Modern monetary theory, or MMT, is here to stay. What investors need to know.

About the author: Stephen Dover is Chief Market Strategist and Head of the Franklin Templeton Investment Institute. Follow his newsletter, Global perspectives On Linkedin.

Modern monetary theory has grown in importance in recent years as American living standards stagnated and inequality increased. MMT’s critics are quick to dismiss it, but investors need to understand that the idea is likely to stand. It is part of a debate that will outlast Trumpism and Brexit and which can shape public policy and economic development for the next half century.

MMT can be roughly defined as the state that borrows money from the central bank to fund public spending. In other words, MMT is the monetization of debt. The MMT’s challenge to orthodox approaches has found supporters in an economic and political environment that is ripe for change. Extremely low interest rates (negatively adjusted for expected inflation) offer governments a unique opportunity to take out loans and invest, especially in goods that private markets do not offer or offer only inadequately, such as roads, bridges, schools etc. healthcare. The distorted distribution of income and the concern that the orthodox economy will only work for a few are causing many social critics to look for new ways.

Central bankers, like most economists, value their independence from political influence. Nonetheless, given the high budget deficits, sluggish growth and low inflation, central banks will remain reluctant to tighten. Hence, it is possible to foresee some form of effective MMT in which central banks monetize deficits, as economic fundamentals require monetary policies that are consistent with MMT objectives. If governments adopt policies that require large banks, insurance companies, and pension plans to hold large amounts of sovereign debt, the low interest rates could last much longer and allow governments to borrow and spend more.

There are at least three other reasons why MMT is unlikely to go away. First, the global financial crisis, rising income inequality, and other forms of economic uncertainty have shaken public confidence in the orthodox economic foundations of free markets, deregulation, and globalization that have dominated political and economic decision-making from the 1980s to the last decade. Second, the widespread and persistent use of quantitative easing (QE) by central banks without boosting inflation has fueled the notion that the central bank is marking public sector debt and deficit as a viable option. Third, a political backlash against the influence of money (plutocracy) and technocratic politics, from which the top 1% of the wealthy have benefited, has unleashed powerful forces calling for the instruments of power to be used for the benefit of ordinary citizens rather than citizens privileged few.

Four decades ago there was a popular thinking that “greed is good” and “government is the problem”. Economic uncertainty and fairness are the buzzwords of our time today. Government intervention to contain the 2007-2008 financial crisis and now to tackle the pandemic has rekindled interest in an era where public investment improves results. Climate change threatens communities and exposes the shortcomings of the “invisible hand” in delivering the common good. There is no turning back to the ideals of free markets and economic liberalism.

The development towards a new paradigm underpins a key component of the MMT: the structural subordination of monetary policy to fiscal policy. QE originally began as a textbook monetary policy response to the increasing demand for money during the financial crisis. Milton Friedman, American economist and statistician, could have put it: If the speed of money collapses (due to an increase in money demand while the financial system is teetering on the brink), the central bank must increase the money supply to prevent a collapse in nominal gross domestic product (GDP ). Friedman and former Federal Reserve Chairman Ben Bernanke, economists who do not often agree on their views, recognized this fact from their study of the failure of the Fed and other central banks during the Great Depression.

QE was also monetary policy’s logical response to the economic collapse caused by the COVID-19 pandemic. Unprecedented slumps in production and prices required massive, but ultimately orthodox, political responses from central banks. It is important that QE did not fuel an undesirable rise in inflation. However, because QE was a crisis response mechanism, many economists and almost all central bankers consider it temporary. Come to the advocates of MMT who believe that debt monetization should become one continuous. She believes that this new role of monetary policy can support government investment in education, climate action, programs to tackle income inequality and universal health care.

Partly because of quantitative easing, prevailing interest rates along the yield curve remain below inflation rates. As a result, the United States and other governments could hold on to historically low funding for a generation or more. That opens up a fascinating possibility. Instead of asking the Fed or other central banks to invest in education, infrastructure, or climate change that will benefit today’s citizens and their descendants, MMT advocates could urge the U.S. Treasury Department (and its foreign counterparts) to pay 50- or 100- Yearly issues to issue debt (maybe even perpetual bonds) to fund investments that will pay off the unborn for the rest of this century.

What could that mean for investors?

If governments were to issue more longer-term bonds, investors would have unique opportunities. For example, pension plans and insurance companies that have long-term liabilities would have access to assets with similar maturities. They would likely be avid buyers of very long-dated government bonds, as is already the case in the UK and parts of continental Europe.

In addition, the ability to take risks increases as large amounts of capital are available at relatively low costs for long terms. This risk appetite is necessary in order to achieve both income and capital growth targets, since traditionally “risk free” investments do not offer adequate returns today. The world after the financial crisis has already given us an outlook on this environment. Falling bond yields have pushed the values ​​of other assets higher. Notably, much of this wealth inflation in stocks has occurred where intangibles such as research and development, brand dominance, and competitive advantage are the dominant value drivers. Financing intangible assets is easier and more lucrative when the cost of capital is low.

Pragmatism and fairness require some tax hike from today’s citizens for investments that also increase their well-being. These benefits may include free technical training from community colleges in the United States or road, bridge, and airport overhauls. A balance must be struck between generations in distributing the costs of social investment.

Taxation must also be broadly based. With US national debt already over 100% of GDP, and given the size of the MMT targets, tax funding cannot be achieved simply by making the rich pay more. If MMT advocates want a huge increase in government spending and investment along the lines of many Western European countries, the total tax share of GDP must rise. This increase will have to be supported by most citizens, most likely with increased consumption taxation to complement personal and corporate income taxes.

While it cannot be done exactly the way its proponents would like, MMT represents a growing awareness that investing in public goods such as education and transport, as well as in programs to combat climate change, are very costly and bring benefits for generations. Achieving these goals can be achieved in part through the unique opportunity to borrow at negative real interest rates, but it also requires a broader and fairer tax base.

MMT – at least in some form – is likely to remain.

Guest commentary like this is written by writers outside the Barron’s and MarketWatch newsroom. They reflect the point of view and opinions of the authors. Send suggestions for comments and other feedback to [email protected]

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