(Updated in 2022 for entity valuation changes).
This will be a short post about MMT, a relatively new theory of economics that claims mainstream economics is all wrong. They claim to describe the monetary system more accurately than traditional economics. But in reality, MMT distorts the actual way the monetary system works in an effort to promote a theory of economics that is not grounded in facts and has never actually been tried.
The following are two demonstrable flaws in the theory.
1) MMT Misconstrues Government Entities and Government Funding.
MMT advocates often claim to be describing economic reality, but the theory is actually a series of carefully crafted distortions based on generalizations and unorthodox terminology. For example, MMT people claim that taxes “destroy” money and government spending “creates” money. They also argue that government bond sales are unnecessary and that the government does not need to get money from the private sector in order to spend money.
Parts of this are true and parts of this are misleading. The government has a printing press and could theoretically just credit people’s accounts when they spend. The government doesn’t need to sell bonds to do this. But that does not mean the government doesn’t rely on taxation to maintain purchasing power. After all, most domestic output is created within the private sector and that process generally starts with bank lending. Bank lending is independent of government and does not require prior government spending. Therefore, when the private sector creates loans/deposits it uses these deposits to create and mobilize resources the government did not create.
MMT people like to say “resources constrain government spending”, but conveniently leave out the fact that most resources in the economy are mobilized by the private sector. Therefore, the government has more spending capacity when the non government creates resources. Economic “resources” include things like land, labor, capital and technology. When the private sector mobilizes resources the government has more funding because they’re able to tax and redistribute some of those resources and value creation. Importantly, this is often endogenous value creation and that value creation gives the government greater purchasing power than it would otherwise have.
For example, when Bill Gates created Microsoft he created an innovation that transformed the world. He raised money from private investors to fund Microsoft’s investments over time and this has grown into a $2.5 trillion dollar firm with 200,000+ employees. This is wealth and value that was created endogenously within the private sector and all of that wealth and income is potentially taxable by the government. It is wealth and income that would not otherwise exist. When the government taxes this wealth they are obtaining purchasing power they would not otherwise have. In other words, Microsoft’s value creation provides purchasing power for the government and that purchasing power is obtained via taxation (and redistribution) of these pre-existing resources.
Or, let’s use a more concrete example of spending and taxing in the USA. As of 2022 the US government spends about $6T per year. About $4T of that comes from taxing existing income and assets. The other $2T comes from printing money (running a deficit). That $4T is money/value that already exists and is merely being redistributed and much of that value is created endogenously in the private sector. Of course, MMT would say that the government had to create the money before it could be taxed, but the government did not create most of that money and value. Most of that money and value was created endogenously in the private sector and the only reason the government can tax it is because the private sector invested in real resources that gave them value. The government can also deficit spend so MMT is correct in saying that the US government doesn’t have to “pay for” all its spending $ for $, but they’re wrong in saying that the government doesn’t tax to fund spending.
The conclusion here is simple – the government absolutely funds itself from taxes because taxes often reflect the transfer of existing private sector created assets. Yes, the government also has a printing press and can spend without taxing, but taxation reflects the transfer of pre-existing value. The government does not need Microsoft to be able to spend, but the domestic government that can tax Microsoft has a much stronger purchasing power position than governments that cannot tax such value. So, while the government doesn’t necessarily need taxes to spend the government has more purchasing power when the private sector builds a large resource base that the government can then tax. The US government doesn’t have more purchasing power than Somalia because they have different printing presses. The US government has more purchasing power because its private sector creates trillions of dollars of resources every year that the government can then tax and redistribute.
MMTers sometimes respond to this by claiming that taxes are settled with reserve balances in the Treasury General Account and if you consolidate the Fed into the Treasury then this “destroys” the money. This is extraordinarily misleading. First, the Fed and Treasury are specifically independent entities for specific reasons. Once you consolidate them you can’t claim to be describing reality. Second, reserves only exist because we have many private banks. Reserves come after banks by definition and banks only obtain them after loans are made. The government cannot destroy bank deposits in aggregate because the government did not create the deposits in the first place.
