This conceptual money-equals-debt identity allows Kelton to create what she calls the “hierarchy of money.” This is an ontology of money-debt ranked in descending order of acceptability based on liquidity and convertibility of one form to another. At the top of the pyramid are central bank dollars and Treasury bonds, because these are issued by the state. Next come bank deposits, because these are practically indistinguishable from central bank dollars due to the banks’ license to create credits to citizen accounts. At the bottom of the pyramid come corporate debt and household debt. While these debts are denominated in dollars, they are not equivalent to bank liabilities due to credit risk and illiquidity. The importance of this ontology is that it demonstrates, at least to the satisfaction of the MMT gang, that the concept of money is highly elastic. Literally anyone can create money in some form by issuing an IOU. It’s as if the Federal Reserve expanded its definitions of money supply from M0, M1, and M2, to include M4, M5, M6, and so on. It’s all money, all credit, and all debt at the same time.
Kelton is honest about the state coercion needed to make this system work. She writes, “Only the state, through its power to make and enforce tax laws, can issue promises that its constituents must accept if they are to avoid penalties.”18 She does not explicitly say penalties include property confiscation and imprisonment, yet her meaning is clear. State power is the root of state money.
MMT’s conflation of Treasury and central-bank functions leads to the heterodox conclusion that high tax rates can control inflation. The logic is that if money has value because it is accepted as payment for taxes, then higher tax rates make money more valuable because citizens need more of it to avoid prison. When money gains value, the effect on prices is deflationary. Kelton offers the example of the U.S. Civil War, during which the Confederacy had taxes equal to 5 percent of spending with 2,800 percent inflation, while the Union had taxes equal to 21 percent of spending with only 100 percent inflation, the implication being that high tax rates contribute to lower inflation. News from Gettysburg and Vicksburg might have more explanatory power for comparative inflation in the Civil War; Kelton acknowledges counterexamples to the thesis, but her point lingers.
MMT theorizing is not merely abstract; it is a means to an end. Once money is viewed as a double-entry bookkeeping exercise initiated by Treasury spending and backed by state power, there is no limit to the amount of money the state can emit. This means there is no limit to how much the Treasury can spend. If that’s true, there is no social problem, from poverty to infrastructure to education, that cannot be solved with more spending. The country does not get poorer when the Treasury borrows and spends, it gets richer, because Treasury spending becomes the wealth of the recipients.
Many MMT tenets are true, notwithstanding its muddled conflation of the Treasury and the Fed, and its dodge of the unseasonable truth that gold is one form of money that is not simultaneously debt. It is true that state power can proclaim the kind of money acceptable as payment of taxes. It is true that citizens may regard the declared form of money as money in order to pay taxes and avoid prison. It is true that a central bank and a treasury can work together, not as MMT describes it, but in a condition that former Fed governor Frederick Mishkin calls “fiscal dominance,” to monetize unlimited government debt and support unlimited government spending. Finally, it is true that government spending goes into someone’s pocket and enriches that individual or company by that amount of spending at least temporarily. All this is true, even obvious.
MMT analysis relies on the fact that the Federal Reserve balance sheet has no legal limit. From 1934 to 1945, the Fed could expand base money to a level that did not exceed 250 percent of the U.S. gold reserve. That 250 percent ceiling was repealed in stages from 1945 to 1965, in part to facilitate deficit spending by President Truman during the Korean War and President Johnson during the Vietnam War. The last vestige of a U.S. gold standard was abandoned entirely by President Nixon in 1971. In the absence of a gold standard, there is no limit on the amount of government debt the Fed can monetize. The Fed is also not subject to mark-to-market accounting. If the Fed buys government debt and interest rates later rise, the Fed is not required to record the decline in the market value of its bonds on its financial statements. The Fed is not subject to minimum capital requirements, nor is there a prohibition on negative equity on the Fed’s balance sheet. In a private conversation with a former member of the Fed board of governors at dinner in Vail, Colorado, I pointed out that the Fed was insolvent. She told me bluntly, “Central banks don’t need capital.” The Fed really does have unlimited capacity to monetize debt, as MMT proponents claim. This implies that the Treasury has an unlimited capacity to spend.
