(Bloomberg Opinion) -- The date: Aug. 5, 2011. This columnist had just celebrated his 22nd birthday. Those in the Obama administration were far less cheerful: S&P Global Ratings announced it would downgrade America’s credit rating for the first time ever, even though lawmakers had finally agreed to a hard-fought compromise on raising the debt ceiling.
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in its statement. Market strategists warned that “sovereign credit quality is going to remain under pressure for years to come.”
This episode could be considered a crowning achievement of the Tea Party movement, which traces its name back to a rant against the federal government from CNBC’s Rick Santelli in February 2009. It ushered in a wave of hard-line Republicans in the 2010 midterm elections, like Senator Mike Lee of Utah and Senator Rand Paul of Kentucky, who vowed to save the U.S. from “a mountain of debt that is devouring us.” Grover Norquist, president of Americans for Tax Reform, praised the debt-limit deal, saying that “in five to 10 years it will lead to a different country.”
Norquist was right. But probably not in the way he expected.
Since August 2011, the U.S. public debt has increased by almost $9 trillion, to $23 trillion, and virtually no one has batted an eye, S&P included. Benchmark 10-year Treasury yields are lower, not higher.(2) Main Street hasn’t faced any hint of runaway inflation. Government debt hasn’t crowded out companies from borrowing and investing. Simply put, nothing the Tea Party warned about has come to pass.
Perhaps this is why, in what may ultimately be seen as a watershed moment, the House Budget Committee last month held a hearing titled “Reexamining the Economic Costs of Debt.” The session included testimony from four economists, including Randall Wray, a senior scholar at the Levy Economics Institute of Bard College and a leading thinker in Modern Monetary Theory. Though he wasn’t given much time to speak, when he did, he told lawmakers this: “We do not have to repay the debt — what we have to do is make the interest payments.”
If there were one sentence that captured the drastic change in economic thought over the past decade, that might just be it. (As a reminder, MMT argues that sovereign governments with their own currency can’t go broke and can spend until inflation becomes an issue.)
The shift from the Tea Party to MMT reveals two crucial and interrelated themes of the past 10 years. First, it shows that former Federal Reserve Chairman Ben S. Bernanke was right: “Monetary policy cannot be a panacea” to cure all that ails developed-market economies. Second, relying solely on central banks tends to create financial-asset distortions that foster income inequality and dissatisfaction among broad swaths of the world’s population.
Wray says Americans don’t seem to have confidence in their elected representatives to do the right thing when it comes to the economy. And perhaps Congress doesn’t believe in itself, either. “In the aftermath of the global financial crisis, there was a tremendous overreaction against fiscal policy in favor of putting all the trust in monetary policy,” he said in a phone interview. “It caused unnecessary suffering and secular stagnation in the U.S. and abroad. We can’t continue this way.”
Consider the Atlanta Fed’s wage-growth tracker for prime-age U.S. workers, currently at 3.9%. It bottomed out at a record low 1.6% at the end of 2010, down from 4.2% before the recession began. It didn’t reach 3% for another four years and still hasn’t reached the levels seen from 1999 through 2001.
The S&P 500 Index, on the other hand, has produced a 15% annualized total return since the recession. It’s setting record after record — something President Donald Trump likes to trumpet. The Russell 2000 Index has gained an average of 13.5% a year, while high-yield corporate bonds have produced a 9.1% annualized return in the past 10 years. Basically, holders of financial assets have had a great decade while those who rely on salary bumps have fallen behind.
An MMT-inspired fiscal policy, in theory, would hope to change that. None other than Ray Dalio, founder of Bridgewater Associates, has said he sees MMT as “inevitable.” Policy makers, he says, have to figure out “how to get the economic machine to produce economic well-being for most people” when typical central-bank tools fail. He sees a coordination of fiscal and monetary policy as the only answer.
The big question, Dalio says, is whether elected officials can responsibly push and pull on the economy. Wray thinks they can. “Give the policy makers the truth, and if you believe in democracy, you’ve got to trust them to do the right thing,” he said. “I don’t think there’s any danger that just because they realize the government can’t run out of money, let’s spend until the cows come home. I’ve never met any politician who wants inflation.”
