Is printing money bad for the economy? Well, it can cause inflation, devalue a currency and have adverse impacts for investments.
But there’s an “unorthodox” macroeconomic theory that has gained popularity called Modern Monetary Theory, also known as MMT, that challenges the traditional way we think about how the economy works: Government spending is financed through taxes and debt issued through government bonds and that we should work toward reducing the national deficit.
MMT has been widely talked about by economists, politicians and the media and has been met with controversy as there are different interpretations of the theory.
We may not be in an MMT economy yet, but since this theory continues to gain momentum — and now that the national debt is larger than the economy — it’s meaningful to understand the theory’s elements and how MMT’s effects would impact investors:
— What is MMT?
— MMT principles in action.
— What MMT means for investors.
What Is Modern Monetary Theory?
Modern Monetary Theory was pioneered by American economist and theorist Warren Mosler in 1992, along with Bill Mitchell, a university professor based in Australia and a key developer of the theory.
MMT argues that nations with the ability to produce their fiat currency can issue as much money as they need, and as a result, they have no pressures when it comes to financing. In other words, the government cannot run out of money and it essentially has no financial constraints. While the government should have a budget, under this theory, the government doesn’t necessarily have to worry about the deficit because it can fund projects by printing new money from its central bank.
“The idea is that under MMT, because the U.S. has the dollar, it would no longer have to borrow money; it could just print it,” says Andy Snyder, founder of Manward Digest, a column that discusses macroeconomics in Baltimore.
If the economy is shrinking, Snyder continues, that printed money would go into the economy to stimulate it; otherwise, if the economy is booming, the government would not print as much money and “pull back via taxes,” if the economy gets overheated, Snyder says.
Supporters of the theory say printing fresh money and government spending won’t be a problem unless it’s not managed properly, leading to high inflation as a result. However, MMT proponents say inflation and consumer demand can be managed by cutting back on spending and raising taxes.
Tax revenues are not used for government funding under MMT, similar to when a business uses its revenues to pay for its expenses. Rather, taxes are used to control inflation. A widely disliked tax policy among many is increasing taxes, which is why Snyder says the bearish case for MMT is “taxes never go up because they’re unpopular and inflation runs rampant.” But this is a fundamental principle of MMT: When there is too much demand in the economy, taxes must be raised to subdue demand.
MMT has been embraced by progressives, like Rep. Alexandria Ocasio-Cortez, who see MMT as a framework for increased government spending that could help finance initiatives such as the Green New Deal policy on climate change.
Stephanie Kelton, a professor of public policy and economics at Stony Brook University and a leading advocate for MMT, served as an economic advisor for Sen. Bernie Sander’s 2016 presidential campaign.
MMT advocates say that government should be responsible for setting economic policy, which is currently part of the Federal Reserve’s responsibility in mainstream economics. In MMT, however, the Fed would have less control in setting monetary policy and would primarily help fund the government’s debt.
But there are a number of economists who have been critical of MMT, saying rising deficits are dangerous because they push up interest rates and lead to hyperinflation, which could have adverse impacts on investment returns.
Fed Chairman Jerome Powell says, “The idea that deficits don’t matter for countries that can borrow in their own currency is just wrong,” and that, “decisions about spending are meant for you,” when speaking before the Senate Banking Committee in February 2019. Powell stressed that the purpose of the Fed, as the central bank of the U.S., is to maintain the stability of the financial system and to pursue full employment.
Legendary investor Warren Buffett is another stern critic of MMT.
MMT Principles in Action
Greg Weimer, partner at Confluence Financial Partners in Pittsburgh, says, “The optimist view of this (MMT) is putting money in the economy is a good thing.”
MMT has gained popularity throughout the years when a government has to step in to help relieve the economy in times of financial duress.
This was seen during the Great Recession: The U.S. faced critical financial hardship, where the government had to step in and take quantitative easing measures through government spending, cutting taxes and lowering interested rates to near-zero levels — all this to get consumers to spend more and stimulate economic activity. This swift action didn’t drive interest rates up, nor did it lead to uncontrollable inflation.
More recently, in March 2020, the government had an even deeper and larger-scale response compared to that of the Great Recession in response to the global health crisis. Federal authorities used fiscal policy to address the pandemic-induced recession through stimulus relief packages. The first was with the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, a $2.2 trillion economic stimulus bill signed into law in response to the economic fallout of the pandemic.
As a result of pumping a lot of money into the economy, there was more cash is in circulation — much of which was poured into the stock market. Throughout 2020, a lot of that money went into stocks and exchange-traded funds, in particular. This investing activity propped up asset prices, rising to valuations out of their fundamentals, and the stock market surged to all-time highs.
This financial support from the government, which could be seen as an expression of MMT, ultimately worked. “There’s a belief that this money is going to be spent over the next several years, and that’s why the market is doing so well in anticipation of all of this growth,” Weimer says.
The concern is, Weimer continues, that “in the future, is that going to create more taxes, will it create something inflationary. Those are the two longer-term problems people are worried about.”
What It All Means for Investors
Ludovic Subran, chief economist at Allianz in Munich, explains that there are different market behaviors between risk-tolerant versus risk-averse investors because of the way monetary policy is set.
“People who are rich enough to take risks are going to get richer, but if you want to save for retirement and have a safer risk profile because you can’t allow for big volatility, you will make less money because the 10-year Treasury is low,” Subran explains.
There has been seen a new generation of retail investors, which Subran dubs the “Robinhood generation,” who are buying up high-risk stocks. “It’s good that more people are in the financial market. The problem is how sustainable is it,” Subran says. “Monetary policy has been fueling volatile stock market investments over something less risky.”
The fear that some people have, Subran says, is that we are fueling riskier behavior by “pumping in yields in riskier assets” because investments that are supposed to be less risky like, government bonds, are not giving you much return.
Regardless of the long-term effects, Weimer suggests that for retail investors to come out on top, they need to keep investing in quality companies.
“Great companies will navigate through inflation or higher taxes, but if you have hyperinflation, it’s a headwind for business, and clearly if you have higher taxes, it would be negative for businesses,” he explains.
“Investors need to understand, asset prices are going up and this is going to continue,” Snyder says.
Despite investors thinking they can’t get in because the market has reached its peak, Snyder says investors need to weigh their risk and get in the market to combat inflationary pressures and prevent losing their purchasing power.
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Clarification 01/11/21: A previous version of this article was not clear that the Federal Reserve’s role is to maintain the stability of the financial system.