Modern Monetary Theory – Weak on Theory – Wrong for the Free Market
In the March 19th paper, Inflation Confusion Plus Recession Confusion Equals Stock Market Confusion posted in georgeeconomics.com, I discussed the often perplexing relationship between the direction of the economy and reaction of the stock market to the various economic scenarios that were mulled over by the media experts. They fussed over the possibilities of a hard landing versus a soft landing for the economy as the Fed raised the target Federal funds rate to combat stubborn inflation. That article and other papers posted in www.Georgeeconomics.com discussed in substantial detail the root causes of the economic morass we have been experiencing after the disastrous economic policies of the Biden Administration starting in 2001, coupled with the myopic Federal Reserve’s inflation blindness, had enough time to spike the rate of inflation, and lead to two consecutive quarters of negative GDP (Gross Domestic Product). I postulated that it was far more likely, given the amount of money sloshing around the economy, unless the tightening policies tanked the economy, inflation would be far more stubborn than expected and that the economy would experience a slow landing with the possibility of lingering stagflation. Another reality I spelled out is detailed in the following quote in the paper referenced above. “Until the economy is sufficiently slowed down such that the Fed’s 2.0% inflation rate target is expected to be achieved in a timely manner, inflation, recession and stock market confusion will continue to be significant issues. From my viewpoint unless that clarity is reached by the end of Q2 (2023) the Federal Reserve’s tightening stance will remain in place well into 2024.”
As the end of Q2 (2023) approaches, the media’s economic wizards and stock market prognosticators are still in basic disagreement mode with some calling for the end of the Fed’s tightening cycle with no or only a minor recession and others viewing a lingering recession as inevitable, if not already here. In other words, there is still no real clarity regarding the tightening policies for the remainder of 2023. There is no clear indication that the lagged effects of the Fed’s tightening efforts will bring the rate of inflation close to their target rate. The market is presently pricing in a pause by the Fed in June (next week), but not necessarily for the rest of 2023. It is highly unlikely that the Federal Reserve will signal the end of their tightening cycle, because there is no decisive movement in the economic data that indicates that inflation will drop sufficiently, in a timely manner, to satisfy their mandate. Remember, the Federal Reserve was horribly late to addressing inflation in 2021 and 2022, which exacerbated the inflation issue and significantly increased the difficulty of their task to reel in the severe inflationary damage caused by the (socialist inspired) agenda driven policies of the Biden Administration.
Recently, the stock market has experienced a surprising increase attributable to a very narrow artificial intelligence driven NASDAQ spurt (by a select group of mega cap tech companies). The S&P just left bear market territory (up 20% from it’s low) and many exuberant stock market analysts have proclaimed the beginning of a new bull market. In contrast, all of the economic indicators are projecting a recession later this year or early next year (if we are not already in one). This is more than just a minor possibility given the severely inverted yield curve, persistent inflation as indicated by the stubbornly high PCE (in the neighborhood of 4.7% since the beginning of the year), and initial unemployment claims now above 200,000.* The economy, in a technical sense, has only held up as well as it has because of the historically massive amount of money dumped into the economy during 2021 and 2022 by the Biden Administration and the excessive liquidity that has propped up the capital market. That, however, is not a good thing because, as mentioned above, that reckless spending, along with myopic fiscal policy (especially related to energy) has caused the present economic problems facing the country. Unfortunately, as is to be expected in a severely inflationary environment, the people who suffer the most as their real income is eroded by record inflation are the middle- and lower-income individuals, whose quality of life and purchasing power have been decimated. The rest of 2023 is not likely to be any better.
The relationship between the present direction of the economy and the stock market is reminiscent of the “Cheshire Cat” in “Alice in Wonderland”, when asked “which way I ought to go from here.” The response is that it depends on where you want to go followed by pointing in opposite directions at the same time. It is likely that the stock market has already found its bottom. Historically, the stock market has always started a recovery before the economy has bottomed. It is also highly unlikely that there won’t be some retracing in the market as liquidity finally tightens to the point where investment is severely constrained and the consumer is basically restricted to subsistence related purchases (which is already the case for many wage earners). Given their tardiness in addressing inflation in 2021 and 2022, which aggravated an already serious inflationary situation, the Fed should be and will be cautious not to enter a loosening cycle prematurely. In summation, the euphoria in the stock market is welcomed by most investors, but there is likely to be at least a little more pain inflicted by the “stock market gods” that sometimes “giveth’ and sometimes “taketh” away, while the economy slowly finds a bottom and the Fed enters a loosening cycle. It is fairly apparent that the economy is in the process of a slow landing and the economic malaise will be not be entirely resolved this year. The takeover of the House of Representatives by the Republicans and their efforts to curtail federal deficit spending will ameliorate some of the economic pain and shorten the path to recovery, but the existing damage to the economy will linger through this year and at least partially into 2024.
Behind much of the outrageous spending that has created the economic havoc the country is going through, has been the emergence of what is called modern monetary theory, Modern monetary theory posits that powerful economies can print and spend money with little or no consequences caused by massive deficit spending. It proposes to move monetary policy from the central bank to the fiscal taxing authority (Treasury) thereby combining monetary policy and fiscal policy as a single function with taxation used to control the money supply and stabilizing the economy. The printing of money would fund deficit spending without the need for increased taxation to cover the deficit. In this manner, modern monetary theory ignores the painful economic lessons learned over time that led to the isolation of monetary policy in the control of an independent central bank. The overall impetus of Modern monetary policy is the increased control of the economy (distribution of goods and service) by the central government, which can tax and spend without constraints. In effect, it has become a veiled defense of the socialist model (originally articulated by Marx and Engels) is a flawed attempt to create an economic theory that validates socialism as a functioning economic option.
When examined in detail, however, modern monetary policy fails the test of preserving individual freedom and insuring the role of government as a referee and not the dominant player. Modern monetary theory is now the mantra of the American left. Even though it is a theory that must be dealt with and recognized as an insight into the old mechanisms of gold standards, balanced budgets and debt given new forms of exchange (digital currencies, etc.), it sets up government to be all powerful, with the unsaid unrealistic underlying assumption that the central government and, therefore, politicians are prudent, non-partisan and genuinely righteous. By unleashing the government’s ability to spend at will, regardless of deficits, it seeks to present the government as a better avenue than the free market for identifying slack areas of the economy that can be more efficiently activated. History has shown that to be a flawed assumption and that the free market, if allowed to operate without undue interference, is the most effective format to incentivize efficiency over time. The damage quickly done to the American economy by the Biden Administration, by policies in agreement with modern monetary theory, should eliminate any credibility of modern monetary theory as a contribution to economic thought. The continued adherence to these policies will cause catastrophic damage to the American economy.
Note:
* * The PCE is the Personal Consumption Expenditures Price Index, which is the Federal Reserve’s preferred measure of inflation.