The Saturday Economist on Modern Monetary Policy November 2020
Earlier this month one of readers wrote in as follows ... what follows is our response
I'd like your opinion on something. I read a report this morning from one of our investment counselors that went into some detail on Modern Monetary Theory. What I understand is that it supports the printing of dollars to keep the economy going, no matter the amount of deficit spending.
Central Banks then become the buyer of the ensuing debt to prevent austerity measures from being put into place, and it continues until inflation becomes "an issue" which who knows what that number will be until the time comes.
Sounds like the closest thing to a free lunch since I became a wealth advisor 25 years ago. But I feel like there has to be an end game, doesn't there? What are your thoughts?
1 Theory …
A supposition or a system of ideas intended to explain something, especially one based on general principles independent of the thing to be explained …
2 Modern Monetary Theory …
Modern Monetary Theory suggests sovereign nations with their own fiat currency can print as much money as they need to because they cannot go broke or be insolvent … hence, for example, the US can sustain much larger deficits, than previous thought, without cause for concern.
3 Quantitative Easing …
Quantitative Easing (QE) is the monetary policy whereby a central bank buys government bonds or other financial assets in order to inject money into the economy to expand economic activity.
The central bank implements quantitative easing by buying financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets, lowering yield, increasing money supply and liquidity within the economy generally.
4 Modern Monetary Policy …
Quantitative Easing (QE) is the monetary policy whereby a central bank buys government bonds. The central bank implements quantitative easing by buying financial assets directly from the Government debt management office or issuing agent. The central bank acts as the “Buyer of Last Resort”. In the US the Fed is both the buyer and seller.
5 Dire Straits Economics : Money For Nothing Gilts for Free
In the UK, HM Treasury funds the government deficit by issuing gilts via the Debt Management Office. The Bank of England buys the gilts from the DMO. Any risk is underwritten by the Treasury. Any dividend or yield on the Gilts purchased by the Bank of England is remitted to the Treasury.
Of the £300 billion of gilts issues by the DMO in the current financial year, including roll overs, the Bank has purchased the majority (almost all) of the new issuance.
As the Governor of the Bank of England admitted this year, without central bank intervention, the Government would have had difficulty in getting the volume of gilts away. The government was confronted with a possible gilt strike.
6 One Man’s Asset is another man’s liability …
The liability owned by the Treasury, is an asset owned by the Bank of England. Both the Treasury and The Bank of England are owned by the British Government. At some stage in the future, a process of “intergroup consolidation” will ensure the long term debt, just like old soldiers, will just fade away.
7 A Critique ...
MMT is based on a rather quaint terminology about the “printing of money”. An increase in money supply should lead to an increase in inflation at some stage in the future if our economics 101 is correct. The velocity of circulation where MV = PT rules OK.
However, the inflation impact is mitigated. MMP funds government spending at a time of economic weakness. The output gap or rather the demand gap is generated as household spending and investment falls. Government spending is an endeavour to bridge that gap. The boost to output does not create an inflationary excess.
In any case, MMP has a slightly different impact. The impact of an increase in liquidity is exported into asset prices (and a deteriorating balance of payments deficit). As Andy Haldane Chief Economist at the Bank of England has stated, the process of QE has created “the greatest bond bubble in history.”
Asset prices rise, yields fall, the curve is distorted. The search for alpha pushes equities, property and alternative assets higher.
Logically the increase in liquidity should lead to currency weakness. However the Dollar, Sterling and the Euro are equally vulnerable to the process. Step up the renminbi as a “safe haven in a volatile world”. At some stage the money will move East. China is down-weighting Dollar exposure in its own international reserve portfolio.
8 It’s all About Credibility …
In July Fitch Ratings revised its outlook on the US credit score to negative from stable, citing a “deterioration in the U.S. public finances and the absence of a credible fiscal consolidation plan.” “High fiscal deficits and debt were already on a rising medium-term path even before the onset of the huge economic shock precipitated by the epidemic” it said.
In October, Moody’s lowered the UK’s sovereign debt rating by one notch to Aa3 from Aa2.
Domestic and International institutions will take note of the down grade but will understand any increase in risk is underwritten by the central banks in North America, UK and Europe. The prospect of debt cancellation in the future will provide further support in part to the underlying values.
If MMT was so easy anyone could do it. It is not clear the Governments of Argentina or the Weimar republic would be offered such largesse.
9 So what’s the end game?
Trapped on Planet ZIRP, interest rates on the floor, yields flat, asset prices pushed higher, the search for yield continues. The process of MMP, Modern Monetary Policy, continues. Inflation will not be the end game. This is not MMT or QE, it is important to understand the subtle difference.
Dollar weakness, the Euro not really a plausible substitute, Sterling swinging in the Atlantic vortex. Money will move East. The renminbi will find favour as Washington disapproves.
The Saturday Economist
John Ashcroft publishes the Saturday Economist. Join the mailing list for updates on the UK and World Economy.
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