Are economists experiencing their 15 minutes of fame? Long derided as the dismal science, the economics profession is arguably reviving its image. Today, newspapers, the blog-o-sphere and TV broadcasts feature regular debates on obscure monetary and fiscal policy issues, topics usually discussed only in academia or policy forums. The narrative encompasses different policy proposals including deficit spending, job guarantees, the New Green Deal and tuition assurances, all rooted in a similar theme.
The topic I’m referring to is Modern Monetary Theory – MMT, for short. It is an idea popular enough to have been raised by senators during the US Federal Reserve chairman’s recent congressional testimony and has even entered the vernacular of US presidential candidates. While not always called MMT, the themes underpinning the idea are similar and warrant the attention of investors should the electorate grow increasingly enamored with them.
Ironically, MMT is neither modern in its origin, nor monetary at its core. It dates back to the early 20th century and is rooted in economic thought closely associated with fiscal policy. Generally speaking, MMT argues that a sovereign entity’s ability to print its own currency alleviates the perceived pressures from higher debt balances. Simply stated, deficits don’t matter as long as the sovereign can print money to service debt; deficits only really matter to the extent that an overheating economy creates inflation.
The theory holds that government deficit spending should continue until the point at which an economy has reached complete employment. Sovereign macro conditions are then balanced. This equilibrium is maintained by removing money from the economy through taxation to reduce stimulus or by creating money for employment to add stimulus. The sovereign stands behind the currency as a backstop even when there is excess issuance, while maintaining the power to tax should the economy overheat.
Simple and balanced, right? Perhaps not.
Our role as active managers entails looking beyond classroom economic theories and simplistic political rhetoric. MMT appears to disregard many of the foundational principals of sound macroeconomic policy and global economic growth. I’ve considered some of these below.
Firstly, debt balances matter. Debt shouldn’t be viewed as an unlimited resource, irrespective of whether the borrower is a sovereign, a corporate or an individual. Deficit spending requires controls. Much research and many well-supported economic theories have shown excessive debt leads to instability for the issuing entity, regardless of its ability to print currency. Economies, like corporations, have breaking points. The stability of the US economy must be considered and respected by policymakers.
Debt servicing also matters. Debt issuance comes with a cost; debt balances and interest payments are a function of one another. Servicing existing debt balances consumes a substantial portion of government budgets. We also know that interest rates can rise quickly. Interest costs increase with higher debt balances, potentially crowding out other important spending initiatives.
The US dollar matters. The US economy is not a closed system. The US dollar is the largest reserve currency in the global marketplace. The value of the dollar is established daily by market participants assessing economic stability, interest-rate differentials, fiscal and monetary policy and various supply and demand characteristics.
The US currency is an important component of the global economy, and confidence in it is paramount for smooth global commerce and economic stability. Fiscal policies that discount the standing of the dollar and risk debasing the currency pose significant negative and likely unintended consequences for the global economy.
Civil discourse also matters. In essence, MMT assumes fiscal policymakers can balance the US economy by controlling the supply and demand of money – sometimes creating money for stimulus, other times increasing taxes to rein in inflation.
This is quite naïve. Such a fiscal process hasn’t resulted in a balanced budget since 1997 and has led to government shutdowns 22 times since 1976; meanwhile, the current political environment could be characterized as the most divisive of our lifetime. For MMT to work, a semblance of reasonableness and congeniality in the political process is necessary.
Investors and markets don’t like uncertainty. Whether one considers companies deploying capital and making hiring decisions or asset managers making investments in the marketplace, certainty matters. Variability and vagueness vis-à-vis fiscal, tax and regulatory policies will rattle confidence in the future. Political environments of this nature run the risk of unsettling both macroeconomic conditions and public markets.
In summary, what’s crucial is a recognition that initial conditions matter. We aren’t starting with a blank sheet of paper. The US dollar has a materially important role in global finance. What might be appealing rhetoric in election cycles must also pass the test of daily “elections” in the global marketplace. In this context, knowing how the world views the US is important. Interest rates, debt balances and currency valuations are key criteria for debt sustainability and economic stability. And for Asian investors, there are lessons that can be learned from this.
The MMT dialogue today is rooted in a broader debate about income and wealth inequality. We’re in complete agreement with those that argue this dynamic is a growing risk to the global marketplace and must be addressed through vibrant political debate and sound fiscal policy.
As political rhetoric evolves as we pass through current election cycles, investors in Asia and around the world will be well-served to keep in mind the long-term economic impact of potential policy outcomes.
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