02 January 2015

The Great Fallacy at the Heart of Modern Monetary Theory

As with all theories that miss the mark, Modern Monetary Theory presents some insights into the matter of course, but seems to hinge on one or two key assumptions that are more matters of assertion than historical or even practical experience. It is founded not so much an economic theory, but on a belief without a firm foundation.

This paragraph taken from Yves Smith's recent article about MMT

"The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency because it is the ISSUER of the currency, not simply the USER (as a household or private business is).

This issuing capacity means that the government does not face the same kinds of constraints as a private sector user of money, which in turn exposes the fallacy of the household analogy, so beloved in popular economics discourse."

The finances of a sovereign are most assuredly NOT like those of a household. And those of a Bank are not like a household either.

In several ways they can be the inverse of a household in their motivations. For example, when household spending is slack because of an economic shock, the government may wish to engage in more spending to counteract this.  Some think it is the role of government to keep the economy out of what is called a liquidity trap or as I understand it a feedback loop of cutbacks that greatly exacerbate the problem of slack demand.

This is one of the points of having a government, that is, to do things that the individual cannot do well alone, no matter how powerful they may think that they are, and to protect the rights of the many from those who are more powerful, both foreign and domestic.

But here is the matter of disputation, emphasis in caps theirs, in italics mine. "The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency because it is the ISSUER of the currency, not simply the USER."

Do you see what is missing here, and more importantly, what is implied?

What is missing is the acknowledgement that the users of a currency, call them 'the market,' can and will and have quite often throughout history questioned the valuation of a currency, and often to the point of practical worthlessness, if certain actions are taken by the sovereign in creating their currency.
This speaks to a principle that I spelled out some time ago, that the practical limit on a sovereign government in printing money is the willingness of the market to accept it at a certain value. And this applies to any sovereign, more readily perhaps if they are smaller and weaker, but always given time nonetheless.

If Russia, for example, were to merely start printing more rubles and set a target valuation for them, they could enforce this internally. And in fact, many sovereigns have done so throughout history. I remember visiting Moscow shortly after the fall of the Soviet Union, and marveling at the disconnect between the official stated valuations and the actions of the ordinary people in seeking alternatives like the US Dollar, gold, diamonds, and even Western style toilet paper, a more useful sort of paper than the ruble.

Technically Russia could not become insolvent in rubles, because they could always print more of them to pay all their debts, make purchases, and salary payments. The great caveat in this is that Russia had to maintain a measure of control and enforcement to make that principle 'stick.'

And this is what probably makes MMT inadvertently statist, and dangerous. That is because this belief only works within a domain in which the state exercises complete control over valuation.

In the case of the US dollar as a global reserve currency, if this theory is applied, and one of my great fears is that it will be, then there is an inherent need for the Dollar Cartel to continuing expanding their span of control over all of the producing and purchasing world, in order to enforce this belief.

I am sorry to have to disagree with people whom I like and enjoy reading, but as you can see I think there is an important point of disagreement here. And given the number of sovereigns who have defaulted, causing significant pain in their people and in the lives of others, it is not a trivial thing.

I suppose that there are many other things in MMT that are correct, as it seems to be quite the usual thing in many ways, but there is an important exception in the assertion that the state has no limit to its power to set value, because that is exactly what is implied in the canard that a sovereign cannot default in its own currency. Technically it cannot because it can always print more than enough pay off debts and make more purchases. But it can create money in such a way as to break the confidence of the market, and call its valuation into question. And this is a de facto default.

What happens when the people refuse to accept it at their stated value?  What happens to people who do not agree that the State can do no wrong?  Because if the State can never be at fault in creating and spending money, that makes it a problem and a source of great mischief.
In the historical examples the government always resorts to force of some sort in varying degrees, and official exchange rates, and other actions not only on their own people but on their neighboring sovereigns who refuse to submit to the valuation of a currency by official diktat.

It is a dangerous statement that might be remedied by an acknowledgement that there are practical limitations on the power of the State in creating money, and that it is related to the willing acceptance and confidence of the people in its fairness and justice, and especially people who are not part of that same economic sphere of influence.   And if the adherents of a belief cannot agree with this, then it calls into question all the other aspects of a belief that is based on such an absurdity a priori principle. 
So it was with the 'efficient market hypothesis,' which believed that people acting in a group are naturally good and rational, and therefore needed little or no regulation.  It was widely accepted in economic circles, and those who did not accept it were dismissed as unsophisticated.  And it did not matter that this assumption was shown to be blatantly incorrect to anyone who is familiar with the reality of the marketplace, or has ever driven on a modern high speed motorway.

People on the whole are not naturally rational, good, and self-regulating to a degree sufficient to permit with the dispensation of the rule of law.  If only this were true!  And a persistent minority among them are so much not inclined to the good as to be sociopaths and inclined to be criminals.

And unfortunately politicians who act for the State are not angelically good and beneficent either. But this is what is implied in creating a system that allows for their acquiring and exercising almost unlimited power that is beyond question, in money or in anything else, but in particular something as important as the general means of exchange and valuation.