Virgin Galactic, owned by Sir Richard Branson, merged with SPAC Social Capital Hesdosophia
We begin 2021 with an article on a new alternative source of capital for innovators.
The first topic of the new year is on SPAC, special-vehicle acquisition company. In the US innovators have taken their companies public by merging with SPACs.
Through SPAC owners of start-ups have a different, perfectly legal approach to promoting their companies to investors. The approach includes interviews with obscure YouTube channels which are frequented by individual traders, appearance on cable news, and projections that call for billions of revenue.
Publicity and forecasts of rapid growth have become routine of an Initial Public Offering (IPO) of going public through SPACs. The use of what are called blank-cheque companies, which go public with assets and then merge with private companies increased in 2020. SPACs have raised a record US$62.1 billion as compared to US$$13.5 billion in 2019, according to Wall Street Journal on January 3rd, 2021.
Companies that went public through SPACs, including many nascent firms with no revenue, have said that they were attracted to the relative speed and certainty of the process, which can be completed months faster than some traditional IPOs.
In the case of IPOs, the US Securities and Exchange Commission (SEC) requires company executives to stay in a quiet period during weeks around public listing. Regulators don’t want companies to be marketing their stocks to unsophisticated investors outside of a regimented process. Similarly, companies don’t include projections in the IPO documents because of regulations that put them at high risk for litigation if they miss these plans.
Companies that go public through SPACs face fewer constraints because the deals are considered mergers. The Wall Street Journal article quoted an example, Fisker Inc. The company, an electric-vehicle start-up in July 2020 announced to go public by merging with a SPAC. Fisker has ambitious plans but little in terms of product or revenue to show investors. While it had about 50 employees, it disclosed projections to investors that called for it to hit US$13 billion in revenue in 2025, up from zero in 2020. The founder, Henrik Fisker, went on cable television repeatedly and remained prolific on social media. After the deal’s announcement-but before the merger was completed in late October 2020- Mr Fisker wrote on twitter about how the company was sold out of reservations for the SUV it plans to build in 2022 and hinted about coming news before a deal with a manufacturer was announced.
The Fisker spokesman said that Mr Fisker was not marketing to individuals investors and that his interviews were included in regulatory filings to investors.
SPACs offer a new avenue for start-ups to promote themselves as well as raise money in the US.. A SPAC’s most valuable asset, besides all the cash from investors, is arguably is its stock market listing. The company it invests in instantaneously becomes a public one, without many hassles that go along with a traditional IPO.
SPACs offer businesses and start-ups a surer deal-just take this money that had been raised by the sponsor of SPAC. In a world of low interest rate and high valuation on other stocks in the US, investors see SPACs as a reasonable place to park money for a while. A SPAC in the US is typically structured so that an investor can get his/her money out if he/she doesn’t like the deal a SPAC makes, and there us the chance that he/she will be getting early in next hot, growth company.
SPACs in the US have a time limit of 18 to 24 months to acquire businesses. According to BTIC.com, an investment advisory company, there are more than 210 SPACs seeking acquisition in the US. Stockmarket.com provides a list more than 200 SPACs on its website. The major SPACs include :
Draft Holdings
Fisker Inc.
Virgin Galactic
Workhorse Group, and
Repay Holdings
Note: Readers should be aware that the article is not a recommendation to buy a particular SPAC. It only highlights a new avenue for businesses to raise capital by merging with a SPAC.
The Covid-19 pandemic is changing the way Governments in many countries, especially developed countries, run their economies. They have adopted the so-called modern monetary theory or MMT. A clear explanation on MMT has been written by David Smith in the Times London on August 14th, 2020. The following is the extract of the article.
Today, something is slightly different. This is in the nature of an economic version of a request show. I have had many requests to write about what is known as modern monetary theory (MMT) and this is my response. MMT has been around for some time — decades, or even centuries, according to its advocates — but it is relevant now.
My reluctance to write about it has been in part because its true believers can get very exercised when faced with criticism, even if it is constructive.
The reason for writing about MMT now is the book by Stephanie Kelton, professor of economics and public policy at America’s Stony Brook University, and one of MMT’s leading advocates. She advised Bernie Sanders, who ran Joe Biden close for the nomination as Democratic challenger for the US presidency. Her book, The Deficit Myth: Modern Monetary Theory and How To Build a Better Economy, is published by John Murray.
