SIMON BROWN: I’m chatting now with Mohammed Nalla. You’ll find him at Moe-Knows.com. I thought I’d get Mohammed on for my hard question of the week – modern monetary theory. Mohammed, I appreciate your time. I want to give you my sort of synopsis and we can see how right I am. Modern monetary theory in essence is the idea that countries that issue their own currencies never run out of money because they can print it. A business or a person literally can. A country can never run out of money. And, while in one sense that’s a terrifying idea – and Zimbabwe springs to mind – there is a school of thought that’s been growing over a couple of years that says this maybe isn’t the worst idea.
MOHAMMED NALLA: Thanks, Simon. Always a pleasure to chat to you and to the listeners. Modern monetary theory – despite the name, which says ‘modern monetary’ – people think is a new thing. It’s actually something that’s been around, certainly in academic circles, since the 1970s. I think your synopsis is spot on. It’s basically saying for countries that can control their own money supply, effectively print their own currencies, why shouldn’t they do that? And instead of looking at focusing on policy measures like inflation control, that has really become kind of a de facto norm over the course of the last several decades.
MMT, or modern monetary theory, suggests that we should actually rather aim for full employment. How do you go about doing that? It’s a combination of both monetary stimulus and then playing hand-in-hand with something like fiscal stimulus, and that sends all of this into the real economy.
That approach is very different in that, instead of using interest rates as your primary policy lever to try and control inflation, it says yes, when we eventually do reach full employment, yes, inflation might start to come through and start to become a problem.
At that point in time in the future, theoretically, they should then look at taxes as the lever to actually start to curtail expenditure from the private sector. And that starts to take some of the steam off any inflation problem that you might get in the longer term.
So in a nutshell that’s the theory. As you correctly state, people start seeing these images of a Zimbabwe or a Venezuela hyperinflation. Even further back, you look at Weimar Republic in Germany, and that’s really the fear that grounds the world in an inflation-targeting type of a framework.
But for countries like the United States, where you’ve got this exorbitant privilege, you’ve got the US dollar as a reserve currency with tons of demand, I don’t see demand for the US dollar disappearing overnight. That theory may just work over a period of time and it’s something that I think is actually being tested as we speak right now.
SIMON BROWN: You mentioned taxes. In a sense, if we start getting inflation, the typical central banker raises interest rates – and that sort of sucks the money out of the economy. If you raise taxes, you get the same sort of impact, you suck money out of the economy, except of course that money then goes to government which can then put it back into the economy as and when needed, and I suppose when inflation starts to moderate again.
MOHAMMED NALLA: That money would either flow back into the economy or alternately again, as the theory would hold, the government at that point in time could utilise some of these exceptional tax revenues to repay some of the debt. And then, once inflation cools off again, it can look at ramping up the debt again to reinject that money into the economy. So instead of using interest rates as the price of money, and I guess the transmission mechanism to prices that the consumer would eventually pay, this would look at taxation and debt control on the other side as your primary levers to that macroeconomic policy. It turns the way the world has been run on its head quite a bit.
The reason why I say it might actually be with us as we speak is, bear in mind, following the pandemic we’ve had almost an uncanny cooperation certainly in the US – I wouldn’t necessarily say it’s explicit – but you’ve got the Fed that’s really keeping easy monetary policy going.
But then at the same time, you’ve got massive stimulus checks being doled out by the US treasury because, remember, if the Fed controls the price of money they don’t have the direct mechanism to inject that into the economy. It’s got to go through the banking system and so forth. If you go from the US treasury side, they can literally mail you a cheque because that’s how things are done in North America…. And once that money hits your account, you’re free to go out and spend that. So the ability for it to drop through into the real economy is arguably a lot greater in that kind of scenario. And, because of the pandemic, we’ve had both of those levers churning.
I saw an interesting stat the other day that says something like 60% of all base money, or base US dollars that have been created, has been done over the last two years.
I haven’t validated that yet, and it ignores all of the kind of money created in the financial system. But that is a staggering statistic that may also explain why we’ve seen so much activity come through in terms of the cryptocurrency market as well.
SIMON BROWN: You mentioned the idea of sending money directly to people. We kind of do that in South Africa with our social grants – I know (it’s) on a much different scale and aimed at a certain demographic of the economy.
But we’ve seen some retailer updates coming through looking better. We saw GDP. It was ugly, but it looked better than anticipated. (Finance Minister Tito Mboweni) found an extra R100 billion in tax collections. And that’s that ability to get money directly into the economy. Sure, some of it gets saved, some of it goes into Bitcoin, but a bunch of it just gets spent and circulates in the economy.