The problem with chartalism and MMT is not that the theory is wrong as far as it goes; the problem is that it does not go far enough. MMT fails not because of what it says, but because of what it ignores. The issue is not whether there is a legal limit on money creation, but whether there is a psychological limit.
The real source of money status is not state power, it’s confidence. If two parties to an exchange have confidence that their medium of exchange is money, and others regard it as such, then that medium is money. In times past and in various places, money consisted of gold, silver, beads, feathers, paper tokens, and diverse badges of confidence. At the height of the Zimbabwe hyperinflation in 2009, prepaid cell-phone minutes were a popular medium of exchange for citizens there. The primary forms of money among inmates in the Federal prison system today include postage stamps (a chartalist medium, as reckoned by Knapp) and vacuum-sealed packets of mackerel, called “macks.” At current exchange rates, three macks buys you a large bowl of banana pudding made by inmates with bananas stolen from the prison chow hall. The state does not support the mack/banana exchange rate; confidence does.
The difficulty with confidence is that it’s fragile, easily lost, and impossible to regain. The great failing of NKs, PKs, and MMTs is that they take confidence for granted. Reasons for ignoring confidence range from overreliance on quantitative models in the case of NKs, to overreliance on state power in the case of PKs and MMTs. As for the former, ignoring psychology because it does not fit neatly into quantitative equilibrium models is no less than willful ignorance. As for the latter, one need only consider the long history of failed states, the most prominent of which include Venezuela, Somalia, Syria, Yemen, and North Korea. Past prominent examples include Russia (1999), Nazi Germany (1945), victims of Nazi Germany (1939–45), Spain (1936–39), and the United States (1861–65). A comprehensive historical review would yield more failed states than still successful ones. State power is not absolute and it is definitely not permanent. To the extent a form of money in which citizens have confidence coincides with a state’s proclamation of that same form of money, the relationship is convenient, not causal.
At what point will everyday citizens lose confidence in the Federal Reserve and, by extension, the U.S. dollar? What is the invisible confidence boundary at which the intellectual failure of MMT becomes plain?
Between 2008 and 2014, the Fed printed $3.5 trillion of new money to deal with the global financial crisis. In the process, the Fed’s balance sheet ballooned from $800 billion to over $4.5 trillion. MMT advocates like Kelton claim citizen perceptions don’t matter, because citizens are forced to accept dollars to pay their taxes. They further claim politicians will not rein in the Fed because politicians are the ones who voted for the deficits and spending in the first place. History shows otherwise. As long as democracy is functioning, disgruntled citizens can vote for politicians with a credible plan to take control of the Fed and halt debt monetization. This implies an extreme form of austerity, but it may be far preferable to the alternative of complete ruin.
Conversely, if Congress continues running deficits and the Fed continues to monetize them, citizens have historically resorted to self-help by turning to alternative forms of payment such as gold, silver, or barter. Perhaps there is no historical recor
d of an all-barter economy, but examples of dentists and landscapers swapping services are legion. Of course, participants refuse to pay taxes on in-kind transactions, negating the state’s capacity to proclaim money.
MMT’s other blind spot in addition to confidence is money velocity or the turnover of money. Velocity is scarcely discussed in MMT literature. The omission may be a legacy of Milton Friedman’s incorrect assumption that velocity is constant. Only by ignoring velocity could Friedman suppose that maximum real growth was achieved by controlling the quantity of money. Only by ignoring velocity can the MMT crew wish away hyperinflation as confidence in state money erodes. The reaction function to lost confidence in one form of money is to spend it as fast as possible or acquire another form. This behavioral adaptation is the real cause of inflation, not money printing. Confidence and velocity are inversely correlated and together are the Achilles’ heel of MMT.
