Retirement planning requires making assumptions about the future. Our assumptions are typically shaped by the past. But sometimes things substantially and permanently change. When this happens, the future can look very different than the past.
One such situation we’re currently witnessing is unprecedented levels of government spending in response to the economic challenges created by the Covid-19 pandemic.
Consider that in 2009, the $787 billion federal bailout package was considered extreme. Some economists thought a larger stimulus was necessary to address the financial crisis, but $1 trillion would produce sticker shock and not be politically feasible. How things have changed in twelve years!
In less than a year, the CARES Act called for spending $2.2 trillion, the Consolidated Appropriations Act $920 billion more, and the American Rescue Plan yet another $1.9 trillion dollars!
Many people are worried about how this level of government debt will impact a variety of key variables for retirees. How will it impact the ability to pay for Social Security and Medicare benefits? How will this spending impact future inflation, market returns, and interest rates?
Conservatives say we need to cut spending. Liberals say the spending is necessary, but we need higher taxes to pay for it.
Proponents of Modern Monetary Theory (MMT) think both viewpoints are wrong. I recently took some time to learn about this theory that challenged my own assumptions. Here’s what I learned and how I’m incorporating these ideas into my future planning.
6 Deficit Myths According to Modern Monetary Theory
Stephanie Kelton is an MMT proponent. She published the book The Deficit Myth last year. As such, the book is not specifically about the current spending in response to Covid-19. But the timing of the pandemic was impeccable for the book’s relevance.
Kelton lays out what she describes as six “myths” about the federal deficit and counters them with “reality” according to MMT. Some of these ideas seem bizarre at first glance because they are so counter to conventional wisdom about money, the economy, and the role of government spending. But after reading with an open mind, I see where a lot of the theory makes sense, even if I don’t ultimately agree with many of her conclusions.
Here are the 6 myths Kelton lays out as the basis of her arguments:
“Myth #1: The federal government should budget like a household.”
Kelton argues that because our federal government issues the currency it spends, it operates nothing like a household. The US federal government is also different from local and state governments and even other federal governments that do not maintain monetary sovereignty. Those entities all must pay back any debts they incur. Federal governments who maintain monetary sovereignty don’t.
She explains that maintaining monetary sovereignty requires the federal government:
- Granting themselves the exclusive right to issue the currency,
- Not promising to be able to convert their currency into something they could run out of (i.e. gold), and
- Refraining from borrowing in a currency that isn’t their own.
This framework distinguishes countries that maintain monetary sovereignty, like the U.S. and Japan, from those that don’t. Examples of the latter include European Union countries that use the Euro and other countries that use the U.S. dollar or borrow in it rather than creating and using their own currency.
Under this framework, a government doesn’t need to tax to get the money it spends. It can just create more money at will.
The purposes of taxes under MMT then are not to supply the money needed for government spending. Instead, taxes serve to:
- Create ongoing demand for the currency the government creates,
- Provide the government implicit authority “without the explicit use of force,”
- Control inflation by cutting the ability of individuals to spend while allowing for government spending,
- Alter the distribution of wealth and income, and
- Incentivize or discourage certain behaviors.
Kelton argues that free of the restraints of the gold standard, the US doesn’t have to operate its budget like that of a household. However, there are “real” constraints to spending. This leads to her second myth.
“Myth #2: Deficits are evidence of overspending.”
Kelton’s next point is that since our federal government doesn’t operate like a household, deficits are a poor indicator that the government is overspending. Instead, MMT looks to inflation as a sign of overspending.
Inflation is the real constraint that limits how much the government can spend according to Kelton and other MMT proponents. If too much money is created, then the real production capacity for goods and services can be exceeded. When this happens, high inflation results and money becomes less valuable, or in the worst-case scenario of hyperinflation essentially worthless.
Traditionally, we relied more on central banks and monetary policy setting interest rates to drive the economy. Kelton argues that this works mainly by encouraging consumers to borrow and spend more, driving people into debt.
MMT encourages moving away from monetary policy. Instead, it places more emphasis on fiscal policy, taxing and spending, to drive the economy and control inflation.
“Myth #3 One way or another, we’re all on the hook (for the national debt).”
