MMT – QE for the people?
“Inflation is always and everywhere a monetary phenomenon” – Milton Friedman (The Counter Revolution in Monetary Theory)
As real return investors, our performance targets require us to consider both the opportunity set of returns as well as the inflation environment to achieve our clients’ investment objectives. The opportunity set of returns are considered through the risk and return potential from various asset classes such as equities, bonds, alternatives and cash. This means that we evaluate the likely yield of these assets and their potential to grow in value versus the likelihood of a default in payment of income or a decline in capital value at some point in the investment cycle. The inflation element however, requires an understanding of a range of factors which, in combination, tend to impact prices of goods and services in general.
A few important considerations when thinking about inflation are the prices of raw materials, wages of labour and also the impact of foreign price pressures on the domestic economy. Some inflationary forces are purely driven by demand dynamics, whilst others predominantly by their supply characteristics. Many inflationary forces, however, can be understood by considering the policy maker’s social, economic and financial motivations. These highly individual motivations tend to be driven by economic beliefs, political ideology and promises to various constituents.
Avid readers of financial and political press may have come across, many times, the debate on whether or not economic policies adopted following the financial crises of 2007/08 were productive. It is argued that asset price purchases by central banks in the form of quantitative easing (QE) fuelled asset price inflation whilst not trickling down to the real economy to support productivity and fuel economic growth. Furthermore, this tends to be a heavily politicised debate as the implemented policy measures have benefitted those with financial assets whilst the lack of the ‘trickle down’ effect has left behind those without them.
Proponents or defenders of QE often claim that things could have been much worse if policy makers had not reacted with the ‘unconventional’ tools at the time and that, although inflation has been relatively low, unemployment was markedly controlled and economic growth remained low but robust. Regardless of which side you find yourself leaning towards, there are facts from both arguments which heed consideration.
More recently Modern Monetary Theory (MMT), which has also been dubbed ‘debt monetisation’ by some commentators, has come to the forefront of policy debate. One may wonder, what is this apparently ‘new’ economic theory? Why are so many mainstream politicians, academics and financial practitioners deliberating its merits and implications now? Also, what does it mean for investors in financial markets with long-term time horizons?
There is nothing new about this set of ideas; at its core, it is an amalgamation of well recorded theories proposed by several non-mainstream economists, which essentially counters the neo-classical school of thought. MMT questions the recent wisdom that monetary policy provides the solution to economic difficulties. It takes the premise that fiscal policy is a stronger stimulant than monetary policy and should be used more aggressively as a policy tool to steer the economy. This effectively means that rather than central banks stimulating the economy by buying debt, economic change can be affected by governments raising finance to spend on goods and services. MMT asserts that government deficits are not as sinful as mainstream economists would suggest and that the government should be free to run deficits as long as it propels employment and output growth. It recognises that public (government) sector deficits eventually become private sector surpluses and that instead of deposits creating loans in the financial system, it is loans that create deposits within the system.
MMT or ‘debt monetisation’ can be implemented by a country if and only if, the government is a sovereign issuer of its own currency and has not issued debt in any currency other than its own. This in effect, allows government to spend freely on goods and services and to support economic activity, with the inflationary impact caused being the only actual ‘constraint’ to the level of deficit. Another way of thinking about this is to consider the government as being the buyer of last resort for goods and services. When the economy is sluggish, they could purchase more goods and services and in the process spur growth and inflation whilst increasing their deficit. On the flipside, if the economy is ‘over heating’ they could reduce the amount of goods and services they demand, decrease their deficit and reduce their inflationary impact.
The core principles of MMT require monetary sovereignty and most would agree, the US is monetarily sovereign with the dollar being the reserve currency of the world. Therefore, MMT could be put into practice relatively easily there. It would require changes in legislation and bipartisan agreement to remove central bank independence however and this may not be easily accepted. Emerging Markets, on the other hand, generally tend to be borrowers in foreign currency (usually USD and EUR) and therefore are impacted by US dollar and Euro liquidity as well as their respective interest rates, meaning they would struggle to implement such policy. In Europe, the single currency union prevents most nations from adopting such a policy as both the fiscal and monetary constraints are dictated by the European Commission and the ECB.
One of my colleagues, Philip Bagshaw, wrote recently in his article on shareholder value, that financial markets, politics and economics tend not to exist in a vacuum but instead are constantly interacting with each other. I think this is one of the main reasons MMT has come to the forefront of economic debate now. It has been well documented that balance sheet enlargement, in the form of QE, has resulted in asset price inflation and not consumer price inflation. Said another way, the price of bonds, equities and other assets has risen but wages and the cost of a basket of consumer goods have not done so. Furthermore, the beneficiaries of QE have mostly been savers or investors and, with wage growth not keeping pace over the last decade, we have seen the emergence of a wealth gap, particularly in the developed world. It is argued that MMT is ‘QE for the people’ and although this may not necessarily be the most sensible approach to public finances, one can see how the theory is gaining traction amongst politicians or policy makers that are trying to win over the masses. It has been the clashes of ideology between the ‘new’ and the ‘old’ that has resulted in so much shouting amongst commentators.
What does all this rhetoric around economic policy mean for politics, financial markets and real return investors? For starters, rightly or wrongly, it is definitely a sign that the voting population is demanding a different set of policies to steer the economy. It is also very timely, in the sense that election campaigns in the US are on the go and the ‘left’ will surely be using this as ‘ammunition’ in any political debate. Bernie Sander’s 2016 economic advisor has long been a proponent of the theory and more recently we have seen Andrea Ocasio-Cortez, advocate that MMT should be used to fund tuition free public schooling and a job guarantee scheme. The ‘right’ in their ambitions for a smaller role of the government in the economy and with sound public finances may have to unwillingly come to a middle ground if they want a shot in the election rhetoric.
Without a view on whether MMT is good or bad for the economy per se, the conflict and clash this will cause adds uncertainty to the political environment and, potentially, to financial markets. More broadly for the inflationary outlook, this would suggest that policy makers, on the margin, are looking for more unconventional routes to win elections and this time round it seems like it’s the loosening of fiscal finances. A return to the approach of old when governments were perceived to spend their way out of economic difficulties. It is yet to be seen what the direction of this policy will be or how it will be implemented, but its potential inflationary impact cannot be ignored. We continue to believe that having a global investment universe provides us with the flexibility and diversification needed within portfolios. Furthermore, our focus remains on seeking inflation linked returns that are reasonably valued with both social and economic value. These assets should be able to command pricing power and continue to create value, if and when the tune of economic policy changes.
Aqib Hashamali, CFA
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