What MMT Gets Wrong, And Monetary Sovereignty Gets Right (Part Deux)

Recently, we wrote an article discussing the theoretical and practical differences between Modern Monetary Theory (MMT) and Monetary Sovereignty (MS).  But still, some may wonder why there is essentially no correlation between deficit spending and inflation, at least not in the post-gold standard era and not even during WWII.

Surely there must be some connection, right?  Well, there technically is, but essentially only at the extremes.  Why?  Because of the "velocity of money", spending (sources of dollars) need NOT be symmetrical with taxes (sinks of excess dollars), only that enough dollars are clawed back in the long run (with the definiton of "enough" being quite elastic).  And as the velocity of money increases along with actual or potential inflation, so too does the tax take, narrowing the gap between sources and sinks.

For example, if the velocity of money factor is 7 (i.e. newly created dollars changing hands seven times on average, before being destroyed), spending can theoretically exceed tax revenues at any given time by up to a whopping factor of seven (!) before the excesses begin to accumulate year after year to the point where inflation increases when demand for goods and services grows much faster than supply, all else being equal.  Of course, the velocity will vary, and all else may not be equal, but that only makes it even more of an automatic stabilizer overall.

(Of course, it sure didn't hurt that during WWII, taxes were collected in real time (i.e. withholding) and the tax base was greatly broadened as well, despite record-high yawning deficits.)

And of course, another major sink is the FERAL Reserve draining excess bank reserves, while raising interest rates increases the demand for dollars and thus the relative value of dollars.  And paying down debts of any kind is another major sink as well.  And of course, a growing economy requires a growing supply of money, just to prevent recession and/or deflation, so the sources can still exceed sinks of all kinds by quite a large margin before inflation begins to bite, and we are currently nowhere near that point.

And of course, banks create money out of "thin air" all the time every time they make loans.  The difference is they don't create the interest that is owed, which must come from somewhere when it is paid back.  And if this were the only method of money creation (which it would be, if federal "deficit" spending money into existence interest-free were zero or negative, that is, a so-called "balanced budget" or "surplus"), then there would NEVER be enough money to pay it back, leading to net destruction and artificial scarcity of money.  And that would be VERY harmful for any economy--it was, after all what turned the mild-at-first 1929 recession into the full-blown Great Depression by the time 1930 had come and gone.

So it's no wonder we don't see any robust correlation between deficit spending  (i.e. money creation) and inflation in either the short or long run.  Thus, another myth bites the dust.