Professor Kelton is a leading advocate of MMT
It is proving popular, for good reason. Not only are plenty of people interested in MMT, but it is written in a non-technical, accessible, even folksy style. It is being read by non-economists, as all the emails I have received urging me to write about it attest, as well as being on the summer reading lists for many economics students. Last time I looked, it was Amazon’s bestseller in macroeconomics and inside the online retailer’s top 1,000 among all titles.
It is arranged as a series of myth-busting chapters, although people who are aware of conventional economics do not believe many of these myths. The first “myth” is that the government’s budget is not the same as a household budget; something I thought had been buried many years ago. The same goes for most of the other myths.
The central idea of MMT is simple. It distinguishes between currency issuers and currency users. The only currency issuer in America is the US Treasury, with the Federal Reserve acting as its agent. Everybody else is a currency user.
As a currency issuer, the government has the ability to print as much money as it needs. The budget deficit itself is not a constraint, and neither is government debt. Some claim — wrongly, I think — that MMT has already been adopted in response to the Covid-19 crisis in the form of quantitative easing (QE).
In the world of MMT, the government can print enough money to cover a deficit of any size and, in extremis, to pay off all the accumulated debt of the past. The only tests of whether a budget deficit is too large or too small are inflation and unemployment. If inflation is low, the budget deficit cannot be too high, and if there is unemployment, the budget deficit must be too low.
Many people will catch their breath at this point, not least because Kelton claims that this is not just a theory but an explanation of how the world works. However, that requires us to be taken down a rabbit hole of implausibility.
If deficits can be costlessly funded and managed by the simple device of issuing currency, why do governments need to levy taxes? In perhaps the least plausible explanation of how incentives work, people apparently need to work to meet their tax obligations. If they did not have to pay tax, they would not need to work. I rather think they would, to satisfy their wants. Another reason for taxing — to redistribute wealth and income — does not wash either: you can redistribute wealth and income within the tax system without raising any net revenues by taking from the rich and giving it to the poor in tax credits.
Taxation exists in the real world to raise revenue. And borrowing by governments also plainly exists. Kelton says this is not to raise money, because governments don’t need to, but “to offer people a different kind of government money, one that pays a bit of interest”. Try telling that to US and British governments in the past, which have paid a lot of interest to fund borrowing and sometimes struggled to do so.
There is plenty more in the book. Some of it, like the policy of a job guarantee for everybody, is not so much part of MMT but an add-on to it, although at a time of high unemployment possibly a popular one.
MMT is misnamed because it is not monetary at all but almost entirely fiscal. As Kelton puts it: “MMT requires us to demote monetary policy and elevate fiscal policy as the primary tool for macroeconomic stabilisation.”
So what should we think of this? MMT has drawn robust criticism from some eminent economists. Kenneth Rogoff, a former chief economist at the International Monetary Fund, writing last year under the headline “Modern Monetary Nonsense”, described its central idea as “just nuts”. An exasperated Paul Krugman, the Nobel Prize-winning economist, described debating with MMT advocates as like playing Calvinball, a game where players make up the rules as they go along.
Larry Summers, economist and former US treasury secretary, attacked “ludicrous claims” by “fringe economists . . . offering the proverbial free lunch: the ability of the government to spend more without imposing any burden on anyone”.
I am going to be polite. We always need new, fresh thinking and nobody wants to kill off ideas clearly in a state of gestation and in no way workable in their present form. Some, like the economists above, might say it is necessary to kill off MMT because it is dangerous. There is, however, little chance of it being adopted as real-world policy. Not even Jeremy Corbyn and John McDonnell embraced MMT, despite being urged to by some supporters.
They were wise not to do so, because there are fundamental problems with MMT. It would take another book to address them fully. Kelton has fun with Margaret Thatcher’s “backward dictum” because Thatcher described a government’s finances in the way you would describe a household’s finances.
However, Kelton has more in common with Thatcher than she thinks. In the early 1980s, when the Tories launched their monetarist experiment, Thatcher thought the key driver of inflation was the budget deficit. The deficit had to be cut to reduce money supply growth and inflation. It is why people associated monetarism with “cuts”. Kelton looks at it from the other end of the telescope but applying the same principle.
