By Iain Dooley
In a recent article on The AIMN, ‘What is Modern Monetary Theory and will it help?‘, Ken Wolff gives an excellent outline of Modern Monetary Theory (MMT).
It’s a great article and covers all the key points about MMT with absolute clarity, and yet in the comments we still had many people who either:
- Said they were still trying to understand MMT
- Disagreed with elements of what Ken had said, or
- Claimed that MMT was somehow flawed (with reasons variously given or not given).
I have been “monsplaining” (a term I coined to describe the act of explaining MMT to people on social media) for about a year now and I have found that the key difference between critics and proponents of MMT is which creation story of money they subscribe to.
This is a debate that predates the development of MMT by about 350 years and one that most people don’t realise even exists.
Basically it comes down to the following 2 options:
- Currency arose spontaneously out of barter and markets are created spontaneously, or
- Currency is a constitutional project created by a sovereign which thus creates markets.
In the former story (advocated by people like Positive Money UK, Austrian school economists, monetarists and other orthodox economists) people created money because they are enterprising geniuses and then the government came and screwed everything up by wanting a piece of the action.
This is the dominant money creation story.
In the latter story people were living a life devoid of liquidity and therefore lacked the ability to create complex organisational structures in the public purpose. A sovereign creates liquidity in the form of currency that not only allows it to provision resources to the public purpose but also allows private markets to flourish.
I’m sure you can see how the money creation story you believe will determine all your subsequent economic and political views.
What does this have to do with MMT?
If you try to understand MMT without first accepting the state theory of money, you will face an uphill battle.
You will look at equations and find them daunting and confusing. You will be blinded by the operational contrivances of our current economic system. You will find statements made by MMT economists and proponents confusing and unintuitive, and will be prone to believing people when they criticise MMT based on their own flawed understandings of economics.
On the other hand, if you start by accepting the state theory of money, you will find that everything about MMT is a logical extension from it.
You don’t need maths or models and you can easily see through the veil created by our system of “sound financial policy” to the heart of how things operate.
The whole exercise becomes tremendously simple.
This is why MMT economists and proponents call orthodox economists “flat earthers” and why on more than one occasion I’ve stated that “disagreeing” with MMT is like disagreeing with gravity: you might not understand how it works, but this is how things do work.
And it’s not just how things work now that we have a “fiat” currency; in fact this term is misleading because all successful currencies have been “fiat”.
Even when money is made from a commodity, has a fixed exchange rate or is convertible to a commodity, it is still a “fiat” currency, it’s just that the way you set things up can restrict your domestic policy space.
But until you have internalised the state theory of money, you will not believe me.
So in this article I’d like to present the state theory of money, some resources where you can read further if you don’t believe me, and provide direct responses to several of the comments people left on Ken’s original article.
The economy is a chore chart
You are a parent and you have some children. You want your kids to do some chores around the house so you put a chart up on the fridge for each kid. When they do a chore they get a tick, and 10 tickets equals 15 minutes time playing computer games.
Some things should be immediately obvious:
- The amount of chores you can get done is limited by the number of children you have, not the number of ticks you can write down
- The children cannot redeem ticks unless you have issued ticks; in other words the “spending” of your currency precede the “taxation” of your currency
- When you issue ticks, you create them and when the children redeem ticks they are destroyed
But something else has to happen before these “ticks” become “currency”.
What we have looked at a system where the transactions occur only between the parents or “sovereign”, and the children or “citizens”.
This is basically a communist system where we have 100% employment by the sovereign and no private purpose.
The kids have no mechanism to trade their ticks and do not produce anything for sale.
Now imagine that we created ticks inside a spreadsheet instead of written down on paper, and we created a system whereby kids could allocate ticks to one another.
We might find that the kids start to pay each other for things.
This would mean that kids actually wanted to have more ticks than they needed simply for getting their computer time. In other words, we would have to issue more ticks than were redeemed in order to allow this “horizontal” medium of exchange to exist (issuing more ticks than are redeemed? Should sound familiar to you: this is called “deficit spending”; more on this below).
So we might find that the kids actually do more work than they need to, in order to have some ticks left over after they redeem them for computer time to spend on goods and services created by their siblings.
But if the kids wanted a means of trading between each other, why didn’t they just make up their own system? Why didn’t they just do the bare minimum required to get their computer time, then do no more chores and create a “parallel” currency that allowed them to freely trade between each other?
Here’s a thought experiment:
Imagine they did: the kids decided to use poker chips. So each child did just enough work for the “sovereign” to cover their computer game needs, then they used poker chips to get each other to do stuff.
The chips could be redeemed later with the same or a different child to get them to do work in return.
The first week, child 1 worked really hard for all the other kids and collected all the poker chips.
The second week, child 1 said “okay now I am going to pay you guys to do work for me” and the other children said “nah we aren’t using poker chips any more” or “I only do 5 minutes work for 20 poker chips” or something like that.
There was no anchor for the value of the poker chips; nothing that they represented as an obligation to a sovereign that the children all had in common.
Such a fundamentally flawed system could never survive for very long, and could never be as robust as a sovereign monetary system (this little thought experiment should be enough to demonstrate to you how ludicrous the notion that currencies spontaneously emerge is, but again the resources provided at the end of the article go into this in much more detail).
This “parallel” currency failed and so the kids asked their parents for a way to trade officially issued ticks, and did more chores in order to acquire them.
Sure you might say that the kids could draw up a charter of value for poker chips and enforce that people accept them in payment but this is just another form of sovereign authority, albeit more democratic.
Tomorrow: What the Fiat?!