The Ultimate Bubble Blower

Chapter 6 (Complete)

Unleash the trillions

Back in April of 2019, the Evergreen Virtual Advisor (EVA) newsletter series on Bubble 3.0 ran a chapter called Can An Acronym Save The World?  That initialization represents the once obscure but now economically, and politically, dominant concept known as Modern Monetary Theory, or MMT for short. 

At that point, less than three years ago, even our firm’s most astute clients were, to nearly a woman or man, totally unaware of this thesis.  In the prior chapter that ran in March of 2019, called No Way Out, I had made enigmatic reference to a proposed solution to a problem some pundits have called secular stagnation.  Among the most prominent proponents of that dilemma is former Treasury Secretary Larry Summers.  His essential point is that America has long been in a low-growth phase caused by various factors.  But in his view, and that of many other economists, the overarching growth impediments are a savings glut and an investment deficiency.  Here is his explanation from an article he wrote for Foreign Affairs in 2016: 

“The key to understanding this situation lies in the concept of secular stagnation [5], first put forward by the economist Alvin Hansen in the 1930s. The economies of the industrial world, in this view, suffer from an imbalance resulting from an increasing propensity to save and a decreasing propensity to invest. The result is that excessive saving acts as a drag on demand, reducing growth and inflation, and the imbalance between savings and investment pulls down real interest rates. When significant growth is achieved, meanwhile—as in the United States between 2003 and 2007—it comes from dangerous levels of borrowing that translate excess savings into unsustainable levels of investment (which in this case emerged as a housing bubble).”   (Emphasis mine)

Mr. Summers has long believed that an intense blast of Federal deficit spending could pull the U.S. out of secular stagnation.  His view was that radical monetary policies, such as zero or even negative interest rates, plus trillions upon trillions of central bank money fabrication, which had already been in place for seven years when his article ran, had clearly failed to break the secular stagnation cycle. 

Fast-forwarding to the spring of 2019, that was still the case despite an initially promising growth spurt early in Donald Trump’s administration.  For a time, the catchphrase “synchronized global recovery” had replaced “secular stagnation”.  But unfortunately, U.S. trend growth soon returned to the flaccid 2% real GDP increases that had persisted in the post-Global Financial Crisis era.  (By contrast in the 1980s and 1990s, U.S. GDP growth averaged over 3% per year, as noted earlier.)  Europe and Japan fared even worse.  Secular stagnation was once again in the limelight.

Accordingly, MMT was emerging from obscurity by April 2019 as a promising antidote to the growth deficiency disease.  Stephanie Kelton, Bernie Sanders’ economic advisor during his 2016 surprisingly effective (for an avowed Socialist) presidential campaign, stood out as one of its leading advocates.  In the early spring of 2019, MMT was still back page news, but that was about to change.  In our April 5th EVA of that year, I opined that it would soon be on the frontpage.  Frankly, I had no idea how soon.

Before going there, let’s examine the actual theory, because I suspect that even today many Americans are as perplexed by MMT as they are about Bitcoin.  Similar to the cryptos, despite what most of us hear and read about it constantly, there is still a fog of uncertainty as to how it works and what it really is.  (In my case, the more I study Bitcoin, the more I realize how clueless I am on that one.)

As briefly discussed in Chapter 1, the basic idea is that since the U.S. can issue debt in its own currency, which also happens to be the world’s reserve currency, it can deficit-spend to its heart’s delight. Per an Investors’ Business Daily article that ran in the spring of 2019, as MMT was zooming into the national economic debate, “it (the U.S. government) can simply print more money when it needs it to pay off its debts”.

If this falls under the too-good-to-be-true category in your mind, please bear with me. MMT advocates assert that, no worries, as long as the Fed keeps interest rates low, like below the increase in GDP (it seems to excel at that these days), AND lower than the growth of government debt (that one’s not so easy in this era of deficits gone wild), then it’s all good — and not too good to be true.

Perhaps you detect a hint of cynicism in my tone. If so, you are definitely not tone-deaf. But I need to give the in-favor-of argument a fair hearing.

