This is the first in a series of Weekend Reading articles looking at the impact of MMT on emerging markets. The following pieces will introduce a model and supporting data to identify the emerging markets that are best positioned to succeed in an MMT world.
Developing world governments were forced to choose between death by Covid or starvation in 2020, but developed country governments had another route: Modern Monetary Theory or MMT. The details of a heterodox economic theory may not be quite the thing for weekend reading, so I refer you to James Galbraith, whose excellent introduction is available on Tellimer and is entertaining and insightful in equal degrees.
A tiny bit of theory
For the purposes of this discussion, we only need to highlight a few things about MMT. First, MMT argues that countries with a fiat currency system should not see the size of government debt as a constraint on government spending because the government’s deficit is the private sector’s surplus. Rather, the only constraint on government spending is the real resources in the economy. So long as real resources (eg workers, physical plant, raw materials) are available to be purchased, the government can continue to create money and purchase resources. Inflation is seen not as a problem of the availability of unutilised real resources in the economy.
In practice, this means that countries should not be concerned about expanding government debt to fuel economic growth so long as they can issue and borrow at low interest rates in their own fiat currency and inflation remains low. For those who want to dig deeper, Stephanie Kelton, one of the leading MMT thinkers, explains these ideas clearly and succinctly here and here.
Second, while MMT is new, much of the thinking behind it is not. It’s worth watching this exchange from 2005 in which Alan Greenspan, whose sonorous New York voice always reminds me of my grandparents’ generation, explain to a youthful Paul Ryan why the US government can print money to keep the social security retirement scheme solvent so long as the “real assets” are created that these social security benefits will be used to purchase (begin at 2:42 here). Now that Speaker Ryan is moving into private equity alongside Mitt Romney’s son Taggart, hopefully he will look back to this exchange as he plans his investment strategy for the MMT era. Greenspan explains his views in more detail in this 1997 speech.
Finally, we can think of MMT as an extension of the ‘exorbitant privilege’ of reserve currency status. Essentially, reserve currency status is granted by the market. The US, EU, UK, etc., can print as much money as they like without the market taking umbrage, while those without are quickly punished for printing money or increasing government spending. In principle, countries without reserve currency status could seek to pursue MMT but, in practice, it would be naïve to expect investors to tolerate MMT in developing countries when it hasn’t even been properly tested in developed markets. Thus, markets also have a role in determining how MMT unfolds. As long as investors are willing to tolerate expanding debt without sharply raising interest rates or inflation expectations, then MMT is a viable option. However, if interest rates and inflation expectations rise as borrowing expands, then MMT stops being practically viable, even if it is still theoretically possible. Most developed markets are in the former category, while most developing countries are in the latter.
Is it fair? Probably not, but it also may not be forever. Indeed, some critics argue that, by turning on the printing presses, the US and others risk squandering their exorbitant privilege and losing their reserve status, potentially triggering an inflationary vicious circle and accelerating the adoption of other currencies like RMB in favor of USD and EUR in central bank reserves. In practice, once the inflection point is hit, the move away from one reserve currency to another can be quite sharp (just look at how quickly GBP declined as the reserve currency of choice after WWI and again after the Bretton Woods Agreement, never to regain its former might – albeit under very different circumstances than we are today). Nevertheless, MMT appears to be firmly on the cards, despite recent volatility in US Treasury yields.
Forget the rocket boosters and bring out the nuclear-powered spacecraft
From 1957-65, under the auspices of Project Orion, much of the Los Alamos team that had developed the hydrogen bomb worked on plans for a 4,000 tonne spacecraft powered by nuclear bombs that would travel to Saturn and Jupiter in five years, an idea that is now being revived to send humans to Mars. If traditional fiscal stimulus is a rocket booster to right the economy and get it back on course, MMT is more like the nuclear-powered spacecraft.
Lockdown intervention was not a blip. The developed world is in the midst of the biggest peacetime expansion in government in a century, perhaps the biggest in human history. To put this in perspective, consider the US. The share of government spending in GDP was roughly constant from 1800-1920, with expansion during war time and then contraction with peace. With the rise of the welfare state, the size of government began to expand, with wartime expansion and contraction around WWII, a one-off expansion in the 1960s, a slight contraction during the Reagan era and a further expansion after the financial crisis.
Figure 1: US government spending as a percentage of GDP
The picture is much clearer when we look at the annual change in government spending in percentage points of GDP. President Biden’s economic stimulus plan, at up to 14% of GDP, has only been paralleled once before in peacetime, in 1960, although even in that case one can argue that the Vietnam war contributed to the sustained expansion in government.
Figure 2: Annual percentage points of change in US government spending as a percentage of GDP
Europe’s stimulus plans are smaller than those of the US, but they may well grow. MMT provides the fiscal resources, and influential thinkers, like Mariana Mazzucato (also available on Tellimer), have eloquently argued for a much wider role for government investment and industrial policy in what Mazzucato terms a “mission-driven economy”.
Why this matters for investors and for emerging markets
Pulling all of this together, MMT is going to change the role of government in the economy, the roles that companies play with respect to government and the opportunities for investors. Governments will bifurcate between those with the credibility to pursue MMT and those that cannot. Most emerging markets will not be able to pursue MMT, so risk falling behind economically. Meanwhile, although MMT theorists disagree, in practice MMT risks crowding out the private sector, if only because of the difficulty of dynamically adjusting the size of government spending. If this crowding out happens, investors will need somewhere to go. Capital will flow to EMs as well as to speculative assets, like Bitcoin for example. Will it work? Who knows? Politics is in the driving seat, and the economic reconfiguration will be done before history gives us a verdict on whether MMT is ‘right’.
In the developed world, investors will need to understand how the state intends to use its newfound resources to reconfigure the economy. Although Stephanie Kelton has argued for a flexible universal income to smoothly scale government spending up and down, political reality means that MMT-driven spending will usher in a new generation of industrial policy. Investment success will require not only understanding the business, the problems it solves for customers and its competitive edge, but also how it is impacted by government spending. Can it position itself at the centre of an ecosystem that government is seeking to configure? Or will it be side-lined as government prefers alternate solutions to the problem that the business seeks to solve?
Looking to emerging markets, there are at least three ways to thrive in an MMT world:
Some emerging markets may be able to pursue MMT in their own right, notably China and South Korea;
MMT promises to drive developed market economic growth, and emerging markets that are well connected to the developing world stand to benefit;
Finally, if MMT does drive capital inflows to emerging markets, some emerging markets will be better positioned to absorb that capital and deploy it effectively than others.
The next piece in this series will explore the factors that can be used to assess the relative strength of emerging markets to thrive in the MMT world.
Thanks to my Tellimer colleague, Patrick Curran, for his input on this piece.