I have a new topics to write about – macro-economics. My interest is partly due to the enormous economic upheaval caused by COVID-19, but is more specifically due to reading Stephanie Kelton’s “The Deficit Myth” which outlines MMT – Modern Monetary Theory. I find this theory to be interesting and valuable but not entirely convincing (sometimes because I don’t agree, sometimes because there are gaps in the presentation). As this is my first post in a long time I’ve decided to start small and explore one simple topic: the value of money.
MMT is predicated on a sovereign government issuing a fiat currency. For a few decades after the wars of the early 20th century most developed nations used currency backed by gold. The idea was that the money in circulation was effectively an IOU for a (small) amount of gold that the government held for you – though to a large extent the USA held it on behalf of other countries. This common standard for money enabled international trade by providing a clear basis for exchanging currency from different nations.
From the early ’70s the Gold standard went out of fashion, in part it seems because there was more money that gold. We found that we didn’t need the gold, and that exchange rates could be managed using the supply and demand principles that work in any market economy. But this opens up a question about what money really is. To some extent that doesn’t matter as long as we can use it to buy and sell things, and there is adequate evidence that we still can. But it can still be helpful to have a clear idea of what money is and in particular where it gets value from. If money no longer gets value from the gold it can be exchanged with, where does that value come from?
This question is particularly important in MMT as a key component of this theory is that the government can spend before taxing or borrowing. It can always print money and spend it. “We don’t have enough money” is never a valid justification for a sovereign government that issues its own currency to refuse to spend. There may be other reasons, but lack of money cannot be one of them.
Given that money is so easily obtained, our previous understand of money seems to lose substance and we need a new perspective. In the first chapter of The Deficit Myth, Kelton tries to provide an answer by suggesting that the value comes from the fact that the government gives value to dollars by accepting only dollars as payment of taxes. Taxes must be paid, so people need dollars, so people require dollars from others as payment for goods and services, so everybody needs dollars, so dollars have value. I find this logic unsatisfying and unconvincing.
I think many things have value and we don’t need taxation to create that value. Rather value comes from need. If I have a need, then I will value anything that meets that need, whether directly or indirectly. If I’m hungry then I will value a ready-made meal, or I will value the ingredients to make a meal, or I will value a good book if I know someone who likes to read and has some spare food. Or I will value dollars if I live in a society which commonly exchanges dollars for food. None of this needs any direct intervention by the government.
The primary role of the government in giving value to dollars is to make them universal. Legislation which requires that any debt may be settled using dollars has a dramatic effect on how we relate to dollars. I suggested earlier that a good book might be useful to get a meal, but that would only apply if I already knew someone who might make the exchange. Similarly I might know someone who will take some hand made toys that I can produce in exchange for some warm clothing. I may even have a network of contacts which each have different resources and different needs and I can trade and barter among this group and help everyone get most of what they need or want. The introduction of universally accepted dollars makes this all much easier. I no longer have to get to know everybody’s different needs. Because everybody can use dollars to meet their needs, they will all accept dollars, and so I can focus on collecting dollars to meet my needs. This is the value of dollars – of money – I can use it to meet my needs. Certainly I need to pay the taxes the government demands and this one of the needs that give value to money, but it is certainly not the only one.
Underlying all this and giving it substance are promises and trust. It isn’t really enough that the government declares and promises that all debts can be settled with dollars, I need to trust that this is actually true. If the society is functioning well, if the government seems to generally be in control, and if there are generally enough resources available to meet all the needs, then there is good reason to trust that promise. If I try exchanging dollars for donuts and am happy with the result, then I’ll be encouraged to try again, and again. If any of these foundations of my trust change – if the government loses control or the resources become unavailable – I might lose trust in my dollars and might look for other ways to get my needs met.
The sort of promise that the government would make is that it will only legal recognize debts that a denominated in dollars. If someone incurs a debt in dollars, then the government gives full support to the creditors to get the debt paid when it is due. If the debt in not in dollars, then the government will be much less supportive. This promise of support combines with the basic value of needs being met, to provide the full value of government issues dollars.
To sum up, the value of money is not that it represents a share of some stockpile of gold, but that it represents some share of the total resources of the nation – my share of the Gross Domestic Product if you like. That is what the dollar represents and the government – as administrative representative of the whole society – promises that I can trade my dollars with any other agent in the economy to get access to my share of these total resources. I find this to be a satisfying picture of money, and I think it leads to useful perspectives on other parts of the economy, which I might explore in future posts.
Coming back to one of the ideas that started this: now that we know what money is, what does it mean for the government to print new money? What is their basis for doing that?
Though The Deficit Myth doesn’t make this clear, it doesn’t really propose printing money for any and every expense that the government incurs. A government has many arms and many responsibilities and they shouldn’t be expected by handle money exactly the same way. The most obvious example, for nations like USA and Australia, is that while the federal government can potentially print money, the governments of individual states or cities cannot do that. State governments must earn, tax, or borrow all the money they spend. Similarly some arms of a federal government should as well. The particular area of federal government expenditure that is given in The Deficit Myth as being an area to spend money before receiving it is social welfare. The obvious example is keeping everyone out of poverty by (as MMT proposes) guaranteeing jobs for everybody who wants one. The government will find work for you to do, and will print money to pay you. Less obvious areas which are potentially just as valuable are health and education. From a social-good perspective, the only possible reason not to provide food, shelter, health services and education is if the nation does not have the resources to do that. Money should never be an issue.
When the government spends on social welfare, it is saying “All residents deserve a share of the produce of the nation”. There is a risk that this might produce inflation, which reduces the value of everyone’s dollars. If that happens then a reasonable interpretation is that the whole society bears a small cost so that none go without basic necessities. I think that would be justified, but I also suspect that most of the time in a healthy society with a wise government, it wouldn’t be necessary.
An alternate perspective on government spending is to see it as investment. If some members of the society are not benefiting society, whether because that don’t have the knowledge or skill, or because they are unwell, or because they simply haven’t found a job to do, then that suggests that the nation has resources that are not being fully realized. If the government can intervene in a way to make these people more productive, then that is likely to be a valuable investment. When spending on employment health and training is well targeted, it is to be expected that the nett results, in the long term, will be positive. The results will likely be more than sufficient to “repay” the initial investment. Conversely, there is substantially evidence that if such resources (people) are left under-utilized, there can be substantial cost, whether from crime, or from incompetence, or from health conditions getting worse and so being more costly to treat.
Exactly how government should direct the money that it prints in order to boost society is not an easy question to answer, It would require risk taking and ongoing measurement and is fundamentally a political question which economics cannot give a full answer to. But the economic theory makes it quite clear that spending as an investment it perfectly defensible, even if you don’t have the money already. Certainly the government could borrow the money like the rest of us have to. But it doesn’t need to. It can instead print the money as a way of promising the to people that they have a share in the total resources.