Modern Monetary Theory

The Great Recession has shaken the world. It not only sent the global economy to the verge of collapse, but also sank the whole science of economics into disarray. The orthodox approach was questioned and alternative theories emerged. One of them is the Modern Monetary Theory (MMT) which is gaining traction with some economists and politicians, especially within the left wing of the Democratic Party. What is it and what would it bring for the economy and the gold market, if implemented?

The Modern Monetary Theory is the heterodox macroeconomic theory which posits that the government which issues debt in its own currency cannot go bankrupt simply because it can always print more money to pay off its obligations. Hence, tax revenues are unnecessary while budget deficits are meaningless – after all, the government is the monopoly issuer of the currency, so it can always cover its expenditures.  

Well, in a sense, this is true. Governments can print money, so they cannot get “insolvent” like private individuals. This is why we still hear about hyperinflations from time to time – Venezuela being the most recent example. And this is precisely why in the West this power was taken away from governments and handed it over to independent central banks. We know, we know, the central bankers are not fully free from political influence – after all, the governors are nominated by the politicians – but they are definitely less likely to mindlessly print money. Moreover, in many countries, the central banks are prohibited from directly financing the fiscal deficits (i.e., they cannot buy government bonds in the primary market).

The MMT acknowledges the risk of inflation, but it assumes that the inflationary genie can get out from the bottle only when the economy operates at full potential. Apparently, the supporters of the MMT have not heard about either all the practical issues of determining that elusive, unobservable potential production, or about stagflation, i.e., a simultaneous occurrence of both unemployment and inflation. Stagflations shouldn’t have happened, yet the 1970s prove otherwise. Even if prices go up, we should not worry, as the government can always tame inflation by increasing taxes. However, taxes do not decrease the money supply, they just redistribute money from private to public sector – so how could they limit inflation?

Last but not least, the MMT conflates money with capital. It’s true that the government has the extraordinary privilege to print money, but money is not real capital. The banknotes or bank deposits are not wealth – they are media of exchange. These are debt instruments, actually. What really matters is the amount of goods (and services) we can afford to buy with them. The government may pump any amount of money into the economy – but it does not own the cornucopia, so it cannot eliminate the resource scarcity. The government can create money in almost a costless manner, but it cannot in similar way increase the supply of goods that really improve our standard of living, such as airplanes, cars, computers, electric wires, highways, pipes, smartphones, steel, tractors, trucks, etc.

Modern Monetary Theory and Gold

What would the implementation of the Modern Monetary Theory mean for the economy and the gold market? As the theory calls for even looser fiscal policy, we could expect greater government spending and further increase in the public debt. It should be clear that gold would be among the biggest beneficiaries of the introduction of the MMT. As the charts below show, the yellow metal, as the inflationary hedge and the safe-haven asset, has shined both during the stagflationary 1970s and during the rapid accumulation in the US public debt in the 2000s and 2010s. 

Chart 1: Gold prices (yellow line, right axis, London P.M. Fix, in $) and inflation rates (red line, left axis, annual % change in CPI rate) from 1971 to 1989.

Modern Monetary Theory and Gold - Inflation Rates Chart

Chart 2: Gold price (yellow line, right axis, London P.M. Fix, $) and the U.S. public debt to GDP (red line, left axis, in %) from Q1 2000 to Q4 2018.

Modern Monetary Theory and Gold - Public Debt to GDP Chart

The MMT is being seriously discussed in the U.S. but it’s still very far from being implemented in the US. However, this may change in the upcoming years, as the left wing of the Democratic Party is citing Modern Monetary Theory to make the case for massive federal government spending bonanza such as a Green New Deal. Hence, the MMT would be one of the key themes during the election campaign in 2020, which could push the candidates toward promises of higher government spending. Given that the American public debt is already above 100 percent of its GDP, the increase in public expenditures could shake the investors’ confidence in the US dollar at some point in time. Then, gold should shine.