The causes of inflation are many and varied, particularly when you do not use the simplifying assumption of a closed economy. Dylan Grice, whose review of Kelton’s book was republished by Albert Edwards of Société Générale, is not unsympathetic but points to the “preposterous” idea that getting the Congressional Budget Office in America, or equivalents elsewhere, to predict inflation will take care of the inflation risk from large budget deficits. Given the forecasting record on inflation, it plainly will not. As Grice puts it: “In short, MMT is a recommendation that policymakers press harcelerator without knowing where the brake is.”
He is right and, while advocates of MMT see it as a two-way street in which spending would be reined in if inflation took off, politicians may see it differently. Would it be a recipe for huge instability in the provision of public services, with public spending cut in response to rising inflation in a way that would make George Osborne’s austerity look like a tea party? Or would the government decide it could live with a lot more inflation? Either way, it would not be pretty.
India had overtaken France and UK to become the fifth largest economy in 2019. It will rank fourth in 2026.
The decade of 2020 will be in days. According to
Centre for Economic and Business Research, by the end of the decade of 2020,
there will be significant changes in the World Economic League Table.
In its 2020 World Economic League Table 2020 report, the highlights are as follows:
• The USA in 2019 reached 24.8% of world GDP, its largest share of the world economy since 2007. And the US is now expected to remain the world’s largest economy throughout the 2020s and is to be overtaken by China only in 2033, three years later than we forecast two years ago.
• We do not expect China to go into recession in 2020 and, although Chinese
growth will slow as a result of demographics and greater concentration on
quality of life, we expect China to become the world’s largest economy in 2033.
• India has decisively overtaken both France and the UK to become the world’s
fifth largest economy in 2019. It is expected to overtake Germany to become
fourth largest in 2026 and Japan to become the third largest in 2034. India is
also set to reach a GDP of $5 trillion by 2026 – 2 years later than the current
government target.
• The latest revised data suggests that despite Brexit, the French economy
failed to overtake the UK economy in the 2016-19 period. We now expect that by
2034 the UK economy will be a quarter larger than the French economy.
• Two ‘Western’ economies with particular success in attracting skilled migrants, Canada and Australia, should continue to rise in the rankings. By 2034 Canada is predicted to be the 8th largest economy and Australia the 13th largest.
• Because of its success in diversifying into tech, Russia is expected to do far better than any other energy dependent economy in a world of weak oil prices, falling only one place from 11th to 12th by 2034.
• Korea is set to become one of the world’s top ten economies in 2027.
• Indonesia is set to be on the verge of entering the group of the world’s top
ten economies by 2034, reaching 11th place in the table.
• Three rapidly growing Asian economies are the fastest risers in the table
amongst the larger economies. The Philippines rises from 38th place in 2019 to
22nd place in 2034; Bangladesh from 41st to 26th and Malaysia from 35th to
28th.
Malaysia will rank 28th largest in 2034 from 35th in 2019
• Poland enters the world’s top 20 economies in 2031, reaching 19th place.
• Weakening oil prices through the 2020s will push Saudi Arabia out of the
world’s 20 largest economies by 2028, eventually sinking to 21st in the
rankings by 2034.
The latest edition of the World Economic League
Table, the WELT 2020, is produced by international economic forecasters, the
London-based Centre for Economics and Business Research (Cebr) at a time of
significant change in the world order and increasing global economic
uncertainty. It is Cebr’s 11th annual world economic outlook report.
This edition of the World Economic League Table (WELT) shows some interesting
moves as the world’s richest powers jockey for position.
The WELT tracks the size of different economies across the globe and projects
changes over the next 15 years, up to 2034.
The past year, 2019, has been a bad year for the world economy with the weakest
GDP growth since the recession year of 2009. But the clouds started to lift
towards the end of the year and we predict that expansionary fiscal and
monetary policy around the world will cause growth to accelerate in 2020.
In 2019, any lingering ‘feel-good factor’ from the upswing of the global
economy in 2017 has largely dispersed and has been replaced by renewed
volatility and uncertainty. Trade tensions have come to the fore with the US
and China imposing substantial tariffs on each other’s export sectors.
Perhaps the most unexpected element in this report is the ongoing strength of
the US economy, though we expect that 2019 will prove the high water mark as
the problems of the trade war and the deficit impinge. But in 2011 the US
economy was 21.2% of world GDP. In 2019 its share had risen to 24.8%, its
highest share since 2007. And it is now forecast to remain the world’s largest
economy throughout the 2020s, only being overtaken by China in 2033.
