Not So Modern Monetary Theory

What is true in modern monetary theory is not modern, and what is different in it is and has always been nonsense.

Modern monetary theory is an unorthodox theory that says that scarcity is a convention. With fiat money, you should not be afraid of deficit spending. If the economy isn’t working, just let the government spend more. After the 2008 financial crisis, Paul Krugman lamented that the world was not being invaded by space aliens because such a threat would incur huge, huge, gigantic costs, and those costs would solve all of our economic problems.

Last year, on pandemic-related deficits and government-ordered shutdowns, The Amazing Joe Biden said, “No one is suggesting that runaway inflation is on the way, not a single serious economist.” Inflation has picked up this year.

Modern monetary theory suggests that money has no intrinsic value, but is, in fact, fiat or fiat currency. Accordingly, government spending is not limited to tax revenue or even the government’s ability to borrow. The government should only print any amount of money needed for spending. Those who insist on balancing the budget are fixated on something that is no longer relevant. They are not “modern”. Or, as Amazing Joe put it, they’re not “serious.”

If deficits don’t matter, then what are taxes for?

MMT supporters say that in addition to redistributing wealth, the purpose of taxes is to control inflation. If inflation breaks out – definitely not because the government is spending the deficit and printing new money! – then the government can solve this little problem by removing some of the money circulating in the economy by raising taxes.

Wait, you might say, doesn’t this use of taxation to fight inflation bring us back to mainstream economics?

No, you’re missing the point, MMTers say. Modern monetary theory presents a different approach. Modern monetary theory says that instead of limiting spending because of concerns about deficits and inflation, spend freely. If inflation happens, just raise taxes.

What is true about the relationship of fiat money and taxation was discussed by Adam Smith and was incorporated by the British Parliament in the Currency Acts of 1751 and 1764.

The Currency Act of 1751 covered (only) the New England colonies. Typically, the issuance of (interest-free) “credit notes” (i.e., fiat money) was limited to the “current service” of the government. Having no intrinsic value, these notes circulated like money (although they did not have the status of legal tender) because they could be used to pay taxes due in the near future. The Currency Act 1764 essentially extended the same terms to the other colonies of British North America.

Adam Smith, Wealth of Nations studied the experience of tax-backed paper currency in British North America and said that if the amount of paper money was below the amount payable in taxes, and if it was otherwise convenient as a medium of exchange, that paper money would circulate at its face value. price. However, he said that the amount of paper money “was in all the colonies far in excess of what could be used in this way.” The last statement was something of an overgeneralization. The colonies abused the right to issue paper money to varying degrees. Not all of them “very” abused this power.

Two additional episodes involving tax-backed fiat currency originated in Texas in the mid-19th century.th Century. When Texas gained independence from Mexico in 1836, there were no significant taxes. The first president of the Republic of Texas, Sam Houston, estimated the demand for the national medium of exchange at $800,000 and believed that this demand could be met in part by limited issuance of a tax-backed currency, combined with the imposition of a tariff. and spending controls to bring the budget back into balance quickly.

His successor, Mirabeau Lamar, was something of an MMTer before it came along. Lamar had big ambitions for Texas as well as the necessary spending plans. And where was the money to come from? Through the issuance of millions of dollars worth of Texas Treasury notes, dubbed “red backs”. Needless to say (for mainstream economists) red backs have dropped to US dollar pennies per US dollar.

During the Civil War, Texas, now a Confederate state, issued treasury warrants that circulated as money. After the collapse of the Confederate dollar, Texas raised taxes and took other measures to support its warrants. The warrants then rose in value until the issuance and promotion of the Yankees in Texas warrants ceased, as had already happened with the Confederate dollar.

Later at 19th The century was another test of tax money security. This test involved silver money either in the form of coins or in the form of (paper) silver certificates. Since the value of silver in relation to gold fell at the end of the 19th century.th The United States has been in a quandary for centuries. Either continue to issue silver currency and be forced to abandon gold and switch to a devalued silver standard, or limit the issuance of silver currency.

The issue came to a head in 1893, when President Grover Cleveland, the last of the hard-money Democrats, called an extraordinary session of Congress to repeal a law requiring the issuance of a certain amount of silver currency, and thus oblige the United States to act on the “four squares” principle. . to gold.

Again and again in the history of this country, the ability of taxes to support an unbacked or underbacked currency has been tested. Each time, the answer was clear: the acceptability of a currency for paying taxes can support the value of such a currency; but this ability is limited. If the issuance of a fiat or under-backed currency exceeds the amount needed to pay the tax, and even exceeds the amount demanded as a medium of exchange, the value of that currency will fall (or there will be inflation).

You might think that someone as old as Amazing Joe knows the story. However, if this story had not been written down by the student who sat next to him during the test, it is unclear whether he would ever have learned it.

Clifford F. Tees

Clifford F. Tees

Clifford F. Tees is Professor of Economics and Finance at the University of Shenandoah. He is the author, co-author, author and editor of over one hundred books, articles in encyclopedias and scientific journals.

He is a member of the editorial board of the Journal of Private Enterprise and a former Bradley Fellow at the Heritage Foundation. In the past, he was President of the Faculty Senates of the University of Shenandoah and the University of Baltimore. He also served in the US Army and the Army Reserve.

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Gary M. Peke

Gary M. Peke is Associate Professor of Economics at Central Michigan University.

He has a Ph.D. in economics from Virginia Tech and State University, and a master’s and bachelor’s degree in economics from Louisiana State University.

He also worked as a licensed public accountant in New Orleans from 1996 to 2003.

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