A Wide and Deep Misunderstanding of MMT and inflation

There is a wide and deep misunderstanding of the modern monetary system and the causes of inflation. This leads to poor results for the majority of investors. For example, starting almost two years ago, the prediction by almost every analyst on the Planet was that a recession was ‘just around the corner’, based on the false assumption that inflation is caused by too much money and that monetary policy can fix inflation. Most investors missed the start of the bull market because it turns out that higher rates actually stimulate the economy (unless they get too high).

MMT (modern monetary theory) describes how a floating-exchange monetary system works (in contrast to a fixed-exchange system like the gold-standard). One does not “do” MMT anymore than one “does” the theory of gravity; both are simply descriptions of reality.

In a fixed exchange-system, like the gold-standard, the value of a currency is determined (and fixed) by taking the number of currency units and dividing by the amount of gold in the possession of the currency issuer. The US went off the gold-standard in 1931 domestically, and in 1971 internationally. The value of the US$ is now determined at the FOREX auction and is dependent on how the currency traders feel about US policy and trade.

Unfortunately, the majority of economists, journalists, academics, politicians, investors, and every-day people continue to think we are still on a gold-standard. The main reason for this, I believe, is because it benefits the financial industry (especially the big banks).

Treasury bond sales began in 1917 as a way to deficit-spend on the war effort without crashing the value of the dollar. Instead of simply spending more money into existence, they said… “we won’t print new $ — which would dilute the value of the $ relative to the amount of gold (unless they acquired an equal amount of gold) — we instead will borrow already-existing $ that are in the private sector, and we will pay interest on them”.

This was only temporarily successful because at maturity the Government had to return those dollars plus interest, which meant they had to print new money anyway (which diluted the $ relative to gold). That is why the dollar was taken off the gold-standard domestically in 1931, and in 1971 Nixon removed the dollar from its fix-to-gold internationally in order to fund the Vietnam war.

Since then, the US$ has been free-floating against the other world currencies. However, they continue to match deficit spending with Treasury sales, even though it is no longer required as a hedge against currency devaluation, and is NOT borrowing dollars in order to spend. Treasury sales are now a way to drain reserves and to control interest rates…and a way for the banks to make risk-free income!

Inflation (especially hyper-inflation) is always due to a shortage of real-resources, not simply the printing of too much money. The later is a response to the former, not a cause of it. Inflation is always caused by shortages, but the shortages themselves can have several causes like: war, natural disasters, corruption, and monopolies. Too much money printing is a bad policy response to the shortages, it is not the cause of the shortages, and, therefore, not the cause of the inflation.

Zimbabwe is often (and wrongly) used to argue that printing too much money causes inflation. Zimbabwe’s hyper-inflation arose from a shortage of food. The white farmers were stripped of their farms and the businesses given over to corrupt officials. As a consequence of this, the agriculture industry (Zimbabwe’s main foreign-currency generator, and food source) collapsed, causing shortages of both food and foreign currency. The government, instead of investing to increase food production, responded by printing money to try and buy food…food that didn’t exist inside the country, and that no foreign supplier would sell in exchange for their corrupt (worthless) money. The inflation came from a shortage of food, not from an excess of money. The latter was a disastrous response to the shortages, not the cause.

Having the correct understanding of how a floating-rate monetary system functions, and what the causes of inflation are, gives investors an advantage over the ‘herd’.

Join us at www.angtraders.com or on seekingalpha.com (Away From the Herd investor group).