Wednesday, January 23, 2013

MMT Seminar Note #1

Thank you for joining me here. These are notes that I used in the first seminar class of a series on Modern Monetary Theory (MMT).

This isn't intended to be a debate about the truthiness of MMT but just a tutorial of the basic idea. And you might wait until all the Legos are in place before debating how well it hangs together.

During a recent discussion I was asked why I accept MMT (Modern Monetary Theory) as a working theory. First we must understand that only with mathematical theories can we say, QED (quod erat demonstrandum - "which was to be demonstrated"). That is to say that only math theories can actually be proven. In economics, as in science, we can only say that a theory may be true because there is enough supporting evidence so that it would be perverse to with hold conditional acceptance. (Thank you Jay Gould.)

There are other theories and operating systems that have been, and are being, used to set financial policies and then to explain why the policies aren't working. If I look at the policies and the results of financial decisions going back to the 18th century and see what MMT would have predicted would be the result, I find a good bit of agreement with what actually did happen. Besides, MMT is simple and straight forward once you get the hang of it and that is appealing.

Understand that I am not an economist but and engineer/mathematician. MMT appeals to me because the theory presents a nice neat machine with all the wheels and gears fitting together and working.

 I want to start by discussing what MMT isn't. The easiest point of approach is to start with a "kitchen budget" and then seeing where a budget under MMT digresses. The term kitchen budget isn't meant to be at all derogatory. It is simply used as a term for an understandable form of budget that is used by almost all financial centers. The few exceptions will be noted.

A moment's thought and you will see that the term actually covers the vast majority of budgets in the world: Yours, your town's, your state's, General Motors ---- AND ----

Your federal government's IF -- AND ONLY IF -

it has currency based on the value of some commodity. Your kitchen budget depends on you acquiring some commodity that has a market value to exchange for goods and services that you might need or want. You write a check that can be exchanged for  that commodity. In this context, the currency issued by a government can be considered a commodity. It certainly has market value or you wouldn't want it. It has market value or others would not want it in exchange for goods and services. All of these entities are users of the government's currency. Even the government if it is basing currency value on some commodity.

Now the question becomes; how do you acquire the commodity you need?

Borrow it. Perform a service for which you collect a payment. Make something that you can sell. Steal it (Frowned on in polite circles.) Etc. (Be inventive.) :=))

Now look at the government that is operating in exactly the same way you are, i.e. has a currency based on a commodity. The commodity can be anything that has market value, radishes, lumber, gravel.

These would work but they do have problems in that their market value fluctuates over time - and radishes and lumber will rot. (Oddly, good quality construction gravel would work rather well.)

Basically, a commodity that is easy to store, easy to valuate, hopefully holds its value steady over time, would be good. Presumably gold and silver work fairly well; however, they are subject to price swings, and these price swings can be sharp if new sources are discovered.

Now, how does the government acquire the commodity it needs?

Essentially the same way that you do. Borrow it. Perform a service for which it collects a payment (taxes and fees). Make something that it can sell. (Rare but it can happen I guess.)

Steal it? Well, that used to be a reason to have a war.

Having a currency tied to a commodity will suppress any long term inflation. (It will, however, exacerbate short term economic swings leading to rather severe deflation and depressions.)

It is important to note: like a kitchen budget, government insolvency is possible and has happened not infrequently.

Let's consider running a sovereign  government on a currency that isn't tied to any commodity. This currency would be the sovereign's currency by decree. It would be established by a fiat. (not the car). Hence the term "fiat currency".

The term "sovereign" means the ultimate authority of a political entity - A country. In the United States the head of government and the head of state are the same. In most other countries this is not true.

Theories on this type of currency were developed by Keynes and Galbraith (Father and son). These have been expanded into MMT. (Finally got to it.)

So the sovereign, with its printing press, issues this currency. It says, "This is legal tender for debts  foreign and domestic."


That's nice.

It's just paper.

Oh! I forgot to tell you. This "paper" is the ONLY thing the sovereign will accept in payment of taxes. And the sovereign frowns on non-payment of taxes. It's the only thing that any business with the sovereign can be conducted in.

