Barron's Streetwise - Are We MMT-ing Yet?

Episode Date: July 17, 2020

Economist Stephanie Kelton says soaring deficits aren't a problem. Has she converted her critics? Learn more about your ad choices. Visit megaphone.fm/adchoices

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where we have the capacity to provide sustained fiscal support, but we let our fear of adding to the national debt or of large deficits prevent us from doing what we could and should be doing. Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Stephanie Kelton. She's an economics professor at Stony Brook University and the informal leader of a movement called Modern Monetary Theory, which says that government debt and deficits in the United States in particular are less worrisome

than they appear and that the government should spend much more to manage the economic downturn. In a moment, we'll hear more from Stephanie Kelton and look at what our... Oh my god, I'm sorry. It couldn't be louder. Matt, I take it there's some construction going on outside your home. There is a major construction going on right outside my window. Good. It's economic activity and that's exactly what we're looking for. Let me continue. In a moment, we'll hear more from Stephanie Kelton and look at what our pandemic spending might mean for the stock market. Listening in, as always, is our audio producer, Meta. Hi, Meta.

Hello. Sounds quieter at the construction site there now. It's a little quieter, but it might return in a moment. Okay, so I want to say a few words about the stock market. I understand we have a question about that. We've got a question from Rachel, who lives in New York. Let's hear it. Jack and Meta, I've been listening to your podcast since its debut.

So I'm definitely a fan. So last time we had QE because of financial crisis, it didn't do much to the dollar, I guess. But it did push up the stock market and the real estate market, now that we have this, I would say, QE and steroid, right? Do you expect the same outcome that the stock market and real estate market will go even higher? Thank you, Rachel from New York. The short answer is yes. While there's no way to accurately predict short-term swings in the stock market. I wouldn't be surprised to see stocks and house prices continue to rise through the current economic downturn. We hit two milestones this past week that I think sum the situation up nicely.

On Wednesday, the S&P 500 index traded at a level that erased all of its losses for the year, as though the pandemic had never occurred. a level that erased all of its losses for the year, as though the pandemic had never occurred. Also this past week, we entered the thick of reporting season for the second quarter. That'll be our first look at what a full three months of shutdowns did to company earnings. Estimates vary wildly, in part because many companies have stopped giving advanced forecasts of their own earnings. People say we're flying blind, but I think maybe it's not as alarming as it sounds. No one expects second quarter earnings to look good. S&P 500 earnings for the quarter are expected to fall more than 40% from the same quarter a year ago.

Now, maybe the actual numbers will be better than that, in which case stocks might rise. And maybe the numbers will be worse, in which case stocks might rise. And maybe the numbers will be worse, in which case stocks might rise just the same. That's because one of the key drivers of stock returns has been near zero interest rates. You mentioned QE or quantitative easing. That's a tactic the Federal Reserve uses to reduce bond yields in an effort to make loans more attractive and spur business activity. But a byproduct of that effort is that low bond yields also make stocks more attractive by comparison. That causes investors to shift money to stocks and it pushes stock prices higher too. Rates are about as low as they've ever been and the Fed has committed to keeping them there until 2022.

So although we might have limited visibility on how quickly company earnings will recover, we have plenty of clarity that bond yields and savings account interest rates aren't going to provide much competition for stocks for years. All that interest rate manipulation might sound like a risky setup for stock buyers. But although the broad market does trade at an elevated valuation, it doesn't trade at a crazy valuation. Goldman Sachs this past Tuesday published a new prediction of stock returns for the next 10 years. It says to expect the S&P 500 to return an average of 6% a year, including dividends. It says that a range of 2% to 11% captures one standard deviation around its estimate.

In other words, as long as things get only a little wacky and not really wacky, stock investors should make somewhere between 2% and 11% a year. That's no guarantee we'll stay inside that range, of course. Eight years ago, Goldman issued a similar forecast predicting 8% yearly returns. In that time, the range was 4% to 12%. Stocks since then have actually returned more than even the high end of that range, over 13% a year. I wouldn't count on stocks topping the high end of Goldman's new projected returns from here. Frankly, I'll be content if that baseline forecast of 6% a year works out. But who knows? We don't have a lot of experience with the effects of keeping interest rates this low for this long.

