Modern Monetary Theory (MMT)

Originally sent to VIXCONTANGO subscribers on Sep 28th, 2018

A big reason behind the lack of negative reaction in the market over the past 2-3 months to the prospects of Democrats winning the House is the emergence of Modern Monetary Theory (MMT) in the national economic discourse. A big proponent of MMT is Dr. Stephanie Kelton from Stony Brook University (a tony university at the far end of Long Island, which also happens to be the closest university to the fabled summer house town of New York billionaires (The Hamptons) and also a recruiting base for Renaissance Technologies, the rarely mentioned 30% per annum quant hedge fund owned by Jim Simmons and former Bannon sponsor and Breitbart owner Robert Mercer). She has been making the rounds in the press lately and has gotten significant traction in liberal circles. She published the following articles recently:

Sep 28, 2017: LA Times “Congress can give every American a pony”

Oct 5^th, 2017: NY Times “How We Think about the Deficit Is Mostly Wrong”

Sep 24^th, 2018: Barrons “Just When Should We Start Worrying About Deficits”

Prior to her recent ascent in liberal economic circles, Stephanie Kelton was mostly an unknown academic specializing in what was considered to be a highly progressive and somewhat fringe economic theory. Her fortunes started rising in 2015 when she was designated Chief Economist for the Democratic Minority Staff of the Senate Budget Committee and during 2016 she left that position to become economic advisor to the Bernie Sanders campaign. Once Bernie Sanders campaign took off, her star was born. Now there is palpable enthusiam about Stephanie Kelton and the economic theory she is a proponent of and once Democrats win back the House, MMT has a high likelihood of becoming governing economic theory in the United States even with Trump in office (I will explain later why).

So what is Modern Monetary Theory?

As we discussed in a prior newsletter the dominant economic theory right now is New Keynesianism. Many people in power including the former FED governing duo of Janet Yellen and Stanley Fischer are big proponents of that theory. New Keynesian economics believes that markets are inefficient, that market competition is imperfect and that market prices don’t adjust quickly to economic conditions thus leading to less than optimal macroeconomic outcomes. The government using fiscal policy or the central bank via monetary policy can correct these market failures and lead to a more efficient macroeconomic outcome than a pure market economy (laissez faire) would.

Modern Monetary Theory (MMT) goes one step further and doesn’t just place the government as a fixer of market failures, but instead postulates that the government is the dominant driver of macroeconomic activity. This is not quite communism as MMT does recognize the existence of a large private sector and private property rights and is also not socialism as it doesn’t think that the government should be responsible for the means of production in large economic sectors. MMT looks at the world from a monetary point of view and recognizes that money in an economy is established and created by a sovereign government. By handling the levers of money correctly in the economy, the government can produce optimal macroeconomic outcomes.

Origin of Money

MMT is seen as an evolution of Chartalism and is sometimes called Neo-Chartalism. The word “Charta” is the latin word for “token” or “piece of paper”. In Russian, the word “karta” means “map”, but I am sure the Russian guy back in the day didn’t get the translation quite right J In other words, Chartalism means theory of “token money”. MMT starts with a different definition of money than what you are probably are used to. The traditional view of money is something the MMTers call “Metallism”. Historically, money is considered to originate from barter between private entities (people). At some point, metal coins was picked to be a medium of exchange because it made facilitation of barter easier – it was easier to carry, it survived through time and disaster (durable commodity) and it was easier to use for measuring worth and wealth (unit of account). At that time people didn’t want the medium of exchange to be completely worthless and wanted money to also be a store of value. Thus they chose to use rare metals like gold or silver which had intrinsic value because of their rarity and use as jewelry (visible display of wealth). Ultimately, in the traditional or “Metallist” view of the world a unit of currency derives its value from the precious metal backing it. A gold-backed fiat currency derives its value from its claim on a certain amount of gold. That was what was considered money for thousands of years, in the USA until 1971 (when Nixon decoupled the US dollar from gold) and by many to this day.