It’s no exaggeration to say that MMT has both strident defenders and attackers. The former point out that the government should only employ MMT as long as it doesn’t create inflation.  Back in 2019, inflation was melting right along with global interest rates.  Accordingly, it seemed like a reasonable assurance. But more on that later because, to this author, inflation is this theory’s ultimate Achilles heel… and one that has already been exposed. 

Let’s back up a bit to understand the genesis — but certainly not, in my view, the genius – of MMT. As one critic opined in the aforementioned IBD article, it’s “… sort of turbocharged Keynesianism”. My partner and all-around hero, Charles Gave, wrote on this topic which we ran in our March 14th, 2019, EVA. 

For those who would like the Twitter version, Keynesian economic theory dates back to the Great Depression. It was the creation of Lord John Maynard Keynes, and its essence was, and still is, that during periods of a collapse in private demand due to a crisis – like the stock market crash of 1929 and subsequent bank failures – the government needs to spend far more than it takes in from taxes. In other words, deficit-spend as much as necessary to revive the economy. Ok, I know, that was a lot more than the max 140-character Tweet, but it’s still pretty concise.

Many Boomers, like me, who remember where they were when JFK was shot—and, an infinitely more pleasant memory, where they watched the Beatles first performing electrifyingly live on The Ed Sullivan Show a few months later (February 9th, 1964) — are also at least vaguely aware of Keynes’ brainchild.  Moreover, many of us recall it was the dominant economic policy in the U.S., and most of the developed world, from after WWII until the late 1970s. (At that point it was superseded by supply-side economics which were a key aspect of the “Reagan Revolution”.)

Interestingly, and quite likely most relevantly, “Keynesonomics’” quasi-demise was triggered by inflation. Further, the rampant CPI rises of the mid ‘70s happened at a time when unemployment was soaring. According to the many disciples of Keynes, that was nigh on impossible. (In 1946, the Lord himself went to be with the Lord of lords — maybe — well before his dogma became viewed as the Bible of economics.) Keynesian theory held that a high jobless rate virtually guaranteed low inflation. But as Charles Gave wrote in his EVA on MMT, another great macro-econ thinker, Yogi Berra, once said: “In theory, there’s no difference between theory and practice. In practice, there is.” The growing legion of MMT fans out there might do well to remember those sage words.

However, a key difference between Keynesian economics and MMT is that the former assumed deficits generated during downturns would be financed by bonds. In turn, that debt would be repaid by surpluses during expansions. For a number of years, governments more or less adhered to that approach.  (Accordingly, I would argue pure Keynesian economics has gotten a bum rap; if it was implemented as Keynes himself had suggested, it might have proven viable in his famous “long run” timeframe. But politicians have increasingly opted for all-deficits, all-the-time.)

For example, in the U.S. the massive debt incurred to win WWII was gradually paid down over the next three decades, at least as a percentage of GDP.  (How it did so is fascinating and highly applicable to the debt fiasco America finds itself in today; the post-war experience of debt reduction, at least relative to the size of the economy, will be analyzed further in Chapter 15.)

                                                                                Figure 1                       

Again, being old enough to remember the extreme angst of the 1970s, when it seemed like nearly all the economic news was bleak, it’s hard not to wistfully yearn for a time when the U.S. government was so lightly indebted. This was especially true compared to the swelling size of the economy during the polyester-&-bell-bottoms decade. As bad as things were in the ‘70s, at least the economy grew faster than government IOUs did in those days.

Ironically, it was the supply-side policies of Ronald Reagan that began the great debt lift-off. And, equally ironically, inflation and interest rates went down, pretty much the exact opposite of what was expected to happen as deficits under “The Gipper” blew out to unprecedented levels, at least in peacetime.

Basically, for many years Keynesian theory looked like a winner until it met its inflation Waterloo. That’s actually a relevant lead-in to the first dramatic example of MMT (which perhaps should stand for Modern Monetary Terror) in action. One of the main causes of Napoleon’s rise to power in the late 1700s was the French Revolution and its revolting Reign of Terror excesses.

