Pragmatic Capitalism

Practical Views on Money, Finance & Life

Modern Monetary Theory (MMT) Critique

The following provides a brief overview and critique of a relatively new monetary theory called “Modern Monetary Theory” also known as MMT.

Back in 2010 I came across a rather new economic theory called Modern Monetary Theory. As someone who had long studied Hyman Minsky and Post-Keynesian Economics I found the theory to be intuitively appealing given that it overlaps with these theories in many ways. For a brief period I was intrigued enough that I promoted some of their views on the Pragmatic Capitalism website even though I never fully adopted their views. However, after I learned more about the theory, I realized that MMT, much like most other economic theories, has some significant flaws. As a result I found myself rejecting components not only of mainstream economics, but also heterodox economics which has resulted in my position as being an economic independent. Hence, I do not associate myself directly with any “school” of economics.

I am sympathetic to many of the views espoused by MMT and I would argue that they have many useful insights. But I would also argue that MMT takes a basic Post-Keynesian framework and adds a bunch of “modern” understandings that result in inconsistencies and in some cases overreach.  The following 4 critiques (as well as my own brief comments below) are useful and elaborate on those inconsistencies.  MMT, like all other schools, is definitely worth understanding if for no other reason than it will open your mind to alternative views.  So dive in and make up your own mind.

  1. MMT, The Emperor Still Has No Clothes, Thomas Palley
  2. The Monetary and Fiscal Nexus of NeoChartalism, by Marc Lavoie
  3. MMT and the Real World Accounting of 1-1<0, by Brett Feibiger
  4. A Critique of MMT, by Steve Waldman

Here’s a shorter version of what I believe are the primary flaws in MMT. This is a brief rebuttal, but covers the main points of confusion. In addition I have added the standard MMT responses to these myths with corresponding answers:

MYTH #1: MMT says a sovereign currency issuer need not fund itself via taxes or bond sales.

     REALITY: Any endogenous issuer of money must “fund” itself.

This is one of the core underlying ideas in MMT, but it is obviously false once one understands endogenous money. In an endogenous money system anyone can issue money denominated in certain state based units of account. The state can legally attribute some credibility to certain forms of money, but it cannot force the private sector to accept these forms of money as having value.

Anyone who issues money in an endogenous system must be able to find willing holders of their liabilities. This is as true for a state as it is for a private citizen. The key difference between a household and a government is that once a private citizen cannot fund its liabilities it is deemed bankrupt. The state, however, will not deem itself bankrupt and is generally not susceptible to such laws (except in rare cases like Greece where it has essentially outsourced its own monetary sovereignty). Instead, when a state cannot find willing holders of its liabilities it will suffer a currency crisis or an inflation crisis. The fact that the state can always “fund” itself by printing more money or having the Central Bank fund its liabilities is a powerful and important understanding, but it does not preclude the state from having to fund its liabilities by finding willing holders.

MMTers sometimes say things like “taxpayers do not fund anything”. But this is like saying that my income does not fund my spending so long as I can find willing holders of my debt. I am essentially issuing money simply by finding a lender who will hold my deposits (a new loan is the equivalent of issuing the bank a new asset to fund some spending). That is, if I could perpetually find new lenders then I would have no need for an income. You could even say that my income doesn’t “fund” my spending because I can spend without having any income. But this is obviously silly because output and income gives one credit. If a sovereign currency issuer could not tax some level of output then they would have no credibility. They would essentially be bankrupt because no one would hold the liabilities of an entity that has no chance of being able to repay those liabilities since there is no output base upon which those liabilities can be given value. Although a sovereign government has unique powers it is not immune to the reality that it can run out of willing holders of its liabilities.

In this sense, it is rather meaningless to say that the state doesn’t “fund” its spending because just like any other liability issuer it most certainly needs to find willing holders of its liabilities.

Standard MMT response to Myth #1: “It’s not about funding, it’s about understanding that a currency issuer creates the money that is used to pay taxes which then destroys money. Therefore, a government cannot fund itself when it is the creator of money.”

CR Response: The modern monetary system is not set-up in such a way that the US government issues money directly. Banks issue most of the money in the monetary system and the reserve system is used to transfer funds within the banking system. MMT says that you can consolidate the Fed into the Treasury to show that taxation results in the government obtaining its own liabilities (reserves where they settle). Thus, MMT says this is where money is destroyed and created. However, this is not meaningful in any real sense since the govt is not destroying a deposit liability, but instead transferring it from one bank to another when it taxes and spends. In reality, it is improper to consolidate the Fed into the Treasury as they are separate legal entities, but it is also misleading to imply that the circuit of money creation begins within a consolidated Central Bank and Treasury balance sheet when the reserve system only exists to help transfer money that was created by banks. When we start the circuit within the reserve system we create the illusion that the government is the actual creator of money when the reality is that banks issue most of the money and the Federal Reserve exists mainly to facilitate the smooth transfer of interbank payments.

