We’re all Modern Monetary Theory now

Move over, John Maynard Keynes: a theory of government debt forever has taken command

Money figures have been converted to 2023 dollars

On the first day of the current century, the United States carried $9 trillion in public debt. Today the United States carries $32 trillion in public debt -- federal borrowing more than trebled in two decades.

Photo by Omid Armin on Unsplash

Public debt – contractual obligations to third parties – is more worrisome than intragovernmental debt, which is subject to the whims of Congress.

The economy has grown, so perhaps public debt as a percentage of GDP is more revealing than the nominal amount. On the first day of the current century, U.S. public debt was 31 percent of GDP. Today it’s 94 percent – trebling in two decades.

Track the spectacular growth of U.S. public debt here. Track the spectacular growth of public debt as a share of GDP here.

Runaway increase in U.S. red ink has come during a period of two national emergencies, 9-11 and COVID. But debt also bloomed during the many years since 2000 when there were no emergencies: in the bona-fide sense, as opposed to politicized special pleading or media heavy breathing.

And there’s not a hint of fiscal discipline on the horizon.

The Congressional Budget Office, a nonpartisan agency, projects that by mid-century, public debt will increase to 181 percent of GDP. That increase is coming even after what President Joe Biden and former Speaker Kevin McCarthy said were “dramatic spending cuts” in the May debt-ceiling deal.

The above figures pertain to national debt – money future generations must repay. Then there’s the federal deficit – red ink in the current year. That too is out of control.

In 1990, President George H.W. Bush, who ran on a promise of “read my lips no new taxes,” was horrified to learn the federal deficit would hit $532 billion and 3.7 percent of GDP. (Remember, numbers are adjusted to 2023 dollars.) Using the thought processes of conventional economics, as enunciated by his very well regarded economic advisors, President Bush feared such red ink would cause a prolonged recession. So he backed a tax increase – a leading factor in his 1992 reelection defeat.

The fiscal year just ended showed a federal deficit of $1.5 trillion – three times the deficit that spooked the elder president Bush.

That’s with the COVID blowout spending programs ended: even so, the deficit has skyrocketed. That’s with a strong economy, very low unemployment, no resource shortages, plentiful goods and services.

The population has grown since 1990. If we adjust for that, the current deficit is double the deficit that spooked a president.

And the deficit is rising fast even after the Biden-McCarthy debt ceiling deal depicting as a dramatic spending restriction. By 2033, according to the CBO, the deficit will hit $2.7 trillion, four times (adjusting to current dollars and for population growth) the red ink that spooked George H.W. Bush. 

The annual federal budget has become the annual splurge. Five years ago the federal government spent $5 trillion. In the fiscal year just concluded, federal spending was $6.4 trillion – that’s after the special COVID programs ended.

Annual federal spending jumping by a third in just five years – though we’re not at war, there is no bona-fide emergency, and the economy is hitting on all cylinders (or on all AC traction motors).

Fiscal discipline is so old-fashioned! Postscript: the new spending is borrowed.

Conventional economics says the runaway government borrowing of recent years is unsustainable. Is that correct?

It took the United States 221 years to run up $9 trillion in debt, 23 years to add another $23 trillion indebtedness. That’s 25X more debt annually since 2000 than in previous years of the republic, far out of sync with population growth.

This has the word “crash” written all over it – and Congress does nothing, much more concerned with who gets to send Tweets and to sit in the best offices.

Conventional economics would say we don’t need to wait for a possible crash, the economy should be collapsing right now: dragged under by Argentina-style inflation and the market-distorting impact of government soaking up available liquidity.

Instead the economy is rock-solid. Inflation is annoying but hardly devastating, less than half the level of 40 years ago. Higher mortgages rates are annoying but hardly devastating, at about the postwar average.

Roughly since 2000, when you ask a traditionalist economist why federal borrowing is not causing more problems, he or she changes the subject. What’s been happening does not correspond with what traditional economics predicts.

Which brings us to Modern Monetary Theory.

This is a loosely defined group of ideas scoffed at by establishment economists – the very group that can’t explain how $23 trillion in national debt could be piled on quickly without the economy melting down.

The leading exponent of Modern Monetary Theory is Stephanie Kelton, an economist at Stony Brook University. Kelton was economics advisor to the 2016 presidential campaign of Bernie Sanders.

Stephanie Kelton. Photo courtesy Stony Brook University.