But numerous historians believe the downfall of the French aristocracy was a function of the hyper-inflation that broke out decades earlier. This was, in turn, caused by the economic theories of the on-the-lam Brit, John Law – who apparently got sideways with the law back home – as briefly described in Chapter 3.

A blast from a bubble past

John Law’s plan, which he sold to the heavily indebted French monarchy, involved the idea that France could effectively borrow enormous sums by issuing shares in a company backed by its vast holdings in North America (what would eventually become the Louisiana Purchase).

As the gifted wordsmith Jim Grant retells it, the “System” was based on, in Law’s own words: “An abundance of money which would lower the interest rate to 2%... reducing the financing costs of the debts and public offices, etc, relieve the King.” Previously, the then-reigning majesty’s treasury was subject to the indignity of borrowing at 8%. Thus, a quartering of the interest cost could be theoretically realized.

Now, pay special attention to this part, again quoting Law himself: “It would enrich traders who would then be able to borrow at a lower interest rate and give employment to the people.” Does that sound familiar? Let’s compare Law’s words to the following excerpt from former Fed Chairman Ben Bernanke in his now legendary November 2010, Op-Ed article for the Washington Post in which he described the alleged benefits of his upcoming “System”, officially known as Quantitative Easing:

“The FOMC (Federal Open Market Committee) intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth… Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

Ah, enriching traders/investors and the virtuous circle. That’s exactly what Mr. Law promised the French monarchy and, for a time, in basketball parlance, he swished it. Law quickly became a hero of both aristocrats and the common folk. In the process he also became very, very rich — always a nifty side benefit. Per Jim Grant, as one of Mr. Law’s biographers noted with exquisite irony, he was a “twenty-first century banker in the eighteenth century”.

Essential to his “System” back in 1715 was setting up a bank. But not just any bank. It needed to be one with some serious gravitas, like having its notes or debt convertible into gold. It also needed a grand name — the Royal Bank. As Jim Grant observes, it became France’s first central bank.

If you are wondering what could go wrong with a bank whose obligations could be exchanged into gold, just wait a bit. Once the bank was officially the King’s own, it issued notes backed by… you guessed it: royal edict. In other words, it was fiat money. Accordingly, notes could be issued at will, at least by regal whim or inclination. And the King was very much inclined.

Once thus structured, the Royal Bank increased the supply of said notes somewhat — like by 400% in 18 months. Again, anticipating those to follow in his crafty footsteps, Law required the Royal Bank notes to be accepted for transactions. Then he made it illegal to hold gold and jewelry, beating President Franklin D. Roosevelt to the punch on the gold possession ban by over 200 years.

Yet Law’s ambitions went beyond the Royal Bank. He needed a narrative, a sexy story to get speculative juices really flowing. He got that with the Mississippi Company, which he established to acquire and possess the trading rights to France’s vast holdings in what would eventually be the United States, representing nearly half of the future superpower’s landmass. The Mississippi Company also secured a tobacco monopoly, trading monopolies, taxing power, and the royal mint. And you thought Google had a fantastic business model! Shortly thereafter, it managed to acquire all of France’s national debt, which he offered to refinance at just 3%. (Ironically, today that sounds like a lofty yield, at least for a government to pay.)

Law also issued shares in his Magical Money Machine, the first triple “M”, if you will (as it turned out centuries later, he had nothing on the U.S. Fed’s MMM). After initially trading sideways, the Mississippi Company stock price began a spectacular ascent in 1719, as shown in this chart (again, credit to Jim Grant).                                                                                     

Figure 2

The Royal Bank offered loans at just 2% for those wanting to buy its shares, not unlike today’s Fed encouraging the use of what has been, for the bulk of the past dozen years, nearly free margin money (though, admittedly, to buy shares in the S&P, not in the Fed itself).

Law’s grand scheme predictably produced a raging bull market not only in France but throughout Europe. As Jim recounts, land prices quadrupled, and the Mississippi Company’s stock price soared to 50 times earnings (lofty indeed, though a far cry from some of today’s outlandish P/Es). The French economy boomed to a degree that puts the Obama and Trump expansions from 2008 through 2020 to shame.