Of course, there are still any number of lawmakers — mostly, but not exclusively, Republicans — whose views are rigid as ever about the budget. “I certainly don’t want my grandkids to see the crisis scenario in which the interest rate on the debt will skyrocket abruptly because investors will no longer have confidence in our government’s ability to pay its bills,” lamented Steve Womack, an Arkansas Republican, at the House hearing. Ralph Norman, a Republican from South Carolina, peppered Wray with questions, including if he had ever run a business or knew the inflation rates in Chile, Peru and Venezuela. “Hyperinflation hurts the little man,” he warned.
And for every big-name investor like Dalio who’s sanguine about MMT, there’s at least one who dismisses it outright. Jeffrey Gundlach, chief investment officer at DoubleLine Capital, has blasted it as a “crackpot idea.”
By now, MMT economists are no strangers to ad hominem attacks. “The most important thing is just the weight of the evidence,” says Stephanie Kelton, a professor of economics and public policy at Stony Brook University who is also an adviser to the Bernie Sanders campaign and has written occasionally for Bloomberg Opinion. “At some point, people become increasingly willing to rethink the theories, the models, the conventional wisdom because all of the things that were supposed to happen kept not happening.”
Kelton points to Japan, which is running a debt-to-GDP ratio of about 238% with low inflation and interest rates locked near zero, as an example of failing conventional wisdom. “Increasingly you’re hearing central bankers talking openly and candidly about a need for a fiscal partner,” she said in a phone interview. “There’s growing but reluctant acceptance of the idea that fiscal policy is going to have to take on a bigger supporting role — and maybe even a starring role.”
This is where Representative Alexandria Ocasio-Cortez’s Green New Deal, or something like it, comes into the picture. Wray co-wrote a paper titled “How to Pay for the Green New Deal,” in a nod to John Maynard Keynes’s 1940 book “How to Pay for the War.” To consider how far MMT still has to go, just consider Wray’s view of taxes:
“It is possible that we will need to constrain domestic consumption in order to release resources for the GND effort in a noninflationary manner. The problem is not that we cannot financially afford the GND — government can always bid resources away from private use by paying higher prices — but spending on the GND will generate private income that can support higher bids in competition with the government for scarce resources. This is the real reason that tax hikes might be desirable: to reduce private income and thereby remove competition for resources.”
To condense the argument: Taxes are not about raising revenue for the government. They’re to reduce spending power to avoid price inflation.
For many people who have just a cursory understanding of the U.S. monetary system, this can be difficult to grasp.(1) After all, it has been a long time since fiscal policy has played a “starring role,” as Kelton says. It’s why Wray has to go back to World War II for any sort of comparable government initiative.
It’s still far too soon to say whether MMT will catch on in the 2020s. But in some ways, the Trump administration has washed away what remained of the Tea Party’s resolve. In a bipartisan move, the House this month passed two spending bills that provide $1.4 trillion to fund the U.S. government. The U.S. will almost certainly run at least a $1 trillion annual deficit in the coming years.
The Peterson Foundation, one of the last voices calling for fiscal restraint, bemoaned the budget deal: “Another $400 billion in debt is the worst possible holiday gift for our children,” the group said. “We should be looking at ways to reduce our interest burden so that we can fund important national priorities.”
That sounds awfully familiar. One of Peterson’s tweets last month was flooded with replies of the “OK Boomer” meme. It’s one example of how MMT has a passionate and growing base of supporters who are tired of the way Washington has operated for decades.
For all its connotations with Sanders, Ocasio-Cortez and democratic socialism, Wray doesn’t see MMT as some sort of showdown with capitalism. Quite the opposite — he imagines what a World War II-like effort would look like if instead of producing guns and bombs, the government turbocharged renewable energy projects that would last for generations.
The past 10 years have been defined by relatively restrained fiscal policy and unprecedented stimulus measures by central banks. If the 2020s turn out to be the decade that governments step up to the plate, what might America look like come December 2029?
“Last time around, in spite of all the sacrifices of the war, we had the golden age of U.S. capitalism,” Wray said. “What are we going to have after this 10-year period? There’s no reason to believe it’s not going to be this new era of high productivity with environmental sustainability, high wages and full employment.”
(1) JPMorgan Chase & Co., for instance, estimated that the downgrade would raise the nation’s borrowing costs by $100 billion a year.
(2) That includes myself. Almost 10 years ago to the day, I was taking a macroeconomics final exam at Northwestern University with Robert Gordon, who literally wrote the book on the topic.
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Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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