In “State Theory of Money” Georg Friedrich Knapp in 1905 defines money as “creature of law” rather than a commodity. Money’s worth comes from the power of the state to levy taxes and to demand payment for taxes, fees, licenses, surcharges and whatever other payments are due the state in whatever form they desire. That money can take the form of a piece paper, a stamp or any other worthless token. The token itself doesn’t have value, the power of the state is what imbues the token with value. An example often given is when getting a token in exchange for giving up your coat in a theatre. The plastic token has no worth in and of itself but represents a claim on your coat. Because money’s usage in MMT is mainly as a medium of exchange and unit of account and the money itself is a worthless token, the theory is called “Chartalism” or “token” theory of money. The concept of the power of the state imbuing money with value is first articulated in detail by Knapp but this is a concept that goes back as far as Adam Smith’s 1776 book “Wealth of Nations” which contains the following paragraph:

A prince, who should enact that a certain proportion of his taxes should be paid in paper money of a certain kind, might thereby give a certain value to this paper money.

Because governments can demand recurring payment for taxes “at the pay offices” in a their chosen currency that currency then becomes the basis on which business contracts are written because ultimately every entity in the economy whether it is a person or a business has to make regular payments in that currency. Obviously instead of incurring exchange costs, volatility and inconvenience all the time switching between payments in a random currency (let’s say gold) and the state currency, people ultimately do the easy and convenient thing and base majority of their commerce in the government’s currency. Not to mention that government may penalize usage of other forms of money. Thus Alfred Mitchell-Innes writes in 1913 that money is a deferred payment of a debt the government may reclaim through taxation. Money is debt to the government and occassionally the government collects them back as taxes.

Or simply put: Money is credit (Innes, 1913).

Money is a debt relation, a promise or obligation which exists between human beings and cannot be identified independently of its institutional usage. Money is both an asset (credit) and a liability (debit). When two people/entities enter a contract, money is created.

Hierarchy of Money

Because money is credit, there is also a hierarchy of money. Since any token can be money and various organizations can issue tokens (or financial instrumens like stocks and bonds), there is various degrees to which money have credibility. Since money is credit, money basically has a credit rating. It has various degrees of acceptability. And the closer a money token is to the government, the higher its credibility and acceptability is. The pyramid of MMT money consists of debts of households, corporations, banks and the state. With households having the lowest credibility, corporations next, banks next and state sitting at the top. You can measure credibility of debts by the interest rate being charged. For example, interest rates are highest for house mortgages, they are lower for corporations, even lower for banks and for the state money is essentially free (because it can print the money).

Finally, MMT postulates that the state will NOT accept any price for limited goods like gold. In fact quite the opposite, the state will seek to suppress the price of limited commodities like gold. Ideally, it will set it to $35 like it did for decades before World War 2. Why? Because the state views money as a tax obligation. In order to force the population to work and be productive, the government is constantly asking for taxes to be paid. Thus the tax liability is equivalent to a unit of work. If the value of a limited commodity like gold can skyrocket in the token currency, then holders of that commodity can cheat on their tax obligations. In other words, they will be able to pay their tax obligations without putting in the amount of work that the government desires. Thus in MMT, gold (or limited durable commodities) don’t have their own intrinsic value, they do have value but their value is set by the state.

To conclude this origin of money discussion, compared to Metallism, MMT says that money is what the government says that money is (dollars in the US, pesos in Mexico) and I think in the modern day and age, it is very hard to argue with that point.

National Income Identity

The government is considered to be the Treasury and the Central Bank. The private sector includes domestic and foreign private individuals and firms (including the private banking system) and foreign buyers and sellers of the currency. Transaction between the government (or public sector) and the private sector is called a “vertical” transaction. Transactions between private sector entities (including private banks) are called “horizontal” transactions. It is important to understand that in MMT, horizontal transactions don’t result in increase of the “monetary base”. Horizontal transactions (contracts between banks and businesses and people) or bank credit should be considered “leverage” of the monetary base since the private sector money doesn’t have the credibility of state issued money. Thus only the state can expand and contract the “monetary base” and then private sector can only leverage that monetary base. In these terms, by expanding the monetary base, a government can expand the potential economic output of the economy.