MMT has superficial appeal to the uninformed because it purports to offer a painless way out of the slow-growth, high-debt structural stagnation now afflicting the United States, Japan, and Europe. You won’t hear MMT advocates talk much about state power, tax police, or hyperinflation. Instead, MMT voices such as former PIMCO honcho Paul McCulley talk about the benefits to society if the Fed simply swaps its dollar debt for Treasury debt.
One voice that disagrees with MMT is the Fed itself. While the Fed may have no legal constraints on its ability to monetize debt, it recognizes political and psychological constraints. Current Federal Reserve chair Jerome Powell expressed these concerns in his comments during a Federal Open Market Committee meeting on October 23, 2012. At the time, he was a member of the Board of Governors. The minutes of that meeting capture his view of unlimited money printing:
I have concerns about more purchases ….19 Why stop at $4 trillion? The market in most cases will cheer us for doing more …. Second, I think we are actually at a point of encouraging risk-taking, and that should give us pause. Investors really do understand now that we will be there to prevent serious losses …. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road …. My third concern … is the problems of exiting from a near $4 trillion balance sheet …. We seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think.
Powell is correct when he says markets are much more dynamic than economists believe. This recognition by Powell, who will be Fed chairman until at least 2022, suggests the destructive portents of MMT may be well understood by those who matter most in monetary policy. Yet Powell’s alarm does not mean all is well. We are still left with the unpalatable choice of Eliot’s bang or whimper as explained by Reinhart and Rogoff—either a collapse of confidence in the U.S. dollar or decades of economic stagnation.
This poses a dilemma for investors. If the collapse of confidence comes, it will be expressed in the form of higher inflation as investors dump dollars for hard assets and money velocity skyrockets. On the other hand, if the future holds decades of stagnant growth, this suggests a deflationary period similar to the one Japan has suffered since 1990, following the collapse of stock and property values after a 1980s debt-fueled bubble.
Yet the conjurers of free money have another trick up their sleeves. Even as MMT is disputed, its advocates offer the allure of a guaranteed basic income.
More Free Money
For MMT economists like Kelton, free money is not an end itself; it serves a policy purpose with aims including infrastructure spending, health care, and education. The primary purpose proposed by MMT advocates is eradication of unemployment and underemployment. It is beyond the compass of this volume to describe the full scope of the employment crisis in the United States today, and to offer a comprehensive treatment of the proposals for remediation. This book focuses on the international monetary system, especially the future of the system’s dollar-based superstructure. As the dollar goes, so goes the real value of dollar-denominated investments in stocks, bonds, and hard assets. Yet the scope of the U.S. employment crisis is so great, and solutions so radical (radical in the sense of going to root causes, not in the sense of left- or right-wing extremism), an acute impact on U.S. fiscal and monetary policy is inevitable.
Real wages will be the dominant domestic policy issue in the 2020 presidential elections. A host of issues including tax cuts, budget battles, and debt ceiling debates will be seen for what they are—mere battles in a larger war to create higher paying jobs. In an earlier crisis, on the eve of a shooting war in the Middle East in November 1990, U.S. Secretary of State James Baker grew exasperated at the inability of the press to understand U.S. policy. At an ad hoc press briefing he blurted, “To bring it down to the level of the average American citizen, let me say that means jobs.20 If you want to sum it up in one word, it’s jobs.” Baker’s message is as relevant today in the midst of currency wars and trade wars as it was almost thirty years ago preceding the Gulf War. It’s jobs. Investors who do not grasp the importance of this will be blindsided by the solutions offered up by politicians and ultimately embraced by the voters.
