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The Vices of the Modern Monetary Theory

Economics / Economic Theory Aug 01, 2011 - 04:37 AM GMT

By: Aftab_Singh


Best Financial Markets Analysis ArticleA few months back, I wrote about a virtue of the MMT; namely, the way it focuses on sectoral balances. I think that this view is both interesting and useful for the contrarian investor. However, I do have some misgivings with the convictions of the typical Modern Monetary theorist. Here, I discuss some of the problems with the MMT frame of mind.

For those that don’t keep a keen eye on the financial blog space, I should mention that there have been a few heated debates about the MMT lately. To name just a couple: Keynesianism (Krugman) Vs MMT & Austrian Economics (Bob Murphy) Vs MMT. Rather than repeating or refuting whatever was said in these debates, I thought I’d highlight a few issues that I have a problem with.

‘The US Government cannot default’:

Some advocates of the Modern Monetary Theory say that certain governments cannot default (in our modern fiat currency system). Stand-alone monetary systems (like the US one) – they say – imply that the government cannot default. They argue that there will always be a central bank to buy the government debt, and hence they can never default on their debt.

I have no problem with the premise; that is, that a Government has its central bank to buy its bonds. However, I have misgivings with the supposed implication. The reason is quite simple: Default on government debt is characterized by an inability to pay as well as a lack of willingness to pay.

Regardless of whether the US government has a potential buyer of new bonds or not, they might not want to pay. To say that – for example – the US will never default (insofar as the current fiat currency system persists), is to say that under all circumstances the US government will choose the printing press over outright default/restructuring. In January of this year, Robert Prechter highlighted something interesting related to this (video below). He mentioned that the US government is highly dependent on its short-term debt, and that – conceivably – the long-term debt could be given up in order to ‘save’ the shorter-term debt. In other words, rather than completely ‘breaking the government debt market’ by printing, the government could choose to let the long-end go in order to salvage the short-end. [start the video at around 15:45].

Cheerleading for ‘Net Savings’:

Advocates of the Modern Monetary Theory tend to use the notion of ‘private sector savings’ to push their policy prescriptions. They rightly say that the private sector’s ‘net savings’ (S-I) must equal the government sector balance plus the foreign sector balance (see here for the explanation). They then say that if you advocate the private sector improving its ‘net savings’ then you must also advocate a concomitant increase in the government’s deficit.

The above is entirely true as far as it goes. That is, insofar as we take ‘net savings’ to be (S-I) and a desirable thing if positive, the above holds. However, this is somewhat misleading. ‘Net savings’ as is described here, is not ‘net abstinence from consumption’. Rather it is the dollar amount saved in excess of the dollar amount spent on investment. However, ‘net savings’ in this sense is not necessarily what people conceive of when they hear the term ‘net savings’, and it is not necessarily a desirable thing.

A pertinent example of this kind of peculiar labeling can be seen in Stephanie Kelton’s recent article on ‘What happens when the Government tightens its belt?‘. She uses crystal clear diagrams and accounting tautologies to demonstrate that the government sector and the private sector cannot both credit each other at the same time (on a netted-out basis). But her presumption is that this refutes Obama’s recent statement that:

[S]mall businesses and families are tightening their belts. Their government should, too.

After having outlined the accounting tautologies about the private, government and foreign sectors, she expresses her misgivings with the above statement by saying:

Wrong! When we tighten our belts, it means that we are trying to build up our savings. We do this by spending less. But spending drives our economy. Sales create jobs. So unless Obama has a secret plan to reverse three decades of current account deficits, the Government needs to loosen its belt when we tighten ours. If it doesn’t, then millions of us will lose our shirts.

