Pragmatic Capitalism

Practical Views on Money & Finance

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 2011 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 for several reasons. 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.

In retrospect I should have known better than to trust a theory that very few mainstream economists trust, but mistakes are only mistakes if we don’t learn from them. I have attached some links here to critiques as well as a brief overview of my own thoughts that will help others avoid the mistake that I made. The following critiques are notable primarily because they’re by other Post Keynesian economists (MMT is a subset of Post-Keynesian Econ). 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. A Critique of MMT, by Cullen Roche
  2. MMT, The Emperor Still Has No Clothes, Thomas Palley
  3. The Monetary and Fiscal Nexus of NeoChartalism, by Marc Lavoie
  4. MMT and the Real World Accounting of 1-1<0, by Brett Feibiger

Here’s a shorter version of my verbose paper:

1)  MYTH: MMT states that 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.  The state, just like all issuers of money, must be able to to find willing holders of its liabilities which means that, for all practical purposes, it most certainly funds the liability side of its balance sheet.

2)  MYTH: 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.

3)  MYTH: 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:

[Unemployment is] “due to the refusal or inability of a unit of labor … to accept a reward corresponding to the value of the product attributable to its marginal productivity,”

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.

4)  MYTH: MMT says that “taxes drive money”

REALITY: Private output “drives money”

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. 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. As mentioned above, 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.


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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