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Are MMT and AE Compatible?

This is going to be a technical article. Smiling Dave will give you the lowdown on a new theory circulating in the world, Modern Monetary Theory, or MMT.

The mises forum  [and here and here] has nice long threads where the proponents of MMT dropped in to discuss their theory in detail, and deflect the various challenges to it. I personally think they were found wanting. This article, however is a response to one written by Robin Koerner on huffingtonpost where he explains that he is an Austrian, and thinks MMT does not contradict AE, but supplements it.

The gist, in his own words:

Here’s why. MMT makes the simple point that the net amount of dollars in the private sector were originally created by the government to acquire goods or services from the private sector (by crediting the private accounts of suppliers of those goods or services, such as Boeing when the government buys a warplane). Therefore — and this is the grist to the Austrian mill — in our system of government-issued fiat, there is only any monetary economy — any trading at all — because the government has, over time, spent more money into the private sector than it has taken back in taxation. In other words, in our modern monopoly fiat system, the private economy, in the simple sense of an accounting identity, is a government debt. If this government debt were fully paid off, there would be no money in circulation. (This is not “debt” in the sense of government bonds, but of money spent by government in excess of money taken in as revenue.)

In such a system, our entire economic existence depends on government spending. If I were to set myself up as king and I wanted complete and utter control over the economic life of my citizens, this is exactly the system I would establish: everyone has to accept my currency, and I can make any amount I like whenever I like to acquire whatever I like from anyone.

This system is surely the very definition of economic totalitarianism. Under it, no trade made by any two Americans is ever (unless it is barter) without the government’s permission and enablement. Should the private sector wish to accumulate monetary assets, it can only do so if the currency issuer, the government, creates that money by removing (buying) goods or services from the private economy. So again, private monetary saving is, as an accounting identity, the transfer of economic production to government.

OK, time to look at it again, a little at a time, with Smiling Dave’s snarky comments:

Here’s why. MMT makes the simple point that the net amount of dollars in the private sector were originally created by the government to acquire goods or services from the private sector (by crediting the private accounts of suppliers of those goods or services, such as Boeing when the government buys a warplane).

Basically, he’s saying that the only reason you have a dollar bill in your pocket is because the govt took something from you. After all, the govt is the only one who makes dollar bills, so it has to have originated with them. Plus, they don’t hand ’em out for free, so that when they gave you the dollar bill, they took something back in return. Which, with minor quibbles, I can agree with.

Therefore — and this is the grist to the Austrian mill — in our system of government-issued fiat, there is only any monetary economy — any trading at all — because the government has, over time, spent more money into the private sector than it has taken back in taxation.

Meaning that should the govt decide to take it all the dollars back [=taxation] we would have no dollars in our wallets or our bank accounts. Yes, this is obviously true.

In other words, in our modern monopoly fiat system, the private economy, in the simple sense of an accounting identity, is a government debt.

Here’s where we part ways. What does he mean by “the private economy”? If he means the amount of cash in the private sector, then that is a very special use of the phrase. And what does he mean by “govt debt”?
In the old days, a dollar bill was a debt of sorts, because it said that you could trade your dollar in for gold held by the US govt. But MMT is talking about nowadays, the days of fiat money, where a dollar bill cannot be exchanged for anything. It no longer represents debt at all.

And don’t think these are mere quibbles. By renaming things, MMT draws ridiculous conclusions. Here is their thinking.

Step 1. Amount of paper money in hands of the populace = Amount of dollar bills printed by the US govt.
Step 2. Rename to: Private Economy= Govt Debt.
Step 3. Deduce from this that Increase in the Private Economy = Increase in Govt Debt.
Step 4. Rename to: Prosperity for Us All = The Govt Borrowing More Money.
But of course, the truth us that prosperity for us all is not going to happen from either meaning of “Govt Debt”. Whether “Govt Debt” means printing more money, or if means actually borrowing money from the Chinese or anyone else foolish enough to lend us more, it won’t bring us prosperity.
Yes, it will mean we have more paper money, but that is not prosperity.

Now, in fairness, Robin Koerner might disagree with this conclusion. But he really should not sling around the definitions in the sloppy way MMT does. And he gets into trouble by doing that, in the very next sentence:

If this government debt were fully paid off, there would be no money in circulation. 

What exactly has to be paid off? The money in circulation is not a debt. It does not have to be paid off.

(This is not “debt” in the sense of government bonds, but of money spent by government in excess of money taken in as revenue.)

Oh, so you admit you are using the word “debt” in different ways. How can that kind of debt be “fully paid off”, or even “paid off” at all?
Not to mention that “money spent by govt in excess of money taken in as revenue” just means “money printed by the govt to spend more than it gets in taxes”. So you are just saying that if the govt only spent what it took away in taxes, and printed no new money at all, there would be no money in circulation?

That is silly. Say this year there are no taxes at all, an no new money is printed. According to your theory, all the paper money we have would melt away. I mean, is this what AE is supposed to learn?

In such a system, our entire economic existence depends on government spending.
If by “economic existence” you mean the paper money we have, then yes. The govt doesn’t give its paper money away. It spends it.

