(Bloomberg Opinion) -- There’s no avoiding it: If you work on Wall Street, you should probably have an opinion on modern monetary theory.
Just this week alone, BlackRock Inc. Chief Executive Officer Larry Fink weighed in, calling it “garbage,” while former New York Federal Reserve President Bill Dudley reiterated that it’s a “crackpot theory.” Larry Summers insisted MMT was “fallacious at multiple levels,” and the back-and-forth between Paul Krugman and Bloomberg Opinion contributor Stephanie Kelton rages on. Bloomberg News’s Emily Barrett interviewed Paul McCulley, who sort of spoke up for the doctrine. The article points out that “few Wall Streeters have been willing to seriously debate the theory’s merits,” and, indeed, the former chief economist at Pacific Investment Management Co. at least takes a stand in dismissing those who say America will inevitably turn out like Venezuela and Zimbabwe.
Yet for all the invective, why has virtually no one come up with a blueprint for how to invest should the world’s largest economy lean into MMT? Traders are paid to stay ahead of the curve, and it’s becoming clear the theory isn’t going away anytime soon.
The lack of a plan may stem from their experience in recent years. After all, even though MMT has won over Democrats like Alexandria Ocasio-Cortez, who aim to finance social policies like the Green New Deal and Medicare For All, President Donald Trump is arguably doing a test run of sorts. His administration has blown a nearly $1 trillion hole in the U.S. budget by unleashing a round of fiscal stimulus some eight years into the economic expansion – ordinarily a time for the government to trim the deficit as the Fed raises interest rates. And yet, benchmark 10-year Treasury yields are just 2.64 percent, about average since the recession ended in June 2009. The market expects inflation to run at less than 2 percent over the next decade, even with the national debt exceeding $22 trillion.
This equilibrium likely can’t last, and particularly not if MMT becomes the nation’s economic policy, says Kevin Muir, a market strategist at East West Investment Management Co., who happens to have the rare MMT trading thesis. “Putting your head in the sand regarding MMT would definitely be a mistake,” he wrote on his blog, The Macro Tourist. Importantly, “spending time arguing about its relative merits/detriments will not help your trading or investing one iota.”
His strategy boils down to this: Buy real assets – real estate, infrastructure, commodities including gold – and stay away from fixed-income at all costs.
At first glance, this looks like the same advice of those who feared the Fed’s quantitative easing would bring about rapid inflation and currency devaluation. Obviously, that didn’t come to pass. Instead, equity prices surged on the back of cheap money, enriching those wealthy enough to be heavily invested in the stock market in the first place.
Muir sees MMT as a way to shift gains from Wall Street to Main Street. “Monetary stimulus with fiscal austerity doesn’t do anything except make the rich richer,” he wrote. “MMT is novel, ambitious, and a little bit scary. I get it. But let me let you in on a little bit of a secret – young people aren’t afraid of trying something new. They know the system isn’t working and are desperately looking for an alternative.”
Then again, MMT might not even be all that novel. Just look at Japan, which has a debt-to-GDP ratio of about 225 percent and a central bank that’s hasn’t just controlled interest rates, but also bought a record 6.5 trillion yen of exchange-traded funds in 2018. And yet no one seems concerned, judging by Japanese bond yields and inflation expectations.
The goal of MMT isn’t to become Japan, though. The way Muir sees things, inflation will take hold because fiscal spending would be injected straight into the real economy (think free college or a federal job guarantee), rather than quantitative easing’s more indirect route (buying bonds to suppress interest rates, which encourages companies to borrow cheaply, which then maybe gets them to boost wages or headcount). In the post-crisis era, he argues, households have been overwhelmed by debt, which has suppressed economic growth. If that pressure dissipated, the economy could run hot – and so could inflation.
Kelton, for her part, isn’t arguing for inflating away everything and financing social programs no matter the cost. There’s a limit – the point at which spending creates rapid price growth. She explained it here in her most recent Bloomberg Opinion column.
For bond traders, with the head-fake of quantitative easing still fresh in their minds, it’s understandable why they might remain skeptical that developed-market inflation will ever really take hold. Even Bill Gross, one of the more vocal critics of post-crisis stimulus who invested during periods of rampant price growth, now seems at ease with unprecedented budget deficits, judging by comments he made in a recent interview with Bloomberg News’s Erik Schatzker:
Why can’t the government have a $2 trillion deficit if the Fed is simply going to buy it, like they do in Japan? Well, Jim Grant would say, “Mmm, it would be inflationary.” But it hasn’t been. So, yeah, I would say Trump or the next president, whoever he or she is, could go to $2 trillion, as long as the Fed was willing to accommodate.
Let’s assume that MMT becomes the go-to economic policy. Muir’s conclusion – buy real assets that protect against inflation – may hinge not only on how much money the federal government spends, but whether American citizens believe price growth will accelerate. It’s those expectations that are arguably just as important as inflation itself. The Cleveland Fed noted in a 2014 report that in the quantitative easing era, it was critical to keep tabs on the “public's perception of the central bank's commitment to maintaining a low and stable rate of inflation.”
This is the great unknown surrounding MMT. Titans of finance have their soundbites – usually something like “deficits matter!” – but aren’t widely positioning for any fundamental change. Markets are largely behaving as they always have, even with winds of change blowing through economic thought at the highest levels. It shouldn’t be too long before traders start placing their bets.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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