However, one of Law’s former cronies, Richard Cantillon, suspected something was rotten, and not just in Denmark. Cantillon believed that eventually all the fake money would lead to cost-of-living inflation. By early 1720, it wasn’t just asset prices that were rapidly rising. Consumer prices were going — to use a 21st century colloquialism — postal, as well.

But there was another problem, per Jim, which today’s central bankers only seem to dimly perceive: “It was all very well for the bank to buy assets in a rising market. But to whom would it sell in a falling one?” Suffice to say what happened in France in 1720 was a debt crunch followed by uncontrolled inflation and a currency crisis. The Royal Bank printed money to frantically buy shares in the Mississippi Company, in a vain effort to support the share price. This caused the money supply to explode and the franc to implode. In short order, Mr. Law was out of a job.

Not long after, he was on the wrong side of the law once again. He fled into exile and, although formerly among the wealthiest men in Europe, he died (sorry) dead broke in Venice in 1729.  As previously noted, the social malaise and cynicism toward the government that followed was believed to contribute to the eventual overthrow of the French monarchy. One could say that France’s aristocracy really lost their heads over this early version of MMT.

Of course, such events could never play out in the modern world.  Not with central bankers, who so presciently saw the dangers of the tech and housing bubbles, in control of the situation, right? As Jim notes, despite all their computers and hundreds of on-staff PhDs, entities like the Fed may soon find out how tough it is to raise rates enough to combat mounting inflationary pressures without puncturing the series of asset bubbles they’ve blown over the last 12 years.

Undoubtedly, the many eloquent defenders of this “new and improved” economic theory (after all, it has “modern” in its name) will quickly point out the differences between what became known as the Mississippi Bubble and what they are proposing. As described above, Stephanie Kelton, the former economic adviser to Bernie Sanders, is among the most articulate. She is on record as being highly satisfied with the MMT policies the U.S. has followed as a result of the pandemic. 

It’s exactly the right response, in her view, and it seems like Congress agrees with her.  At least there has been little opposition to $6 trillion, and counting, of deficit spending, most of which has been financed by the Fed and its Magical (Fake) Money Machine.  Ms. Kelton’s satisfaction with current fiscal and monetary policies would seem to be proof-positive that MMT is now the law of the land in America. John Law must be patting himself on the back somewhere (unlikely in the company of angels) for being so far ahead of the times.  

Despite, or because of, the current ragingly bullish asset markets – stocks, bonds, real estate, cryptocurrencies, SPACs, IPOs, et al – there are haunting similarities to the ultimate undoing of John Law’s grand scheme.  In particular, it is the apparent belief that creating enormous sums of new money, or money equivalents, can produce real wealth and lasting prosperity. As my good friend Will Denyer, one of Gavekal’s keenest analysts, wrote in a treatise on MMT: “At its core, (it) is a recognition that government spending is not constrained by how much the government can tax or borrow — not if the government has independent control of its own printing press and no obligation to maintain a fixed exchange rate (such as against gold or another fiat currency).” Because the U.S. qualifies under those terms, it is the perfect candidate to adopt MMT — at least based on this logic.

Covid’s financial variant: Mainstream Monetary Theory

A key reason MMT has become transcendent, in addition to the pandemic, is a growing awareness of how harmful it is to the banking systems in those countries that have exterminated interest rates. And when banks are under siege, they tend to be reluctant financiers of enterprises, especially of the smaller variety. They tend to prefer lending to big business, where the risks are lower, or simply to hold government bonds which have essentially zero reserve requirements.

As my various newsletters over the years have opined, it’s very dangerous to force interest rates down to levels that impair the planet’s lending apparatus and serve mostly to inflate asset prices. That view is becoming more accepted on almost a daily basis. Thus, there was a growing chorus, even pre-pandemic, particularly on the progressive end of the political spectrum, that fiscal stimulus needs to step up to the plate.  Covid provided the ideal circumstance for MMT to go primetime.