MYTH #2 : MMT says “taxes drive money”

REALITY: Many things “drive money” and taxes are not likely an important one

MMT claims that the government creates demand for its currency by imposing a tax on its users. They claim that this drives the desire to obtain currency and that this currency is ultimately paid back to the government in bank reserves. In establishing this point MMT claims that the government spends first and imposes a tax that generates the demand for this currency.

The ability to tax or charge fees is not unique to a government, however. All banks charge a tax on their loans when they charge you an interest rate. This involuntary fee helps to create demand for bank money. Should we now argue that banks, as the primary issuers of money, create demand for money because they charge fees? Of course not. The reason there is demand for bank money is because there is desire to consume/invest in private output denominated in that currency. Most liabilities are issued with some form of involuntary obligation attached to them. The government is not unique in its ability to charge taxes/fees or impose obligations. We should not misconstrue this idea as being unique to government currency.

This is related to the MMT view that the government “spends first” and “taxes second”.  They have even gone so far as to claim:

“it would be impossible to collect dollars from the private sector unless they had first been spent into existence by the public sector”

Of course, this point is demonstrably false. I can borrow from a bank and the government can collect taxes without ever having spent a dollar into existence. The government doesn’t need to spend a single dime in order for it to collect a tax on inside bank money.

Further, MMT misconstrues the role of Central Bank reserves in this idea. They argue that taxes are not actually paid in bank deposits, but are paid in Central Bank reserves because the Treasury settles tax payments in its account at the Federal Reserve. This point misconstrues the purpose of the Reserve system. The only reason the Reserve system exists is because of private bank inside money. So, if there were just one private bank in our financial system there would be no need for a Federal Reserve System. Hence, there would be no reserves. And the Treasury would settle its payments in bank inside money at this one bank. If reserves did not exist due to the large private network of private banks then the US Treasury would be exposed as a mere user and redistributor of inside money. In fact, the existence of the Fed does not change this fact since all government spending is merely a series of debits and credits that settle through the interbank system, but are ultimately initiated and finished in the private inside bank money system.

MMT would be better served by saying that users of a certain currency are confident using that currency because there is a government regulatory system that gives this currency credibility. An established court system and regulatory structure can give credibility to a currency by enforcing claims. But we should not be confused into thinking that this means the government “drives” demand for the currency. The credibility of a form of money is contingent on many things and a structured legal system is one element of this demand. But at its most basic level it should be obvious that the demand for any money is based on its credibility in purchasing output. So while a government regulatory system is certainly an important link in the demand for money it is not necessarily the “driver” of this demand.

As a litmus test for this idea we can simply ask ourselves if we would continue using the US payment system if there were no taxes? I suspect most people’s use of US dollars would not change much if there were no taxes to be paid. Instead, we use the US payment system primarily because it gives us access to a credible form of money that allows us to purchase the output denominated in that currency.

Standard MMT response to Myth #2: “Governments create involuntary demand for money by requiring that taxes be paid in a specific form of currency”.  

CR response: The fact that the government charges an annual fee does not mean that this is why people use money. If this were true then the demand for money would not collapse during a hyperinflation. Again, we should get the order of procedures right here. Taxes are fees that are charged on our output. When output is high tax receipts are high. When output collapses tax receipts are low. But you cannot have tax receipts if there is no output. So sustainable and productive output MUST, by necessity, precede taxes.  In this sense it is proper to say that productive output drives money.  And if productive output collapses then there is no quantity of men with guns that can force people to pay taxes.

MYTH # 3: MMT says that state money sits atop the hierarchy of money in the monetary system.

REALITY: Most modern governments have outsourced money creation to the private banking system placing it in the dominant settlement and payment role.  

In placing state money at the top of their hierarchy MMT boxes itself into the same corner that the rest of exogenous money theories do. This creates a state centric theory of money that is not all that different from the money multiplier theory. The difference being that MMT phrases things differently and applies an endogenous banking system into their model. Instead of saying that state money is “multiplied” MMT will say that it is “leveraged”. These are just word games that are utilized to make the endogenous money understandings appear compatible with the State Theory of Money.

The reality is that inside money dominates our financial system. The state has essentially outsourced money creation in our financial system to private banks.  This means that outside money (state money) has been rendered secondary to inside money (bank issued money).  Although the state could change this by nationalizing the banks it does not change the current reality of the financial system in which we reside.