Also, we've rarely seen the federal government intervene with spending on the scale of what it's doing now. Whether or not we call that modern monetary theory, as we'll discuss now, and regardless of what it does for the economy, it might keep stocks climbing for longer. I read this past week that the U.S. budget deficit reached $864 billion. That's not for the year. That's for the month of June. And it's a new record.

I realize that numbers this large are difficult to relate to. $864 billion? That might as well be 11 skajillion Klingon darseks. And yes, I did just Google Klingon currency. But let me explain the deficit this way. First, people sometimes use the words deficit and debt interchangeably, but they're not nearly the same. The debt is how much we owe. The deficit is how much we go further into the hole each year. A trillion dollars works out to around $7,700 per American household.

So if the federal government spends a trillion dollars more than it collects in taxes one year, a typical household accrues $7,700 more in debt to be repaid through future taxes. Now, I should note that everything I'm saying now is a misguided way to think about government spending in the view of Stephanie Kelton. More on that in just a moment. The U.S. ran deficits topping a trillion dollars a year for four years straight through the housing bust and Great Recession. That's more or less what governments are supposed to do. In a recession, there's not enough demand. People lose jobs. Then people respond by spending less, pushing demand even lower, and costing more jobs. The government can replace lost demand by spending borrowed money, or by giving consumers perks for certain spending,

or by cutting taxes, or by just sending people cash. When the recession is over, the government can pay back that borrowed money by spending less, or raising taxes, or both. That's called Keynesian economics, named for a British economist called John Maynard Keynes. It's how I thought the world worked, or was supposed to work. In the years following the Great Recession, the economy slowly expanded, regained jobs, the stock market rose, tax receipts increased, and the deficit shrank. First it went below a trillion dollars, and then below a half trillion dollars. We begin tonight with the breaking headline today from the White House. President Trump unveiling what the White House is calling the biggest tax cut in American history.

But then in 2017 came a set of large tax cuts and a hefty increase in spending in 2018. The deficit began growing again, but this time it wasn't during a recession. It was years into an expansion. We did get a boost to economic growth and to the stock market. But during the fiscal year that ended last September, we ended up with a deficit that once again came just shy of hitting a trillion dollars. The National Budget Office is now releasing some new data out with its latest forecast, and it sees the federal budget deficit hitting one trillion dollars this year. The deficit is at its highest level in eight years. Early this past March, I wrote

for Barron's that when the next recession inevitably hits, we could see a $2 trillion deficit. That's because recessions put people out of work and shrink the amount the government collects in taxes. Just weeks after I wrote that, mass quarantining began and businesses shut down. Now it turns out that my prediction was well short of the mark. Forecasts for the current fiscal year have the deficit reaching not $1 trillion or $2 trillion, but $3.7 trillion. That's more than double the record set in 2009. And that prediction is surely conservative because it doesn't include another round of stimulus like an extension of unemployment benefits. I spoke recently with the chief of a very large American bank who said he expected another trillion dollars in assistance this year. If he's right, the deficit could approach five trillion dollars. Numbers like that make it sound

like we've reached the point of no return on government spending, but not everyone sees it that way. I reached out to Stephanie Kelton. Hi, Stephanie, are you there? I'm here. Okay, good. I have 12 hours worth of questions for you, but I'll tell you. Yeah, I'll bet. Okay, we'll do our best. Stephanie is a former chief economist for Democrats on the Senate Budget Committee and a former campaign advisor to Bernie Sanders. If you're wondering about my political leanings,

I'd rather jump into a dumpster with angry raccoons than argue partisan talking points. I don't belong to either political party. I'm never going to join. I'm also in between monetary theories, by the way. Sometimes I do this thing where I hear people out whose views I don't necessarily share. And sometimes I even relay those views to others without first reducing them to absurd straw man caricatures. I know I'll never make it in cable news. Anyhow, I asked Stephanie what to make of a $3.7 trillion deficit. She basically told me that the $3.7 trillion part isn't necessarily a problem, but my use

of the term deficit might be. necessarily a problem, but my use of the term deficit might be. We use this word deficit and it's just mind-boggling in many ways because we could just as easily sit down and have the conversation that we're about to have substituting the word surplus in place of deficit, okay? Because we use this word deficit, but that's looking at things from a perspective of what's happening to the budget that's kept on the government's books. So it is in many ways unhelpful to sit down and say, do we think that a $3.7 trillion deficit is too much? Why not ask whether we think a $3.7 trillion surplus being deposited into the non-government part of our economy is excessive?

