Review: The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy⁽¹⁾ by Stephanie Kelton (published by John Murray, 2020).

Stephanie Kelton, a professor of economics and public policy, formerly chief economist on the US Senate Budget Committee with the endorsement of Bernie Sanders, is a leading proponent of modern monetary theory (MMT). Since the 2008 global financial crisis which finally put paid to monetarism, in practice if not in theory, the overseers of the capitalist economy have been without a credible policy framework. To the horror of some commentators MMT is gaining ground amongst university and political circles alike, including many on the capitalist left, as Sanders’ endorsement of Kelton testifies. The Deficit Myth, which came out at the beginning of 2020, is clearly Kelton’s attempt to gain MMT a wider following. Without a single graph or algebraic equation, she adopts a chatty, anecdotal style and uses down-to-earth “parables” to get across the essence of the MMT message to the “ordinary” reader. It doesn’t always work (at least for this reviewer) and her key tale about a disgruntled parent trying to persuade his lazy kids to contribute to the household chores is particularly opaque. (He ends up dishing out some of his own business cards to each of his kids who are then persuaded to return them to him bit-by-bit each time they complete a chore. He, in turn, rewards them from time to time with a special treat. Apart from the naive middle class assumption that a story based on a dad with business cards will conjure up a familiar situation that will make her message easy to understand, it’s not clear what the rewards are or indeed why the kids don’t just continue as before.) Never mind. Anyone reading the book cannot escape the central message that, unlike you or I, or businesses or local governments, who are “users” of money, the Federal/central government — or rather the Federal Reserve Bank (the model of course is the USA) — is alone the “issuer” of currency. While the rest of us have to think about balancing a budget, not spending more than our income or fretting about the cost of borrowing and repaying loans when we do, there are no such constrictions on the state Bank, the sole currency issuer, which has no need to worry about repaying the debt it has issued to itself. In other words, there is no need for officialdom to be concerned about a mounting national debt or how to repay it. There is a caveat to this. To truly reap the advantages unlocked by MMT, a government must enjoy monetary sovereignty. Here, being a currency issuer is a necessary but insufficient condition. There are two other conditions, as Kelton explains:

To take full advantage of the special powers that accrue to the currency issuer, countries need to do more than just grant themselves the exclusive right to issue the currency. It's also important that they don't promise to convert their currency into something they could run out of (e.g. gold or some other country's currency). And they need to refrain from borrowing … in a currency that isn't their own. … Countries with monetary sovereignty, then, don't have to manage their budgets as a household would. They can use their currency-issuing capacity to pursue policies aimed at maintaining a full employment economy.

pp.18-19

At first glance this is simply pared-down Keynesianism but Kelton points to MMT’s roots in chartalism and its dubious argument on the historical origin of money in ancient society (exactly which ancient society varies with the theorist). The chartalist argument goes that money was created by the state in order to impose taxes on the working population and thereby get them to labour at least part of the time directly for the state. It is fashionable to argue that money has its historical origin in anything but the exchange that developed out of barter on the fringes of communities. (See our review of the late David Graeber’s book Debt the First 5,000 Years, which argued that money developed both as a means of enslaving and avoiding enslavement.) The truth is that it is all more or less conjecture. Kelton is not really concerned whether MMT is grounded in credible historical evidence or not, she just wants to hammer home her argument that since the state is the sole creator of the currency which it can issue at will, it can’t run out of money. Therefore, when it runs a deficit, i.e. issues dollars that are “added to people’s pockets without subtracting (taxing) them away” (we’re back to the Federal Reserve again) then this is no burden while the famous clock ticking up the national debt in New York City is really a US dollar saving clock, an index of how many dollars are not being spent!

In truth the consensus of capitalist economic thinking on the build-up of national debt has not always been that it spells a dangerous threat to national economic stability. On the contrary, in the first volume of Capital Marx observes wryly:

The only part of the so-called national wealth that actually enters into the collective possessions of modern peoples is — their national debt. Hence, as a necessary consequence, the modern doctrine that a nation becomes the richer the more deeply it is in debt.

