A narrative to take markets higher

In June 2016 we wrote a light-hearted article called “Solving Japan's Financial Problems”. In it we proposed that Japan's Reserve Bank, which at the time owned over a quarter of the Japan government’s debt, should just write it off.  What little income it was earning was going to the Reserve Bank, the maker of money, that had no need for it. The only consequence would be the risk of inflation, but Japan was, and still is, struggling with deflation. The Japanese government would then be unencumbered by its debt problem and be able to borrow more and spend it on infrastructure, providing much needed stimulus to its economy and potentially pulling it out of deflation woes. Simple! 

And apparently, we weren't the only ones thinking about this. Policy and business circles are increasingly talking these days about an economic theory called Modern Monetary Theory (MMT).

MMT is being discussed for one main reason. It provides a rationale for government spending despite high levels of debt, a problem that most of the largest economies of the world are encumbered with.  In countries with sovereignty over their currency MMT argues that, rather than using interest rates to regulate employment and inflation, it can be regulated by spending and taxes. It is sort of an extreme version of Keynesian economics, asserting that interest rate changes have no discernible effect on an economy’s aggregate demand. The risk-free (government) interest rate can therefore be set at zero so the level of debt a government holds becomes irrelevant. Nice!

There are a fair number of MMT critics. Former US Treasury Secretary, Larry Summers, has called it “voodoo economics”. Warren Buffet is "no fan" of MMT either. However, MMT also has a few high-profile supporters. Ray Dalio, the highest paid hedge fund manager in the world last year, is a backer of the philosophy behind MMT. He recently noted that MMT can be used to redirect stimulus from those who own financial assets to those who don’t, helping to reduce the wealth inequalities that are part of the current rise of populism. “Quantitative Easing (QE) and interest rate cuts help the top earners more than the bottom (because they help drive up asset prices, helping those who already own a lot of assets). Those levers do not target the money to the things that would be good investments like education, infrastructure, and R&D.”