Explaining what is wrong with Magic Money Theory [MMT]

This was from Beachcomber in the comments:

Hi Steve, I just read a fascinating essay by Peter Smith at Quadrant: Money printing in the age of Covid

In the essay it states:

In the age of COVID-19, bonds sold to finance deficit spending are being largely or wholly bought up by respective central banks. This is manifest in banks’ holdings of deposits with their central bank and of treasury notes or bills.

In comments the question is asked as to from where the “central bank” garners the money to buy the bonds.

To which Peter Smith answers:

It creates it out of thin air cos it can.

The central bank simply issues a cheque or like instrument, drawn on the central bank, which allows the holder of the bond (assume it is a non-bank – the process is short-circuited if the holder is a bank) to lodge the cheque in its bank account. The bank correspondingly lodges the cheque with the central bank and sees its deposts with the central bank increase accordingly. The central bank now has an asset – the bond – and a corresponding liability – the bank’s deposit. It can go on doing this till the cows come home. Or, practically speaking, until inflation rears its ugly head.

Is this true? Can this continue forever? With shrinking incomes and the associated shortage of money supply, inflation seems unlikely. Peter Smith makes a distinction from Modern Monetary Theory without explaining how it is different. Can the creation of money from nothing by the Government continue forever? If so, then Andrews can reign forever!

First, if there is an authority on the banking system in Australia outside and beyond the reach of government, it is Peter Smith. He was, when I first met him, the economist for the Australian Bankers’ Association, then became the Chief Economist for the State Bank of Victoria and finally was the first Chief Executive for the Australian Payments Clearance Association. No one gets this stuff better than he does.

But let me buy into this because this is part of my expertise as well. And to follow this with any understanding you have to divide the economy into two halves. On one side is production, the actual goods and services produced, which also includes the production of inputs into the production process, such as iron ore and natural gas.

And on the other side there is the monetary side of the economy which is completely distinct. This comprises:

  • money as a medium of exchange, say a $100 note, but represents the value of goods and services so that we can sell what we produce to buy what others produce
  • money which we set aside as a store of value, such as bank accounts or superannuation savings, and
  • money which we use as a unit of account so that businesses can calculate how much things cost to produce so that they can determine what to charge so that they can calculate whether they are making a profit.

And it should be emphasised that only profit-making businesses create more value than they use up in production. Loss-making enterprises – which include virtually every activity run by governments – slow the economy, using up more value than they create. Loss-making enterprises cause the economy to contract. Only if there are other enterprises making profits – almost always private sector enterprises – can the economy expand. Without understanding that, you cannot understand the first thing about how an economy works.

Creating more money does NOT create productive resources. Giving more money to governments, or allowing them to print more money out of thin air, lets governments spend on non-productive activities which they inevitably do. Spending more on non-productive activities means less is spent on productive activities.

And adding to the problems, when the government expands the volume of money by just printing the stuff up, they undermine each of the uses money has: as a medium of exchange, as a store of value and as a unit of account. The economy can no longer be run as productively as it might have been and often even leads to a fall in real income across the entire community.

Virtually no politician I have ever met has understood this. Virtually no political leader I see in the news today understands this. All of the others are Keynesians now, who believe the mere spending of money creates jobs, growth and higher real earnings. On this they could not be more wrong.

We will be paying for this ignorance for a very long time to come.

Mostly empty (MMT)

There are a lot of cranks in economics, and it only gets worse all the time. I have been sent a copy of this editorial in The Oz yesterday which is a reminder of just how off the rails economists are: The promise and pitfalls of Modern Monetary Theory. The final para:

MMT certainly has theoretical appeal, even for rational, hard-nosed economists. It’s axiomatic there is no budget constraint in such a model. But we live in a complex, even messy world. Imagine telling a populist National, a clueless Green or a Labor class warrior there is no spending limit. How can you hope to manage the economy? … As an analytical tool the theory has merit. But with printing money in the real world, there is a day of reckoning or just a long stagnation. Our income can never be guaranteed, so we need to earn and pay our way.

They seem to come down against it, but only just, and hardly in a way that might alert you that any genuine application of MMT will wipe out cash-denominated savings, along with driving our economy into a wasteland of unproductive outlays. Living standards would be guaranteed to crash. Yet with government debt that way it is everywhere, why not just print the stuff up. No political leader lasts for ever. Leave things to the next lot to fix.