Interestingly, the only reason this view is even viable within MMT is because we have private bank money in the first place. In the MMT world bank reserves are a government liability that payments are settled with which makes them the top of the hierarchy. But the only reason bank reserves even exist is because the Federal Reserve is a clearinghouse that supports private banks through the interbank system. In other words, the very existence of the Fed contradicts the MMT view. To prove this we can imagine a simple one bank system. In this system there would be no need for reserves and a Central Bank. All payments would clear through this one private bank and the US Treasury would be a user of the system just like all other users. Private bank deposits would obviously be the primary form of money and the government would be a mere redistributor of this bank money.  MMT flat out contradicts this view and even goes so far as to create their own alternative reality wherein they consolidate the Fed into the Treasury in order to make their fantasy accounting world appear more accurate. They literally create a fictional world in order to make the flawed accounting look correct.

Standard MMT response to Myth #3: “Reserves might be a smaller quantity of the aggregate financial asset pool than deposits, but that does not mean they are less important”.  

CR Response: The idea of a hierarchy is misleading precisely because it misleads one as to the actual importance of various financial assets. The monetary system relies on many healthy functioning pieces to work properly. I do not say that reserves are unimportant. I simply highlight the fact that they facilitate the transfer of payments. They are a secondary instrument of exchange in this sense since deposits naturally precede them. This is about understanding the monetary for what it is and not constructing some sort of government centric perspective whose end goal is policy ideas.

Further, if we wanted to highlight financial assets in terms of their importance it should be uncontroversial to note that equity is the cornerstone of any modern economy as it is the market value of our output. Without valuable output there is no need for a monetary system in the first place. MMTers will often imply that deficits add to equity as “net financial assets”, however, this is a misleading view since, if it were true, then governments could simply print equity at will and give their economies real value. While deficits can, at times, add to demand, we should not be fooled into thinking that deficits ALWAYS add to demand and equity. In fact, deficits can be quite damaging to equity at times as is evidenced in the case of any hyperinflation.

  MYTH # 4: MMT says that unemployment is caused by the deficit being too small. 

REALITY: Unemployment is caused by a lack of private investment. 

MMTers claim that small deficits cause unemployment. Warren Mosler, MMT’s founder says:

Involuntary unemployment is evidence that the desired H(nfa) of the private sector exceeds theactual H(nfa) allowed by government fiscal policy.

To be blunt, involuntary unemployment exists because the federal budget deficit is too small.”

This cannot be correct though. Keynes would roll in his grave if he knew what modern day descendants of his were doing to his views! As Keynes described in the General Theory:

“The outline of our theory can be expressed as follows. When employment increases, aggregate real income is increased. The psychology of the community is such that when aggregate real income is increased aggregate consumption is increased, but not by so much as income. Hence employers. would make a loss if the whole of the increased employment were to be devoted to satisfying the increased demand for immediate consumption. Thus, to justify any given amount of employment there must be an amount of current investment sufficient to absorb the excess of total output over what the community chooses to consume when employment is at the given level. For unless there is this amount of investment, the receipts of the entrepreneurs will be less than is required to induce them to offer the given amount of employment. It follows, therefore, that, given what we shall call the community’s propensity to consume, the equilibrium level of employment, . . . will depend on the amount of current investment. The amount of current investment will depend, in turn, on what we shall call the inducement to invest; and [this] will . . . depend on the relation between the schedule of the marginal efficiency of capital and the complex of rates of interest.”

In essence, unemployment results from a lack of private investment and the refusal of capitalists to reduce wages to the extent that laborers will accept the wage rate.  This makes sense given that capitalists are natural profit hoarders and risk managers. Capitalists will rarely spend enough into the economy to provide for full employment because the profit motive is too strong. One could actually argue that the idea of “full employment” is at odds with the natural profit seeking goal of capitalism.

But more importantly, this has nothing to do with the budget deficit. This is nothing more than an accounting error within MMT wherein they view private sector saving as (S-I) or saving net of investment. MMT has a long history of stating that private sector saving is equivalent to the size of the deficit (S-I) = (G-T). They say that the private sector cannot adequately save without government net financial assets. This completely contradicts the fact that investment adds to private sector saving and is the key driving component of private sector saving. In fact, as of 2012 the quantity of domestically held government bonds (NFA) was just 4.3% of private sector net worth. NFA is not just a small part of private sector net worth. It is practically insignificant relative to other components, yet somehow, in the MMT world this is portrayed as the key driving piece of the economy and unemployment.