First of all, let me say that I’m not a fan of Obama (or even government per se). Nevertheless, I’ll defend him as I think he’s been wrongly accused. As a matter of pedantry, I should mention that ‘Small businesses and families’ do not necessarily constitute ‘the private sector’. Moreover, although I think that Stephanie is on the right track when she says, “When we tighten our belts, it means that we are trying to build up our savings”, she is merely defining her way into her own solution: We are not necessarily trying to build up our ‘net savings’ as defined by S-I! Instead, we are trying to build up the stock of wealth that we acquire by abstaining from consumption. We are not trying to increase the degree to which we credit the other sectors (or, in other words, the degree to which we save dollars in excess of the degree to which we spend them on investment!). And even if we were trying that, it doesn’t automatically mean that we should fix the results so that we succeed. In other words, that doesn’t automatically mean that governments should increase their deficits. That would only be the case if recessions were an inherently unlovely and evil thing. Only if the premise ‘recessions should be avoided at all costs’ were universally valid, would this be a correct line of reasoning.

We Probably Need a Recession:

As I mentioned the other day, the whole problem that brings on a recession is that entrepreneurs engage in activities suitable for a richer and/or more abstinent society. The Austrian business cycle theory describes this process with extreme clarity. In fact, I find it hard to believe that some people take the time to understand it, and manage to subsequently reject it.

The problem lies within the structure of our monetary system. As Carroll Quigley described in Tragedy & Hope: A History of the World in Our Time (available at the book store):

This unique character in the American economy rests on the fact that the utilization of resources follows flow lines in the economy that are not everywhere reflected by corresponding flow lines of claims on wealth (that is, money). In general, in our economy the lines of flow of claims on wealth are such that they provide a very large volume of savings and a rather large volume of investment, even when no one really wants new productive capacity …

The reason why we can have recessions (i.e. revelations of ‘clusters of errors’), is that entrepreneurs – all at once – realize that they are wasting resources (that is, they are using relatively more valuable resources for the production of relatively less valuable resources). Recessions constitute a re-alignment of the structure of production to meet reality. That is, they are the means by which the diverging patterns between wealth itself and ‘claims on wealth’ can be corrected. In this way, they should be embraced rather than feared.

All this being said, I do not advocate any particular circumstance (recession or whatever else), all I advocate is the universally valid truth that people own themselves and their own stuff. This truth should not be ignored (which it is when government is called in to do anything other than protect private property rights).


I certainly admire many of the insights of the MMTers, however I believe that some have strayed off track in a few of their value judgments. I have no bone to pick with their accounting tautologies as such, rather only the way in which they associate such identities with common concepts (such as ‘net savings’).

[For a more thorough refutation of Chartalism, see Pater Tenebrarum's excellent article here.]

Aftab Singh is an independent analyst. He writes about markets & political economy at .

© 2011 Copyright Aftab Singh - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2015 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Tom Hickey
02 Aug 11, 17:52
MM Theory

1. The MMT economists have consistently said that the US cannot be forced to default due to inability to meet its dollar obligations because it holds a dollar monopoly. That have also consistently said that the US can be forces to default due to voluntary (politica) restraints that have been imposed by rules like the debt ceiling and the rule against Treasury overdrafts at the Fed. Imposition of such rules does not alter the fact that the US always "afford" to meet its operations operationally as the currency sovereign monopolist. Default must result from a political decision that is based on unwillingness to pay.

2. As you say, theoretically MMT is impeccable. This theory leads to a set of policy options that are feasible under the current monetary regime. Political decisions are largely value judgments, as you also say. However, value judgment should have a rationale. You propose the Austrian solution of "liquidating malinvestment" at the end of a business cycle. MMT points out that this is not a business cycle recession but a potential depression coming at the end of a long financial cycle that culminated in Ponzi finance. The danger of forced liquidation at this point is the kind of debt-deflation depression that Irving Fisher and Hyman Minsky describe. In addition, even in business cycles, liquidation is extremely expensive in terms of destroyed capital (not everything that gets destroyed is malinvestment), high unemployment, and an output gap, that is, vast idle resources. This is extremely inefficient and unnecessary, and MMT explains why.

03 Aug 11, 08:53
MM Theory

Just would like to add that it's not recessions per se that are inherently bad and should drive policy desicions to be avoided, it's unemployment. My understnading of MMT is that it advocates policies to get to full employment, disregarding the effect of those policies on deficits and debt. Only at full employment does MMT start worrying about deficits (as it relates to inflation, not increased debts, which can always be paid back).

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