At that time Sanders wanted a big increase in federal borrowing, to be used for higher entitlement spending, including Social Security bonuses. The economics establishment ridiculed the Sanders/Kelton proposals, saying more debt would sabotage the economy.

Not long after the Sanders 2016 campaign came COVID and a $5 trillion federal spending blow-out grounded entirely in borrowed money. And the economy was just fine – in fact, great when measured by low unemployment and rising living standards, plentiful goods and services; none-too-shabby when measured by real wages.

Exactly what Kelton said would happen did happen – there was a wild spree of borrowing and the economy was fine.

People complain economics is a dismal science, but there’s nothing dismal about Modern Monetary Theory. Kelton’s book, The Deficit Myth (PublicAffairs Books, 2020), is practically a stroll in the park, a laff a minute, full of crazy ideas and entertaining nonsense.

Except – Kelton has done a better job than the traditionalists at forecasting the near future.

When people say money isn’t anything tangible, just strings of zeros – you can’t eat a $100 bill – Kelton goes further. The kinds of cash we care about, especially the USD, the world’s reserve currency, are just “fiat money,” she contends, kind of a mutual consensual illusion.

The USD is worth something because we say it’s worth something. It’s money announced by fiat, formed ex nihilo (just like the universe!) and backed by nothing.

Since it’s backed by nothing, Kelton reasons, we can have as much as we want. The Federal Reserve can add zeros and use the result to purchase Treasuries and securitized mortgages, or sell foreign central bank swaps. Tradition calls that borrowing and lending, but Kelton argues it’s not because we’re just rearranging zeros rather than executing any tit-for-tat transaction.

For this pie-from-the-sky to work, Kelton says, two conditions must be met: currency must be fiat money (not backed by anything tangible, such as gold) and government must exert a monopoly over national currency.

Many nations meet these conditions, not all. The United States meets the conditions – which is why Kelton is bullish on deficit spending.

This could change if cryptocurrency and DeFi (peer-to-peer currency) expand in importance. Then the free lunch of “printing money” not at a mint, but by adding zeros, would end.

As they say on late-nite TV, Wait there’s more!

One might enquire, if government can self-generate all the fiat money it needs, why must we pay taxes? Government could just materialize revenue while we get to keep our dollars.

The reason for taxes, Kelton contends, is to compel people to work. If government funded itself and fiat money came into existence via a person in a robe crying abracadabra, people would only need cash for food, clothing, shelter and pleasure. They’d work a lot less; society would become unproductive. Charging taxes forces men and women to be productive.

To sum – government can borrow whatever it wants, and higher taxes are good!

I’ve phrased the Modern Monetary Theory argument to make the idea sound outlandish, because it is.

But then – conventional economics cannot explain why there was almost no inflation, and no soaring mortgage rates, during the 2000-2020 period when federal borrowing reached reckless levels.

Modern Monetary Theory may be on to something. At the least, if the United States keeps borrowing and can’t repay, what are our creditors – Japan, not China, holds the most U.S. public debt -- supposed to do, attack us? They won’t have any practical choice but to “take a haircut,” in international finance terms, though, wouldn’t lend anew.

If it’s really true that nations with a currency monopoly over fiat money – the United States, most of Europe – can borrow forever without consequences, one must wonder why none of the world’s finance ministers has ever mentioned this.

Are they idiots? Trying to keep the public passive before demands for more taxes? Do they think endless borrowing is irresponsible to future generations?

In 1796 George Washington said Congress should pay the national debt in order not to place “upon posterity the burden we ourselves ought to bear.”

Contemporary capitals of the United States and several other major nations are enthusiastically placing burdens on posterity.

The Federal Reserve has been adding zeros to federal accounts with glee, including buying Treasuries to lower federal interest expenses while creating an illusion the Washington balance sheet is in good shape; covering for the fact that that the White House and Congress are acting irresponsibly with money.

When the term of Fed chair Jerome Powell, selected by the Republican Donald Trump, was up in 2022, Democrat Biden re-nominated him.

This was because Powell represents the sole policy on which Democratic and GOP leadership are in lockstep – borrow, borrow, borrow and place the burdens upon posterity.

The eight GOP representatives who provided tipping-point votes to oust Speaker Kevin McCarthy have been widely derided as harebrained.

Okay, that is true of Rep. Matt Gaetz!

