The Dangers of Modern Monetary Theory | The Free Market Center Journal

At the core of Modern Monetary Theory (MMT) lies the implicit premise that the acquisition of money represents an end of itself. MMT bases its argument on what some people refer to as a “missing premise.” They present a proposition that contains an unstated premise that they assume everyone accepts. Give people more money, created out of nothing, and their spending will increase economic activity.

Although this premise seems quite appealing to many people, it contains a flaw that invalidates the entire theory.

Introduction

I first encountered MMT several years ago on one of the social media platforms. The people involved seemed almost fanatical about the idea, but I found it lacking logical consistency. For that reason, I thought the whole idea would die a natural death.

Recently, almost by accident, I have encountered several new references to MMT. This seeming resurgence may have occurred because one of the economic advisors for Bernie Sanders strongly advocates for MMT. In addition, I think that the rise in popularity in socialist ideas has given new vigor the conversation about MMT. People seem to like the idea — advocated by MMT — that you can receive things at no cost, e.g., medical care, schooling, retirement, etc.

I hope to point out, in this post, some of the weaknesses in the argument for MMT. To accomplish this, I would like to address just a few basic premises that the advocates of MMT either ignore or misunderstand.

  • They seem ignorant of the role of money as a medium of indirect exchange.
  • Demand does not exist in the aggregate or without the prior production of goods.
  • Double entry bookkeeping proves nothing about the results of expanding the money supply.

I cannot make exhaustive comments in the space that I have allotted myself. I only want to open your thought to some of the unanswered questions left by advocates of MMT.

The Role of Money

If you consult almost any textbook on economic theory, the author will describe money as a “medium of exchange.” This phrase, although accurate, does not explicitly portray the real role of money. Money actually acts as a medium of indirect exchange. Ignoring the importance of this fact brings MMT to its knees (as it does any theory about monetary manipulation adhered to by the Federal Reserve).

Any good that somebody exchanges for another good acts as a medium of exchange. The important distinction comes in identifying mediums of indirect exchange. With an indirect exchange, one party accepts a good for the purpose of exchanging it a second time for yet another good. That good has little or no value to them without the possibility of exchanging it for the third good. A medium of indirect exchange simply facilitates an otherwise goods-for-goods exchange. One must understand this distinction to comprehend the role of money clearly.

The single role of money consists of its use as a medium of indirect exchange. Unlike other goods, it never gets exchanged for the purpose of consumption. For that reason, the system requires no change in the quantity of money. It only requires, to accommodate declining money prices, that whatever good (or claim on that good) used for money can be divided almost indefinitely. The government or the banking system need not increase the quantity of money—for any reason.

In a market system, with goods prices based on money, the relationship of the goods-for-goods prices become distorted when the quantity of money changes arbitrarily. This price distortion forms the basis for economic malinvestment and boom and bust cycles, which wreak significant havoc on economic activity.

MMT (along with the Federal Reserve) ignore the critical importance of the real role of money. The ignorant use of monetary expansion leads to the economic boom and bust cycles addressed by the Austrian Business Cycle Theory.

Aggregate Demand

MMT relies to a significant degree on the concept of “aggregate demand.” This idea, popularized by John Maynard Keynes, claims that the government should stimulate an economy by doing something to increase aggregate demand. The idea of aggregate demand, however, represents a pure fantasy.

First, demand cannot exist without prior production. In the goods-for-goods exchanges facilitated by media of indirect exchange, some good must be given up in the acquisition of money. Without that good being given up, a reduction in the overall goods and services occurs. With the introduction of artificially created money, some traders find they have exchanged something for nothing. (For more insight, refer to “Increasing Demand Won’t Make the Economy Grow” by Frank Shostak.)

Providing money for nothing means that eventually, some buyer discovers that sufficient goods do not exist to complete transactions. But, we cannot know specifically what goods the economy lacks. Which leads to the second problem with aggregate demand.

Second, one cannot aggregate, or sum, the demand for a multitude of separate goods. You cannot add five chickens, two iPads, four Chevy Volts, etc. and derive a meaningful total. Summing the dollars exchanged in an economy gives no real information about the sum and substance of the goods exchanged.

Double Entry Bookkeeping

MMT advocates make a big deal about the importance of double entry bookkeeping and balance sheets. One person’s spending does indeed represent another person’s income. This tautological statement proves nothing regarding the validity of the argument for expanding the money supply to “stimulate demand.” It only means that in a double entry bookkeeping system debits and credits must always equal.

Since the entries in bookkeeping systems reflect quantities of money (both debits and credits), this only means that when somebody gives up money for a particular good, they record (as a debit) the amount of money given up. They do not record the quantity, or the characteristics, of the thing acquired.

Remember that money denominated double entry bookkeeping does not reveal what goods, if any, were given up to acquire that money. Although the books may balance, if the money used in the underlying transaction has been created ex nihilo (out of nothing), the transaction represents a fraud somewhere in the system.

Conclusion

The increasing popularity the socialism, and socialist politicians, leads me to believe that MMT presents a real danger. The danger lies in its appeal to people’s desire to get something for nothing. Socialism by itself cannot allocate economic resources effectively and efficiently. The implementation of what I would describe as a “free money policy” would only add to the misallocation of resources caused by the administration of a socialist system.

People need to learn the valid propositions behind sound money. We live in an environment in which people accept monetary expansion as a natural phenomenon. Artificial monetary expansion represents a stealthy form of violent intervention—it dilutes the purchasing power of personal property. Despite the problems with our current monetary system (also based monetary expansion), the system could be worse. The implementation of monetary policy based on Modern Monetary Theory would undoubtedly be worse than what we already have.

 

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