China, on the other hand, has had a particularly difficult 2019 with growth
slowing and Beijing property prices falling. At the end of the year, however,
growth seems to have started to recover and the prospects for 2020 are
improving. Where China has been particularly successful is in reorienting
policy – its success in virtually abolishing extreme poverty over the past two
decades deserves to be applauded while the focus of policy has now shifted onto
improved environmental performance. We still expect China to become the world’s
largest economy in 2033.
Indian data revisions mean that 2019 was the year when the country’s economy
finally overtook the UK and France (as predicted in WELT 2019). But slow growth
during the year has increased pressure for more radical economic reforms. Our
prediction that India will overtake Germany and then Japan to become the
world’s third largest economy in 2034 assumes success in implementing such
reforms.
In Europe, revised data means that even after the sharp fall in sterling after
the Brexit referendum, the United Kingdom just managed to stay ahead of France.
We now predict that by 2034 the UK economy will be a quarter larger than the
French economy.
One of the persistent themes of this report is that countries that are
successful in attracting skilled migrants tend to grow faster. And reflecting
this, Canada and Australia, which are two of the most successful countries at
attracting inward migration, are predicted to rise in the rankings, Canada to
8th and Australia to 13th by 2034.
We have had a chance this year to conduct an in-depth study of the prospects
for the Russian economy. Our conclusion is that they are having some success in
diversifying from energy to tech and as a result, despite our prediction of
weak oil prices in the late 2020s and 2030s, we expect Russia only to drop one
place in the rankings to 12th by 2034.
Poland is expected to join the ranks of the world’s top 20 economies, reaching
19th position in 2031.
In the long run, many Asian economies will rise
through the ranks of the WELT as these countries cash in on their demographic
dividends. The two most prominent examples are the Philippines, which will
enter the top 25 largest economies reaching 22nd place in 2034, and Bangladesh,
which will rise to 25th.
Cebr Deputy Chairman Douglas McWilliams said: “The World Economic League Table
2020 tracks relative economic progress. The biggest surprise is how well the US
economy has managed to do, reaching its highest share of world GDP for 12 years.
Though our view is that it has reached its high water mark and moving forward
the deficit and its trade disputes will start to hold it back. Still, this is a
remarkable performance for an old world economy. ”
“The battle for the top spots in the WELT league table remains fiercely
contested,” said Kay Daniel Neufeld, Head of Macroeconomics at Cebr. He added:
“In December, the US and China agreed on a de-escalation in trade tensions
between the two economic juggernauts.
Whether the conflict, which has been weighing
heavily on global growth, can be entirely solved in 2020 remains to be seen. We
expect growth in China to slow further throughout the year as the country
manages not only the fallout from the trade war but also its transition towards
a consumption-driven economy offering a higher standard of living. This has
delayed its ascent to the top spot in the league table until 2033. Meanwhile,
Japan, Germany and India will battle for third position over the next 15
years.”
“Despite the rapid ascent of countries such as India and Indonesia, it is
striking how little an impact this will have on the US and China’s dominant
roles in the global economy. Indeed, their share of world GDP is forecast to
rise to 42% by 2034. The 2020s are set to be a decade marked by continued
tensions between the US and China on multiple fronts ranging from trade to
tech, which will cast a long shadow over the rest of the global economy.” said
Pablo Shah, Senior Economist at Cebr.
Note:
The World Economic League Table (WELT) is an annual calculation by Cebr jointly published by Cebr and Global Construction Perspectives. The base data for 2019 is taken from the IMF World Economic Outlook and the GDP forecast draws on Cebr’s Global Prospects model to forecast growth, inflation and exchange rates.
Cebr is a leading independent commercial economics consultancy based in London. The report has been produced by the Cebr team of economists led by Cebr’s Deputy Chairman, Douglas McWilliams.
Copper prices have declined more than 20 per cent since June last year, according to Neil Hume, who noted in Financial Tines dated October 5th, 2019.
Cooper has long been seen as a health check for the global economy
because of its wide range of industrial uses. As a result of its excellent
electrical conductivity, copper’s most common use is in electrical equipment
such as wiring and motors. As it corrodes slowly, copper is used in roofing,
guttering, and as rainspouts on building. It is also used in plumbing and
cookware.