 

The monetary base (or the highest order, government money) constitutes of the spending the government does and of the taxes it collects. In the US, the Congress meets and authorizes a budget every year and by simply authorizing the budget, it creates money. Then when it starts to collect taxes, it takes the money back from the economy and thus it destroys money. A government’s budget can be either in deficit or surplus. Surplus is when the government taxes more than it spends. Deficit is when the government spends more than it taxes. As a matter of accounting government deficits add net financial assets to the private sector. In other words, the government has deposited more money into private bank accounts that it has removed in taxes. A budget surplus means the opposite – the government has removed more money from private accounts via taxes than it has put back with spending. Budget deficits add financial assets to the private sector while budget surpluses remove financial assets from the private sector. The “National Income Identity” formula governing these vertical and horizontal transactions is:

G – T = S – I – NX

G = Government Spending

T = Taxes

S = Private Sector Savings/Wealth

I = Investment

NX = Net Exports (Imports – Exports)

Let’s rewrite this formula in a different way.

S = G – T + I + IM – EX

How do you maximize Savings (S) or private sector wealth? You want more government spending (G). You want less taxes (T). You want more private investment (I). You want more Imports (IM). You want less Exports (EX).

Vertical Transactions: Government Bonds and Quantitative Easing

In MMT, understanding reserve accounting is critical to understanding monetary and fiscal politcy options. The government has an account with the central bank. From that account, the government can spend and receive taxes and other inflows. Each private bank also has an account with the central bank where its “bank reserves” are stored. When the government spends money, treasure debits (takes money out) its account at the central bank and deposits this money in private bank accounts. This government money add to the total deposits in the private bank sector. Taxation works in reverse. Private bank accounts are debited (money is taken out) and total deposits in the private banking sector decline.

In MMT, the issuance of government bonds is an operation to OFFSET government spending rather than finance it. Private bank accounts at the central bank must have positive balance at the end of the day (usually set as proportion of customer desposits or the “reserve requirement”). Every day, a private bank have to examine the status of its reserve accounts. The accounts that are in deficit (have lower balance than they should) have the option of borrowing the funds from the Central Bank and for that they get charged the “lending” or “discount” rate on the amount they borrow. Banks that have excess reserves (balance is higher than it should be) can simply leave them at the Central Bank and earnd a “support” rate from the central bank. In Japan, the support rate is set at zero. In the US, banks actually make money off the support rate. But banks with excess reserves (surplus banks) can also lend money to the banks with deficit reserves (deficit banks) in the “interbank lending market”. Surplus banks want to make higher than the support rate while deficit banks want to pay lower than the discount rate. In a balanced system where the reserves of deficit and surplus banks match up, the overnight “interbank lending rate” will be between the support rate and the discount rate.

Under MMT, government spending injects new reserves intot he banking system while taxes withdraw it. Thus government spending has instant effect on interbank lending. On days that government spends more than it taxes, reserves have been added to the banking system. When you have systemwide surplus of reserves, the interbank lending rate would go down towards the lower Support Rate. Vice versa, on days when government taxes more than it spends, reserves have been removed from the banking system and the systemwide deficit of reserve, sends the overnight interbank lending higher towards the higher Discount Rate.

 

The Central Bank needs to ensure that there is enough money in the system in case the system isn’t balanced (there is not enough or there are too many overall reserves). The Central Banks manages this by buying and selling bonds on the open market. If Central Bank buys bonds, it adds money to the system. If it sells bonds, it removes money from the system. The Central Banks buys bonds by creating money out of thin air and by selling bonds it destroys money.

This is how “Vertical Transactions” in MMT work. It should be clear by now what this is: Quantitative Easing!

Imports and Exports

MMT views imports and exports as horizontal transactions. It views foreign trade strictly as currency exchange. An export is the desire on behalf of the exporting nation to obtain the national currency of the importing nation. And vice versa, an import is the desire of the other nation to acquire your currency. Imports are seen as economic benefit to the importing natino because they provide real goods for consumption it otherwise it would not have had. Exports, on the other hand, are an economic cost because it is losing goods it could have consumed. Thus imports are good and exports are bad for the wealth of the nation.

A net importing nation will transfer portion of domestic currency into foreign ownership. The curerncy however will remain with the importing nation because the foreign owner of the local currency can only spend it purchasing local assets (investment) or deposit them in the local banking system (buy government bonds). Ultimately, the holder of the bond is irrelevant to the issuing government. As long as there is demand for the currency, it is all good. The governent can never default on debt obligation in its own currency because after all it can conjure up all the money needed out of thin air. There is no constraints in creating its own currency. The government obviously can default on debt obligations in foreign currencies since it doesn’t have ability to create those and thus that is a fiscal risk to government. If its currency is desired by foreigners there are no problems, but if foreigners dump the currency, foreign obligations will multiply many times over, making impossible to repay. In that case the government can shift to an export-led strategy or raise interest rates to attract foreign investment in the currency. Both of those situations are seen as negative because they reduce the private sector wealth in the nation (exports reduce savings).