MOHAMMED NALLA: I think you raise a very important point, Simon. South Africans seem to think that there’s some degree of austerity when it comes to the South African policy framework. But if you look at it, money is the cheapest it’s been in South Africa, pretty much ever, in a post-pandemic world. That’s the central bank keeping the price of money relatively cheap.
Then you correctly say that on the fiscal side it’s actually been a very expansionary budget. Yes, we’ve got a pandemic going, but even pre the pandemic South Africa has [had] a reasonably large component of its expenditure from a fiscal side that goes into a social safety net. And those two levers effectively then translate into a large build-up of debt on the sovereign’s balance sheet. So that’s what you’ve been seeing.
I think for me, the caution for a country like a South Africa, any emerging market effectively, is that your currency is not the US dollar. So your currency would very much be reliant on what global appetite looks like for emerging market debt. Thankfully, South Africa continues to remain one of the favourites. If you speak to any emerging-market manager out there, we’ve got fairly high-interest rates in South Africa relative to some other emerging markets, and that makes holding South African government bonds relatively attractive. And then they obviously manage to hedge their currency risk out on a more dynamic basis.
But bear in mind, if that dynamic shifts, if demand for South African debt starts to get eroded, if we go into a global risk-off type of environment, those are all potential vulnerabilities that might just upset the applecart off what you could effectively call pseudo-MMT that has been in existence in South Africa as well.
SIMON BROWN: And that currency is a real risk. Our rand has been sort of strengthening a bit recently, but we are still around the R14.50, R15/dollar level. And obviously, we’re an economy [where] yes, commodities are doing great. That’s helping us on the export side. But we import a lot. We import oil as a significant use in our economy; we import a lot of manufactured goods. And that could be a significant risk in the process. If our rand blew out to R20/dollar suddenly, we could start importing some inflation – and there’s debate around whether we would or wouldn’t. But, assuming that we do, we start importing inflation, then we start raising taxes, and we are in a whole heap of trouble.
MOHAMMED NALLA: And on that point of raising taxes, Simon, the way you’ve outlined it is 100% correct. South Africa also is a country where taxes are relatively higher than they are in other parts of the world. A simple example would be that corporate taxes are higher than you’d find in the rest of the world. Personal income tax is a bit higher, maybe Vat is a little bit lower. But the ability for South Africa to levy additional taxes on what looks like a fairly thin taxpayer base does also become another risk should that chain of events actually play out.
The US, for example, experiments with MMT. It has the ability to do so, whether there are adverse consequences [or not]. Even in the US, for example, if you look at the US 10-year yield, that has started to tick higher as world markets digest this. So you’ve got that US 10-year that is now the highest it’s been over the last 12 months. You’ve got inflation expectations and break-even yields in the US that have also ratcheted up now above 2%. And it’s all well and good because the Fed says it can tolerate slightly higher inflation. Remember if US inflation’s at around 2% and so forth, that narrowing inflation differential between the US and South Africa is also one of the beneficial factors, I guess, that has kept the rand reasonably resilient.
But, if that starts to get unstuck, obviously an emerging market, specifically a high beta emerging market like South Africa, will always have some of those idiosyncratic vulnerabilities.
SIMON BROWN: To conclude, we are in a sense – tongue in cheek, thanks to the pandemic – trying this experiment, and we’re trying it in the US, the world’s largest economy, with the US dollar as the most in-demand currency there. It’s something which in the years ahead – not even this year or next year, but maybe in five years, maybe in 10 years – we’re actually going to have an on-the-ground pseudo experiment which we can look back at to a degree and get a sense of how the modern monetary theory panned out and what flaws there potentially were.
MOHAMMED NALLA: It’s good. I guess when the experiment happens in the world’s largest economy, those impacts flow through to the rest of the world. It’s something that I certainly am keeping a very close eye on. And again, as you mentioned at the start, people can go and check me out on my website, at moe-knows.com or follow me on Twitter, which is @MohammedNalla.
As I see these things developing, Simon, I’m going to comment on them as well. It’s scary, simply because I think markets are trying to digest what this means. No one really knows, either from an academic perspective or even from a markets’ perspective. We’re feeling this out.
Let’s hope it doesn’t all end in tears. But for me, coming from a classic basis, the rising debt levels are something that certainly needs to be watched. We don’t want the world to necessarily turn into a Japan once again.
SIMON BROWN: Yes, and that’s the word. We’ll save Japan for another whole scenario because certainly there are risks. This is not a risk-free scenario. It looks lovely from the outside. It works perhaps in the US. The rest of the world we need to see, and Japan is always that risk in the corner of the room. Mohammed Nalla at Moe-Knows.com and, of course, Mohammed Nalla on Twitter, I really appreciate your time.