To further prove that the deficit does not drive unemployment just imagine if we redistributed private sector savings across the economy. Is there any doubt that the wealthiest 400 Americans, with a net worth of $2.3T in 2014 could afford to employ the 9 million unemployed? The top 10% of earners in the USA earned over $1.1T last year. If the highest earning Americans simply chose to hire all of the unemployed there is no doubt that they could afford to do so in perpetuity given the proper level of redistribution. The most basic factual data proves that a key MMT concept is demonstrably false. Unemployment is not a function of small deficits as much as it’s a function of a lack of private sector investment and a problem of wealth distribution. But MMT goes out of its way to misconstrue both the accounting and the operational facts. Thankfully, some basic data debunks such thinking.

By defining “net saving” as (S-I) MMT confuses traditional economics which defines net saving as net disposable income less final consumption expenditure. When MMTers talk about “net financial assets” and “net saving” they are referring to financial savings net of domestic real investment by the private sector. It is not remotely close to representing household savings. By netting this huge quantity of private sector assets they are netting most of the cornerstone assets in our economy such as real estate, corporate stocks, corporate bonds, etc. When we think of “saving” in this sense we marginalize the two most important sources of private savings:

  1. Surplus from investment.
  2. Market value of existing assets.

The MMT view is a useful concept for understanding the importance of risk free assets and especially for discussing the value of government liabilities relative to the economy, but MMT has a tendency to take this conversation out of context and imply that the private sector is producing assets that are necessarily less safe or less important to the monetary system than government issued assets.  For instance, MMTers sometimes say things like “the national debt is the equity that supports the entire global credit structure”.  This is problematic for several reasons. First, government debt is, within the scope of the “global financial system”, an asset and liability that nets to zero. It is not properly referred to as “equity”. Second, this idea implies that government debt is the backbone of the economy when this cannot be logically true. After all, government debt is financed by private sector income.  Without a highly productive revenue generating private sector there is nothing special about the assets created by a government and it is literally impossible for these assets to remain valuable.

None of this means government debt and deficits aren’t important or that they can’t support the private sector economy. But understanding the context here and the relationship is of special import when understanding the economy. It would be more accurate to say that private sector net worth is the equity that supports the domestic economy and government debt can, at times, serve as a useful insurance instrument that supports that equity. But when we talk about “private sector saving” we should view the aggregate scope of assets instead of cherry picking the components that result in confusion and an unnecessarily government centric view of the world.

Standard MMT response to Myth #4: “Deficits add to demand.” 

CR response: Deficits do not always add to demand. If this were true then printing money in a hyperinflation would improve the economy when the problem of a hyperinflation is a decline in the currency generally because the demand for currency declines. In reality deficits can at times exacerbate problems in the economy. Generally speaking, when an economy is operating above capacity deficits would only contribute to inflation whereas when an economy is operating below capacity deficits can add to demand and output. Of course, “capacity” is a moving target and could deteriorate in an environment in which a government is running a deficit. In this case a deficit could actually contribute to inflation and exacerbate private sector woes. But the key point here is understanding that deficits are not a permanent panacea. It is better to argue that deficits, can at times, add to demand and benefit the private sector.

MYTH # 5: MMT is a Post-Keynesian School

REALITY: MMT Agrees With Some Elements of Keynesian Economics, but is Closer to Marx

Over the years MMT has been associated with the Post-Keynesian school of economics which is a school that aligns itself closely with the original views of JM Keynes.  Keynes, however, would not have agreed with much of MMT.  As MMT co-founder Bill Mitchell has stated:

“There are MMT proponents, who while sympathetic with much of Post Keynesian theory, disagree on key propositions – specifically relating to debt and deficits (as an example). But then they also point to Keynes’ work as seminal in the development of MMT. My own view is that many of the important insights in Keynes were already sketched out in some detail in Marx.”

Keynes was a harsh critic of Marxian Socialism:

“Marxian Socialism must always remain a portent to the historians of Opinion – how a doctrine so illogical and so dull can have exercised so powerful and enduring an influence over the minds of men, and through them, the events of history.”

Of primary importance here is the Keynesian views on budget deficits, the role of the state and monetary policy.  Keynes felt that a budget surplus should be run in good times while a deficit should only be run during weak economic periods.  This is antithetical to MMT.  Keynes was also a free market proponent who felt that the economy operated most efficiently when it fed the investment needs of entrepreneurs.  Lastly, Keynes was quite open-minded about Monetary Policy and its efficacy.  MMT disagrees with large elements of each of these views due to its Marxist leanings.  Although it has similarities with some Keynesian views MMT is a theory that tends to lean more left of Keynes and often times closer to Marx than anything else.

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC.Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services.He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.
Cullen Roche

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