Minsky Financial Instability Hypothesis

Minsky is an economist most famous for his “Minsky moment” used in popular financial parlance as a moment when a financial system collapses. Even though he got his PhD from Harvard University under Joseph Schumpeter (an Austrian economist who coined the term “creative destruction”), his work was largely ignored by mainstream monetary powers up until the Financial Crisis. Then people started looking at this work (10 years after he died). It is important to understand that Minsky is an MMT economist and his theory of financial instability is based on MMT. I will describe his “Financial Instability Hypothesis” (FIH) as it acts as a check on what appears to be the possibility of an unlimited economic expansion if you were to apply MMT as permanent monetary and economic policy. I will also need the FIH lessons in my conclusions later on.

In prosperous times when corporate cash flow is beyond what is needed to pay off debt, a speculative euphoria develops (yield chasing) and soon thereafter debts exceed what borrowers can pay off from their incoming revenues which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks tighten credit availability even to companies that can afford loans leading to a contraction in the economy. Thus the financial system slowly moves from stability to fragility and ultimately to a crisis and that is what Minsky is best known for. The moment the financial system goes into a crisis or a “Minsky moment”. Minsky showed that financial markets move frequently to excess which is something no other economist has modeled. Because financial system is frequently unstable he was always a big proponent of a counter-cyclical institution like the Federal Reserve to act as a “Lender of Last Resort” and the Government to act as an “Employer of Last Resort”. Minsky’s theories which emphasize macroeconomic impacts of speculate bubbles in asset prices have not been incorporated into central bank policy, but after the Financial Crisis, some central bankers (Janet Yellen) started advocating that central bank policy should now include a countercyclical Minsky factor.

According to Minsky the accumulation of debt by the private sector is what pushes an economy into a crisis. There are 3 types of borrowers that contributed to the accumulation of insolvent debt:

1. “Hedge” borrowers
2. “Speculative” borrowers
3. “Ponzi” borrowers

Hedge borrowers can make debt payments (covering interest and principal) from current cash flows from investments or operations. Speculative borrowers are only able to service the interest of the debt, but not the principal. Speculative borrowers must regularly roll over (re-borrow) the principal. The Ponzi borrowers can not cover neither the interest nor the principal. They borrow based on the belief that underlying asset will appreaciate rapidly in such a fashion that s/he will be able to refinance the debt at a later day.

If use of Ponzi finance is widespread enough throughout the financial system, the eventual disillusionment of the Ponzi borrower can cause the entire system to collapse. When asset prices stop increasing for some reason, the Ponzi borrower obviously can’t make interest and principal payments or refinance and thus he defaults. But then when asset prices stop going up or even worse start to GO DOWN, Speculative borrowers blow up because they are unable to refinance their loans even if still able to make interest payments. Ultimately, the collapse of speculative borrowers brings down even hedge borrowers who are unable to find loans because banks seize all credit activity. Ultimately, these dynamics lead to bigger booms and bigger busts. The self-reinforcing debt accumulation feeds rapid inflation and the debt bust feeds rapid deflation. Human nature is inherently cyclical – there are no value investors. Only momentum investors. People naturally take actions that expand the high and low points of the cycles. Ultimately, policy makers have to implement counter-cyclical policies such as increasing contigent capital requirements for banks during booms and then reducing them during busts.

Policy Recomendations

Since the private sector wants to maximize wealth (or savings), MMT economists advocate for budget deficits (G – T) and trade deficits (IM – EX). MMT claims that government “borrowing” is a misnomer when it comes to issuance of government bonds because the government is accepting back its own debt and nobody can borrow back their own debt instruments. Sovereign government goes into debt by issuing its own liability but those liabilities are financial wealth to the private sector. Private debt is debt, but government debt is financial wealth to the private sector.