Marx, Capital vol 1, Ch 31: Genesis of the Industrial Capitalist

And even the sceptics were proved wrong, as the English Liberal historian Lord Macaulay famously boasted in 1855:

At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt kept on growing; and still bankruptcy and ruin were as remote as ever.

And so it was throughout the nineteenth century when the British pound sterling was the currency of international trade and Britain was the world’s largest creditor state, thanks, from the 1850s onwards, to “invisible earnings” from financial assets. It took two world wars for the US to take over as the world’s dominant power. In the process Britain’s (later UK) national debt grew from about 30% of GDP (gross domestic product) at the beginning of the twentieth century to more than 150% percent in the aftermath of the First World War. By the end of the Second World War the debt was around 250% of GDP and the revival of the ruined British economy was prompted by US Marshall Aid. In 1956 Harold Macmillan, then Chancellor of the Exchequer, used the same Macaulay quote in his budget speech to downplay the significance of the national debt which by then stood at 146% of GDP. Sure enough, as the post-war boom picked up the deficit was reduced as a percentage of a bumpily growing though steadily slowing down GDP. Well, that’s one side of the coin, so to speak.

The other side is the continuing decline of the UK currency in the global economy. No longer the major currency of international trade or financial wheeling and dealing, the pound sterling was officially replaced by the US dollar in the Bretton Woods system brokered by the United States towards the end of the Second World War. The aim was to secure rules to ensure an international economy no longer beset by trade wars with their tariff barriers and competitive currency devaluations. But the US was adamant about rejecting Keynes’ proposal for an independent currency medium to be set up for international transactions. The compromise solution was for the newly-established IMF to establish the exchange rate of each currency in relation to the US dollar which itself would be pinned to gold (at $35 per ounce). Instead of go-it-alone currency devaluations, the IMF rules provided for the possibility of “revaluation” of a currency in the case of a fundamental balance of payments “disequilibrium” and after prior consultation. In fact the UK could not maintain the nominal wartime value of sterling against the dollar and as early as September 1949 negotiated a 30.5% devaluation so that the pound exchanged for $2.80. This put another nail in the coffin of one of the UK’s legacies of empire: the “sterling area”, as several ex-British colonies also devalued against the dollar. By the 1960s sterling was under pressure from speculators selling pounds for dollars and in November, 1967 after a brief consultation with the IMF, the Labour government devalued sterling by 14.3% to $2.40, famously prompting prime minister,Harold Wilson to announce:

It does not mean that the pound here in Britain, in your pocket or purse or in your bank, has been devalued.

Less than four years later, in August 1971, Richard Nixon unilaterally announced the “temporary” cancellation of direct convertibility of the United States dollar to gold on the grounds that there wasn’t enough gold in Fort Knox to cover the dollar reserves held by foreign central banks. (There were more dollars in banks outside the USA than in the Fed.) This problem might have remained a technical aspect of the growing demand for dollars as global trade increased in the Sixties. But as inflation edged up towards the end of the 1960s those dollars were increasingly being converted to gold. The “Nixon Shock” spelled the beginning of the end of the Bretton Woods economic frame for the world economy. By the time Nixon confirmed the permanent end to a fixed exchange rate with gold in 1973 the price of gold had reached $100 per ounce. The equivalent price today is around $1,900. Clearly there can be no going back. Which brings us again to Stephanie Kelton and MMT.

Far from seeing the collapse of the Bretton Woods system as an historic disaster which dramatically disproved the idea that capitalism could be managed both domestically and globally to provide steady economic growth and full employment, Kelton argues that it gave the United States the monetary sovereignty it had previously lacked to manage its own economic destiny. (With a fiat currency it’s impossible for Uncle Sam to run out of money.) Although they don’t take full advantage of it, she claims other states “like the United Kingdom, Japan, Canada and Australia” also enjoy “a high degree” of monetary sovereignty and “are able to run their fiscal and monetary policies without fear of painful backlash from financial or foreign exchange markets.” (p.142) That’s not how the architect of the “new economic policy”, Nixon's Treasury Secretary John Connally, saw it when he famously remarked that “it’s our currency and your problem”. Nor was there much sign of British monetary sovereignty when, in the face of rising global inflation (as commodity prices reflected the devaluation of the dollar) and the danger of another run on sterling, the UK was obliged to submit to IMF-imposed public spending cuts in return for a loan. Prime Minister James Callaghan famously told the Labour Party conference:

We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step.

