As Sir John Lockwood surveyed his post at the helm of the H.M.S. Audacious, he marveled at the wonder of empire.
Several shillings in his waistcoat (a peculiar choice of dress considering the 90-degree heat), Lockwood surveyed the deck of the Audacious as native workers, referred to derogatorily as “coolies” loaded all manner of exotic spice and fine silk into the holds of one of Her Majesty’s finest tall ships.
During the latter half of the 19th Century, Britain’s empire was unparalleled. An empire stretching so far across the planet that it was said the sun never set on it, Her Majesty’s influence knew no boundaries.
Whether it was sweet meats from the Near East or exotic spices and bolts of finest silks from the Far East, the glorious British Empire was want for nothing.
And the lubricant fueling this global empire? The Sterling Pound. Even today, the noun “Sterling” is used to describe something which is “first-rate,” “exceptional,” or “outstanding.”
Yet when one surveys the mess of Brexit today and the quagmire of the once great British Empire, it’s hard to imagine that this was a land whose currency fueled global commerce.
Had a coolie told Lockwood that one day, the shillings in his waistcoat would no longer be the pecunia franca of the modern world, he would most likely have curled his stiff upper lip into a scornful scoff at such a preposterous possibility.
Modern Monetary Theory — Long on Theory, Short on Reality
Yet Lockwood’s assumption that the Sterling Pound would forever persist as the global reserve currency is consistent with the rise of Modern Monetary Theory, which suggests, like Scottish financier and arguably the author of the French revolution, John Law,
“I maintain, that an absolute prince who knows how to govern can extend his credit further and find needed funds at a lower interest rate than a prince who is limited in his authority.”
“In credit, supreme power must reside in only one person.”
In a nutshell, Modern Monetary Theory espouses three basic tenets:
- The government has a monopoly over the issuance of national currency.
- Unlike households or companies, the government does not have a budget constraint. It can never run out of money to spend, because it can print money; and
- The only limit to the government’s spending power kicks in when it generates excessive inflation.
Proponents of Modern Monetary Theory, or the John Laws of our time if you will, argue that governments should set public spending and taxes to generate maximum employment and stable, moderate inflation.
Had most of that public spending been on education, infrastructure and research and development, an argument could be made that such deficit spending would yield significant future economic gains such as to negate the costs of funding such spending.
Yet over the last one and a half decades, the public debt-to-GDP ratio has risen dramatically and most of it has not gone to such investments in the future.
Quantitative Easing (QE), or the government purchase of assets since 2008 to 2016 has distorted normal market economics, leading to the perverse situation where rising U.S. public debt has coincided with a period where the cost of servicing that debt has declined.
To make matters worse, public money has been diverted into private pockets, with the Federal Reserve piling on debt to acquire troubled assets to shore up financial system stability.
Such a perverse situation where debt has risen while the cost of that debt has fallen leads to a counter-intuitive feedback loop, where it may actually cost more not to borrow money.
Distorted Signals
But that market-distorting anomaly is set to change. Interest payments on government debt has already started to rise and as many analysts predict, will only continue to rise, which means that the asset markets that debt has propped up, will be in for a rude shock when the flow of cheap money begins drying up.
But advocates of Modern Monetary Theory would say that the increasing public debt doesn’t matter because the deficit can expand further through the issuance of even more government bonds.
And if investors’ appetite for government bonds weakens? No matter, because the central bank can step in to finance the deficit.
And if this all sounds like the Ponzi scheme run by the Scottish financier and convicted murderer John Law, that’s because it is.
Which is why the advent of has proved an uncomfortable challenge to an absolute prince’s monopoly over the issuance of national currency.
Take for example Venezuela, where hyperinflation led many Venezuelans to abandon their own sovereign currency for currencies which retained their value, including the U.S. dollar and .
But it’s not just increasing the deficit that matters, it’s what the deficit is being spent on as well.
In the United States for instance, there are increasingly louder calls to spend on left-wing policies like universal free education, universal free healthcare and a guaranteed minimum income.
And the way these socialist and populist policies will be funded?
By issuing more debt, possibly supported by central bank bond purchases.
