In today's Finshots we offer a simplified take on Modern Monetary theory and see if it could solve most of our financial problems


The Story

A few days ago, we wrote an innocuous piece explaining how Sri Lanka would be ill-advised to print new money while attempting to wriggle out of this current crisis. And while we didn’t think much of it at the time of writing the article, we were a bit taken aback by the slew of interesting comments we received soon after — most notably from exponents of the Modern Monetary Theory.

For the uninitiated, advocates of the theory argue that countries that have the power to issue their own currency can technically never “run out of money.” They’ll contest that the government can spend on food, healthcare, infrastructure and other things without having to worry too much about the debt burden (fiscal deficit, more specifically).

And even though the theory seems to fly in the face of well-accepted ideas, it isn’t that radical either, to be honest. Many countries spend more than they earn. In India, we’ve been running a deficit for ages now and on many occasions, the central bank helps control the burden by printing money.

In some cases, we even breach thresholds that are considered sacrosanct. For instance, during times of war or Covid, we do have the provision to borrow beyond our means. And while traditional economists would caution us from straying too far with this experiment, modern monetary theorists argue that governments shouldn’t worry too much about such debt.

Take for instance the US government. As of August 2021, the public debt of the United States stood at 28.43 trillion U.S. dollars. This is a gargantuan sum by any account. However, proponents of the theory will argue that the US shouldn’t have to worry about the debt because they can always pay back the creditors using dollars they can print. They’re the only authority that can do this and so technically all they have to do is print new money to pay back their debt.

And this is where things get interesting. If you’ve been reading this publication, you’ll now say something like this — “When you offer anything in abundance, the value of said commodity must depreciate. Offer a person too much attention, maybe they won’t value you as much. Circulate a ton of money, maybe the dollar will suffer the same fate. It’s the laws of demand and supply. If all the freshly minted money makes its way into the hands of people, the value of the dollar may tumble. You’ll have to pay more to get less. While once you could buy a gallon of milk at $2, you’ll now have to shell out $4 to buy the same stock. Ergo, there is a very real risk of stoking inflation.”

But modern monetary theorists argue that governments don’t have to worry about this too much — since they’ve been printing money for almost a decade now without triggering runaway inflation. So the question then is — “Why can’t Sri Lanka do this? Or even better, why can’t India pursue such a program?”

Well, because the Indian Currency or for that matter, even the Sri Lankan currency does not enjoy the same status as some of these other currencies.

For instance, the Federal Reserve (US Central Bank) can keep printing and pushing more dollars into the ecosystem simply because there’s always more demand for the currency. Americans use it. Foreign investors buy it. Big corporations trade with it. And considering there is an almost overwhelming consensus that the US economy is more stable than other emerging economies, they can simply get away with it.

India doesn’t enjoy the same status. So there’s always a risk that an emerging economy like ours could potentially risk triggering inflation if we simply threw all caution to the wind. Then there’s the fact that we also have to contend with a current account deficit — the kind of thing that happens when we import more than we export. See, although we have the luxury to borrow in our own currency, we can’t use it for trade. Much like Sri Lanka, India too must pay in dollars while buying oil and other stuff from foreign nations. And if we constantly print more money in a bid to facilitate extravagant spending, then we run the risk of devaluing our currency i.e. We will need more rupees to buy the same amount of dollars and importers will have to pay a steep price for the government’s misadventure.

So yeah, Modern Monetary theory might hold merit for some economies, but for the likes of India and Sri Lanka, maybe not so much.

Until next time…

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