In MMT, sovereign governments are not financially constrained in their ability to spend. The government can buy anything that is for sale in its own currency and the only constraints are usually self-imposed (like a debt ceiling law). The only constraint is that excessive spending by any one sector of the economy (whether households, corporations or public) has the potential to cause inflation pressures. But then inflationary pressures can be constrained by the government’s ability to tax and remove money from the economy.

MMT economists also advocate for government funded job guarantee program which would eliminate involuntary employment. This is consistent with price stability as it targets unemployment directly rather than attempting to increase private sector job creation indirectly through a much larger and more inefficient economic stimulus. Ultimately, a job guarantee program maintains a buffer stock of labor that can readily switch to the private sector when jobs become available during the expansion. A job guarantee program is thus an automatic countercyclical stabilizer to the economy expanding when private sector activity cools down and shrinking in size when the private sector activity booms. Minsky refers to this activity of the government as an “Employer of Last Resort”.

Criticisms of Modern Monetary Theory

As you can imagine MMT has its fair share of criticisms. For one, if you can believe that, New Keynesian Paul Krugman argues that MMT goes too far in support for government budget deficits and ignores the inflationary implications of maintaining budget deficits when the economy is growing. Please, wait a second, until I can get up from the floor and get back into my chair! Policies proposed by MMT would cause serious financial instability in an open economy with flexible exchange rates while using fixed exchange rates would restore hard financial constraints on the government and undermines MMT’s main claim about sovereign money freeing government from standard market disciplines and financial constraints. MMT also lacks a plausible theory of inflation particularly in the context of full employment when the government is the “Employer of Last Resort”. MMT also assumes that Treasury and the Central Bank are basically coordinated entities (a “fictitious” consolidation of government and central banking operations) and that there is no friction between them and basically assumes zero interest rates forever. Austrian economists say that MMT is “dead wrong” and that cutting of government deficits only erodes only the portion of private savings that is not invested and that national accounting identities can be sued by the government to completely crowd out private sector investment. Ultimately, the biggest charge is that economics is not accounting and the counterintuitive policy prescriptions in MMT stem from the theory being based primarily on accounting principles and not real world economics.

MMT is Actually Not THAT Fringe

The initial panic about huge government deficits is that the government will later have to increase taxes to pay. The people who are particularly concerned about higher taxes on them are our usual folks in the Midwest and rich guys everywhere. You want to ruin a rich man’s life is tell him that more of his income will go to the government and you’ll never hear the end of it. So Stephanie Kelton who taught in Kansas for a while is very adept at deflecting this particular criticism and making our rich folks feel right at home with her progressive radicalism. Obviously, this is standard leftist subversion tactic until they hold the power and then people finally understand they have been lied to all along. But then it is too late. In any case, when people raise taxation concerns to Kelton she says – don’t look at yourself, point to Congress (the politicians). They approve budgets out of thin air. You don’t have to pay for anything because the government can create money out of thin air. It is not your taxes that funds the government. The government funds itself. If Congress approves the government budget, boom money is created out of thin air.

In particular, Kelton right now is defending the Trump Tax Cuts the GOP just passed. You would think a progressive economist who led Bernie’s economic team will be all up in arms about it but MMT theory says that lower taxes would result in higher private sector net worth. And we did get a good economy after the tax cut, stock market is way higher, consumer and business confidence is at all-time highs. MMT and Kelton predicted this correctly. Deficits don’t matter in MMT – even during a good economy – and rightfully so. Even though we are running a larger budget deficit, everything is great. Kelton doesn’t see the budget deficit as a government problem she sees is a benefit for the private sector. Instead of saying, we have a 860 billion deficit, she thinks people should say – the private sector is 850 billion richer!

So it is very important to understand that Kelton and MMT appeals not only to Bernie folks who want money to be conjured up out of thin air for Medicare-for-all (30 trillion) or Free College (roughly the cost of the Trump tax cut) but also to Trump and neoconservative GOP types like Larry Kudlow. Kelton will walk into a room with Larry Kudlow, Trump and Bernie Sanders and they are all having champagne at the end. The only people who don’t like MMT is the Freedom Caucus but they are a minority right now. So Kelton is a bit more influential than you would think – particularly right now in light of what happened after the tax cuts. The snowflakes desperately need a progressive to explain it to them in terms that they can understand. Modern Monetary Theory is that theory du jour.

