In the late 1960s Milton Friedman clarified his famous quip by stating that “In one sense, we are all Keynesians now; in another, nobody is any longer a Keynesian.”
In the first part, we are all Keynesians because the government’s out of control spending has forced us to be. In the latter sense, we are not Keynesians because that spending has decimated our financial well-being. Modern Monetary Theory (MMT) is essentially an offshoot of Keynesianism in that government can spend ad nauseam and commensurately print money without any ill effect. With the historic inflation we are now experiencing, MMT has been thoroughly repudiated. MMT is dead–it must now be buried.
In his basic economic textbooks, Professor Paul Krugman preaches Keynesianism. He teaches students about a government spending multiplier. In his fairy tale, the government spends a dollar and the economy grows by more than a dollar. The student’s first question should be: Where does that dollar of spending come from? The student’s next question should be: If this mystical multiplier were in fact real, then why not spend and spend and spend? The answers are straightforward and form the basis of the repudiation of MMT. A dollar of government spending must come from a dollar of taxation, at some point. On the second, the federal Government believed in both Krugman’s myth as well as MMT, and spent as much as they possibly could. Eventually, the inevitable ending came, and it was not a fairy tale.
If there were no discernible consequence to government spending, then the incentive for any government would be to spray money in every direction. Keynesianism, Krugman’s multiplier, and MMT all attempted to provide cover, and enable government to spend. It is simply impossible, and not in dispute, that at some point, that dollar of spending must come from a dollar of taxation. If there is a budget deficit, the government borrows dollars to make up the shortfall. The government mostly borrows dollars by issuing government bonds. To sustain its insatiable desire to spend money, and to not raise current taxes to unappealing levels, the government issues substantial debt.
In recent years, the debt to GDP ratio has crossed the 100 percent level and is now at a historic high. This creates numerous problems, not least of which is rising interest rates. If the government adds to the supply of bonds, the price should go down, and the yield (interest return) would go up. With that gargantuan debt, rising yields would force the government to spend even more on interest payments, resulting in all kinds of other negative effects on the overall economy.
Enter the magic of Quantitative Easing (QE) and MMT. The Government wants to spend, but not raise taxes too much. It then must issue debt, but not cause interest rates to rise. Well, the Federal Reserve can just step in and buy bonds! Sounds perfect – certainly to government officials who want to spend, and claim they are stimulating the economy. Even better, there is no real limit to how many dollars-worth of bonds the Fed can buy. Trillions upon trillions are possible. The Fed balance sheet rose by approximately $8 trillion over the past 20 years, with more than $4 trillion of that in the last two years alone. There is a crucial problem, and this is where MMT is used to obfuscate: When the Fed buys bonds, it is printing money.
It is a rather straightforward printing press. The Federal Reserve purchases a bond from a seller. The seller delivers the bond to the Fed, and the Fed hits a button to deposit money into the seller’s account. That money is created with a keystroke. The sound of this printing press is Enter-Enter-Enter, click-click-click. And just like that, in the last two years, the Fed “printed” $4 trillion new dollars. The Fed is also by far the largest holder of United States Treasury bonds – with a current balance sheet of more than $8 trillion. But MMT said this is not a problem, and for years and years it seemed to be correct as the Fed was growing its balance sheet with no discernible sign of inflation.
But there was inflation. It simply manifested itself in other places besides consumer prices. Inflation is a monetary phenomenon. It is basic math. If new dollars are added to the total supply of dollars, then the price of everything a dollar can be exchanged for must go up. That is just a mathematical fact – not an economic theory like a multiplier, or printing and spending ad nauseam. Dollars are added, prices in dollars go up. While the Fed was performing QE by adding to its balance sheet and printing dollars, the price of financial assets was shooting to the moon. We witnessed one of the greatest transfers of wealth imaginable to holders of financial assets, from the public at large. Ironically, many who promoted Keynesianism and MMT are the same who grouse the loudest about the wealth inequality that their policies directly caused. Bubbles are inflated with dollars. And since the implementation of QE was the cornerstone of Fed policy, that bubble was not in danger of bursting, because the Fed would simply buy more bonds, and print more money. MMT said it was okay.
Like water, though, money eventually finds its way and breaks the dam. With stocks and crypto and real estate headed to the moon, it was only a matter of time before all that money found its way to consumer goods. Inflation, as we commonly understand it, had arrived. It was mathematically pre-ordained, and yet still somehow unexpected. Historically high. We’re talking 1970s high. Family budget-busting high. Economic growth-crushing high. And all because of the failure to loudly ask and understand those two very basic questions: Where does the money come from, and if the theory actually worked, shouldn’t the government just spend infinite money?
Perhaps those in government simply did not want to ask or understand those questions. It was fun, for some, while it lasted. But it’s over now. Those questions need to be asked, over and over again. Because the answers are obvious, and clear, and indisputable. Sadly, so is the painful solution to our current inflation crisis. The government needs to dramatically reduce spending, and the Fed needs to unwind its balance sheet.
Weaning the government and the Fed off spending and printing will be a lengthy and agonizing process. And entirely necessary. Nobody should be a Keynesian anymore. Certainly not if the goal is to reduce inflation and have a growing, robust, and free economy.
Keynesianism, Krugman’s multiplier, and MMT have all been empirically, logically, mathematically, and thoroughly repudiated.
Dave Sukoff is an advisor to the investment management community and previously co-founded and ran a $500mm fixed income relative value fund. He is also the co-founder of a software company and inventor on multiple patents. Dave graduated from MIT, where he majored in finance and economics.
This article was originally published on FEE.org. Read the original article.