Economists once understood what the problem with such an approach actually is, as discussed in my Classical Economic Theory and the Modern Economy. As discussed at length within the book, until 1936 economists always first thought about the real economy and then, but only then, brought in money at the end. Here is the turning point in economic theory. From The General Theory itself where the approach taken by Mill is to examine the issues in relation to commodities and not money.

In J. S. Mill’s Principles of Political Economy the doctrine is expressly set forth:

What constitutes the means of payment for commodities is simply commodities. [That’s Say’s Law, by the way.] Each person’s means of paying for the productions of other people consist of those which he himself possesses. All sellers are inevitably, and by the meaning of the word, buyers. Could we suddenly double the productive powers of the country, we should double the supply of commodities in every market; but we should, by the same stroke, double the purchasing power. Everybody would bring a double demand as well as supply; everybody would be able to buy twice as much, because every one would have twice as much to offer in exchange. [Principles of Political Economy, Book III, Chap. xiv. § 2.]

Contemporary economists, who might hesitate to agree with Mill, do not hesitate to accept conclusions which require Mill’s doctrine as their premise. The conviction, which runs, for example, through almost all Professor Pigou’s work, that money makes no real difference except frictionally and that the theory of production and employment can be worked out (like Mill’s) as being based on ‘real’ exchanges with money introduced perfunctorily in a later chapter, is the modern version of the classical tradition.

I might add that money was hardly introduced “perfunctorily”. Mill even explicitly states the quantity theory of money. Virtually no one today any longer thinks in real terms. In fact, virtually no one, especially economists, even know how to think in real terms – they think they do but they don’t. It’s why they are incapable of understanding even the basics that were once universally taught and understood. That is why our economies are heading straight for the rocks.

“The best way to destroy the capitalist system is to debauch the currency”

Can you guess who said that?

Something that I have focused on in my Classical Economic Theory and the Modern Economy, but which is an otherwise unknown consequence of the Keynesian Revolution, was the shift in emphasis from the real side of the economy to the monetary side. If one is to understand the operation of an economy it is essential firstly to look at the actual real level of activity and only then look at the monetary side that lies above it and largely outside of it. Every classical economist understood the point. Virtually no modern economist does, and certainly no one without a serious study of economics ever does, which really does mean that near enough no one at all any longer understands this even slightly. Which leads me to this: Pandemic moves Modern Monetary Theory from the fringes to actual US policy.

[Modern Monetary Theory (MMT)] has received increased publicity over the past three years as politicians realized there was not a plausible plan to raise the funds necessary to fund “Healthcare for All,” the “Green New Deal,” free college and other initiatives through taxes alone.

The core principle of MMT is that sovereign governments with sovereign currencies can “print” or “coin” money to support full employment or essentially any government program that would benefit society in the here and now. Critics have labeled it the “Magic Money Tree Theory.” Those detractors include Keynesian and Monetarist economists, who cite Hungary in the 1840′s, Brazil in the 80′s, Mexico in the 90′s as examples of where easy money policies led to hyperinflation.

Warren Mosler was one of the founders of MMT, and what is known as `Mosler’s law’ states: “No financial crisis is so deep that a sufficiently large increase in public spending cannot deal with it.” These words fundamentally represent the actions our policy makers have taken in response to the virus. This pandemic has moved MMT from the fringes to the dead center as the actual monetary policy of the United States.

These are people with PhDs in economics who will comprehensively ruin us, and on this let me quote Keynes with absolute approval:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth….

As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

It was Lenin who said it, but quoted by Keynes as a warning to us all. Are you that one in a million who sees the point? Well if you are, there are then the other 999,999 who do not, which includes every single political leader heading every single government across the Western world today, each one of whom is engaging “all the hidden forces of economic law on the side of destruction”.

These socialist loons are completely mainstream

Start with this, from the New York Times: Modern Monetary Theory Makes Sense, Up to a Point. It begins:

The term “modern monetary theory” has been talked about so much lately that we mainstream economists need to try to understand it.

We’re having trouble, though I’m beginning to suspect that it may be because M.M.T., as it’s often called, is really just a voguish name for a group of old and, for the most part, sensible ideas, repackaged in a new form.

And just what are these old ideas in a new form?

Because there are great opportunities for government investment at the moment and interest rates are low, these programs should go forward with deficit spending. Once again, this is a conventional argument: It makes sense to spend when the return on government investments exceeds the borrowing rate.