Obviously, the Achilles heel of MMT is inflation. We saw immediately after the tax cuts that inflation rose from very low readings in 2015, 2016 and 2017 to decade high readings over the past few months in 2018. This was a very rapid and sharp jump in inflation which everybody is dismissing because the inflation readings finally got to 2%-3%. What they don’t understand (but should because Minsky clearly alludes to that) is that inflation has its own momentum and once people are in an inflationary environment they will act pro-cyclically to push inflation even higher. So what is 2-3% today will be 4-5% a year or two from now and 7-8% in a few years. Kelton never mentions how the government controls inflation in MMT. Which is through raising taxes. That is how government takes money out of the economy in an MMT model, because monetary policy is always pinned at zero interest rates. She prefers to focus on the goodies (bribe the capitalists) instead of how to combat inflation because obviously today we don’t have inflation and she really doesn’t want to deal with this aspect of her theory because it is not politically convenient. That is what everybody is afraid of. Particularly progressive rich people who hate taxes more than anybody. You just have to look at the tariff tantrums being thrown around by Bloomberg (the publication) right now. Ultimately, MMT says that higher taxation is a cure for inflation and points to the reason for most hyper-inflationary crises to be the loss of the ability of the government to tax. For example, the hyperinflationary episodes in the South during the Civil War are attributed to the loss in the ability of the South to tax its citizens (only 5% vs 21% in the North). MMT struggles to explain hyperinflation in Argentina and Peru since the tax systems there didn’t collapse, but suffice it to say if the tax system collapses (which means trust in the government and its money collapses) you will have hyper-inflation. Which is a fair point. But make no mistake about it – if MMT policies do bring about unexpected bouts of inflation, the next step that Kelton will recommend is higher level of taxation.

Let’s revisit the revised National Accounting Identities formula:

S = G – T + I + IM – EX

G = Government Spending

T = Taxes

S = Private Sector Savings/Wealth

I = Investment

IM = Imports

EX = Exports

Now let’s think about what a succession of Democratic and Republican governments have done over the past 30 years. Republicans have cut taxes – reduce the T. Democrats and Republicans have increased government spending dramatically (whether health care or military) – increase the G. They have both worked very hard to expand the Budget Deficit. Both Democrats and Republicans have worked hard to dramatically increase the Trade Deficit as well – increase the IM and reduce the EX. And what is the result of this? Massive twin deficits – both budget and trade which resulted in huge maximization of S (savings) or in other words stock market wealth. This is what the US government (across many administrations) has been doing all along. Tinker with all the ingredients of the National Income Identity formula to maximize savings which in the US today is 401(k) plans – which are more or less the stock market. Obviously, this formula says nothing about how S (savings) is distributed among the society (inequality) and whether having no exports and importing everything serves the national geopolitical interest, but if the private sector wants more wealth, the formula says less exports and more imports and massive budget deficits. Using this formula, you will now understand why the government and mass media (like Bloomberg and CNBC) take on the interesting mix of ideological positions that they do. Notice they are always in favor of more government spending. They are also in favor of tax cuts (which you would think is strange for liberals). Their issue is not the tax cut per se but who gets it. And they are in favor of imports over exports. Budget and trade deficits don’t bother the Mainstream Media one bit. Even though MMT has been described as a “fringe” theory, it really has been the theory that has been driving actions by the US government and US establishment for decades. If you look at what Larry Kudlow advocates all along (higher budget deficits) or what Bernanke has done (ZIRP and consolidation of FED and treasury to do QE infinity), you see MMT in play everywhere.

The Fight Against MMT

A central bank which is independent from Treasury really screws up MMT. You can see how the GOP is trying to fight this ideology today by stacking the FED with distinctly non-MMT types like Powell, Clarida and Goodfriend. The GOP knows that after them comes Bernie (or his ilk) and Bernie/Warren will want to dramatically increase the public sector. To do that he needs the QE spigots to open up again – and this time it will not be for emergency purposes but for “moral” purposes – free education and free medical care for everybody. One way to put a constraint on QE is to have higher interest rates. Another way is to discourage foreign governments from buying US treasuries (which also would hike interest rates). As you can see, the Trump administration is pursuing both of those ends despite public rhetoric. By jacking up interest rates, the FED can prevent a huge spending program from being authorized by Congress because Congress will have to figure out how to service the treasury debt needed to finance (or offset) this new spending. They will then have to raise taxes which is not nearly as popular as unpaid for spending. MMT really depends on zero rates for their grand designs of unlimited government spending. If the Congress falls to Democrats, I expect rates to go up faster as the FED tries to prevent a massive inflationary spending program by a coalition of Trump and Progressive Democrats. The reality is that Trump is a spender and he will not provide the anti-inflationary fiscal policy check needed. The FED has to do it. So expect interest rates and Federal debt service to continue to skyrocket.