Neil Hume noted that copper was trading close to a two-year low of US$5,625 per tonne in early October 2019. Rates published so far last month have pointed to deterioration in global manufacturing activity as the US-China trade war continues.
Copper, which is used in almost all constriction projects and white goods, can offer powerful indication unmatched by other commodities and raw materials. That also makes selling the metal as a default mechanism for investors who have bearish views on growth and China, the biggest consumer of copper. Citigroup analysts have estimated that copper demand would grow only 0.2 per cent in 2019 because of lower grid spending and in car sales. Since the US started the trade dispute with China in June last year, the price of copper has fallen more than 20 per cent. According to data from www.mcarotrends.net , the yearly closing prices of copper from 2010 to 2019 are as follows.
Year
Average closing prices (US per tonne)
2019
6,005
2018
6,466
2017
6,201
2016
4,852
2015
5,449
2014
6,847
2013
7,360
2012
7,959
2011
8,827
2010
7,575
“Copper has endured the most frustrating 2019 out of all the base metals,”
noted Deutsche Bank analyst Nick Snowdon. This year’s near 2 per cent fall in
global mine supply would usually have led to higher prices, Mr Snowdon said.
But a combination of “sluggish demand” outside China and a significant reduction
in the country’s inventory “has limited tightening effect for most of the year”,
he said.
Neil Hume noted that analysts and investors are bullish on copper in the long term, arguing that it will play a role in the shift to a low-carbon economy. It is noted that a wind turbine capable of generating a megawatt of power, which is enough to supply 500 homes, requites more than three tonnes of copper. The metal is also needed in the lithium-ion batteries that power electric vehicles, as well as their motors, inverters and charging parts. At the same time, it is difficult for mining companies to find long, high-grade copper projects. According to the USGS Mineral Commodity Summaries 2017, the major producers of copper are:
Country
Production (Tonnes)
Australia
920,000
Canada
620,000
Chile
5,330,000
China
1,860,000
Congo
850,000
Indonesia
650,000
Mexico
755,000
Peru
2,390,000
US
1,270,000
Zambia
755,000
Other countries
4,300,000
19,700,000
It is for that reason that analysts forecast a significant gap to open up
between supply and demand by the middle of the next decade unless new projects
come on stream.
Investors beware
A few years ago, during the height of copper prices, we were approached by a company to invest by purchasing copper recovered from construction wastes collected in Middle East. We were guaranteed high returns. Now, a friend and the company are embroiled in a court to recover the investment of US$50,000. Copper prices move up and down with the state of the world economy. The friend was convinced by the company that China, the biggest user of copper, would continue to grow at a pace.
We note that high copper prices will lead to disruption of communication lines when thieves steal copper cables. We would experience sudden loss of telecommunication services. Ten year ago, our remote factory experienced regular stoppages of service because thieves have stolen copper cables, every time the copper price spiked.
We read an interesting article by Jonathan Black in Financial Times on June 24th, 2019.
He wrote that most people do not seem to think that deploying patience is a viable course of action at work. The word, which originates from the Latin word for “suffer”, nowadays tends to suggest passivity, forbearance, tolerance and even resignation. None of which are prized in the working world. Yet it has a distinguished history, with the first known use of the phrase “patience is a virtue” in the late 14th century poem “Piers Plowman”, by William Langland. And patience was listed as one of the seven heavenly virtues by the Roman Christian poet Prudentius 1,000 years earlier in his book, Psychomachia (Battle of the Soul). Patience may be unfashionable, but it is making a modest comeback.
He had interviewed a number of people working across a
variety of sectors — the law, banking, the civil service and scientific
research — all of whom thought patience could be active and effective. Most of
them saw it as an important workplace skill, along with teamwork, leadership
and communication.
An interviewee thinks patience can be an asset in the civil service: “If you can crack patience as a tool, then you stand a good chance of being seen as professional and reliable.” Yet he had sometimes seen patient people being marginalised by more dynamic and impatient colleagues. And he notes that “patience should not, however, be seen as an excuse for indecision.” While those who are naturally impatient can use it as a tool, they too have to learn how to manage their impatience and use it wisely. He considers that patience is learned, often through mistakes, rather than taught and concludes that patience can be used as one of many, interconnected skills.