Kelton argues that “the national debt poses no financial burden whatsoever.” At first, this was really hard to wrap my head around. That is likely a result of the constant political debate around whether we need to cut spending or increase revenue (taxation) to get deficits under control and pay down debt.
Kelton reinforces the idea that the government doesn’t need to borrow at all. Instead, it chooses to offer treasuries, which are essentially a different form of money that pays interest. Eliminating the nation’s deficit spending means eliminating the US treasuries market.
Conventional thinking is that debt is sustainable if the economy’s growth rate is greater than the interest rate. Debt becomes unsustainable when the interest rate is greater than the growth rate.
According to MMT, the government can manipulate the interest rate because it sets the terms by choosing to borrow at all. Thus, interest rates will always be lower than the growth rate.
“Myth #4: Government deficits crowd out private investment, making us poorer.”
Conventional thinking is that there is a fixed supply of money. Thus, the private sector and local governments are competing with the federal government for these limited resources. As federal government spending increases, interest rates must go higher. This crowds out private investment, making us poorer.
According to MMT, the exact opposite is true. The federal deficit is not a problem. Often, it is a good thing. This is because deficit spending increases our collective wealth and savings. Federal deficits only become a bad thing when so much money is added to the economy that we start to see inflation increase too rapidly.
“Myth #5: The trade deficit means America is losing.”
Kelton’s counter-argument is that America’s trade deficit is actually its “stuff” surplus. This argument had little relevance to changing my assumptions related to retirement planning. So we won’t dive any deeper into it here.
“Myth #6: ‘Entitlement’ programs like Social Security and Medicare are financially unsustainable. We can’t afford them anymore.”
Kelton’s response to this “myth” builds upon her earlier counterarguments to the other “myths.” She states that the reality is, “As long as the federal government commits to making the payments, it can always afford to support these programs. What matters is our economy’s long-run capacity to produce the real goods and services people will need.”
Planning Implications of Modern Monetary Theory
In the introduction to the book, Kelton states that she and other proponents of MMT think the federal deficit is not a problem. On the contrary, it is a good thing. She compares the shift in the way MMT frames deficit spending to the shift in thinking that occurred when Copernicus showed that the earth revolves around the sun and not the other way around, as it was previously believed.
I’m not recommending you fully embrace MMT and the conclusions Kelton’s book leads to. I haven’t.
It is wise to continuously learn and challenge your assumptions. Try to gain a fuller understanding of the way the world works and see what you may be missing.
Here are a few key points that I took away from The Deficit Myth that will impact my thinking, assumptions, and planning going forward.
Money = Trust
Since the United States went off of the gold standard, the US dollar has become a fiat currency. As such, its value is derived by supply and demand, driven by the stability of and trust in the US federal government. Nothing else backs it up.
This is not news. Still, repeatedly reading how easy it is for the government to create essentially unlimited supplies of new money “with a few strokes of the keyboard” drove that point home and brought it front of mind.
According to MMT, this is simply reality. It’s nothing to be concerned with.
I disagree with that.
Seeing the loss of trust in our government, and the erosion of value placed on democratic processes, institutions, and traditions over the past couple of decades makes me realize how fragile the entire system is.
Gold bugs and crypto fanatics have been making this case for years, leading to the conclusion you should invest heavily in these asset classes. I do not agree with those viewpoints either.
Our economy, and society with it, could collapse if people lose faith in our system that is backed up by nothing but trust. I’m not optimistic that having some gold coins in a safe or a hard drive with Bitcoin on it is going to do anyone much good if that happens. The currency will likely be the least of our concerns.
My alternative takeaway is to continue to de-emphasize the importance of money in my life. At the end of the day, money is nothing beyond what it can buy. Yet we often waste years or even decades of our lives in the pursuit of more of it because we place far too much value on it and the security, control, status, or power we think it provides.
Faster Economic Cycles
One of the ideas endorsed by MMT is to emphasize fiscal policy (taxing and spending) over monetary policy (interest rates) to drive the economy and limit the impact of economic downturns.
Whether you agree or disagree with the idea, it’s hard to miss how prevalent this viewpoint has become or deny the impact it has had recently. After a near-collapse of the financial system in 2008-2009, then record economic stimulus packages helped the S&P 500 surpass previous highs in just a few years.
