The
full-scale assault on the Federal Reserve System is something to behold. On
Sunday, April 14, the president tweeted: “If the Fed had done its job properly,
which it has not, the Stock Market would have been up 5,000 to 10,000
additional points, and GDP would have been well over 4% instead of 3% … with
almost no inflation. Quantitative tightening was a killer, should have done the
exact opposite!”
Trump
has been exasperated with the seeming ineffectiveness of his Twitter harangues
and verbal assaults on the Fed Chairman Jay Powell. Consequently, he has
attempted to stack the Reserve Board with partisans whose biases and
questionable credentials have not gone unnoticed. His efforts have been
anything but subtle. “I’m certainly worried about central bank independence in
other countries, especially … in the most important jurisdiction in the world,”
said European Central Bank President Mario Draghi on Saturday, April 20, referring
to the U.S.
Former
Godfather’s Pizza CEO and unabashed Trump lackey, Herman Cain, is the latest
log to be thrown on the fire currently boiling away the independence of the
Fed. Rebuked by four Republican senators even before being nominated, Cain has recently
withdrawn from consideration.
Flying
in under the radar, however, is a more existential threat to our monetary
system. This threat is beginning to gain traction largely because, to put it
simply, so few really understand it. “Modern Monetary Theory” (MMT) is being
championed by a number of leading U.S. progressives who could loom large after
the 2020 elections. Self-proclaimed Democrat socialist,
Alexandria Ocasio-Cortez, is among its most ardent proponents. Perhaps it’s
time to shed some light on MMT.
A
“Modern” Theory
According to Harvard’s Ken Rogoff,[1]
MMT advocates propose using the “Fed’s balance sheet as a cash cow to fund
expansive new social programs, a case made more compelling in view of current
low inflation and interest rates.” Moreover, since the U.S. dollar remains the
default reserve currency in global trade and finance, the world seems
unperturbed about absorbing more dollar debt.
The Fed itself is responsible for a
good deal of the confusion surrounding the use of its balance sheet. In the
years following the 2008 financial crisis, the Fed engaged in massive
“quantitative easing” (QE). It bought long-term government debt from big banks,
increasing their reserves. The Fed attempted to convince the public that these
reserves would lead to increased lending, which would magically stimulate the
economy. Unfortunately for U.S. policymakers, the recovery was anemic, with GDP
growing well below the average since the Great Depression. The lending on those
new bank reserves did not lead to productive projects like business capital
spending, but rather to share buybacks and acquisitions intent on engineering
corporate earnings higher.
Few analysts, however, attribute this
decade’s economic weakness to Fed policy. Confused about
the dynamics of debt, MMT proposes more of the same, though it would deploy
government debt financing differently. Here’s how the process might work,
according to Hoisington Investment Management’s Van Hoisington and Lacy Hunt,
two men whose work on monetary theory I have long admired.
Instead of padding the reserve funds
of commercial banks, the Fed’s bond buying would pad the accounts of the
Treasury. The Treasury would issue zero-maturity and zero-interest rate bonds
to the central bank. The funds the Treasury would receive from the sale could pay
government expenditures not covered by tax receipts or traditional bond
issuance. In effect, the Fed, an agency of the government, would be funding its
“parent” by accepting these worthless IOUs from the Treasury. It takes little
effort to imagine how others would view the value of the dollars issued by the
Fed’s monetary firehose.
Historically, this sleight-of-hand has
worked for a while in countries whose currency was not a global reserve
currency. In the case of the U.S., such action could immediately destabilize
the global financial system. There would be no real increase in goods or
services because people would quickly realize that inflation, and not real
purchasing power, was being created. Hypothesizing a step further, if the
government responded by issuing even more central-bank legal tender, the end
result would be more of the same.
Spending these new dollars on governmentally determined necessities is a form of central planning. That does not solve the problem of slowed economic growth. The growth conundrum is more systemic. Slower population growth is a secular change that shifts the demand curve downward. The same is true of slowed growth in educational attainment. Further, today’s technologies are not guaranteed, as evidenced by recent trends, to shift productivity growth back to the levels of recent decades. The argument that government can orchestrate such impressive results is historically weak indeed.
