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Recently, the media was talking about the U.S. debt ceiling and the struggle that the U.S. government had to convince the U.S. Congress to approve additional borrowing.

In this article, the main focus will be on the Modern Monetary Theory in contrast to the U.S. debt ceiling.

The Debt Ceiling

Since 1917, the U.S. Congress has had the power to “To borrow Money on the credit of the United States”, given by Article I, Section 8 of the U.S. Constitution. This mechanism sets a limit on the amount of national debt that the U.S. Treasury can hold.

This debt can be used for paying social security, military salaries, tax refunds, and more. It basically helps the U.S. government’s revenues, which are mainly derived from taxes, to meet its expenditures.

The U.S. government is not the only country in the world that has a debt ceiling mechanism in its constitution. In contrast to the US’s nominal debt ceiling, the E.U. countries have a debt ceiling that corresponds to a percentage of their GDP.

In that sense, when a government runs with more debt than revenues, it is called a deficit. When the revenues surpass the debt, the government runs on a surplus. According to the CIA world factbook, the U.S. government ran in 2017 with 3.40% of its GDP at that time as a budget deficit.

Although a budget deficit increases the overall debt of a government and its probability of defaulting when left unchecked, many economists think that that is not the case.

1. Georg Friedrich Knapp & The State Theory of Money

Georg Friedrich Knapp (1842 — 1926) was born in a small village near the German city of Frankfurt. He studied political economy in Germany, where he also published, in 1924, his book “Staatliche Theorie des Geldes”, which was later translated into English as “The State Theory of Money”, which was published forty-seven years before the infamous “Nixon-Schock” that created our modern fiat money system.

In it, Knapp argues that money in general doesn’t have intrinsic value and is created by a stroke of the pen of the lawmaker. Money is then fiat by nature and does not derive value from its metal, or any other material that it could be made of. The simple fact that something is recognized as a means of paying a debt to the government, is the source that gives money its value. Because of this lack of intrinsic value, money is categorized as a liability. Knypp’s theory came to be known as “Chartalism”, from the Latin word “charta,” which means “token” or “ticket.”.

2. Alfred Mitchell-Innes & The Credit Theory of Money

Against the notion of “The Commodity Theory of Money” which suggests that money obtains its intrinsic value from the material (commodity) from which it is made, the “Credit Theory of Money” suggests that money does not have any intrinsic value at all.

Alfred Mitchell-Innes (1864 — 1950) was born in the Scottish capital Edinburgh and grew up to be an influential British diplomat and contributor to economic thought via his writings.

His first article, “What is Money?” of 1913 published in “The Banking Law Journal” was reviewed and approved by non-other than the great economist of the time, John Maynard Keynes. This review motivated him to write his second article, “The Credit Theory of Money” of 1914 which was published in the same medium.

With these two articles, Alfred Mitchell-Innes concluded that money is more of a “promise to pay” than anything else, it holds value due to the belief that it will be accepted by others, and it has more of a credit and debt value than intrinsic value.

3. Abba P. Lerner & Functional Finance

Abraham “Abba” Ptachya Lerner (1903 — 1982) built his economic theories, which stood against thinkers like Adam Smith and the theory of “sound finance”, who proposed that a government had to carefully balance its budgets and, similarly to a household, avoid excessive (public) debt.

He was born in Bessarabia, modern-day Ukraine, and migrated to Great Britain along with his family at the age of three. He studied under Friedrich Hayek at the London School of Economics and under John Maynard Keynes at the University of Cambridge. At the age of 62, he accepted a professorship at the University of California and later taught economics at Florida State University until his last days.

His work, entitled “Functional Finance and the Federal Debt” published in 1943, argued that governments should not act like households and should guide their decision-making and policies according to the economic outcome they produce, even if this could lead to budget deficits.

Another key idea, contrary to classical “sound finance”, was that since public debt is held by the citizens within a government, it is transferred from one group of the country to another, never leaves the economy, and thus is not a burden to a country’s future generations. Not to mention that inflation will eventually eat out the debt and reduce it over time.

Lerner’s ideas have strongly influenced the Modern Theory of Money by also stating that a government cannot default on its debts denominated in its own currency, since it could always issue new currency, and thus pay off its debt.