These are reasonable ideas. They are not always expressed in ways that are appealing to mainstream economists, however, so it’s not surprising that two Harvard economists recently wrote articles severely criticizing modern monetary theory. Kenneth Rogoff did so in “Modern Monetary Nonsense,” while Lawrence Summers wrote, “The Left’s Embrace of Modern Monetary Theory Is a Recipe for Disaster.”

I wouldn’t be that harsh. It seems that modern monetary theory is not so much a recipe for disaster as it is a not entirely original series of ideas that are not well defined or well integrated, and whose implications have been exaggerated.

Entire fields of study in economics departments are devoted to grappling with some of these problems. For a serious examination of issues concerning public debt, for example, consider the classic 1979 study “On the Determination of the Public Debt,” by Robert Barro of Harvard.

Professor Barro said, in essence, that the government faced time-varying expenditure needs and, optimally, could attempt to keep tax rates constant by varying borrowing. Then there is the 1936 opus of John Maynard Keynes, “The General Theory of Employment, Interest and Money,” which prescribes countercyclical deficit spending to stabilize the economy.

Demonstrating once again that pretty well the whole of modern textbook theory is junk science. Paying attention to almost any of it will drive your economy off course and into the sand.

Which brings me to this: Beto O’Rourke Goes Full Socialist, Says He Will ‘Break Apart’ American Wealth.

He may be a far left nutter but is centre stage among Democrats. As dangerous as he is ignorant, but when did that ever stop a politician from succeeding?


That’s MMT, Modern Monetary Theory. I am just following behind a thread at Instapundit: NASSIM TALEB IS NOT PUTTING UP WITH YOUR BULLSHIT: which began with this:

It’s this Stephanie Kelton who is the focus here, another economic tragedy in the making. Never heard of her, but the comments thread quickly brought out everything you need to know.

Stephanie Kelton is the proponent of Modern Monetary Theory (TL; DR: we can just print more money and tax it all back if inflation gets to high.) Even Paul Krugman thinks it’s off the wall, leftist, la la land thinking that could completely screw us all.

She’s a Professor. People actually pay her

She’s a fancy professor at Stonybrook. LOLOL. That’s like young adult day care – not a college.

Not just a professor, but a professor of economics. And economic advisor to Congressional Dimocrats.

She’s Bernie Sanders Chief Economics adviser. Of course. He’s the dumbest man in America

This is even more enjoyable when you click through to find out who he is pwning. Kelton is someone who ought to know better but makes a living pretending she does not: Prf. of Economics & Public Policy @stonybrooku.

Was Chief Economist for the Dems on U.S. Senate Budget Committee.I have an old video clip of her making the case that the government can never go broke because it is the source of money and thus can print all it needs. The Weimar Republic could not be reached for comment.

She said “you take it from your workers.” The exact opposite is true.

Somehow she missed the lesson on mutually beneficial exchange. And yet she is ‘Chief economist for the Dems.’ Go figure.

She is actually probably slightly above average in intelligence. That’s the kind of person who becomes a lefty. People significantly less intelligent than average are suspicious of clever ideas, because they think (quite rightly, as it turns out) that nobody would propose them if they weren’t more advantage to the proposer than the proposee. They’ve been snookered plenty by bright people and clever schemes, so they have a basic enhanced animal wariness. People significantly more intelligent than average are deeply skeptical of any social enterprise, because they expect it to be executed incompetently (by their own standards) and degenerate into parasitism and failure. The people who love social schemes are just smart enough to dream them up, smart enough to be dissatisfied with the status quo, but not smart enough to be wary of the unknown unknowns, the unanticipated side-effects, the limits of the ability of plain smarts to accurately predict the future.

Being educated doesn’t mean you’re not stupid. It means you’re not ignorant in the things you were told to repeat to get passing marks in class.

Well, our cultural values are kind of screwed up that way. We value raw intelligence far more than we should, and value character far less than we should. The world doesn’t need that many Einsteins, and having a surplus of them won’t do anyone much good. But it has an endless need for men and women of good character.

There’s no creationists running biology departments.
There’s no flat earthers running geography departments
So why are there marxists running economics departments?

I thank her for writing the most succinct summary of the socialist fallacy that I’ve ever seen.

That last one is from “Aussie Pundit” (not me).