One of the main arguments of those cheering on MMT is that most of the planet’s developed economies have been hamstrung by fiscal austerity. In other words, governments have been too worried about their debt levels and have not been bold enough in spending to revive growth.

This has been argued for years by those who feel if governments would only really cut loose with deficit spending, the world’s growth problems could be solved. But the rise of MMT has taken this debate to an entirely new level and it’s coinciding with another mega-trend my newsletters have been chronicling for several years: America’s “Leftward Lurch”.[i]

It’s increasingly clear that millennial Americans have, on balance, more affinity for socialism than capitalism. Moreover, the following words by Bernie Sanders, when he was running against Joe Biden for the Democratic nomination in 2020, are not just a campaign boast: “The ideas that we talked about when we came to New Hampshire four years ago, ideas that seemed so radical at the time — well, today virtually all of those ideas are supported by a majority of the American people.”

In this regard, it’s been startling to see that almost half of all Republicans support the onerous tax proposals by those once considered to be on the fringe left, such as Elizabeth Warren. You may have noticed that she’s no longer the most firebrand woman in Congress. That designation has now passed to Alexandria Ocasio-Cortez, also popularly known by an abbreviation, AOC.

If you didn’t know this, AOC is a proud and self-avowed socialist, like Sen. Sanders. One of her top advisors went so far as to say that every billionaire is a policy mistake (apparently, these boo-boos include prominent Democrats such as Bill Gates and Jeff Bezos). AOC is also a proponent of the Green New Deal, estimated by some to cost as much as $90 trillion.

Unfortunately, even a tab half that high would be most inconvenient given that the U.S. budget shortfall hit nearly $3 trillion for the fiscal year ending on September 30th, 2021. The math problem becomes far worse when you look out at the next 10 years and consider the tsunami of entitlement spending the aging Baby Boomer generation represents.  As previously mentioned, super investors, like the new King of Bonds, Jeffrey Gundlach, believe those total $150 trillion.  Consequently, they believe the real annual federal budget deficit is far higher than officially reported (which is already horrifying enough). 

To raise taxes to a level to pay for all the promised benefits and normal government operating expenses would almost certainly crash the economy. Thus, when AOC and others try to pay for the Green New Deal, it creates a situation that is utterly impossible. And that’s another key reason MMT looks so irresistible to those who feel like a blitz of government spending is the answer to secular stagnation, the pandemic, climate change, social injustice and a long list of other societal challenges. In their minds, it is not just a way out of this quandary, it is the only way.

Luke Gromen writes a niche newsletter called The Forest for the Trees that is popular with a number of professional investors and financial scriveners, including this author.  As MMT first began to attract national attention, appalling many mainstream economists like Larry Summers, Luke wrote these snappy words: “If we didn’t want to do MMT, we either need 75 million baby boomers to vanish by the end of next week or we need to get in an ’83 DeLorean with a flux capacitor and go back to 1937 and stop FDR from passing social security and then make a stop in 1968 and get LBJ not to pass Medicare and Medicaid… the bottom line is there are 75 million people who overspent and under-saved for 80 years because they were told the government would take care of them in the end. And the bill is due… The bottom line is if we didn’t want to get to MMT or something like it, that was a decision that should have been made 80 years ago, 50 years ago, 20 years ago with Medicare Part D. But it’s human nature. Politicians like to spend and people like free stuff that’s not going to show up until ‘someday’. It sort of stinks for the people who are there when ‘someday’ arrives.” (Emphasis mine)

Based on the policy decisions we’ve made in the U.S. (and, for that matter, most of the rich world), it’s hard to argue with the part about politicians liking to spend and people (voters) liking to get free stuff. As Luke wryly writes, it’s no worries… until “someday” arrives.