4. Hyman Minsky & The Concept of Endogenous Money

Hyman Minsky’s (1919–1996) concept of endogenous money is another idea that contributes to the MMT.

Minsky’s family immigrated to the U.S. from Belarus to Chicago, Illinois. He earned his Bachelor’s degree in mathematics from the University of Chicago, and his Master’s and Doctorate degrees in economics from Harvard University.

In his 1986 book, “Stabilizing an Unstable Economy," Minsky argues, contrary to popular belief, that banks and their lending are the key components of money creation rather than a central bank. This idea would later be called the concept of “endogenous money”.

Under this model, government spending is a source of money creation, and thus government spending can proceed with government tax collection or bond issuing.

5. Wynne Godley & The Sectoral Balances Approach

Wynne Godley (1926–2010) was born in London, and although he had a passion for music, he earned his Bachelor’s degree in economics from Cambridge.

Godley’s concept of “Sectoral Balances” studies the relationship between the government sector and the private domestic and foreign sectors. When one part of the formula has a deficit, the other must have a surplus in order for the sum to be equal to zero.

Putting it all Together: Warren Mosler & The Modern Monetary Theory (MMT)

Warren Mosler (1949) can be considered the “father” of “Modern Monetary Theory” due to the fact that he popularized the theory.

He earned his Bachelor’s degree in economics from the University of Connecticut, and then he started his career in the banking and finance sector. His career also includes many years as a hedge fund manager.

Through his book “Soft Currency Economics” which was published in 1995 and coauthored with the economist Mat Forstater, Mosler popularizes the idea of Modern Monetary Theory by combining the works of many economists in the past, some of whom have been mentioned above.

Under the MMT, unemployment, and inflation are key components of a country’s economy. As an example, when unemployment moves towards zero then a country’s deficit should be minimized. With that being said, MMT doesn’t suggest unlimited borrowing. As soon as a country tries to pay its own debt with its own currency, inflation starts to kick in, and thus inflation is MMT’s worst enemy.

All modern major economies that issue their own currency, are using MMT for their decision-making. Countries like the U.S., U.K., China, and Japan, can all be described as MMT countries.

Japan’s economy might be the best example of MMT at work. Despite the fact that its Debt-to-GDP ratio is at 258.2%, the country is fully functional and doesn’t have any default risk, as seen by its credit ratings.

Sources

1. Kelton, S., 2020. The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy. 1st ed. New York: PublicAffairs.

2. Chartalism. (n.d.). In Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Chartalism

3. Georg Friedrich Knapp. (n.d.). In Wikipedia. Retrieved from https://de.wikipedia.org/wiki/Georg_Friedrich_Knapp

4. Lietaer, B., Arnsperger, C., Goerner, S., & Brunnhuber, S. (2012). What is money? A brief exploration. Community Exchange Systems. Retrieved from https://www.community-exchange.org/docs/what%20is%20money.htm

5. Alfred Mitchell-Innes. (n.d.). In Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Alfred_Mitchell-Innes

6. Knapp, G. F. (1924). The state theory of money. The Credit Theory of Money. Retrieved from https://www.modernmoneynetwork.org/sites/default/files/biblio/the_credit_theory_of_money.pdf

7. Abba P. Lerner. (n.d.). In Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Abba_P._Lerner

8. Functional finance. (n.d.). In Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Functional_finance

9. Lerner, A. P. (1943). Functional finance and the federal debt. Duke University. Retrieved from http://public.econ.duke.edu/~kdh9/Courses/Graduate%20Macro%20History/Readings-1/Lerner%20Functional%20Finance.pdf

10. United States Department of the Treasury. (2022). Financial Report of the United States Government: FRUSG 2022. Retrieved from https://fiscaldata.treasury.gov/static-data/published-reports/frusg/FRUSG_2022.pdf

11. The Debt Ceiling: An Explainer. (2021, October 6). Council of Economic Advisers. Retrieved from https://www.whitehouse.gov/cea/written-materials/2021/10/06/the-debt-ceiling-an-explainer/

12. Minsky, H. P. (1986). Stabilizing an unstable economy. Yale University Press.

13. Endogenous money. (n.d.). In Wikipedia. Retrieved from https://en.wikipedia.org/wiki/Endogenous_money

14. Mosler, W. (1995). Soft Currency Economics. AVM.

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