Because that's what we're really talking about. If you're not familiar with modern monetary theory, Stephanie has a new book out called The Deficit Myth, Modern Monetary Theory and the Birth of the People's Economy. That'll do a better job than I can of summing it up. But here's my best effort at a 30-second version. MMT starts with the observation that you can't go broke if you make your own money, like the U.S. does. There's actually pretty broad agreement on that point.

So when you hear people say that the government is spending and borrowing so much that it's going to go broke, what they really mean is that it's spending and borrowing so much that it might have to eventually create a lot of new money to make its debt payments and avoid defaulting. And creating a lot of new money can lead to fast inflation, where consumer prices jump and life becomes unaffordable. So we create artificial limits like debt ceilings and balanced budget amendments to keep our spending in check, even if those things don't seem to work for very long. MMT advocates say, forget about the artificial limits. The only real limit on spending is inflation. Here's Stephanie. There is a limit in the sense that if the deposits become excessive,

if the government's financial contribution, which is what the deficit is, become excessive, it will show up in the form of inflationary pressure. There was a lot of talk about inflation when we were running those big deficits during the Great Recession. Some people said all that spending would turn us into the next Zimbabwe. Zimbabwe could be on the verge of economic collapse. It is facing its worst economic crisis in a decade. And if you don't get that reference, it refers to hyperinflation.

Just know that you can go on eBay and buy $100 trillion Zimbabwe notes issued in 2008. They're actually handsome pieces of paper. There's an illustration of a rock formation on the front, and on the back there's Victoria Falls and a water buffalo. My favorite part is on the front, just above the $100 trillion part, where it says, I promise to pay the bearer on demand. It sounds so resolute. I suppose if you're promising to pay someone $100 trillion, you might as well not sound iffy about it.

Somewhere I have eight or 10 of those notes unused. I think I paid less than $20 for all of them. And if you think they're defunct and worthless now, you're only half right. The government scrapped the currency a year after issuing it, but I just checked eBay and there's a crisp $100 trillion 2008 Zimbabwe note. It's selling for 71 US dollars. Maybe I should sell mine if I find them. Apparently, a lot of people display them as conversation starters. There must be a lot of conversation going on about hyperinflation out there, which is strange because inflation has been unusually low for many years. Even before the pandemic, we had deflationary forces, like rich countries where people were both growing older and having fewer babies.

On top of that, technology and globalization have been holding down some consumer costs. Now we have a sharp recession too, of course, and that has created slack in the economy in the form of available workers and resources. There's little inflation in sight, which means if you're an MMT devotee like Stephanie, there's plenty of room for spending well beyond what we're already doing. Given how depressed the economy is, we are nowhere near running up against our economy's real resource capacity. And that's the limit that we should be talking about. So can we pass the HEROES Act? The House has already passed it.

Could the Senate take it up and commit to another $3 trillion in spending? Of course it could. Would that be excessive? I don't think so. The HEROES Act would send $1,200 checks to adults and kids, making it more generous than the CARES Act, which was signed into law in March and which provided $1,200 per adult, but only $500 per kid. You know how people say there are no dumb questions? Well, I asked how we know when we're doing MMT. For example, are we doing it now? That might have been a dumb question because apparently MMT isn't a thing you do. But if it were, we might be doing it. Here's Stephanie. I don't think of MMT as a verb. It's not something we do. It's more of an adjective. It's meant to be a description of how the monetary system that we have today works. And with an understanding of the monetary system, and that involves the Treasury and the Fed, where are the limits? But you're right to say that if I'm working with an MMT understanding of the monetary system, I was looking at the economic landscape back in 2008, 2009, 2010,

and was definitely among the economists who was, you know, decrying the pivot from supporting the economy, providing fiscal support, to shifting toward austerity. Stephanie, of course, is referring to the Great Recession. And back then, there were few takers for MMTing. I know I'm not supposed to use it as a verb. I'm trying to quit. Now there's more willingness for doing MMT-ish stuff. We've seen Congress step up in bolder ways. And because they've moved four pieces of legislation already, five, if you count the HEROES Act that the House has passed, there does seem to be a different willingness and appetite for doing what needs to be done