In truth this had also become the situation in the United States and the whole of the advanced capitalist world. Except that the trade-off between increased spending to maintain jobs and the inflationary consequences of printing the money turned into more than a decade of rising inflation and increasing unemployment: this was termed “stagflation”, a combination of stagnant industrial production and inflation. At the time most of the blame for inflation was put down to a dramatic rise in the price of oil as a consequence of interruptions to supply, first by OPEC’s oil embargo (1973-74) during the Arab-Israeli war and then the disruption to supplies during the Iranian Revolution in 1979. This "first oil shock" saw the price of oil on the world market rise from $3 per barrel to nearly $12. (US domestic prices were considerably higher.) The "second oil shock" was even bigger with the world market price doubling to almost $40 per barrel. By this time the US position in the world was threatened by the declining value of the dollar as inflation reached a new height. The priority for the new head of the Federal Reserve, Paul Volcker, was to bring down inflation. Volcker was a follower of Milton Friedman who advocated restricting the money supply to tame inflation and thus he instigated a major rise in interest rates which were echoed worldwide. By 1982 interest rates had reached 21.5%. The sky-high rate pulled inflation down (from a high of 13.5% in 1980 to 6.2% in 1982) but GDP shrank by 3.6% and during the 16-month recession which followed unemployment (officially) went beyond 10%.

US manufacturing and industrial production were decimated, especially round the old industrial heartlands whose empty factories and de-populated cities conjured up the term "rust belt". But the "Volcker shock" revived confidence in the dollar and, industrial restructuring notwithstanding, during the following decades the US economy became increasingly dominated by an array of financial and so-called business services which now account for around a third of “economic growth”. Many of these services have little to do with providing the capital to finance productive industry. They can make a profit simply by wheeling and dealing in a sector where an original outlay of money capital is deployed to generate more money (M-M1) without having anything to do with the production of commodities. So long as the dollar holds up against other currencies this is fine for the financiers and their hangers-on. Thus as financialisation proceeded US governments have made it their priority to pursue policies which ensure the dollar maintains its pivotal role in world trade. Above all, the US aims to ensure that the bulk of the world’s oil continues to be priced in dollars and, as the fate of Saddam Hussein and the decimation of Iraq after two US invasions (1991 and 2003) show, is prepared to use its military might to prevent the dollar being replaced by any other currency.

In 1999 the Glass Steagall Act was revoked, allowing retail banks to sell a host of financial services direct to the public. A legacy of a lesson learned from the Wall Street Crash, the Act had separated investment banking from retail banking and was designed to protect Main Street (the ordinary household saver) from losing their savings in a crash. It was only a matter of time before the financial house of cards built on the "slicing and dicing" of sub-prime mortgages (loans primarily to working class households who could not afford to keep up payments) collapsed. As everyone knows, it provoked the deepest economic recession since the Great Depression and the biggest banking bail-out in history. All over the world unemployment shot up. As well as people losing their jobs, many also lost the roof over their head. It gave birth to the Occupy movement and a palbable sense of injustice worldwide as the central banks of the "first world" conjured up trillions of dollars, euros, pounds … to bail out the banks. In the United States the Federal Reserve cut its interest rate (the federal funds rate) to near zero and began the process of so-called "Quantitative Easing": creating money to buy up the duff mortgage-backed securities, prop up most of the failing banks (although over 140 went bust) and injecting a monthly financial stimulus (more than $1.5 trillion) which had not entirely been wound down when the impact of Covid-19 struck in March this year.