Money For Nothing and Your Chicks for Free
After all, the government can never run out of money to spend — it can keep the printing presses running for as long as it does not cause inflation.
Proponents of such Modern Monetary Theory point to the example of , which supports a mind-boggling 240% debt-to-GDP ratio with tepid inflation.
And Modern Monetary Theorists claim that inflation, specifically in the context of the United States, is not a serious risk, ever, so the federal government should throw caution to the wind and party like it’s 1999. The Federal Reserve will pickup the tab.
But what about Venezuela? Modern Monetary Theory supporters will counter that the U.S. is different because it can print dollars and the rest of the world will always want more because dollars are the global reserve currency.
To paraphrase U.S. Treasury Secretary John Connally — our spending, your problem.
But what proponents of Modern Monetary Theory fail to recognize is that it hasn’t always been this way. The dollar wasn’t always the world’s reserve currency. Just ask Sir John Lockwood.
It was a conscious decision by the rest of the world after decades of growth-boosting, responsible policies made the greenback the stable currency of the world’s strongest economy.
If U.S. policies shift dramatically, the rest of the world could shift its preferences to other reserve currencies, which many major economies are already doing, paring down their dollar reserves quietly and diversifying their currency holdings.
The notion that it is America’s choice to have the dollar as the global reserve currency is particularly misled.
To make matters worse, Modern Monetary Theorists believe that the only potential risk to excessive government spending is demand-driven inflation and so long as that is not expected to happen, governments are unfettered in their spending, limited only by their imagination. Whether it’s a border wall or universal basic income, there’s no limit to what governments can fund.
And therein lies the biggest threat that Modern Monetary Theory poses, it becomes the intellectual fuel for populism.
Rocket Fuel, Handle With Caution
In both the United States and Europe, politicians have become increasingly susceptible to offering easy fixes and painless solutions, long on rhetoric and short on details.
In a world where the average attention span is comparable to a goldfish’s, electorates are looking for soundbites instead of solutions.
Quantitative Easing did not fuel inflation (but it did inflate asset bubbles) and Brexit didn’t trigger a recession, so who’s to say we can’t have universal basic income and print our way to prosperity?
From New York to New Delhi, there is no appetite to discuss the difficult trade-offs and to accept that success in a more competitive global economy requires hard policy choices and structural reforms that boost innovation and productivity.
It’s easier to pop a pill than to hit the gym.
Which is where come into the fray.
Whereas before, the government had a monopoly on the creation of currency, has proved that that monopoly is no longer a given.
, warts and all, became the world’s first truly global currency. And despite its abysmal rate of transfer, it was still used in Venezuela and continues to be used globally.
Unlike any other fiat currency, is deflationary — we already know that there will never be more than 21 million Bitcoins. While it may not be the choice for value transfer, it’s potential as a of value is apparent.
An unwillingness to tackle hard choices on education, infrastructure and public spending risks undermines the long term growth potential of advanced economies at a time when technology, in particular automation and artificial intelligence are posing real challenges to employment.
Populism and isolationism have direct implications for financial assets and will heighten geopolitical tensions in markets that are already demonstrating heightened volatility.
As politicians and voters become complacent and ready to embrace fantasy policies wrought from the pages of fiction, the risk that something goes badly wrong rises exponentially.
Whether it’s a major sovereign debt crisis, a new financial crisis, a surge in inflation, or a prolonged slump in a major economy, the next shoe to fall will become increasingly difficult to predict or prepare for.
And while these are arguably tail risks, as the distribution of policy proposals develops long and fat tails, tail risks rise commensurately.
Against this backdrop and with the rise of populism, Modern Monetary Theory has become the intellectual fuel that propels reckless government spending and money printing.
The very conditions which led to the last financial crisis, the birth of and the advent of are very much still present today as they were over a decade ago.
As investors, the rising popularity of Modern Monetary Theory should be of concern because it distorts the normal functioning of price discovery but it also presents an opportunity for alternative assets such as , in particular and .
Admittedly, are not tied to anything, but increasingly it seems, neither are fiat currencies.
Published at Mon, 01 Apr 2019 04:48:38 +0000
