I Have an Issue with Modern Monetary Theory (MMT)
Gold Backed Monetary System Keeps our Banks in Check
Is there a benefit to being on the gold standard? Economists that subscribe to Modern Monetary Theory1 would say no. For them, on a gold standard, the economy is not flexible enough in times of crisis. The world went off the gold standard officially in 1971 with an event called the Nixon Shock2. It is worth knowing why we left the gold standard behind, and what we may now be missing as a result. This letter is a brief analysis of the two types of monetary policy (Gold Backed and MMT) and what each of them have to offer.
Modern Monetary Theory
First, I recommend that you read The Deficit Myth. It is a book authored by Stephanie Kelton, a leading voice in the debate around monetary policy in general. Overall it was a good book, but I take issue with many of the tenets of MMT. The book describes how our monetary system is currently structured. In this way, the book adds clarity to understanding government spending and central bank money printing. While the book does good job of explaining MMT, I still have some qualms with it. Let me explain.
Qualm #1: The Government is a Special Entity
I disagree with the notion that the government is a special entity with the power to issue currency. This is too large of a responsibility to place on any one group or entity. I grew up with the understanding that the government is made up of citizens. The people that make up our respective governments are citizens first, and public servants next. I don’t exactly see how our governments become special entities with the exorbitant privilege of manipulating the money supply if it is just made up of citizens.
For me, it is exactly this type of thinking that I think leads to government corruption, consolidation of power, and eventually abuse of one’s governmental privilege. Ultimately I believe the role of government is to protect the country and to administrate justice. There has never been a government that successfully managed the money supply before, and I don’t see why our governments in 2021 are any different. History may not repeat itself, but men sure do.
Qualm #2: Money can be Printed Infinitely
Instead of having our monetary policy set by rulers, I would much rather have them set by rules. The belief that central banks can infinitely print money is extraordinarily hubristic. Barring the fiat currencies currently in existence, there has never been a fiat currency that didn’t fail3. I find it jarring that the people running the central banks have not stopped to consult the history books when printing unprecedented amounts of money. Analyses of past empires will tell you that the fall of an empire coincides with that nation getting off a hard money standard4.
The cessation of being on a hard money standard takes place in several ways. All of which are pertinent to pay attention to in the context of the modern economy. The two most common ways a hard money system is debased is with coin clipping and inflation.
Coin Clipping5 - The practice of shaving or removing small pieces of precious metal from the coin, in order to sell that metal for a profit, and use the original coin at its nominal value.
Inflation - The expansion of the monetary supply, resulting in lower value per monetary unit. This typically results in relatively higher prices in goods and services.
Qualm #3: The Government Can Run a Deficit Year After Year
The government doesn’t work like your household. If you take on debt, you need to pay it back. If the government takes on debt, it is borrowing from its own central bank. It can always ask for more money, to pay the interest on the money it borrowed before. Running a deficit in a country is actually considered to be good politics, because it has an expansionary effect on the economy.
More government spending ideally means more social welfare, more development, and more investment. These are all positive things, but at what cost? If our economists and our central bankers are wrong about the government being a special entity, it means that one day the public will have to bear the consequences of borrowing money from the future. After all, isn’t any government only a sum of its citizens?
The Gold Backed Monetary System
A gold backed monetary system works differently than a fiat monetary system. For starters, each unit of currency is backed by some amount of gold held in reserves. We switched from gold and silver coins to paper long ago because paper is much easier to carry around than gold; especially in large sums. But what is the purpose of backing money with gold in the first place?
Gold Keep the Banks in Check
Having money backed with some neutral scarce resource, like gold, is the only way to keep banks in check. We came from a system wherein any bank could take gold deposits, and issue an IOU (paper bill) for the gold. If the public wanted their gold back, they could go to the bank and trade their IOU for gold. Then banks started practicing fractional reserve banking6. This is the practice of creating more IOUs than the bank’s existing gold reserves. Fractional reserve banking is how we end up with bank runs7, more people wish to get their gold than the financial system can handle.
You can then think of gold as the thing through which the public keeps the banks in check, especially the central bank which now has the sole authority to issue new money. If the public decided that the central bank was printing too much money, they had recourse to express their dissatisfaction. They could withdraw their gold from the bank, depleting the reserves. Now that we’re on a fiat standard, the public has next to no recourse for expressing dissatisfaction with the management of our monetary supply.
Giving The Devil (MMT) It’s Due
In all fairness, MMT has lead to a great expansion in innovation, and economic development. It is extremely useful for a country to be able to print their way out of a crisis where more money is required; COVID being the most peritnant example. We have arguably avoided suffering in the short term by printing and distributing money to people, and businesses.
I do wonder whether or not we should occasionally let things that fail, go ahead and fail. Take 2008 for example; the banks that were supposed to fail due to mismanagement of capital didn’t fail because of a bail out paid for by the central bank. While money printing is useful and can save a lot of pain, it may simultaneously be too powerful a tool for humans to wield responsibly.
Infinite Supply vs Finite Supply
When I am debating this topic with friends, they often point out that a monetary system based on a finite supply will never work. It won’t work because there are not enough units of currency to go around in the event of a currency shortage. This is only partially true.
The entire point of money is to measure the value of all goods and assets, and provide a medium of exchange to trade those goods and assets. If this is the function of money, then we can see a stark different between a scarce money system and a infinite supply money system. I will illustrate the example by comparing how these systems affect the net worth of individuals.
In an infinite money system, the supply of money can be expanded at any time. In order to determine your total share of the world’s wealth, you divide your net worth, by the total amount of money in existence (est. $100 trillion8). With an ever expanding money supply, your share can go down over time without your consent or control.
In a finite money system, the supply of money is static, and doesn’t ever change. In order to determine your total share of the world’s wealth, you divide your net worth, by the total amount of money in existence (21 million bitcoin). With a static money supply, your share can only go up and down by direct action taken by yourself.
Modern Monetary Theory serves socialist governments more than it serves individual people. Inflation sacrifices the wealth of individuals, in the name of the greater good of society. A gold backed system preserves property rights, gives the public an instrument for keeping power in check. As such, a gold backed system is more closely aligned with a libertarian attitude.
I tend to think that we can have our cake, and eat it too. By this I mean that I think it is possible to have mutually beneficial social outcomes, without central administration of those outcomes. Ancient Greece had a concept of Liturgy wherein it was expected for the wealthy to voluntarily give back to the community in any number of ways. Failure to do so would result in public disgrace and loss of favor. In other words, the public stopped respecting the rich if they were not giving back, ultimately leading to the depletion of their wealth.
I don’t have conclusive answers as to the direction that our respective nations should take their monetary policy. I only know that I now have the power to opt out of any wealth degradation due to inflation. I feel it is in my own best interest to do so. This is the latest from my journey of exploring modern economics, and I will continue to write on this topic as I learn more about how and why our economies function the way that they do.