As we traverse into the weird netherworld of the zero lower bound of interest rates, new ideas are flaring into life in the dismal, dry world of macroeconomics. Negative rates have already emerged in some countries as academic economists debate why each iteration of quantitative easing seems to be producing ever diminishing results.
In the next downturn, what’s left in the armoury of central banks? Ideas about helicopter money have been rumbling for decades but a sharper focus has emerged in recent years around a set of ideas based on the idea of central banks in effect printing money and using those proceeds to boost growth.
As this raging debate heads into the mainstream, the implications for investors could be profound. That’s certainly what legendary hedge fund manager Ray Dalio thinks, after he tossed the intellectual equivalent of a hand grenade in an essay on LinkedIn in May 2019. He suggests that Modern Monetary Theory (MMT) might be “one of those infinite number of configurations [for central bank policy] that is in my opinion inevitable and shouldn’t be looked at in a precise way”.
With interest rates fixed at zero, sitting alongside the strict monitoring of inflationary trends, governments could simply use monetary policy to expand demandDalio rightly argues that there are various versions of MMT being kicked around, but all share a simple notion – that worries about currency-issuing governments going bankrupt are wrong because governments (and their central banks) can always print the money they need.
With interest rates fixed at zero, sitting alongside the strict monitoring of inflationary trends, governments could simply use monetary policy to expand demand – and then contract demand via tax rises if inflation does subsequently emerge. Needless to say, many central bankers – who have traditionally adhered to what’s called a 'sound money policy' that focuses on controlling the money supply and bank balance sheets – are horrified by this. MMT comes from the fringes of macroeconomic theory.
It’s not just central bankers who are horrified by this. Leading economic commentator John Mauldin has intelligently weighed in with a series of letters on his website to Dalio that argue he is “kinda, sorta, really wrong”. Mauldin suggests that the only way to finance additional fiscal expansion is to introduce VAT as a revenue raiser. Mauldin’s concerns about MMT also find an echo in criticisms from arch Keynesians such as Paul Krugman, a Nobel prize-winning economist. This latter group (Keynesians) aren’t in principle opposed to the idea of gearing up balance sheets in an economic emergency, but they’ve traditionally regarded that as the job of governments, not central banks.
But the MMT idea refuses to die and finds backing from influential figures as diverse as Stephanie Kelton, an adviser to US senator Bernie Saunders, through to Oxford University economist Simon Wren-Lewis and macro hedge fund manager Eric Lonergan (who runs a fund at M&G Investments). The excellent economics analyst Frances Coppola has also recently published a book on MMT.
Some bond managers echo these thoughts. Jim Leaviss at M&G runs one of the biggest strategic bond funds and says he was the first to suggest that the UK government could simply cancel the quantitative easing (QE) gilts held by the Bank of England. In a recent interview for Citywire, I spoke to Leaviss on the subject. He said that this could destroy economic credibility, but if inflation isn’t an issue then there shouldn’t be any damage.
Investors might be tempted to think these debates are rather abstract, but the real-world implications are very realBut Leaviss also observes that we might not need to go all the way down the MMT path suggested by Dalio (Dalio calls it MP3, with Monetary Policy 1 being interest rate cuts, and Monetary Policy 2 being QE). Leaviss, in the Citywire article, asks why not let governments borrow money at low – or negative – rates of interest, instead of MMT-style money printing, especially when it is cheap to do so?
Investors might be tempted to think these debates are rather abstract, but the real-world implications are very real.
It’s difficult to argue with the notion that we are late in the macroeconomic and stock market cycle, with a recession growing in probability. With interest rates close to zero in most parts of the world, what central banks decide to do next will be crucial. Clearly, they could push even further into negative rates, but over the long term the impact on bank balance sheets could be deadly – already many European bank equities have fallen back in relative terms because of concerns about lending margins.
The next step could be reanimating ideas first floated by arch monetarist Milton Friedman centred on helicopter money – gifting money to individuals through the banking system. If it could be made to work this could be the catalyst that turns the next recession into a boom. But most economists maintain that to do this, interest rates need to be kept as close to zero for as long as possible, which implies a relatively benign environment for bond investors.
But lurking beyond this are two key concerns. The first is that central banks’ independence may be compromised, and monetary policy could become just another arm of partisan politics, with central banks utilised to justify everything from job guarantees to Green New Deals. If markets perceive this to be a real risk, all bets might be off as investors seek out safe havens. The other risk, accepted even by fans of MMT, is that inflation does make a reappearance, forcing governments to raise taxes just as their popularity starts to decline as the cost of living increases. The irony would be overwhelming – inflation makes an unwelcome return to a world used to deflation and easy money. The reckoning could be nothing short of catastrophic.
Views expressed in this opinion piece are those of the author alone and do not necessarily represent the views of the CISI.
David Stevenson is the Adventurous Investor columnist for the weekend Financial Times. He also writes for Money Week, Investment Week and the Investors Chronicle.