Quantitative Easing spelled the end of monetarism and its key idea that excessive expansion of the money supply leads to a dangerously steep rise in inflation. Since 2009, consumer price inflation in the United States has hovered mainly between 1% - 2% per cent and the Federal Reserve has been unable to reach its general inflation target of 2%.

Step in Modern Monetary Theorists with their argument that through a targeted increase in state spending “we can build an economy that provides a good life for all.” The arguments are often dodgy. Here is Kelton:

As we teach our first year students, excessive spending manifests as inflation. A deficit is only evidence of overspending if it sparks inflation. Since prices weren’t accelerating, the deficit couldn’t possibly be too big.

p.42

A clear example of the logical fallacy of affirming the consequence as taught to first year logic students. Still Kelton, is oblivious and continues with her argument that when there is no inflation (or very low) then the Fed could and should issue dollars to finance what appears to be a social quantitative easing programme, a kind of super New Deal where fiscal deficits are used to “channel resources more equitably”. She starts with a Federal jobs guarantee programme where workers would be assured a fairly low minimum wage but which would undermine the equation of cheap foreign imports = loss of US jobs. No need to worry about the balance of trade. Since the dollars the United States spends on imports are mainly returned to the US by exporters who buy US Treasury bonds, these can be used to finance, amongst many other things, a global Green New Deal which would help reduce the 200 million of globally unemployed and provide more people with what should “be a human right” — “employment”. For the most part though the argument revolves round the potential benefits and opportunities for restructuring the United States economy as a result of “the special position of the US dollar”. Essentially she wants a fairer capitalism and seeks to redress the growing wealth divide where “the global one per cent has captured as much growth as the bottom 50 per cent” and in the US “Just three people—Bill Gates, Jeff Bezos, and Warren Buffett—own more wealth than the bottom half of Americans, some 160 million people.” A good part of the book is devoted to outlining reforms for redressing the various social deficits: pensions, health care, “good jobs”, education (“retire student debt”), climate (“We have a little less than twenty-six years to solve our climate deficit.”) And finally the “democracy deficit” must be addressed on both the political and economic front by … reforming the tax system, removing the economy from “irresponsible bankers” and strengthening the unions so that they can “drive up wages and benefits” and sustain “the kind of tight labor markets we saw during World War II”! When it comes down to it MMT/Kelton’s proposals for reform are part of a familiar litany repeated by radical reformers since the 2007-8 financial crash.

The main difference is the perpetual hammering home of the message that “gold standard thinking still dominates”; if only policy makers would recognise that there is no lack of financial ability to pay since there is “is no financial constraint on a currency-issuing government like the US” and what the Federal Government really lacks “is not the financial ability to pay but the legal authority to pay.” (p.164)

Kelton’s book was published at the beginning of the year, shortly before the impact of Covid-19 sent stock markets tumbling as lockdowns paralysed much of industry and global trade. In the weeks and months that followed the Federal Reserve was called on to redress the dollar shortage that ensued. For two weeks in April the Fed was “buying” $1m worth of financial assets per second. Technically, the Treasury issues the bonds which are auctioned off to prospective buyers and the money is then credited to the Fed. So the Federal Reserve’s account of its purchases are actually a record of the number of dollars created by the Treasury. By July the situation had eased somewhat and the demand for the Fed’s “dollar swap lines” had reduced to around $7.1tn per week! Estimates vary, but a plausible calculation is that the US deficit will grow from 106% of GDP to around 136% by the end of the year. In percentage terms this is not the biggest. Japan’s national debt has been over 200% of GDP for over a decade and every country in the world has seen a relative increase its national debt since the Covid pandemic hit. In the case of the United States, however, its global role means the Federal Reserve cannot focus exclusively on domestic funding requirements and the amount of dollars released onto the world market dwarfs the $3tn approved by Congress to deal with the consequences of coronavirus. (Which, by the way, has hardly been put to practical use.)

