Modern Monetary Theory and Trade Deficits

Question: Modern Monetary Theory (MMT) proponents say that, if a country issues its own currency and can borrow in that currency, it can run larger deficits to achieve its goals because the central bank can create the money needed to repay the debts. Does this mean that America can continue its current level of deficit spending at little or no cost or risk?  

Short Answer: This would be true only if the money thus created went primarily or exclusively to stimulating additional production with existing domestic resources. What is generally missing from modern monetary theory is explicit recognition that we live in a global economy and that money created and used in good Keynesian fashion to stimulate full utilization of domestic productive capacity and domestic resources will probably leak out to foreign countries rather than stimulating the domestic economy. 

Why? Because if the Federal Reserve "prints" the money needed to finance subsidies to our households and businesses, we may not be able to produce the goods that Americans want at internationally competitive prices.  When this happens, Americans will use the freshly printed dollars to import what they want from foreign producers 

This is exactly what has been happening during the COVID pandemic. Imports of things like furniture and appliances have soared. As a result, the debt-financed stimulus goes to foreign rather than domestic producers. Our external deficits and debts explode. And we are left with even more debt.

Why has America lost its ability to produce and compete internationally?

America has lost its ability to compete internationally for many reasons, but the most important is undervaluation of the currencies of our main trade competitors – China, Japan, and Germany. A recent CPA study by Ferry, which I highly recommend, shows that of our top 34 competitors, 31 have currencies that are currently undervalued against the dollar.

This creates an implicit tax burden of 15-25% on all goods produced in America, goods that might otherwise be competitive as exports or as import alternatives. This "currency misalignment tax" has dire consequences for US producers. Unable to compete at home or abroad, they reduce or stop producing goods in America. They offshore production to foreign countries. And factories still able to produce in America are forced to depend on fragile supply chains that wrap around the world, creating risks that important inputs will not be available when needed.  In short, with the currency undervaluation of our key competitors, foreign producers thrive while US producers die.

Examples of MMT-style deficit spending financing foreign rather than US producers

The ongoing COVID crisis provides endless examples of ways in which deficit spending – combined with America's loss of international competitiveness because of serious exchange rate distortions – has benefited foreign producers while causing serious short-term and long-term damage to American producers and families. Consider two examples:

(a) Globalized supply chains, which have made America heavily dependent on foreign suppliers for key inputs such as computer chips, have recently made it impossible for American factories to finish and sell products such as motor vehicles, appliances, and tech gear. Consequently, many lose money and reduce output or close. Laid-off workers and their families suffer.

(b) When COVID forced families to reduce their spending on entertainment (restaurants, theaters, and travel), they used their savings – enhanced by deficit-financed COVID relief  – to buy household durables such as furniture, appliances, and home office equipment. This led to increased imports, record trade deficits, more foreign debt, and to a sharp increase in domestic inflation.

In short, MMT advocates may be largely correct if they explicitly limit their recommendations to Keynesian-type stimulus payments that put existing, underutilized, internationally competitive domestic capacity back to work. However, with the sharp undervaluation against the dollar of most currencies of countries with which we have significant trade, deficit spending simply stimulates foreign countries while leaving us and our children with larger deficits and debts, both domestic and foreign. Clearly a very bad deal!

What can be done to make MMT work for America?

America needs to move as quickly as possible to implement the Market Access Charge (MAC). This is a tax on countries that dump their trade surpluses into our financial markets to hold down the value of their currencies so that they can continue to run trade surpluses. With a MAC in place, this undervaluation relative to the dollar will disappear, America's factories will become internationally competitive and profitable, and this will lead to new investments in real plant and equipment that make US production even more efficient and competitive. The MAC will also stimulate the creation of millions of new well-paying middle-class jobs, thereby reducing the need for large deficit-financed subsidies to provide adequate income for American families.  

Once the MAC is in place, the $300-500 billion dollars per year that will be generated by the MAC charge on surplus foreign savings being dumped into US financial markets will make it possible for the the Government to stimulate even greater economic growth and major improvements in infrastructure, renewable energy, education, affordable housing, and all the other things America is lacking today. 

Once the MAC has made America internationally competitive, we can if necessary follow the advice of MMT advocates knowing that the debt-financed expenditures will benefit America and not be siphoned off as trade surpluses to countries with undervalued currencies. 

P.S. "Modern" Monetary Theory is a misnomer unless qualified as noted above. The same basic theory has been used for centuries by the leaders of bankrupt nations. I've worked in countries that have experienced inflation running from 8,000% to 24,000% per year because governments thought they could "print bread." However, if the exchange rate is overvalued, households will find it cheaper to import wheat to make their bread than to buy locally grown grains. The same is true for manufactured goods. And when this happens, local farms and factories die from lack of demand. Not a pretty sight.  Not what we want for America!

America Needs a Competitive Dollar - Now!