The greatest official deception propagated by the U.S. government today is that the economy is at or near full employment. Of course, the U.S. government would deny that and insist on the accuracy of its reporting. The difference in views has to do with definitions. The U.S. Bureau of Labor Statistics’ report dated November 2, 2018, showed the official U.S. unemployment rate for October 2018 at 3.7 percent, with a separate unemployment rate of 3.5 percent for adult men and 3.4 percent for adult women. The 3.7 percent unemployment rate is based on a total workforce of 160 million people, of whom 153 million are employed and 6.1 million are unemployed. The 3.7 percent figure is the lowest unemployment rate since 1969. The average rate of unemployment in the United States from 1948 to 2018 is 5.78 percent. By these superficial measures, unemployment is indeed low and the economy is arguably at full employment. Still, these statistics don’t tell the whole story. Of the 153 million with jobs, 4.6 million are working part time involuntarily; they would prefer full-time jobs but can’t find them or had their hours cut by current employers. Another 1.4 million sidelined workers searched for a job in the prior year but are not included in the labor force because they had not searched in the prior four weeks. If their numbers were counted as unemployed, the unemployment rate would be 5 percent.
Yet the real unemployment rate is far worse. The official unemployment rate is calculated using a narrow definition of the workforce, limited to those with jobs or actively seeking work. But millions of able-bodied men and women between the ages of twenty-five and fifty-four are not included in the workforce. They are not retirees or teenagers, but adults in their prime working years. They are in effect “missing workers.” The number of these missing workers not included in official unemployment rolls is measured by the Labor Force Participation Rate, or LFPR. The LFPR measures the total number of workers divided by the total number of potential workers, regardless of whether those potential workers are seeking work or not. The LFPR plunged from 67.3 percent in January 2000 to 62.9 percent in October 2018, a drop of 4.4 percentage points. If those potential workers were added back to the workforce, the unemployment rate would be 10 percent.
Of course, there are limits to labor-force participation. Some potential workers suffer chronic pain or other disabilities, some are retired, some are students, some are at home raising children. Those are reasons why the LFPR has never been much over 67 percent since the data have been recorded. Still, the drop in LFPR to 62.9 percent in the ninth year of an economic expansion is stunning. America has a missing workers problem that accounts in large measure for the slow growth, persistent low inflation, stagnant wages, declining money velocity, and social dissatisfaction that have characterized the U.S. economy since the end of the last recession in June 2009. American labor markets are not tight. America is not even close to full employment.
America is in a depression.
What is striking about these depressed labor market conditions is the unanimity of opinion from left and right on how serious the unemployment problem is and what needs to be done. Compare the following description from Nicholas Eberstadt, a scholar with the conservative American Enterprise Institute with that of Pavlina R. Tcherneva, a scholar at the progressive Levy Economics Institute at Bard College. It is telling that Eberstadt and Tcherneva have both adopted the language of disease in describing the unemployment crisis in America. That’s appropriate in two respects. The first is the direct health consequences suffered by the unemployed and their families in terms of depression, alcoholism, disability, suicide, opioid use, and other less pernicious yet still serious disorders. The second, explored at length by Tcherneva, is the sense in which unemployment spreads like a contagious disease from town to town and county to county across America.
First, the conservative Eberstadt:
Economically, declining LFPRs and falling work rates have made for slower economic growth, widening gaps in income and wealth, greater budgetary pressures, and higher deficits and national debt.21 They have likewise increased the risk of poverty in the United States, not least for the children whose fathers are found in our huge army of men without work …. Americans may be the hardest working people of any affluent society in the world today, yet no other developed nation simultaneously floats such a large proportion of its prime-age men entirely outside the labor force—neither working, nor looking for work, nor doing much of anything else …. Social cohesion is a direct casualty of this development, and social trust could scarcely help but be degraded by it as well.
Now, the progressive Tcherneva:
While the national unemployment rate today has reached its precrisis level … this “success” is largely due to a mass exodus of people from the labor market after the Great Recession.22 After correcting for labor force participation rates before and after the crisis [scholars] estimate that there are approximately 20 million missing jobs today ….
Aftermath Page 19