If ever the time was ripe for MMT to gain a wider sway this is it. But it doesn’t mean that it can provide a new way forward for capitalism, or rather United States capital because that is really what Kelton’s book is about. In any case she tacitly admits that the proposition at the heart of the theory — that the state can create as much money as it likes — breaks down when she admits the possibility of inflation … as a result of a decline in unemployment. While she quibbles over whether there is such a thing as “the natural rate of unemployment” (and Keynesian policy-makers’ search for the Non-Accelerating Rate of Unemployment) she accepts the premiss that at some, unpredictable, point the “full employment wall” will be hit and any additional spending will be inflationary. Unemployment will cause inflation. In other words, like the Keynesians, she assumes that higher wages resulting from the increased "bidding power" that full employment brings workers will lead to inflation. Not bad for someone who argues that everyone has the fundamental human right to a well-paid job. As long ago as 1865 Karl Marx demonstrated the falsity of this argument in his response to Citizen Weston’s assertion that a rise in wages leads to a general rise in prices by demonstrating that what this really leads to is a reduced rate of profit.

Yet MMT theory is more fundamentally flawed by the chartalist theory of money lying at its heart. In a capitalist society it is simply untrue that the main function of money is to enable the state to collect taxes from the population. Workers need money in order to buy the means to live and in order to do that they need to work for a wage. Capitalists need money to invest in equipment and to pay the wages of their workforce. Marx points out that in all cases:

Once the capitalist mode of production is given and work is undertaken on this basis and within the social relations which correspond to it, that is when it is not a question of the process of formation of capital, then even BEFORE the production process begins money as such is CAPITAL by its very nature, which, however, is only realised as such in the process and indeed only becomes a reality in the process itself. If it did not enter into the process as capital it would not emerge from it as capital, that is, as profit-yielding money, as self-expanding value, as value which produces surplus-value.

In other words, money is “latent capital” or potential capital. …

What makes it capital before it enters the process so that the latter merely develops its immanent character? The social framework in which it exists. The fact that living labour is confronted by past labour, activity is confronted by the product, man is (i.e. human beings are) confronted by things, labour is confronted by its own materialised conditions as alien, independent, self-contained subjects, personifications, in short as someone else’s property and, in this form, as “employers” and “commanders” of labour itself, which they appropriate instead of being appropriated by it. ...

Theories of Surplus Value Vol 3 p.475-6, Lawrence and Wishart edition

We cannot expect a modern economist like Kelton to adhere to the labour theory of value. However, MMT’s cranky theory is completely oblivious to the crisis of profitability that has been bugging capitalism for around fifty years. For all the examination of deficits, Kelton does not tackle the most glaring one of all: the mounting company debt and the growing portion of zombie companies that exist in a semi-morbid state, relying on low interest rates to reduce some of their loan payments. Even less is she in a position to explain, never mind come up with a palliative, to the problem of the declining profitability of manufacturing and industrial capital which is at the heart of capitalism’s economic woes today.

Anyone who thinks MMT has anything in common with Marxism should think again. As the subtitle of Kelton’s book makes clear, Modern Monetary Theory is about how to make the existing economy work better. In plain words that should include how to increase profit rates, how to extort more unpaid labour from the working class. Instead Kelton focusses on how the existing state can conjure up more revenue to fund palliative measures to relieve the social effects of the crisis. If anything, this means widening the power of the capitalist state, certainly not a step towards a new society of freely associated producers who are in control of what is produced. Clearly Stephanie Kelton has no such agenda. But for someone who decided the owl would make a good mascot for MMT “because people associate owls with wisdom and also because owls’ ability to rotate their heads nearly 360 degrees would allow them to look at deficits from a different perspective”, the book is remarkably blinkered about the extent of the crisis that is facing capitalism. Perhaps another kind of owl, the owl of Minerva (Wisdom), which Hegel noted only spreads its wings once dusk has fallen, would be more appropriate for a theory which is unable to see that capitalism today is facing an existential crisis.

E. Rayner

October 2020

(1) In the USA the title’s subclause is “the Birth of the People's Economy” (New York: Public Affairs, 2020).