Emilio Ocampo – Modern Monetary Theory (MMT), which is neither modern nor a theory, is getting a lot of media attention thanks to Bernie Sanders and Alexandria Ocasio Cortez (AOC). Which is quite ironic because in their public pronouncements neither one has shown a minimal understanding of basic economics. Showing her mastery of arcane monetary issues, in a recent tweet AOC even referred to the “famed economist Milton Keynes” (she later claimed it was a typo).
As explained by its leading proponents, MMT’s key tenet is that “the issuer of a currency faces no financial constraints… a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due”. Therefore, “for most governments, there is no default risk on government debt.” (Mitchell, Wray, and Watts, 2019, pp.13, 15). According to a recent Bloomberg article, MMT says the world “hasn’t come to terms” with the collapse of the Bretton Woods regime of dollar convertibility to gold. In a world of non-convertible currencies, MMTers claim, governments “are free to print however much they need”. They also assert that in such a world, “the natural rate of interest” is zero.
According to the cited Bloomberg article, MMTers present themselves as “the legitimate” intellectual heirs of John M. Keynes. In reality, they should call themselves heirs of Silvio Gesell, which is quite ironic. Gesell was a German merchant who immigrated to Argentina in the late 1880s. Keynes admitted Gesell’s influence on his thinking but didn’t give him the full credit he deserved for the interest rate theory he presented in the General Theory (the connection between Keynes and Gesell went beyond monetary theory). One irony stems from the fact that Gesell started developing his own monetary ideas while living in Argentina (he later returned to Germany and died there in 1930). In fact, it was Argentina’s 1890 financial crisis and default, which brought Baring Brothers and the British banking system to the brink of collapse, that prompted Gesell to write his first book. The other irony is that Argentina was also the first country to consistently implement the type of policies that MMTers advocate.
As to the cause of inflation, MMTers claim that there is “no simple proportionate relationship exists between rises in the money supply and rises in the general price level” (ibid., p.263). In their view, the problem of inflation is “intrinsic to the power relations between workers and capital (class conflict), which are mediated by government within a capitalist system” (ibid, pp. 255). In other words, inflation results from the natural “class struggle” between workers and capitalists. This last sounds a lot like the “structuralist” theory of inflation, which was quite popular in Latin America during the 1960s and 1970s. According to this theory, money is endogenous. Structural bottlenecks that put chronic upward pressures on prices are the ultimate cause of inflation.
For anybody who has lived in Argentina in the last seven decades, MMT also sounds like an Anglo-saxon pseudo academic explanation of the economic policies of Peronism, particularly between 1946 and 1948, 1973 and 1974 and 2007-2012. In fact, Argentina is Exhibit A of what happens to a country that follows MMT’s policy recommendations. It would be tempting to dismiss this statement given Argentina’s track record of high inflation, secular stagnation and sovereign defaults. But doing so would only show ignorance of some basic historical facts.
First, from 1900 until 1939, a period during which Argentina mostly abided by the rules of the Gold Standard, its inflation rate and fiscal balances were in line with those of Australia, Canada, the US and the UK, while its GDP per capita grew at comparable rates.
Something happened after WWII and its effects have proven to be very persistent: since 1945 inflation has averaged 143% a year –with three bouts of hyperinflation– and the government had persistent and high fiscal imbalances while the economy stagnated. The country also restructured or defaulted on its public debt, both foreign and domestic, half a dozen times. As a result, Argentina’s position in global GDP per capita rankings dropped from an average of 7 in the period 1900-1945 to 72 in 2019.
When he analyzed the diverging economic performance of Australia and Argentina after WWII, Harvard economist Arthur Smithies had one explanation: after 1945 “a diabolus ex machina appeared in Argentina.” He was referring to Juan Perón, who had started his political career in 1943 as a military dictator but later won the presidency in free elections.
When Perón became president in 1946, Argentina was the largest economy in Latin America by a significant margin, it was the eight largest economy in the world and the seventh wealthiest in the planet as measured by GDP per capita (see The Maddison Project for historical comparative data). Another important fact is that in 1945, Argentina was one of the UK’s largest creditors and, more importantly, its gold reserves amounted to US$1.2 billion, which put it among the five countries with largest holdings in the world (UN, 1951, Statistical Yearbook, p.462). At that time, more than 160% of Argentina’s monetary base was fully backed by gold reserves. The country could borrow in its own currency long term at an interest rate of 4% a year.
