John Greenwood and Steve H. Hanke have an op-ed at the Wall Street Journal, yet another critique of neo-Chartalism, this time using Japan’s experience as an indicator:
At the outbreak of the global financial crisis in 2008, Japan’s government deficit was only 2% of GDP, while the combined corporate and household surplus amounted to 5.1%. Within a year, a massive contraction of private investment and consumption occurred in Japan. By the fourth quarter of 2009, the private-sector surplus had surged to 12% of GDP. At the same time, the government deficit exploded to 9.9% of GDP. The resulting net savings surplus has fueled capital outflows. Today, these outflows amount to 2.1% of GDP and finance a stream of Japanese foreign investment.
This pattern of large private savings surpluses offset in part by large public deficits continues. The result has been a massive increase in the size and role of the Japanese public sector. Government debt has risen from 60% of GDP in 1990 to an astounding 235% today. But contrary to MMT, this fiscal extravagance has done nothing to boost the economy.
Separate from Japan’s overall savings surpluses, its broad-money metrics have grown at a snail’s pace. Since Japan’s bubble burst in 1990-91, broad money has grown at a paltry 2.6% a year, as measured by M2. In addition, since the 1950s money velocity has been negative, decreasing at an average rate of close to 2% a year. This is one of the most striking and consistent macroeconomic relationships on record. Japan’s slow broad-money growth mixed with a contracting money velocity has held down nominal GDP growth.
Faced with a contracting money velocity, Japan would have to increase its M2 money supply at a minimum of 5% a year, which is double its trend rate, to hit its inflation target of 2% a year and reach its potential annual growth rate of 1%. In practice, inadequate M2 growth over nearly three decades, combined with a declining money velocity, has translated into average real growth of just 0.9% a year. This has put Japan into a deflationary straitjacket, with prices decreasing by an average of 0.6% a year, as measured by the GDP deflator.
As long as M2 growth in Japan remains minimal, low inflation—or outright deflation—will prevail regardless of whether the public and private sectors are running savings surpluses or deficits. As Milton Friedman counseled, “Inflation is always and everywhere a monetary phenomenon.†The same is true of deflation. Money dominates.
Understanding Japan and other economies requires classical monetary theory, not MMT nostrums. From 1974-84, Japan enjoyed a golden period with generally stable broad-money growth, steady real GDP growth, and low inflation. Then monetary policy was derailed by the 1985 Plaza Accord and the 1987 Louvre Accord. The Bank of Japan dropped monetary targets and began to focus on interest-rate targets. The result was Japan’s disastrous bubble from 1987-90, followed by a so-called lost decade, which has turned into a lost generation.
While op-eds like this may help dissuade people who are wondering about MMT, I don’t think they’ll convince any advocate. The advocates of MMT have their eyes firmly on the theory rather than on the evidence and make assumptions about government that more practiced eyes would recognize do not recognize how governments actually function.
MMT has two parts – description and recommendation. The description is correct. The monetary system is backed by credit. The monetary system is an accounting ledger, and as long as both sides are balanced, mathematically, size does not matter. MMT recognizes that there is some upper limit to the balance sheet, and exceeding it will produce negative results.
MMT uses inflation to determine the upper limit, but I think it is asset inflation. By evaluating housing price inflation, MMT recognized that there was a housing bubble.
As long as asset prices are not inflating too fast, the monetary system balance sheet can grow as large as possible without causing any problems. Usually, people against MMT inflation limit and concentrate on the growth ability.
MMT goes off the rails because it does not correctly account for credit creation. In a credit-backed monetary system, M1 and M2 are irrelevant. The amount and quality of the credit created (financial assets) is the relevant factor. In a financialized economy, financial assets are assumed to be real and are treated as equal to tangible assets.
This is where MMT goes off the rails. All credit can be used to create M3+ dollars, but these M3+ dollars are not necessarily equal to M1/M2 dollars. If their creation is limited, M3+ dollars can act as M1/M2 dollars, but M3+ dollars are actually fiat currency. They can create value, but this can be fiat value.
Using M3+ dollars to have holes dug and filled adds to the monetary balance sheet, but empty or filled holes are rarely assets. The same is true if ghost cities are created using M3+ dollars, but MMT misses this. On the other hand, using M3+ dollars to create a washing machine factory does add value, and it does not matter whether the credit was created by lending to the government or to the builders.
The word dollar is a homonym for several different concepts. M1/M2 dollars are like gold/silver dollars. M3+ dollars include M1/M2 plus financial assets that are treated like M1/M2 dollars. Eurodollars, petrodollars, and trade-deficit dollars that exist outside the US financial system.
Before LJB removed the gold cover and Nixon defaulted on the dollar, MMT could work. After, it could not There is no natural mechanism that can predict whether a fiat dollar will create tangible or fiat value, and the government is the least qualified to make the determination.
I don’t think that’s MMT’s main problem. I think there are two main problems. The first is the underlying assumption that government actions can be fine-tuned, that you can turn the spigot on and off at will and with pinpoint timing and precision. That is simply not how government works.
The second is that hyperinflation is not just a species of inflation. It’s a psychological phenomenon.
Because US dollars are backed by credit, the amount of unsecured credit required for hyperinflation would need to exceed the secured credit, and even with low capital requirements, it is close to impossible.
Eurodollars, petrodollars, and trade-deficit dollars are another story. These are on offshore balance sheets, and they are not convertible. As such, they are only worth what everybody believes they are. (The hat in your Economic Parable.)
But, they (offshore dollars) can still be used to purchase US domestic assets, and therefore, there is a basis for their assumed value.
MMT does not distinguish between tangible and fiat value, and as you noted, neither is the government. Actually, the government would more likely approve projects creating fiat value – digging holes and re-filling them.