Does the national debt even matter? Modern Monetary Theory says it doesn't.

by Rod Williams, March 15, 2021- Recently I posted, SO, WHY DOES THE NATIONAL DEBT MATTER? I had also addressed the same topic in an essay, How will the $1.9 Trillion stimulus plan be paid for?  These essays were  prompted by the recently passed $1.9 trillion pandemic stimulus bill.  Our national debt was already $27.9 trillion before the passage of that bill. Also, that bill was not the last big spending bill Congress is likely to pass and to finance with borrowed money.  Congress is likely to pass an infrastructure bill, some form of a Green New Deal, maybe Medicare for All, maybe student loan forgiveness, and the Social Security Trust Fund runs dry in 2031 and Congress's fix is likely to call for spending even more borrowed money. We are talking more spending, more borrowing, and a lot more debt.

Forget for a moment the actual merits of the $1.9 Cova-19 stimulus bill which I opined on in a separate essay, Tax dollars to mismanaged cities and states is like giving crack to a crack addict, That essay dealt primarily with the part of the bill that bailed out mismanaged cities. For years, liberal cities were mismanaged. Cities borrowed money and debt payments became a bigger and bigger part of a city's budgets.  The biggest example of this mismanagement and the biggest reason certain cities are on the verge of economic insolvency is due to generous pension plans and retiree health care cost that were not adequately funded.  Not only were they often not adequately funded, but in many cases these obligations were not even acknowledged as debt.  However, beyond the issue of bailing out mismanaged cities, there was much else wrong with the bill.  I mentioned some of the other things wrong with the bill and compared it to a Christmas tree that congress just kept adorning with more shiny ornaments. Also, I pointed out that not only was much of the spending contained in the bill not only wasteful, but much of it was counterproductive and may actually slow an economic recovery and create a climate that traps more people in dependency and poverty.

If for a moment we ignore the issue of the merits of what is in the bill and look at the issue on the increased debt, as discussed in the first two essays, that issues would be of concern even if the bill was otherwise a wonderful bill. Our debt now exceeds our Gross National Product. I point out that the current level of debt is the highest if has ever been except for 1946 but at that time circumstances were much different than now. Just because that debt did not prove disastrous is no reason to think that our current level of debt may not be. To quickly summaries this is why I contend that the debt matters.  

• As we borrow more, it takes more of current revenue to pay interest on the debt. This means we have that much less to spend or we have to borrow even more just to meet current expenses. This means we do not have the money we need to fund things we need to fund.
• When savers buy U.S debt that pulls money out of the economy needed to fund economic growth. If savers buy government debt that is money not available to fund new technologies, research and development, and new business growth.
• When other countries, especially our adversaries such as China, own sizeable amounts of our debt that puts us at their mercy. They could wreck havoc on our economy by dumping our debt that they hold. This would drive up the cost of borrowing. 
• Debt of this size is likely to decrease the inability to meet a future crisis.  We are eating up our borrowing capacity.
• We are robbing from future generations. They are inheriting this debt.  They will pay for it by higher taxes or a lower standard of living.

In one of the essay's mentioned above I expressed amazement that not a single Democrat senator was concerned about borrowing and spending $1.9 trillion dollars. I said I assumed most of them were smart and well educated people. I said I found it hard to believe they could be at peace with this level of borrowing and spending. Maybe, I said, they subscribe to something called "Modern Monetary Theory,"  

I have not heard anyone who voted for the bill defend their decision based on a believe in MMT.  They simply talk about the need for the spending and what they see as the merits of the bill. They do not defend the size of the debt this creates; they ignore it and talk about something else.  While I think the bill fails on its merits, it is easier to argue merits of the package than to argue that debt is nothing to worry about.  So, while those who voted for this spending are not invoking MMT, some academics and think tanks and defenders of this level of debt are doing so.  This theory is providing the intellectual cover for a dangerous and reckless policy.

So what is Modern Monetary Theory? 

Modern Monetary Theory posits that debt is nothing to worry about if it is money created by the government. It is nothing to worry about if the money is created by what we euphemistically call "printing money," or "monetizing the debt." Most money is not actually dollar bills and coins printed and coined by the of course, but just units of accounting.  The money does not exist as a thing in reality. When the government creates money it doesn't actually run printing presses but pushes a few buttons on computers.  Technically, what happens is the treasury borrows from the Federal Reserve.  Money which did not exist before is created out of thin air. Currently of our $29 trillion dollar debt, the Federal Reserve owns $7.1 trillion. 