If I were to set myself up as king and I wanted complete and utter control over the economic life of my citizens, this is exactly the system I would establish: everyone has to accept my currency, and I can make any amount I like whenever I like to acquire whatever I like from anyone.
This is also true. But this is not an insight that is in anyway connected to MMT, or the previous silly equations, or “accounting identities”. Everybody knows that a govt monopoly of the fiat money supply is a disaster, and indeed responsible for the mess we are in right now.

This system is surely the very definition of economic totalitarianism. Under it, no trade made by any two Americans is ever (unless it is barter) without the government’s permission and enablement.

This too, is correct, but unrelated to MMT. It is just a recognition of the purpose of legal tender laws.

Should the private sector wish to accumulate monetary assets, it can only do so if the currency issuer, the government, creates that money by removing (buying) goods or services from the private economy.

He’s got his tenses wrong, confusing past and present. What he is really saying, in simple language, is that you can only save money if you there is paper money to save. And paper money is only here because sometime in the past [look at the date on the dollar bill to know exactly when] the govt printed paper money and spent it.
And yes, this is true.

So again, private monetary saving is, as an accounting identity, the transfer of economic production to government.
Yes, this is true also. this time he was very careful to be precise.

Robin, we thank you for your clear exposition of the tyranny of fiat money and legal tender laws. What you say is true, but it’s not MMT.

Here is what MMT really claims:
1. That the govt can legally print all the money it wants, and spend as much at it wants.
2. This may result in inflation, but inflation certainly that won’t happen during a recession, when there is lack of aggregate demand.
3. When the govt prints more money, it gets into your pocket eventually, Mr Private Sector. So, given that there is no inflation, inflation being a rare event in any case, you are richer.
4. Nothing bad happens to you when the govt raises your taxes.
5. The govt can and should print any money needed to solve our problems.
6. Zero interest rates do not create inflation, as proven in Japan.
7. Time Preference does not determine interest rates.
[Thanks to Meng Hu for pointing out the last two, see comments]
Those who have been following Smiling Dave’s blog know that we are looking at a money crank, and a Keynesian one at that [check here also]. Truly Robin, I don’t get what you see in MMT.

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7 Comments

  1. Meng Hu says:

    Have you ever read this curious paper ?http://pragcap.com/wp-content/uploads/2011/02/WP37-MoslerForstater.pdfMosler should have never heard about time preference. Interest rate is determined by time preference (TP). Low TP = low interest rate. High TP = high interest rate. That the natural rate of interest should be zero… this story is somewhat fishy.

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  2. Smiling Dave says:

    Meng,Yep, I totally agree. I should add to the fallacy list the following:6. Zero interest rates do not create inflation, as proven in Japan.7. Time Preference does not determine interest rates.

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  3. Cheesy Mac says:

    Koerner seems to totally misunderstand MMT, or is a part of some strange cult of MMT. The assertion that “if the government paid all its debts there would be no money in circulation” is absurd and false. The government does NOT create money, and MMT’rs (at least ones with brains) know this already. The government BORROWS MONEY FROM BANKS THAT CREATE IT. Banks create every red cent of money in circulation, and it is not always created from a loan to the government. Money is created from the pen of a banker when a loan is written to anybody at all.

    The assertion that all the money would disappear is simply false, because new money is created every day when businesses and individuals take out credit.

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  4. Smiling Dave says:

    What about the coins and paper money? Isn’t that created by the Treasury, which is not a bank?

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  5. Smiling Dave says:

    Thanks for the link. Like your avatar.

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  6. Cheesy Mac says:

    Yes, currency (coins & bills) must be printed/minted by the Treasury. However, people do not pay taxes in coins and bills. It may be true for MMT to state that “in effect” the government creates money, since the Fed never fails to purchase government debt at the discount rate, but to say that it is actually created by government is simply false. The distinction is, of course, important, because it erases the concept of “government as ultimate authority.” The reality is that ANYBODY can issue fiat currency, if they choose, and the only thing that stops this is whether or not they can use it.

    The government does not pay its debts in currency, either, it simply issues bonds, which are efforts in debiting/crediting and no more than that. If the government paid all its debts, what would be left over is the money created by banks at the demand of their customers that comprise the economy. In reality, the ultimate creators of money are bankers and customers themselves. There is fundamentally no hard constraint on the size of the money supply, even without a government existing at all (assuming that banks retain the authority to print their own fiat of some kind). The only thing that constrains it is the demand (more specifically, lack thereof) for money throughout the economy.

    What MMT advocates whom support the general prescriptive policies of the position fail to recognize is a simple mantra; just because something is possible does not mean it ought be done. Austrians spell out the reasons why exorbitant government spending is detrimental to the economy very well: malinvestment, market deformation, etc. which lead to the business cycle. This isn’t just an Austrian concept, Minsky borrows it as well (although his analysis of the source and fixes for the problem are incorrect, in my opinion).

    Using MMT as a recipe for prescriptive policy is illogical and irrational. No matter how correct you are about how things “actually work,” there is no logical reason whatsoever to presume that you “ought” to do X or Y. Yes, you CAN have full employment. Of course, this is not addressing what it is you are sacrificing to get it. What you are sacrificing is a stable economy that efficiently allocates resources based on the demands of those that comprise it.

    Oh, and thanks for the compliment.

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