In Bellows Falls, Vermont, you might be able to buy candy, ice cream, or even a car with Loonies. But if you want a stamp, you better have dollars because that is the only thing the US Post Office will take. Did I mention that  the sovereign frowns on non-payment of taxes!!!

This give a certain incentive for acquiring this currency.  But, if taxes have to be paid, how do I get this currency?

Well, the sovereign (government) has to get it out somehow. (It has to run a (gasp) deficit.)

What is a deficit?

When you write a check you make an entry in your check register and subtract the check from the balance. If you write enough checks that entry can become negative, which the bank will dislike.

When the government does that THERE IS NO BANK TO GET UPSET!

The balance simply shows a negative amount and that is the deficit. In fact there is no entity what so ever that really is concerned about that.

How about contracting to build a road, setting up a military to protect the country?

Setting up a medical support plan?

Buying land for national parks?

And the people who build the roads, join the military, become doctors, etc. spend this currency on other things. Or, at least, they want to but no one is building these other things. There is an unfulfilled demand?

Trust me, someone will figure out a way to SUPPLY  the DEMAND. (Clever?)

Consider this question: Can the sovereign go broke? (Elegant term is "Insolvent".)

If you are tempted to answer "yes", tell me how; I'll wait.

Answer is, of course, no. It can't. Insolvency can never be a problem with a fiat currency.

If Insolvency isn't a problem, what is?

Ahhhh, the other "I" - Inflation.

Let's see, by printing too much money, the sovereign has increased demand to outrun supply. The solution is to "unprint" money. Anyone have an idea how to unprint money?

Raise taxes. That will drain the excess demand from the economy.

So taxes are seen to be important in MMT. In fact they are really more important than the deficit. Taxes proved the means to give currency value. Taxes can also provided a needed brake on demand. Taxes might also be used to discourage behavior that is detrimental, like, perhaps, limiting vehicle weight and, hence, fuel consumption. Taxes, at a high enough marginal tax rate, can also limit the accumulation of sufficient wealth to avoid having the authority of the sovereign challenged by individuals.

Note well: The one thing that taxes don't do, they don't pay for anything. Consider this well. The sovereign has a monopoly on printing money. Any money it needs -  it prints. In fact it has no way to save money in a vault somewhere. A totally useless concept.

As is borrowing money. If the sovereign can print all the currency it needs, why would it ever need to borrow money? Why would it ever consider selling bonds? Bonds are really a left over from the gold standard when the sovereign really had to borrow money to support some spending.

Ahh, well bonds might consider for setting up  mechanism to allow its people to save money, perhaps for a new car or a little better retirement. Or to allow foreign companies a mechanism to trade easily in the sovereign's currency for business purposes. Or as a drain on excess bank reserves created by deficit spending - if it wanted to control overnight lending rates.

These might be excellent reasons for selling bonds.

Interesting concept, sell securities for the state currency to be repaid in the state currency. A currency that the state has a monopoly for printing. Think about that. Is there anyway possible that the sovereign state cannot pay back the bond?

And, if the sovereign places these bonds on the open market for bid, it can actually control the exchange rate for its currency by limiting how many bonds it puts up for sale. I will point out that the present price for the bonds of countries that have complete sovereignty over their fiat currencies is such that the interest on those bonds is essentially zero. (Note well: this excludes every country using the Euro.)

That National Debt that there is much hand wringing about?

It's actually earning money for us. And it could be eliminated tomorrow. Raise Hell with the banking industry but is of no other real consequence to the health of the country. That National Debt is really the accumulated savings of all the currency that has been issued.

Now to consider the austerity, Austrian economy, craze. Presently the economy is sluggish to say the least. Unemployment is nowhere near zero. Inflation, if there is any, is being driven by oil prices over which we have essentially no control. What is needed is an increase in demand for goods and services. What two things would you not do at this point?

Two things you WOULD NOT DO!!!

I'll wait.

Well, I certainly would not give any thought to cutting the deficit. I would put a lot of money into repairing the infrastructure. Expand health care. Expand educational services. Give states grants to help them out. Remember, states work on a kitchen budget.

And It is not the time to step on the tax brake to drain money out of the economy. (Except for increasing the marginal tax rate to control attacks on government policies.)

More to come.

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