The last way, the GOP can fight against MMT if the FED is not helping is by inducing inflation in the economy. How can that be done? Well according to MMT, that can be done by boosting exports. If exports lead to higher inflation, then MMT would prescribe higher taxation which then acts as a brake on inflation. But we know how politically toxic hiking taxes is. That would play right into GOP hands during the next election.

Investing Implications Under MMT

If MMT became the dominant guiding economic theory and the US drove rates back to zero during a good economy and boosted budget deficits a lot to finance Medicare-For-All or Free College or Federal Job Guarantee, there is no doubt in my mind that inflation would spike significantly. The key control for inflation under MMT lies with the power of the state to tax. So whatever industry the state decides to target will suffer deflation (or will get inflation under control). For example, you saw what removing the SALT provision did for New York real estate prices in 2018 – the bubble was immediately burst while keeping housing prices on the rise in the remainder of the country (where property taxes are below the 10K threshold). Congress and what it decides to tax then becomes super important for investing. Obviously, it is very hard to predict what industries or groups of people Congress will selectively tax in the future.

One thing should be obvious under MMT is that the state will try to suppress traditional “metallist” money. Thus any monetary commodity with a futures market will likely have its price suppressed. We saw that clearly with gold in 2011 – whose price I think is absolutely being manipulated down. Most recently we saw government price suppression via a futures market with bitcoin. A futures market in bitcoin was created precisely so that the price could be driven down and make sure bitcoin holders go back to work to pay taxes. In the modern day and age, a government decree to set a price of a commodity is considered “price control” and they will never do it that explicitly. What they will do is create a futures market for the commodity and allow hedge funds to short it and give them unlimited amounts of money to do it.

Absent specific tax interventions to control specific pockets of inflation, I think what does particularly well under MMT is hard assets with a long life span. Basically you buy them now while the monetary base is small and then later as the monetary base expands you can utilize the same equipment bought on the cheap to produce you profits marked to market at the new expanded monetary base. Real estate is one such investment because it has a very long life span. Another such investment would be a big manufacturing plant or for example a rail road. Also airlines – planes have an expect lifetime of 20 years. Or a brand new oil drilling rig. Or used Japanese cars (which last forever). You want to invest in businesses that use equipment with long life where you don’t need to replace it for the next 20 years. For example, I don’t think equipment with short life cycle will fare well – for example software has a cycle of 2-3 years, you will need to rewrite the software in a few years – you will need to pay people new higher wages to do that. I don’t think software businesses will fare particularly well in an MMT world. Also all of these tech companies, as they get more and more data and as equipment gets more expensive will start to have their profitability severely pinched. God forbid, the government takes away their R&D credit.

So I would say the best sectors to invest in an MMT world are Energy (XLE), Real Estate (XLRE), Transports (IYT), Industrials (XLI), Health Care (XLV) and Utilities (XLU) and to a significantly lesser extent Consumer Discretionary (XLY). I think sectors that depend on human capital and intangibles would deliver below market returns under an inflationary MMT framework – those would be Technology (XLK), Communication Services (XLC) and Financials (XLF). And a sector like Materials (XLB) would suffer because metals and durable commodities are specifically targeted under MMT. You want to focus on companies that have a lot of long term debt at low interest rates (that will get whittled away by inflation over time and will be easier to sustain from savings with higher interest rates) and also have invested in the newest industry equipment. For example, Seadrill would be a perfect company to invest in under an MMT scenario. As inflation brings oil prices higher, they would earn money on their brand new equipment in a currency with a wider monetary basis while they bought their equipment via debt in a currency with a much smaller monetary basis. Seadrill shares would be a slam dunk in such a scenario. You have to hunt for companies like that as they will be disproportionate winners in such a MMT world. Highly leveraged and invested in brand new equipment and ready to benefit from higher final output prices.