Even more federal deficit spending, put directly into the hands of citizens, seems to have had an even greater impact over the past year. The stock market and select segments of the economy (housing, building supplies, recreational equipment, online vendors) boomed, even as the pandemic raged on. It is hard to imagine putting this cat back in the bag now that it’s out.
I won’t make any immediate changes in my investment strategy based on this assumption, but the possibilities of having faster economic recoveries and receiving direct payments from the government during economic downturns could substantially decrease the sequence of returns risk that retirees rightfully worry about.
If we see this pattern of faster economic cycles continuing, it may also be a case for changing your policy for rebalancing a portfolio. Rebalancing when assets exceed a threshold away from your target allocation may become more advantageous than periodic rebalancing. The latter may be too slow to capture the rebalancing benefits if economic cycles occur more rapidly.
Emphasis on Tax Diversification
With MMT’s emphasis on fiscal policy, there is a flip side to increased government spending to limit the impact of economic downturns. That is increased taxation to take dollars back out of the economy when it gets overheated to control inflation.
The potential for more variable tax rates from year to year if MMT becomes more dominant doesn’t change my financial strategies. It does reinforce the idea that having diversification among different tax-advantaged and taxable accounts is a good idea.
Years when temporary tax breaks are offered, such as the suspension of the ACA subsidy cliff in 2021 and 2022, may create great opportunities to recognize more taxable income from tax-deferred accounts at favorable rates. This can be accomplished by spending from those accounts directly or doing Roth IRA conversions.
Conversely, in years when taxes are inevitably higher, it could be more advantageous to contribute to tax-deductible accounts or in retirement spend from more tax-friendly Roth or taxable accounts to limit your personal tax burden.
Returning to “Normal” Interest Rates
When I started managing our household investments about 10 years ago, interest rates were well below “normal.” The ten-year treasury rate was about 2% in early 2012, about half its historical average.
Many people smarter than me were predicting that rates “had to” go up. So I assumed the same thing. In the decade since then, rates have not gone above 3%. They bottomed out around .6% last July.
The assumption that interest rates have to go up may have been faulty under any circumstances. One MMT principle written about by Kelton is keeping interest rates low and stable to promote global economic tranquility. As MMT economists gain influence, this may be another factor making interest rates that are low by historical standards the new normal, at least for the foreseeable future.
Seeing a Plausible Path Forward for Social Programs
Last year I took time to seriously consider how Social Security could impact our early retirement plans. Prior to that, I bought into the gloom and doom around how this program would be funded into the future. We didn’t factor Social Security into our projections.
MMT offers a different viewpoint. It presents a plausible path that we will receive full Social Security benefits when the time comes.
This alternative viewpoint does offer some reason for optimism about this important retirement benefit. It also serves as a reminder to remain humble in our ability to predict the future. There are many things we simply can’t know or control about the future.
Ultimately, I won’t substantially change our assumptions and plans based on MMT. I would rather be prepared for the worst-case scenario and be pleasantly surprised than plan for a best-case scenario and get stuck dealing with anything less. Still, if the MMT outlook is correct, it could create considerable upside for those of us who plan conservatively.
The Deficit Myth was a challenging, but enlightening read. For all of the time and energy I’ve spent learning about personal finance and thinking about money, it was humbling to realize how much faith I blindly put into our financial system that I never took the time to fully understand.
This book challenged me to question things that I “knew,” broaden my horizons, and consider different alternatives. I don’t agree with many of MMT’s ideas and won’t drastically alter anything I do after reading The Deficit Myth. But it is always good to consider different viewpoints, particularly when they prompt you to ask better questions and consider possibilities you may not fully understand or would otherwise overlook.
Have you taken the time to learn about Modern Monetary Theory? Has it impacted anything you are doing to prepare for your retirement? Share your comments below.
Please keep your comments focused on how MMT impacts your planning decisions so that we can all learn from one another. Avoid divisive political name calling and ideological rants. There are many places on the internet for that. This is not one. I reserve the right to edit or delete comments that do not comply with this request. Thank you!
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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. Now he draws on his experience to write about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. You can reach him at email@example.com.]
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