More importantly, this is irrelevant to the concept of funding and endogenous value creation. The bottom line is that the private sector creates most of the resources that make government spending viable in the first place. It is incoherent and contradictory to say taxes don’t fund spending and resources constrain spending when the government obtains purchasing power in large part by moving private sector created assets to public domain via taxation.
MMT advocates often reply to the private bank aspect of this by saying that banks are “agents of the government” or that banks need to get a government license first. This is another distortion. Banks are privately owned and operate on behalf of shareholders, not the government. And getting a license doesn’t mean the government creates all the bank deposits. That’s like saying the government creates all the cars in the world because they require automakers to obtain a manufacturing license first. Further, this is also irrelevant to the conversation. If all banks were nationalized the government would still be reliant on its private sector to create resources via the loan creation process so that it could tax some part of that resource value and spend.
I suspect what happened here is that MMT academics started using the consolidated Fed and Treasury view claiming this “destroys” money. And if taxes are destroyed then they cannot fund spending. But in reality the government cannot destroy the value of assets it did not create and they actually rely heavily on being able to redistribute that value. And it can only redistribute that value by taxing and spending it. Unfortunately, this narrative adds nothing to MMT and if they dismissed it it would not discredit the broader theory. MMT advocates could say taxes fund spending and that would be wholly consistent with some of their broader policy objectives. But instead of correcting this false narrative over time they’ve continued to promote it and that gives the appearance that MMT is spreading misleading narratives based on rhetorical and accounting tricks.
In short, MMT’s description of government funding is based on misleading consolidations and accounting that misconstrues the purpose of the instruments in the system.
2) MMT is a Wholly Untested Set of Policy Ideas.
MMT advocates claim that MMT just describes the existing monetary system, but in reality MMT is a policy idea based on theoretical descriptions. The core theoretical aspect of MMT is grounded in what’s called a “buffer stock of employment”. All modern economies use a buffer stock of unemployment. MMT theorizes that the government causes unemployment and therefore it is the only entity that can provide full employment. Therefore, in the MMT world everyone would be given a government Job if wanted. This is not merely a “description” of how the modern system works. It is a theoretical idea based on several controversial claims such as:
- The government is the currency monopolist. In fact, banks create deposits which are functionally equivalent to currency.
- The private sector can only net save in government assets. In fact, the private sector mostly net saves against itself.
- A lack of government assets and spending causes unemployment. In fact, a lack of private investment and high inequality cause unemployment.
MMT is an entirely different theory of understanding and managing the economy. And the theory argues specifically in favor of a buffer stock of employment approach grounded in the theoretical idea that the government causes unemployment and must therefore provide full employment. This is not just a theoretical description of how the monetary system works – it is something that has never even been tried in a developed economy!
Importantly, the Job Guarantee is not just a policy add-on. It is the essential conclusion from their theoretical description of the system. There is no alternative to a JG for MMT advocates because once you understand the MMT idea that the government causes unemployment then there is no alternative but to implement a JG. It is not an optional policy idea, but an essential component that stems specifically from their controversial description. People who think MMT is merely descriptive do not understand that it specifically describes that a buffer stock of employment is optimal and that a JG is a direct conclusion from understanding how MMT describes the world. And we should be clear – it is controversial at best to conclude that the government causes unemployment.
Make no mistake – MMT is not an accurate description of the modern financial system and it is not even a theory that has been tested. Strangely, however, its advocates discuss the theory as though anyone who disagrees with it does not know what they’re talking about. It’s hard to understand where this confidence stems from given that this sort of macroeconomic framework has never been implemented in the developed world.
In short, MMT is a new and interesting theoretical perspective of the economy. But we should be clear – this theory does not correctly describe the modern economy and it has not been fully tested. It has not earned the credibility its adherents often claim and parts of it are demonstrably false at best.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.