MMT In Action!

One of the qualitative features of Modern Monetary Theory is that nations that have their own sovereign currency are not subject to the same constraints of countries that use another nation’s currency.  A quick look at France and Britain and the reaction of France to a threatened sovereign debt downgrade illustrates this principle nicely.

French officials have now reacted to the prospect of a credit rating downgrade by lashing out at Britain. The head of the central bank, Christian Noyer, has argued that the rating agencies should begin by downgrading Britain. The finance minister, Francois Baroin, recently declared that, “You’d rather be French than British in economic terms.” And even the French Prime minister, Francois Fillar, noted that Britain had higher debt and larger deficits than France.

French officials apparently don’t recognize the importance of the fact that Britain is outside the eurozone, and therefore has its own currency, which means that there is no risk that Britain will default on its debt. When interest and principal on British government debt come due, the British government can always create additional pounds to meet those obligations. By contrast, the French government and the French central bank cannot create euros.

This is why there is no chance of the United States becoming like Greece (or Italy).  We don’t share a currency with any other sovereign nation.  We manage our own sovereign fiat currency and can manage the supply to pay off our obligations without much of a penalty.

Most of the hyperinflationists or gold investors I know are worried that the Fed’s printing press (or button pressing if you will) will ultimately result in inflation.  This is not entirely correct.  As I have previously explained, when you pour an iced tea packet into a pitcher of water you don’t automatically get iced tea.  You have to stir it in.  Our banking system is much the same.  There is no demand for credit as of now and therefore there is no expansion in the amount of actual money in the system.   Because the private sector is busy repairing their balance sheets aggregate demand remains historically low.  Therefore, the hyperinflation argument remains bunk.  The latest readings on wage inflation, demand for credit, etc all point to continued de-leveraging and low demand for credit, and in our banking system that means inflation is not yet a concern.

Hyperinflation, of the type seen in Weimar Germany or Zimbabwe requires a very specific set of economic circumstances to occur, circumstances which do not describe the American economy.  The simplistic beliefs of the Austrians and the other neoclassical economists still rest on a gold-standard currency which no longer exists.  And printing more money won’t bring about hyperinflation either.  It’s a question of supply and demand.

If we think about the Weimar Republic for a moment, the problems for them began long before the hyperinflation, which really went off in 1923. Following World War I the reparations payments required under the Versailles Treaty squeezed the German government so badly that they eventually defaulted. The Treaty was just a bloody-minded pay-back by the victors of the war and brought so much subsequent grief to the World in the 1939-1945 War that you wonder what was going on in their heads.

Anyway, for historians, you will recall that the French and Belgian armies then retaliated after the German default and took over the industrial area of the Ruhr – Germany’s mining and manufacturing heartland. The Germans, in turn, stopped work and production ground to a halt. The Germans kept paying the workers in local currency despite limited production being possible and you can imagine that nominal demand quickly started to rise relative to real output which was grinding to a halt. The crunch came when the export trade stalled and the only way the German Government could keep paying their treaty obligations etc was to keep spending. The inflation followed.

It’s important to understand what inflation is and what it is not.  Inflation is not paying people more.  Inflation is not an increase in the price of milk.  Inflation is not the printing of money.  “Inflation is the continuous rise in the price level.”

That is, the price level has to be rising each period that you observe it. So if the price level or a wage level rises by 10 per cent every month, then you have an inflationary episode. In this case, the inflation rate would be considered stable – a constant rise per period. If the price level was rising by 10 per cent in month one, then 11 per cent in month two, then 12 per cent in month three and so on, then you have accelerating inflation. Alternatively, if the price level was rising by 10 per cent in month one, 9 per cent in month two etc then you have falling or decelerating inflation.

But I digress.  Returning to the question of Britain and France.  Britain, being the holder of a sovereign currency, is better positioned to use monetary policies to manage their deficit, debt and inflation than France who are, for better of worse, tied to the Euro (I like to think of the Euro as Deutschmark II since Germany appears to be calling all the monetary policy shots).

Britain can reduce its current-account deficit by causing the British pound to weaken relative to the dollar and the euro, which the French, again, cannot do without their own currency. Indeed, that is precisely what Britain has been doing with its monetary policy: bringing the sterling-euro and sterling-dollar exchange rates down to more competitive levels.