mainstream economists and government officials, including Treasury Secretary Mnuchin and Fed Chair Powell. Yet, in March, we will basically celebrate the one-year anniversary of the quasi-stealth adoption of Modern Monetary Theory, and we believe it is only going to get bigger in the months and quarters ahead, and the consequences for assets could be substantial over the longer term.
What Is Modern Monetary Theory?
Modern Monetary Theory (“MMT”) essentially says that as long as government spending creates a higher growth rate than it does inflation, then any debt or deficits the spending creates really doesn’t matter. Basically, you can grow out of the debt.
We heard a simple analogy the other day – MMT states that it really doesn’t matter how much credit card debt someone piles up as long as 1) their income is more than the minimum monthly payment, and 2) they can always open more credit cards once they’ve maxed out their limit.
That’s quite a departure from previous economic theories that say debt needs to be reduced, and deficit spending needs to be offset and “paid for.” Simply put, it abandons the idea government needs to be able to afford its spending. And based on Biden’s stated policies, we expect government spending, deficits and debt to grow even larger in the years ahead.
Why MMT Is More Familiar Than You Might Think
While MMT has been ridiculed as an unstable fiscal policy, the truth is that MMT has been the de-facto fiscal policy of virtually every administration (Republican and Democrat) for the past 20 years. Look at the national debt and the size of the deficits—they’ve exploded higher over the past 20 years, as government spending has increased for multiple reasons.
But while this was the stealth de-facto fiscal policy for the last few decades, the pandemic has essentially removed the “stealth” part of it, as both parties in Washington eagerly embraced a total explosion in government spending in response to the pandemic, and in return a surge higher in the national debt and deficits.
Is MMT Really That Bad?
That’s a good question, and so far, the answer has been “no”. National debt and fiscal deficits have exploded higher over the past 20 years, yet inflation, as measured by the government, has been virtually non-existent. We’ve seen it in asset price inflation, but not how the Fed actually measures inflation. Meanwhile, bond yields remain at multi-decade lows. So, given this history, one can be forgiven for thinking that MMT really isn’t bad after all.
Moving Forward, Will MMT Work?
Our historical studies tell us no – at least not over the longer term. But we’ve been wrong on this assumption for the last twenty years. We’ve been told that it may work over shorter periods of time, but not longer periods. Is twenty years not long enough, if not, what is? Well, Modern Monetary Theory makes a few very large assumptions that have been true (and allowed it to work for the past several decades), but these assumptions can, and likely will, change based on MMT itself.
The inherent premise of MMT, is that countries that control their currency can effectively deficit spend forever as long as growth outruns inflation, could be false – just look at Argentina, Russia and Turkey. The problem is that like all deficit spending, it eventually becomes too much and inflation begins to overtake growth – especially if the spending is fast and rampant for too long.
The key that has allowed the U.S. to implement stealth MMT is that “too much debt/deficits” are still a long way off, thanks to two unique factors: The U.S. dollar being the reserve currency of the world, and U.S. Treasuries having no viable alternative in the global debt marketplace. Those two factors have allowed the U.S. unmatched fiscal leniency, and in many ways made it so that MMT actually works.
First, because the dollar is the world’s reserve currency, the explosion of U.S. debt and deficits hasn’t resulted in a material decline in the dollar. As such, the stable dollar has held statistical inflation largely in check. This has preserved the key tenant of MMT, i.e. that growth outpaces inflation.
Second, because there is no rival to U.S. Treasury bonds on the global marketplace, the U.S. hasn’t really seen any ill effects of stealth MMT. Going back to the initial credit card analogy, having no viable alternative to U.S. Treasuries ensures the U.S. can always open a new credit card, i.e. borrow enough money to finance the deficit spending.
Positively, this outcome likely remains years in the future, probably. But then again, we’ve never seen anything like the amount of stimulus and QE being unleashed on the economy, and frankly no one knows what that will bring in the coming quarters and years (and it’s entirely possible inflation accelerates faster-than-expected).
But, overall, we continue to believe that our economy will continue to grow out of this recession, along with our debt. The Fed is highly focused on inflation, as it is the main kryptonite that can really derail this market. They won’t let that happen, as they have multiple levers to pull to slow down actual inflation (not just asset-based inflation).
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