Another interviewee, who recently retired after a career as
a senior corporate tax adviser, agrees that “patience is a hard learned and useful
art form”. She reflects that passing her professional exams required stamina,
resilience and an element of impatience, in order to qualify as quickly as
possible. In contrast, she says, “clients had to be managed with saintly
patience, as did senior staff with unrealistic expectations of workload
management”. More broadly, she found that “patience is useful when you are
faced with a lack of understanding, political motivation to block, or just
misogyny and racism. That said, too much patience allows these factors to hold
you back.”
A third interviewee, who is a senior postdoctoral researcher,
reported that her career in life sciences academic research has depended on
patience. Success is based, she thinks, on “resilience and perseverance and is
mostly incremental wins, while plagued by failures and disappointments in
experiments, paper and funding application rejections”. She also cites the need
to exercise patience with managers who are measuring success in tangible
outcomes, while waiting for her detailed experiments that can take months to
reveal significant results. She thinks that patience gives her the courage and
confidence to stand her ground against the “avalanche of information and
alluring possibilities, the fear of missing out, and the infliction of instant
gratification”. In these instances, patience at work is not to be confused with
complacency, but is rather a learned stillness that allows us to evaluate
before advancing strategically with intention and enthusiasm.
Mr. Black noted that technology has been the big enabler of
impatience and speed: having letters typed and proofread involved a built-in
reflection period that allowed time to reconsider and ideas to develop.
New graduates enter the workplace having been trained by
social media that they can, and therefore are expected to, respond instantly.
The 24-hour news cycle creates a febrile atmosphere in which patient
deliberation can be seen as a personal weakness. No one wants to be seen as
inactive in case it looks like inability to act or complacency. And it is easy
to confuse activity with progress — whereas allowing time for consideration and
just letting things play out can be a more effective approach. An interviewee observes
that “even if one is impatient to act, you still have to time when to strike;
that can require patience itself.” Patience at work is not to be confused with
complacency, but is rather a learned stillness that allows us to evaluate
before advancing strategically.
Mr. Black noted that when we are impatient for change — is
also a useful tool for managing one’s entire career. An interviewee thinks that
“impatience for change is critical for a successful career”. This was echoed
more formally by another interviewee, who every three years asks himself: “Do I
like what I’m doing and should I stay?”
In some fields, patience and impatience are built into the
career development structure. An interviewee, who left the British Royal Navy
as a commodore in 2002, says that after becoming a lieutenant commander,
promotion relies on being selected from the pool, or “zone”. Officers do not
enter the zone for promotion to the next rank for a period of years, in order
to consolidate skills and experience — an approach which he describes as,
“guided patience”.
An interviewee views her career as a “purposeful continuum,
which requires assessing my current position and strategizing the next; if done
mindfully, this requires time and patience”. The urge to act quickly —
responding immediately to an email or chasing a promotion — may have underlying
behavioural reasons.
Economists call this tendency hyperbolic discounting, or
“present bias”, in which humans place a higher value on the more imminent
reward when considering two future events. Taking action immediately can give a
psychological pay-off and show how engaged you are — even though ultimately it
may be less effective at making progress. With decision-making timeframes under
increasing pressure, the virtues of both patience and deliberate impatience
risk being forgotten at work and when we think about our long-term career
plans.
According to Mr. Black, while we do learn from our mistakes,
teaching the importance of patience may result in fewer mistakes in the first
place — which is surely the better outcome.
Advice from Mr. Black on to use patience as a tool at work
If you are going to be patient, or impatient, do it
deliberately. Include “wait and see”, or “do nothing yet”, as an option for all
decision making.
Do not respond to all requests instantly; even the urgent or
important may need time for consideration.
Do let people know what you are doing. If naturally
impatient, use the phrase, “I need to think about this before I can respond”.
If you are too patient, especially on your career, do not wait for others to look after you. Set yourself deadlines, tell other people your plans, and act on them.
Biodata
Mr. Jonathan Black is Director of Career Service, Oxford University, UK.
We have created a new category,
Economic Matters, which features economic topics which would be useful to
innovators in understanding how economies work.
Today, we highlighted the article
written by Martin Wolf, a well-known economist of Financial Times, on 29th,
May, 2019.
