My First Stab At Modern Money Theory

contributed by Nathan Gehring, CFP®

EdgeofworldSometimes a better theory comes along that supplants current prevailing wisdom. Sometimes we discover that the earth isn’t flat. I believe we are moving through one of those moments in economic theory right now. And I believe this change has dramatic impact for you, the individual, trying to make good financial decisions each and every day.

Modern Money Theory

I’m not diving into details of Modern Money Theory (MMT). There’s too much to discuss for a simple blog post, and I’m still very early in my own discovery of it. Instead, I want to highlight some of the dramatic learning items that I’ve had while exploring the theory, then point you to a resource to explore further on your own.

As a way to get started, I’ll share a quote from the www.neweconomicperspectives.org MMT Primer blog: “we have uncovered how money ‘works’ in the modern economy.” This proves particularly relevant in the context of how money works in the United States post gold-standard era.

US Government Going Bankrupt

According to MMT, it is important to understand that the United States is a country which controls its own currency, a currency issuer. Our government has the ability to create and destroy money at will. If the US government requires money, it can always create more with nothing more than a keystroke on a computer. This means that the US government cannot go bankrupt! It will always have the ability to pay all outstanding bills whether those are interest payments on outstanding bonds and debt or paying Social Security benefits or making sure air traffic controllers are getting paid to sit in their towers.

Importantly, despite this freedom to create limitless money, the US government is constrained in its money-creating operation by the risk of inflation. As other economic theories state, MMT agrees that inflation is caused when too much money is chasing too few goods. This results in people having the desire and ability to pay more for something than they did yesterday resulting in inflation. So, the US government must be deliberate in its creation of money in order to prevent out-of-control inflation.

There is a critical element to address in this inflation equation, one that many economic pundits regularly overlook. Inflation is created by the interplay of two elements: too much money AND too few goods. What does “too few goods” mean? Too few goods could be better translated into our inability to produce more goods. So, if the United States economy has the capacity to produce more goods than are currently being produced, more money can be created without rampant inflationary pressure. Periods of high unemployment (as is the case today) are characterized by the ability to produce more goods. People are available to go to work and produce more goods. Low unemployment and high productivity figures are signs that we have reached our capacity to produce more goods.

So, the US government can keystroke more money into existence at will and always has the ability to pay bills. When there is productive capacity (as is the case today), creating more money should not cause inflation. The US government cannot go bankrupt, but its ability to create money can create inflation in the correct circumstances.

Deficits and Debt

There is one more quick item of learning that I think is interesting to consider. There has been tremendous discussion about the US deficit and debt, and the impending doom caused by that deficit and debt. As discussed above, according to MMT, that doom is overblown because the US government cannot go bankrupt. It may cause inflation (something that could still be devastating), but it will always have the money to pay bills.

More interesting on the deficit and debt discussion is this thought exercise. As politicians and media focus on US governmental deficits, these are always discussed as negative. A deficit is bad. Period. No discussion. But take a moment to consider how a dollar is created. The US government either prints that dollar bill in one of its mints or simply credits that dollar into someone’s account. That dollar bill creates a deficit when it moves from the hands of the US government to the private sector. US government account = -$1. However, the US private sector account =+$1!

US dollars cannot exist without a governmental deficit. For you to hold a dollar bill in your wallet, the US government must have created a deficit! Let that sink in. The government’s deficit is our surplus (our savings!)

If we reduce the governmental deficit, the equation works backwards. To reduce the government deficit by $1, the private sector surplus must be reduced. In order to reduce the deficit, we have to give up our savings! Private sector money doesn’t exist without US government deficit.

Why does this matter?

So why is this important to you? Why does the economic theory that you believe best approximates real life matter? One important reason…that theory largely dictates how you go about making financial decisions.

For example, if you believe that the US government is nearly insolvent and may go bankrupt in the near future, the prospects of receiving Social Security retirement benefits appear quite dim. Given this outlook, it makes sense to start receiving Social Security retirement benefits as soon as possible in order to get whatever amount of money out of the system that you can, before it implodes.

But, if you instead follow the Modern Money Theory rubric that the US government, as a currency issue, cannot go bankrupt and will always be able to pay its bills, then the decision on when to begin receiving Social Security becomes a very different one. Instead of trying to get whatever you can out before the system falls apart, you make a decision based on the belief that Social Security will not go away for economic reasons. (Political reasons, perhaps.) You make the decision of when to begin drawing Social Security benefits based on what makes the most sense to sustain your lifestyle.

Start thinking about your financial decisions and you see how this new theory manifests all over the place. A better economic theory can lead you to make better financial decisions.

It’s Just a Theory

At the end of the day Modern Money Theory is exactly that, a theory. It is designed to help explain how the world works, but is not perfect. Even if it gains widespread acceptance (something which seems increasingly likely), MMT will one day be pushed aside by an even better theory. That’s the motion of learning and science.

Yet, the more I learn about it, the more I think MMT offers a much better explanation of how money works than any other prevailing economic theories. The small bit I’ve tried to describe above is highly simplified (and may even be slightly wrong!), and only scratches the surface. I will continue to read and learn about it, and encourage you to do the same.

To learn more about Modern Money Theory, I suggest you begin by reading the New Economic Perspectives MMT Primer.

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