A
Confused Context
The aforementioned confusion about
money printing began when then Fed chairman Ben Bernanke was interviewed on CBS’s “60 Minutes” in March 2009
during the depths of the crisis. He stated that quantitative easing was
effectively printing money. When he returned to “60 Minutes” in December 2010, Bernanke admitted he misspoke.[2]
In keeping with the zeitgeist of our recent posts, “Moore of the Same at the
Fed” and “Thoughts on Ocasio-Cortez and Inequality,” readers are
encouraged to invest a half-hour watching both YouTube videos. A month before
the December 2010 interview, the Fed had authorized QE2—committing to another
$600 billion in asset purchases. The unemployment rate had remained stubbornly
above 9½ percent for the preceding 16 months, and the Fed was nervous. The
recovery was taking way too long to reach liftoff velocity.
By all appearances, Ben Bernanke came
across as an honest, sensitive, and highly educated man. Throughout the
interviews his transparent body language spoke volumes about how difficult it
was for him to keep his composure in a time of great chaos, angst, and
uncertainty. It was Bernanke who, at the time, admitted: “There are no atheists
in foxholes or ideologues in a financial crisis.” When the crisis hit, the key
actors at the Treasury and Fed threw out the old playbooks and resorted to
reactionary plug-the-biggest-hole-in-the-dike decision making. Read all about
it in a new book by Bernanke, Geithner, and Paulson, Firefighting, published in the middle of this month.[3]
We will have other crises, and we shouldn’t labor under the illusion that
attempts at resolution will be any more enlightened or effective than those of
the past.
One common theme through both interviews was Bernanke’s
emphasis on unwinding the zero-bound interest-rate and QE programs as soon as
the economy was stable enough. Nearly a decade has passed, and the halfhearted
attempt to put the easy-money genie back in the bottle that was opened in
December 2015 is now history, as of Powell’s recent capitulation. In the
meantime, government debt has mushroomed from 60% of GDP to 106% at the end of
2018. Given the weak economic performance, it is evident that the debt incurred
to finance our current GDP has become increasingly less productive. We seem to
have run up against the law of diminishing returns. Growth has slowed as
debt-to-GDP levels have risen to current heights.
The emergence of MMT, an attempt to outflank this reality,
is a testament to just how hollow Bernanke’s all-but-abandoned commitment rings
now. Of course, the revolving door of Fed chairs—a political reality in all elected
or appointed office—makes holding predecessors accountable problematic at best.
That’s the mechanism by which these Band-Aid fixes occur in the first place.
But to lay the problem at the
institutional doorstep is, for those of us claiming to be lifelong investment professionals,
to shirk our civic responsibility by feigning forgetfulness. Economist John
Kenneth Galbraith got to the nub of the issue when he concluded that the world
of finance and economics is characterized by …
… extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in a few years, they are hailed by a new, often youthful, and always extremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts for so little as in the world of finance.
Modern Monetary Theory is the latest
illustration of the wisdom embedded in the last sentence above. It is an echo
of the famous Edmund Burke (1729–97) dictum: “Those who
don’t know history are doomed to repeat it.” MMT currently has appeal because it is a policy
polemic for depressed times. That makes for good politics but, unfortunately, is
based on MMT’s questionable claims as to the nature of money itself.
This
doesn’t mean its alternative, a rational repricing of the financial misdeeds of
this millennium, is any more pleasant. To be the Fed chair is to face the
prospect that given the comparatively paltry growth in GDP, population, and
productivity, the amount of public and private debt is simply unmanageable. MMT’s monetary effect would likely be inflation, shifting the
real cost of debt from debtors to creditors.
Herein
lies the conundrum. Meanwhile, the time and attention of the public has been
absorbed in less profound pursuits, like the spurious and distracting feed of
the Twitter-in-Chief president. Bigger threats challenge our nation. The
independence of the Fed—which attempts to avoid the politicization of money—and
the very ontology of money itself are the critical issues at stake in public
policy today. Unfortunately, their complexity and ramifications cannot be reduced
to a Twitter tirade.
[1] Ken Rogoff, “Modern Monetary
Nonsense,” Project Syndicate ( March
4 2019).
[2] Bernanke discussed the
process of printing money at the 8-minute mark in the first interview. At the 6½-minute
mark in the second interview, Bernanke recanted, saying it’s a myth that the
Fed is printing money.
[3] Firefighting: The Financial Crisis and Its Lessons by Ben Bernanke,
Timothy Geithner, and Henry Paulson, Penguin Books, published April 16, 2019.