Essentially, Perón set out to achieve two objectives that were mutually inconsistent –achieving a rapid and “total” industrialization while raising wages above productivity– based on an erroneous assumption –imminent global stagflation– to avoid an inexistent problem –the threat of a communist revolution in Argentina due to hunger and social unrest– using the wrong set of policies –an increase in nominal wages for industrial workers coupled with radical protectionism and massive public spending and government intervention, financed with loose credit policies.
Under Perón’s watch, Argentina was one of the first countries to implement the policies that MMTers advocate today. Fiscal and monetary policies were based on the belief that the government faced no financial constraint and that the Central Bank could issue as much currency as it wanted. Also, neither the government, nor businesses or consumers had to pay a positive real rate of interest on their loans.
To achieve these goals Perón nationalized the Central Bank (which until then was partly owned by private banks) all the deposits in the banking system. In this way, both the allocation of credit and its cost became completely discretionary. The results of implementing these policies seemed to have the intended results. Between 1945 and 1948 real GDP per capita grew at 6.4% annually and real average industrial wages by almost 45%! Perón also boasted that he had actually reduced the burden of public debt in relation to GDP while maintaining a budget surplus. Besides, Argentine workers were supposedly much better off.
Between 1945 and 1948 credit to the public sector grew 28 times and loans to consumers and crony capitalists tripled. The former was used to finance growing budget and off-budget deficits, which were hidden “under the rug” with accounting gimmicks and indirect financing schemes. In 1949 Perón boasted that “we have our budget fully balanced; we have closed our budgets with a surplus”. He could show a Treasury report that said that in 1948 the government accounts showed a slight surplus. However, the government’s actual cash deficit had reached almost 16% of GDP and would reach 13% in 1949. There was no magic behind these numbers.
According to official statistics, inflation had also increased from an average of 2.2% p.a. in 1939-1944 to 31% in 1949. But this number underestimated the true debasement of the currency. First, given that the government imposed strict price and rent controls, the CPI was not a true measure of the actual cost of living. After 1948 scarcity and rationing had become the norm. Second, the ratio of gold reserves to the monetary base dropped from 160% in 1945 to 22% in 1949, while the value of one US dollar in the black market tripled during that same period.
During 1946-1955 the effective interest rate on government bonds averaged 3.1%. Given that the inflation rate average more than 20%, in real terms the government actually paid less than zero to borrow money. There was no magic here either. One particularly perverse way of accomplishing this objective was by forcibly placing government bonds yielding interest rates of between 2.5% and 4% per annum in the state managed pension plans. Approximately 85% of the public financing needs accumulated between 1946 and 1955 were financed with this perverse method. What Perón giveth in wages, he taketh a way by diluting pensions.
If the Argentine Treasury paid a interest rate on its debt that kept pace with inflation, by the end of 1955 total public debt would have significantly exceeded 74% of GDP.
These misguided financial policies achieved one of Keynes’ dreams: “the euthanasia of the rentier”. They also destroyed the domestic capital markets and eliminated it as a source of long term funding for the government. Without it and access to foreign borrowings to finance the deficit, the government had no option than to pursue inflationary credit policies and/or find devious ways of confiscating the accumulated savings of generations of Argentine workers. Given that the annual inflation rate during this period averaged 20% (with a peak of 38% in 1951) the economic losses suffered by savers and pensioners were enormous. Keynes couldn’t have devised a more ingenious way of “euthanizing” the rentiers.
Peronism refuted the notion proposed by MMTers that inflation results from the class struggle inherent in capitalism. In fact, under Perón those struggles were meant to disappear, particularly given the generous nominal wage increases of the first year of his presidency. What Perón accomplished was to break the link between wages raises and productivity. By turning the former into a political decision he distorted and degraded democracy and made it impossible for Argentine industry to be competitive. Peronism also refuted the notion that governments have no financial constraint and that can print money at no cost.
The “Peronist party” didn’t last long. By mid 1948 that the economy was experiencing production bottlenecks, a severe dollar shortage and rampant inflation. In January Perón fired his “finance czar” and a months later he reluctantly accepted a loan from Uncle Sam. The Peronist fantasy was over. Within ten years Brazil and Mexico had surpassed Argentina’s GDP. From then on it was downhill.
The worst legacy of Peronism has been path-dependence. By implementing similar policies to those advocated by MMTers today, Perón put Argentina on a path of economic self-destruction from which it was never able to escape. Nobel Prize winner Paul Samuelson once admitted that if someone had asked him in 1945 which country was best position for an economic take off in the following decades he would have replied that it was Argentina. He hadn’t reckoned with Perón (or MMT).