Large-scale bond buying by central banks will lead to global bond yields trading at lower levels
The post COVID-19 world will not be the same. Many theories and practices are getting challenged. New strategies are being promoted and old ones that were sidelined are gaining ground.
We are seeing the emergence of one such theory in the economic domain – the Modern Monetary Theory or MMT as it is popularly known.
COVID-19 began as a health scare, but its biggest impact has been on the economy and on people’s incomes. Governments, worried about the economy, unemployment and loss of income, have announced large increases in spending.
Taking debt to revive the economy
All this, of course, costs money. This money spent by the government will need to be borrowed. The borrowing will increase the debt burden of the government. It may lead to an increase in interest rates. The extra spending may lead to inflation over time.
An MMT supporter will say that’s perfect. Save the economy, boost the employment. Go ahead and spend the money. The central bank will print the money and will fund the increase in government spending. Interest rates thus won’t rise. We will worry about deficits and inflation later.
Modern Monetary Theory rests on a few broad principles, as I understand it.
-Economies should aim at full employment at all times and, fiscal policy, more than monetary policy, should be the main tool to achieve that objective.
-The government does that by investing in infrastructure, spending on the environment or by guaranteeing a job to everyone.
-If the spending leads to inflation, then the government increases taxes to control it
-Deficits matter but do not worry about them (deficit is the government expenditure over its revenue)
-A country which can print and spend its own currency need not worry about debt and deficits.
-The increase in deficit can be financed by the central bank directly (monetization) and thus will not cause an increase in market interest rates
There is indeed some merit in these principles.
The experience with developed countries
The Central Banks of developed countries have been following the mandate of full employment with controlled inflation for decades. MMT shifts that responsibility on to the governments. MMT also treats the central bank as part of the government. So a bond issued by the government to fund its spending from its left pocket is being financed by the central bank which is its own right pocket.
As we have seen over the last decade, large central banks have undertaken Quantitative Easing (QE – money printing to buy financial assets), which has led to an increase in asset prices. At the same time, governments across the world cut back their spending and reduced their fiscal deficit (austerity). The net result has been that most economies, despite their central banks being on steroids, never saw any sustained improvement in growth, employment and incomes, but have seen their stock markets at record highs.
Imagine, if the governments had instead taken the money printed by the central banks and spent on the ‘real economy’ – by creating more physical infrastructure, cleaning up the environment, providing a job guarantee to everyone, spending more on health and education.
That sounds appealing, doesn’t it? Politicians all over the world should love MMT theorists. Politicians can promise employment, healthcare, education, roads, and bridges without worrying about how to fund them.
But as Yogi Berra, the American Baseball legend once said, “In theory, there is no difference between theory and practice, But in Practice, there is.”
Theoretically, the government is supposed to spend and at the same time use tax increases as a way of ensuring that the spending does not become inflationary. But in practice, it may be difficult to raise taxes or cut back on spending, which may create unemployment.
Post the COVID pandemic, not only in theory, but also in practice, we are seeing large-scale monetization of government’s deficits. So, although MMT may not be the official policy of any government, but certain facets of it is already under use.
MMT and investments
MMT will have implications on how you invest, where you invest and what returns you should expect.
-The immediate impact it seems to have is on fixed-income investments.
-Large-scale bond buying by central banks will lead to global bond yields trading at lower levels
-We are seeing this across the world and to an extent in India as well, with the RBI beginning to finance the increase in fiscal deficit
-The role of the central bank diminishes and the governments may keep interest rates lower than warranted.
-Equities may get a boost
-The increased spending, if channeled to better health and education, cleaner environment and increased physical infrastructure, will boost growth
-Corporates can benefit from the increased spending and from the higher incomes out of full employment.
-Real Assets such as real estate, infrastructure will benefit from the increased government spending
-Higher inflation should make gold attractive an attractive proposition
-Unlike currencies, gold cannot be inflated or printed; it is thus less susceptible to government manipulation and the effects of MMT.
-Gold has historically retained a relatively stable purchasing power, whereas practically all currencies have lost purchasing power in the long run
-Gold thus acts as a hedge in times of high inflation, which pushes gold prices higher in inflationary periods
So if practice is not as per theory, which is to be expected, gold is the asset to own. At Quantum, we have always advocated gold as your hedge against foolish actions of politicians and central bankers. MMT or not, that doesn’t change, does it?
The acceptance of MMT is growing. Japan has followed a version of it for decades. Few more countries may follow.
For India or for that matter any other emerging market, which depends on foreign capital for its growth, we don’t see MMT becoming a reality anytime soon.
(The writer is Head Fixed Income & Alternatives at Quantum Advisors Pvt. Ltd (QAPL). The views expressed are his personal opinion)