Many economists and much of the public are beginning to worry about the massive increase in the money supply and the massive increase in deficit spending. With a public debt approaching $30 trillion and a money supply that has increased by 25% in the last two years, the worry seems justified. However, Modern Monetary Theory (MMT) says we have nothing to worry about.
MMT says that since the US uses a currency that is not backed by anything other than faith in the government, more money can always be printed to pay off the debt. And the increase in the money supply will not necessarily lead to inflation.
Deficit spending has been a normal occurrence since the early 1960s. In fact, in the last 58 years, the federal government has had 54 years of deficit spending. The only exceptions happened from 1997 to 2000, when President Clinton reduced the capital gains tax rate from 28% to 20%.
That rate reduction triggered an investment boom which led to increased revenue from capital gains taxes and a rapid 4 ½% annual GDP growth rate during each of those four years. Because Clinton declared in his 1996 State of the Union speech that, “The era of big government is over” he was able to have budget surpluses.
Beginning in 2009, annual deficits got very large, topping $1 trillion. In 2020, the deficit got very, very large topping $3 trillion. In 2021 it is likely to go even higher. Is the $30 trillion public debt a problem?
Most economists would say it is. There are two problems associated with the huge public debt. The first is that the annual interest expense is approaching $400 billion, which is money that can’t be used for more productive purposes. The second is the potential for a capital shortage since there will be trillions of dollars taken from capital markets by government.
Worse yet, President Biden wants to raise taxes on corporations and high-income earners, where most of the new capital is generated. That will contribute to the capital shortage.
Actually, not all of the $30 trillion will be removed from capital markets, since the Federal Reserve (Fed) will have printed about $6 trillion more dollars to purchase some of the government bonds. Still, that means $24 trillion is pulled and the money supply will have increased rapidly.
Does a rapid growth in the money supply lead to inflation?
Most economists would say yes, citing the numerous historical examples. In 1981, Milton Friedman and others convinced policy makers that it was the increase in the money supply that led to the double-digit inflation of the 1970s. So, reducing the rate of growth of the money supply would reduce inflation.
Friedman’s views were implemented. Inflation dropped dramatically and has been relatively low ever since.
Most economists today are extremely concerned about future inflation. In addition to the rapid growth in the money supply, Biden’s war on fossil fuels has already driven up the cost of energy. Prices will go much higher as the coming high economic growth will fuel a large increase in demand for energy.
At the same time Biden is restricting the supply by halting drilling on federal land and by cancelling the Keystone Pipeline. Not only will that drive up energy prices, but the supply reduction will make the US dependent on not-so-nice countries.
Then there is a concern that a capital shortage will mean business may not be able to respond to the growing economy by increasing output. That means the only other response is to raise the price.
MMT says the large increase in the money supply is not a problem The money supply can increase as much as policy makers feel is needed whether that money is used to finance government spending or whether it is used to simply increase the supply of money to the public.
They say that similar monetary and fiscal policy actions were taken during the past decade and no inflation followed. They say that the most recent data indicates that increases in the money supply will not lead to inflation.
Here is why they are wrong.
When the Fed takes action, which increases the money supply, the initial increase is eventually deposited into banks, which end up lending most of those funds. That creates a multiplying effect to further increase the money supply. As long as banks can make loans, the Fed’s initial increase can finally increase the money supply many times over.
The large final increase in the money supply should be inflationary. That wasn’t the case 10 years ago. From 2010 to 2018, the Dodd-Frank bill placed severe restrictions on bank lending, which reduced the multiplying effect. That could be the reason there was no inflationary impact.
But parts of Dodd Frank were repealed in 2018, so now there should be a greater multiplying effect, likely contributing to inflation.
Rising energy prices, a rapid growth in the money supply, huge government budget deficits and a potential capital shortage all point to a future inflation problem.
Those who support MMT have reached conclusions that are simply not accurate. Continuing to print money and continuing to deficit-spend do have consequences. The first consequence is rapidly rising prices. I am afraid that is coming.
Dr. Michael Busler, Ph.D., is a public policy analyst and a professor of finance at Stockton University in Galloway, New Jersey, where he teaches undergraduate and graduate courses in finance and economics. He has written op-ed columns in major newspapers for more than 35 years.
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