According to Martin Wolf, the state is the most important of all our institutions. It is the ultimate guarantor of security. But its power makes it frightening. For this reason, people sometimes pretend it is weaker than it is.
In one area of economics, this is particularly true; money. Money is a creature of the state. Modern monetary theory, a controversial account of this truth is analytically correct, so far it goes. But where it does not go is crucial: money is a powerful tool, but it can be abused.
L Randall Wray of the University of Missouri-Kansas City set out these ideas in Modern Monetary Theory (MMT). They have the following fundamental elements:
First, taxes drive money. This doctrine is called “chartalism”. Governments can force their citizens to use the money it issues, because that is how people pay their taxes. The state’s money will thus become the money used for domestic transactions.
Banks depend upon the government’s
bank-the central bank- as lender of last resort. The lOUs of banks-the predominant form of money in
today’s economies-are imperfect substitutes for such sovereign money. They are
imperfect, because banks may become illiquid or insolvent and so may
default That is why banking crises are
common.
Second, contrary to conventional
wisdom, no mechanical relationship exists between holdings of central bank liabilities by banks (that is, reserves) and
the creation of bank money. Since the financial crises, central bank balance
sheets and bank reserves have grown hugely, but broader monetary aggregates
have not. The explanation is that the dominant driver of the money supply is
the (risk adjusted) profitability of lending, which is high in boom times and
low in busts. The weakness of credit also explains why inflation has remained
low.
Third, governments need never default on loans in their own currency. The government does not need to raise tax or borrow to pay its way; it is possible for it to create money it needs. This makes it simple for governments to run deficits, in order to ensure full employment.
Fourth, only inflation sets limits on a
government’s ability to spend. But, if inflation emerges, the government has to
tighten demand, by raising taxes.
Finally, governments do not need to
issue bonds in order to fund themselves. The reason for borrowing is to manage
demand, by altering interest rates, or the supply of reserves to the banks.
This analysis is correct, up to a point. It has also implications for policy. A sovereign government can always spend, in order to support demand. Again the expansion of the central bank balance sheet does not make high inflation likely, let alone inevitable.
Some believers in MMT argue that the
power to create money should be used to offer jobs guarantee or finance programmes such as the
Green New Deal proposed by Democrats in the US. But such ideas do not follow
from their analysis. These are suggestions for where the state should spend.
What then are the problems with MMT?
These are twofold: economic and
political
An important economic difficulty, clear
from the painful western experience in the 1970s, is that it is hard to know
where “full employment” lies. Excess
demand may exist in some sectors or regions, and deficient demand elsewhere.
Full employment is a highly uncertain range, not a single point.
A still more important economic mistake is to ignore the expectations that drive people’s behaviour. Suppose holders of money fear that government is prepared to spend on its high priority items, regardless of how overheated the economy might become. Suppose holders of money fear that the central bank has also become entirely subject to the government’s whims (which has happened often enough in the past). They are then likely to dump money in favour of some other asset, causing a collapsing currency, soaring asset prices and booming demand for durables. This many not lead to outright hyperinflation. But it would lead to a burst of high inflation, which becomes entrenched.
The focus of MMT’s proponents on
balance sheet and indifference to expectations that drive behaviour are huge
errors.
The mistakes are economic ones but
there is a related and far worse political error, as Sebastian Edwards of
University of California, Los Angeles, has argued. If politicians think they do
not need to worry about the possibility of default, only about inflation, their
tendency may be to assume output can be driven far higher, and unemployment far
lower, than it is possible without triggering an upsurge in inflation.
That
happened to many western countries in the 1970s. It has happened more often to
developing countries, especially in Latin America. But the economic and social consequences
of big spikes in inflation can be very damaging.
Yet the same
is also true for high employment.
So in managing a modern monetary
economy, one has to avoid two gross errors. One is to rely on private sector to
much, since that can all too easily end up with highly destructive financial
booms and busts.
The
opposite error is to rely on government-led demand too much, since that may
well generate destructive inflation booms and busts.
The
solution, nearly all the time, is to delegate the needed discretion to
independent central banks and financial regulators. Yet proponents of MMT are
right that during a period of structurally feeble private demand (as in Japan
since 1990) or a deep slump, a sovereign government must and can act, on its
own or in cooperation with the central bank, to offset private weaknesses.
There is
then no reason to fear the constraints. It should just go for it.