But it’s convenient for the Washington establishment to dismiss the eight – because they focus on reducing national debt. The Washington establishment does not want to deal with this issue, or even admit it exists.

Prediction: the current continuing-resolution predicament will lead to Biden appointing a commission to recommend unspecified dramatic spending cuts at an unspecified future point.

The White House and Congressional leaders will claim they “took action” on debt by appointing the commission.

The president is significantly older than the population as a whole; Congressional leadership of both parties is significantly older than the population as a whole. Today’s national political leadership consensus is: Somebody else can deal with the invoices after I am gone!

Sadly, this is also the view of the Baby Boomer cohort to which your writer belongs: gimme gimme gimme and consequences be damned, because we’ll be gone when it hits the fan.

FDR liked use analogies to running a household.

Suppose your household is in decent shape financially. You’re not living beyond your means, you are paying down the mortgage, you have a nice credit score. This was the situation for the United States 25 years ago when the federal budget was in surplus.

Then you go wild and buy a Ferrari. In the immediate aftermath, nothing changes.

You go wild again, three-star restaurant dinners, cases of vintage Dom Perignon. Credit card bills arrive, but still things are okay. You and your spouse take a first-class ocean cruise, buy jewelry and designer clothes on credit. You think, “Hey, things are fine, we can always pay these bills some other time.”

Then the bank forecloses on your house.

As recently as about 20 years ago, Congress was leery of going deep into national red ink. Then debt was run up and nothing bad happened. The basic notion that debt is dangerous was forgotten, or assumed away using forms of Modern Monetary Theory.

Today in Washington both parties want more borrowing. The only disputes on at the margins – should it be a lot more borrowing or a huge amount more?

An Oval Office-House of Representatives debt-ceiling “spending cut” that increases spending; Fitch downgrading U.S. debt; Biden from the White House saying Trump is to blame for debts run up during the Biden administration; Trump said to be planning major tax cuts if reelected; “quantitative easing” (money printing) gone from rare expedient to regular event.

All this before the long-known Baby Boom entitlement cost increase for Social Security and Medicare crash-lands on the federal books.

America should have employed the last two decades carefully saving against that day. Instead it’s been ice-cream sundaes for everyone with no plan for how to pay.

In 1971, Richard Nixon took the United States off the gold standard and withdrew from an international monetary agreement called the Bretton Woods system.

Nations with currency backed by something tangible – gold, silver, it could be Styrofoam – can’t just add zeros to accounts, they must increase a physical reserve.

The two 1971 moves made the USD into a fiat currency – if you want more, add zeros – setting the stage for borrowing-based government.

Nixon is said to have remarked, “We’re all Keynesians now,” referring to a 1936 concept from John Maynard Keynes.

John Maynard Keynes. Library of Congress photo.

As the world was recovering from the Great Depression, policymakers wanted to prevent a repeat. Keynes, a British economist, proposed that when the economy is weak, government should borrow and spend, to stimulate demand.

Borrow-and-spend – many governments liked the sound of that! There has been no second Depression, which suggest Keynes was right. So we all became Keynesians.

Only a few governments (Norway is one) also followed the second half of Keynes’s prescription -- when the economy is strong, government should reduce spending and pay down debt.

Pay down debt! These are curse words in Washington.

Headlong government borrow-and-spend during a strong economy – the time Keynes said government spending should be cut back -- was the case under Donald Trump, who actually called himself the “King of Debt.”

Today the United States economy is strong and we’re not making fiscal cuts to pay down debt, we are increasing borrowing and spending at a head-over-heels pace.

That’s because, whether we use the terminology or not, we’re all Modern Monetary Theory now.

The Federal Reserve board in 1913. LOC photo.

Bonus: Everyone Loses the Blame Game. My friend and former Colorado College classmate David Malpass, till recently head of the World Bank, argues there’s no doubt federal borrow-and-spend is the root cause of current inflation.

Also, he thinks federal debt is slowing economic growth, though growth is the sole happy-ending scenario for debt (because growth results in more tax revenue).

The Northeast Corridor establishment could not wait to get Malpass out, even knowing he did a fine job reducing developing-world poverty and took many actions against greenhouse gases.

But he spoke a forbidden thought – that the United States government is too deep in debt. Even Republicans wished him out, for though federal debt is a GOP talking point, events of 2023 made clear the mainstream of the elephant party has no intention of doing anything substantive about borrow-and-spend.

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