If we borrow from the Federal Reserve or "just print the money," then that solves the problem of pulling money out of the market that completes with money that could grow the economy because borrowing from the Federal Reserve doesn't do that. It solves the problem of a foreign power having the ability to wreck our economy by dumping our debt because we aren't borrowing from those foreign governments. Also, if we assume we are never going to pay it back it does not rob the next generation. Also, if it doesn't matter that we borrow, then we can just borrow more to address the next crisis. There is no limit to debt capacity. 

MMT argues that when the government spends money that previously did not exist (monetizes the debt i.e. borrowing from the Federal Reserve), that this is what creates the money.  New dollars in circulation creates demand which results in growth of new goods and services so the created money is not inflationary; it is overtaken by growth in economic activity. 

This sounds like magic. Why collect taxes at all?  Why not just "borrow" from the Federal Reserve to fund everything? MMT says there are limits. We can borrow all we "need." If we borrow more than we need this infusion of money into the economy could be inflationary. That is not much comfort.  If you are a hammer, everything looks like a nail. Elected politicians will see everything as a "need."

Critics of MMT caution than creating money in this fashion will lead to hyperinflation.  Proponents of MMT say it didn't at $15 trillion, or $20 trillion, or $25 trillion.  Why will it at $30 trillion or $35 trillion or some higher level?  

One thing wrong with this line of reasoning is that those lower numbers were debt held by foreign governments, and pension funds, and small investors and the Social Security Trust Fund.  That money was really taken from somewhere else; it was not just conjured up out of thin air.

The U.S. debt held by the Federal Reserve was only expanded in recent years. Up until the great recession of 2007 the Federal Reserve held less than $1 trillion in U. S. debt.  Since then it has shot up to $7.1 trillion and as recent as a year ago it was only about $4 trillion.  This theory that debt does not matter is untested.

It would be great to believe that we can spend all we "need," and never have to worry about debt.  It would be great to believe if we need more money, we just print it.  It would be great to believe in the tooth fairy and a big rock candy mountain.  It would be nice, but I'm not buying it.

MMT is still an unorthodox theory.  Most mainstream economist have not endorsed it. Nevertheless, it is providing an intellectual fig leaf for those who want to engage in reckless spending.  

With a theory to now support prolific borrowing and spending, a return to common sense is now going to be more difficult.  I am alarmed. I hate to be so pessimistic, but I think our best days are behind us.  We are heading downhill like a snowball headed for hell.  I used to think we could correct course the next election; now, not so much.  Republicans voted against the $1.9 stimulus and will no doubt vote against the future big ticket items. However, the Republican Party is not a unified party anymore and some Republicans are more interested in defeating other Republicans than in defeating Democrats.

Also, the Republican Party seems to not have a guiding philosophy anymore. The most popular Republican among Republicans is Donald Trump.  He threatened a veto of the December 2020, $900 billion pandemic stimulus spending bill because it only included direct payments of $600 per adult American rather than $2000.  $2,000 of direct payment is the amount Democrats wanted in bill.  When the leader of our party advocated irresponsible spending, it is hard for Republicans to have a firm foundation on which to oppose Democrat irresponsible spending.  We lost the moral authority for taking a principled stand to oppose Democrat irresponsibility.  The Republican Party is now more of a populist movement than a conservative movement and lacks the grounding necessary to fight a battle of ideas. It is hard to fight a battle against those who say stuff should be free.  Especially, when Republicans also often want free stuff, just different free stuff. 

With only an underrate degree in Economics, I do not have the credentials to be considered an expert on this topic, but I know enough to understand the issue. This is a layman's explanation of the issue and is somewhat simplified.  If one also considers the trillions of dollars that the Fed created to bail out banks that made bad mortgage loans, the reason for alarm is even greater. To learn more see these links: link, link, link, link, and link. 

Update, 3/16/2021: The following comment was made by Michael Dioguardi on my Facebook page,

While we do not seem to have anyone outright saying they are supporting massive debt based upon this theory, it cannot be ignored as being the basis for the amount of peacetime deficit spending we have undertaken. One of the more interesting aspects of MMT is the question of taxes. Basically, why should we have taxation. If debt and deficits no longer matter then what is the purpose of taxation. The answer is actually very revealing and the latest tax proposal is right in line with the MMT explanation for taxation. 

Here is what an MMT theorists says taxes do: 

1. as an instrument of fiscal policy to help stabilize the purchasing power of the dollar; 
2. to express public policy in the distribution of wealth and of income as in the case of the progressive income and estate taxes; 
3. to express public policy in subsidizing or in penalizing various industries and economic groups; and
4. to isolate and assess directly the costs of certain national benefits, such as highways and social security. (source: https://neweconomicperspectives.org/.../taxes-mmt...) 

I found these reasons very interesting as they are a combination of virtue signaling, punishment, economic control and central planning. But revenue to operate the government is not even a consideration.

Feel free to leave a comment or join the discussion on Facebook.  

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