In my view, MMT is the ultimate “someday” deferral technique. It not only kicks the can down the road, it launches it at escape velocity nearly into the exosphere… but not quite out of gravity’s reach. Eventually, that can will start falling back to Earth as fast as it went up. But just like in 1700s France, MMT will likely work for a while.  In fact, as we’ve seen since Covid, we’ve enjoyed an asset boom just like France in the early days of the John Law/Mississippi Company fake-money mania. In many ways, the speculative frenzy has been even more over-the-top. This is the fun phase, as I’ve been writing in my newsletters since the summer of 2020. 

But not everyone is drinking the Kool-Aid. Larry Summers wrote in a 2019 Op-Ed: “Modern monetary theory… is the supply-side economics of our time. A valid idea… has been stretched by fringe economists into ludicrous claims that massive spending on job guarantees can be financed by central banks without any burden on the economy… (MMT) is fallacious on multiple levels.”

Then there’s Paul Krugman, who once again seems to have developed a convenient case of amnesia, as he did over his egging-on of the Fed to create the housing bubble nearly twenty years ago.  Around the time Larry Summers wrote his MMT take-down, Mr. Krugman penned these words in his high-profile NY Times column, noting the ultra-inflationary implications of MMT: “When people expect inflation, they become reluctant to hold cash, which drives up prices and means that the government has to print more money… which means higher inflation, etc. Do the math and it becomes clear that any attempt to extract too much seigniorage (i.e., printing money) — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation. In effect, the currency is destroyed.” (Emphasis mine)

Incredibly, though, now that MMT is in full-swing, Mr. Krugman has had a road-to-Damascus-like conversion to the religion of MMT.[ii] He now ridicules those such as Mr. Summers who warn of its grave perils.  He even cheered on Congress for its patently false financial assumptions, which he has conceded, that are part of the $1.2 trillion infrastructure bill passed in August of 2021.  Perhaps this is because he was an advisor to the ill-fated and fraudulent firm of Enron right before it collapsed twenty years ago, which has largely gone unreported.  Apparently, Mr. Krugman became a fan of deceptive accounting during his Enron stint.

Apolitical types like Jeff Gundlach, have summed up their MMT views in much briefer terms by simply stating: “It can’t work. You can’t drink yourself sober.” That’s one of those pithy soundbites he’s famous for but I’m afraid there are many, especially of the elected-official variety, who don’t believe — or won’t accept — the veracity of those words.

It’s safe to say that MMT has already become one acrimonious acronym – and the controversy surrounding it is almost certain to get more intense, particularly once its dark side is revealed. To appropriately and fairly blame both parties for our nation’s current MMT addiction, it started under Donald Trump in September 2019.  That’s when the federal deficit was already blowing out — due to the enormous corporate tax cuts that were a cornerstone of Trumponomics — even during an economic expansion.  For the fiscal year 2019, the deficit hit 5% of GDP, one trillion dollars, a level unheard of outside of the aftermath of the Great Recession and wars.  (Of course, since Covid we’ve become desensitized to multi-trillion-dollar deficits.)

It was in the fall of 2019, six months before the pandemic, that the overnight bank repurchase market was in turmoil, clearly signaling there wasn’t enough natural demand to finance the Trump deficits, forcing the Fed to restart its Magical Money Machine, yet another triple “M”.  In my view, MMT and MMM go together like heroin and a syringe. 

Of course, once Covid hit, MMT went into hyperdrive.  Yet, it has continued even as the U.S. economy has been in the midst of an explosive rebound from the Covid-intensified recession, notwithstanding a deceleration in the second half of 2021 largely due to the Delta variant and then Omicron.  As I anticipated as long ago as the August of 2020, when the economy was just beginning to heal, inflation is back and looking more and more like the 1970s version — despite the Fed’s many “it’s only transitory” assurances, which it dropped in late 2021. After all, that’s what history teaches us to expect from MMT.  Did we really have the hubris to think we would somehow be miraculously exempt from the payback?

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[i] Per my comment in Chapter 1 about the “Great Pushback”, there are growing signs of a trend reversal against ultra-progressive policies that are increasingly looking out-of-step with what most Americans support.

[ii] Here is what Mr. Krugman told Business Insider in May 2021: "MMTers, at least if they're consistent with their own doctrine, are substantially to the right of people like me…"