and not backing off as quickly. Stephanie says right now the biggest risk isn't doing too much, it's doing too little. We could get into a situation late summer where we are today in the fall and even into next year and possibly beyond where we have the capacity to provide sustained fiscal support, but we let our fear of adding to the national debt or of large deficits prevent us from doing what we could and should be doing. I asked Stephanie, what about the case of Japan? Now, they've had massive deficit spending for years and they haven't had much economic growth. Why would we expect the outcome to be different for the U.S.? She said that Japan turned to a consumption tax each time its spending was beginning to produce better growth,

stalling its own recovery because it was worried about deficits. But she also says Japan has been successful in ways that aren't captured by gross domestic product. You know, you look at the infrastructure. They haven't done what we've done, you know, ignore and allow infrastructure to, you know, defer maintenance for a decade or more, and things are crumbling. It's clean. It's new. It's efficient.

Longevity. Look how long people live. They have health care. Infant mortality rates are very low. Now, you look at growth rates, and you say, well, but they haven't been growing very fast. Well, OK. But is that everything? Is that really the best measure of how an economy is performing for its people?

Infrastructure spending seems like an area with broad support. I might be a fiscal dinosaur, but I'd be up for borrowing at very low rates to build infrastructure because you don't have to rely on fancy forecasts of the benefits. No matter whether the spending pays off in the form of a multiplier effect where workers make more and then they spend more, you still end up with the stuff. You get the roads. You get the power grids. You get whatever they're building near Meta's home right now. Meta, how are things going on the construction site?

It's really quiet now. Maybe a lunch break? Lunch sounds good. Anyhow, I asked Stephanie what else she thinks we should spend more money on. Things like infrastructure, education, and R&D are widely agreed upon as key drivers of an economy's long-term real growth potential. So those are three categories where I think we are long overdue. And look what's happening with education today. I mean, public universities in particular are going to need a lot of support going forward if we're going to have a world class higher education system when we come out of the other side of this.

research who writes a daily newsletter with a focus on the Federal Reserve, has written that MMT is all about, as he puts it, an agenda for more big government and higher taxes. It's true that taxes play an important role in MMT. Remember that inflation is the main constraint on the ability to spend. If inflation returns, which Stephanie doesn't expect to see happening soon, then one MMT tool is to raise taxes to remove excess demand. I asked Stephanie if it's true that MMT is really just a political movement. We were not playing politics. This did not start out for any of us as an attempt to play in the political sphere. We're macroeconomists and we were engaging in scholarship around the introduction of the euro as a currency. And because we understood things differently from contemporary economists, we were able to see well before anybody else. Well, I won't say anybody else. Well before the vast majority

figured out why being a currency issuer was so important. majority figured out why being a currency issuer was so important. By the way, Jerome Powell, the current Federal Reserve chairman, rejected MMT explicitly in congressional testimony as recently as last year. The idea that deficits don't matter for countries that can borrow in their own currency, I think is just wrong. But late this past April, in a press conference, he said, this is the time to use the great fiscal power of the United States. I think it's just wrong. But late this past April in a press conference, he said, this is the time to use the great fiscal power of the United States.

Ed Yardini, who writes that Stephanie's views, in his words, will strike many conservatives as unrealistic and who comes across as no fan of MMT himself, also wrote recently, her views are already reflected in the current Republican administration's fiscal policy making. There's an exclamation point at the end, so let's pretend that I said it with a lot of oomph. So I guess we're MMTing. Whether that's a good thing or a bad thing or an outrageous thing to claim, that depends on your politics. Anyone want to talk about politics? It seems like a good time for me to go find that dumpster with the raccoons in it. Hopefully they're not too partisan. Thank you, Rachel, for sending in your question. And everyone, please keep the questions coming. Just tape on your phone, use the voice memo app,

coming. Just tape on your phone. Use the voice memo app. Send an email to jack.how, that's h-o-u-g-h at barons.com. Also send comments. If you disagree with something I said about monetary theory, if you suspect I don't know MMT from a BLT, let's hear it. And thank you for listening. Meta Lutzhoft is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And follow me on Twitter to find out about stories and new podcast episodes. That's at Jack Howe, H-O-U-G-H. See you next week.