Modern Monetary Theory

The Economics of Life

The pursuit of economic dominance is a consistent theme in American history. Early on, this principle expressed itself through the control of land and resources. The main purpose of Lewis and Clark’s Voyage of Discovery was to identify the long sought after “Northwest Passage", which eluded explorers for centuries. As it turns out, an all-water route from Atlantic to Pacific did not exist, but their mission extended far beyond exploration and scientific revelation. Their chief objective was rooted in economics: to control Western trade by governing access to the Pacific.

During the nineteenth and twentieth centuries, America maintained economic dominance through innovation, dollarization, and influencing the affairs of developing economies. As globalization peaked after the Cold War and domestic growth inevitably slowed, American leaders resorted to fiscal and monetary efforts to sustain economic superiority, leveraging the dollar’s position as the world’s reserve currency to maintain status as an economic superpower.

This edition will discuss Modern Monetary Theory and how Western governments use it to compensate for a stagnating economy.

What is Modern Monetary Theory?

MMT is a fiscal policy which expands money supply through debt creation and government spending in an effort to stoke economic growth.

For decades past, decisionmakers - as well as Wall Street investors - focused on central bank monetary policy (e.g. setting interest rates and liquidity conditions) to manage and determine the direction of the economy. Ever-easing monetary policy gave rise to increased lending and growth. With the return of inflation, the Fed is forced to maintain higher interest rates (i.e. tighten policy) to curtail the severity of inflation - but many investors err on anchoring their investment decisions to monetary policy alone with no regard for the fiscal situation.

Without ever-so-easy monetary policy, how can policymakers promote robust economic growth trends? Enter MMT…

MMT passes the baton from the Fed to our friends at the US Treasury Dept.

This philosophy permits sovereign nations to create money - instead of raising taxes - to finance themselves. Budget deficits are used as a tool to fuel employment and economic growth.

In short, MMT is economic magic.

The nature of it enables inflation to stem from excessive government spending. In theory, governments can cut taxes or curtail spending to reduce inflation or cool down an overheating economy. But there are short-term political incentives to keep spending high, especially in an election year. Longer-term, exorbitant deficit spending is unsustainable, as it opens the door for a potential default on government debt.

Where are we now?

Outstanding US debt sits near $35 trillion. Current US GDP is roughly $26 trillion. The fiscal deficit is running at about $1.7 trillion (6% of GDP).

In 2023, most investors were anticipating a US recession, while the Fed stoked the idea of a ‘soft landing’ for the economy. A ‘soft landing’ occurs when policymakers tighten policy (i.e. hike interest rates) without causing a main street recession.

Recessions occurred in major economies throughout the world last year. Germany, Canada, China, and Japan among others all reported recessions. But the US did not - despite a contraction in economic data.

How did the US skirt recession? Through MMT. The main element of a recession is a contraction in the labor market and a rise in unemployment. Roughly a third of all jobs added in 2023 were in the government sector, offsetting weakness in the private sector.

• The non-farm payrolls report is released monthly and showed strength throughout 2023 in the face of contracting data elsewhere.

• Interestingly, the quarterly census employment and wages report, a more accurate labor market report released later, revised the aggregate Q1-Q3 2023 jobs numbers lower by 735,000 jobs.

So, what does this mean for main street? The dynamics of inflation and MMT have created a ‘K-shaped’ economy in the United States. This is one where the richer get richer and the poor get poorer, accentuating the wealth gap.

• Roughly 70% of US retail sales are conducted by the top 50% of earners.

This phenomenon is extended further when we consider the government’s $1.1 trillion annual interest payments. That level of interest expense represents 3.9% of GDP, 2x the pre-covid ratio.

• Buyers of debt receive interest income that they can spend and contribute to economic consumption (top 50%). High earners are able to compound and invest to offset goods and services inflation.

• Those who are indebted pay higher interest expense due to the rise in cost-of-living outpacing the rise in wages (bottom 50%). Credit card delinquency rates continue to move higher, particularly in sub-prime borrowers.

Where are we headed?

In an interview on Macro Voices podcast, Jim Bianco, Macro Strategist at Bianco Research, explains what may happen if the government does not rein in accelerating deficit spending. He comments on the ‘Liz Truss moment’ that occurred in the UK a few years ago.

Liz Truss was the prime minister for a brief time in 2022. Under her administration, the UK cut taxes and increased spending. The Gilt market (i.e. UK bond market) saw its largest one day and one week rise in rates in its 300-year history and pension funds exploded.

The takeaway: endless debt creation without regard for fiscal responsibility may collapse the bond market

• 20-year treasuries are already down 40% from their 2021 highs.

Josh Steiner, Macro and Financials Analyst at Hedgeye Risk Management, further explains the risk of default by illustrating two potential scenarios:

1. Explicit Default: This occurs when a government or individual is unable to pay their debt. An unlikely scenario if the government is simply able to print more money (inflate the USD) to pay nominal interest.

2. Implicit Default: This is essentially runaway inflation. The government is unable to offer high enough interest rates to incentivize buyers to purchase bonds.

The Wharton School at the University of Philadelphia estimates the US has roughly 20 years to right the fiscal ship before default occurs. Their research concludes 175-200% debt/GDP is the danger zone.

But in reality, we don’t know how long it will take. The Congressional Budget Office is notoriously bad at forecasting future spending. And we don’t know at what spending level the bond market will put its foot down. 6%, 7%, 8% interest rates? This will become a mushrooming problem if/when we approach the unknown threshold. But there is little doubt that running a 6% budget deficit in the long term is unsustainable.

Cultural Contextualization

How did we get ourselves into this mess? And why do we continue to dig deeper despite knowing our ways are unsustainable? I believe the answer lies in our propensity for consumerism as a culture.

Bernard Mandeville, a Holland native who practiced medicine in England during the early 18th century, wrote a poem about this cultural phenomenon after the onset of the industrial revolution. See a summarized version below:

Mandeville’s poem enjoyed immense popularity and criticism during his time. It highlighted the fraud and decreased moral aptitude that business leaders and politicians exhibited in their pursuit of success and prosperity. Sound familiar?

And citizens, in pursuit of pleasure and convenience, became prodigal, shackling themselves in indebtedness to have a taste of luxury - only to find themselves deprived of more meaningful lives.

The government’s application of MMT is a modern-day representation of these principles. It is akin to a shopaholic who does not know when to call it quits, recklessly indebting themselves and sacrificing longer-term stability for short-term gratification.

Maintaining economic dominance continues to be integral to our Western agenda. As evidenced here, this is not a new phenomenon. And it has influenced cultures around the world.

As developing nations close the gap on Western dominance, efforts to sustain economic superiority have become more intangible, more political, and therefore, less effective longer-term - disincentivizing foreign interest in the global dollar reserve system and driving Eastern and Middle Eastern leaders to financially innovate.

Just as Lewis and Clark’s voyage embarked with the purpose of conquering the old Western economy, our modern fiscal and monetary voyages aim to maintain control of the global economy.

It is important to remind ourselves that government is made up of individuals. And in a democracy, if citizens wish to build a castle out of cards, it is reasonable to expect government to follow suit.

To pursue pleasure and convenience - without prioritizing effort - will keep us from maintaining that which we seek.