Week 9: Understanding Modern Money

Hello this week I will be covering my coverage on understanding modern money. This writing is based off of the collective research I have done during this project.

Modern Monetary Theory is a misnomer, it provokes you into thinking that MMT challenges current perception in an irreparable way, that it is a radical ‘theory’ that bears some sort of dramatic change to your understanding of the world. The theory usually describes an idea that holds value but lacks the necessary verifiability to be treated as absolute truth. MMT is not a theory in that sense, it is a re-evaluation of how the systems of currency and statehood work together around us. MMT can be applied to any nation that possesses sovereignty and issues their own fiat currency. These qualifiers exist because MMT shapes the way that we think about currency, currency is not simply something the state does, it is rather a function of the state. The difference is that common perception issues currency as part of the expected action, currency is a measure of wealth above all else, not a reflection of how our government chooses to take action. We think about the way currency moves as part of the circular flow of the economy, dollars move from point to point continuously, are held in banks, distributed as salary, spent at the deli, etc. If you approach currency under the lens of MMT you can remove the perception of a circular flow as the whole of the economy. Currency moves from the government’s budget to the greater economy before eventually returning in taxes to be burned. It moves from point A, its inception through spending, to point Z, its destruction through taxation. The letters in between represent the path it took to get there but do not change the general lifecycle it went through.

To understand further why MMT as a concept exists, it’s important to understand what gives currency such value in our lives. Currency is used typically as a measure of value dependent on your location. In the United States, we accept USD for transactions, it’s rare that we think about why we accept USD though. If a European company opened an office in New York City offering to pay their employees in Euros an equivalent amount to what they could make an alternative company in USD it would be much more difficult for them to find workers. This is not just because you would have to pay conversion fees for all your day to day expenses but because you are required by the IRS to fulfill your tax liability at the end of the year in USD. The federal government mandates that you must make American dollars and that you must hand them over. They have operational control over the flow of currency in the US. 

The flow of currency as understood by MMT is simple. A government creates its own flow of currency by spending into existence the dollars that they print. We commonly think of this as the federal deficit, the money that our government spends that it did not receive in taxes during the prior year. In 2023 the US collected 4.44 Trillion in revenue, they spent 6.13 Trillion this means that we ran a deficit of 1.7 Trillion USD. 

That deficit is a currency that was spent into the economy by the government. It is the manner in which every single USD was created. It is the only access point for dollars to gain entry into our economy and downstream is the growth of the economy. That is why if you line up the US annual deficit and GDP growth there is a strong correlation. The economy’s growth and shrinkage are determined by the supply of USD created by the government, successful corporations can’t drive the economy forward without a continuous supply of USD, and if we accept that the dollars are coming solely from the federal government we must accept that they posses a significant element of control over every aspect of the economy through monetary policy alone. American dollars like any other sovereign fiat currency flow from government spending to the greater economy before being returned through the form of taxation. Understanding this changes the way we perceive government in a key manner. It means that there is no inherent limit on how much the government can spend, this understanding allows you to appreciate the gravity of the decision-making behind monetary policy. The lack of an inherent limit on the government’s ability to spend allows infinite room for error. Spending too much could send inflation into hyperdrive crushing the economy in rapid speed, think Zimbabwe 2008. Spend too little and you pull money out of the economy. 

If you look back at the previous graph you’ll notice a special marker for the Clinton era surpluses. Bill Clinton campaigned to reverse the longstanding deficit and create a government surplus, in this task he was successful. Clinton ‘turned around’ a nearly $300 Billion USD deficit into a $100 Billion surplus. For many this was an economic miracle, if you viewed the government as a business or a household spending $300 billion that you don’t have is awfully poor decision making. The ‘Government-household analogy’ is perhaps the most common talking point you will hear when discussing the government spending balance. A central government is a unique entity within the economy; it is not akin to a household, the goal is not to build a retirement fund rather the goal is to exercise continuous control through policy decisions that build lasting economic success, not savings. Finding balance in controlled and continuous spending supports the economy. It is clear that running a deficit to some degree is an aspect of this, the United States aside from the Clinton years has run a deficit in all but eleven years since 1931. It is why our national debt has surpassed $34 Trillion dollars and why our GDP surpassed 25 trillion by 2022.

The obvious criticism of this interpretation of government ability comes from the fear of mass hyperinflation and absurd federal debt. If we are to understand that the government can do good through its unlimited spending ability, how do we prevent it from going too far? Where do we draw the line? 

Finding the sweet spot for government spending is a complicated question. While MMT effectively declares insolvency from public spending impossible, that does not mean the downsides of excess spending can be avoided. Since the early 1990’s Japan has run a government deficit and has yet to see any signs of mass inflation. Rather Japan struggles to sustain a healthy inflation rate and is constantly fighting to find new ways to try and boost its inflation. This tells us that the way we think about inflation today is flawed, simply increasing the money supply does not have a direct correlation with inflation as is often presented. Rather inflation is the result of many complex factors in today’s economy and has to be dealt with using specificity rather than general observations. Especially when dealing with the era of inflation after Covid-19 it is important to understand how difficult it is to pin down the true causes of inflation.

Thank You for reading.