Chartalism and Modern Monetary Theory, MMT

Chartalism is an economic theory initiated by the German Georg Friedrich Knapp.

Georg Friedrich Knapp (1842-1926) studied a rare combination of physics, chemistry and economics. His father was a chemist as well as his wife’s brother, the famous Justus von Liebig. As a result of his scientific background Knapp had good mathematical skills. He was a professor of both economics and statistics.

As opposed to the, at the time, prevailing gold standard, he advocated that the state could create something similar to gold, which is based on a simple piece of paper (Latin “charta”). Law and the authority of the state would enforce the validity of this paper.

Therefore he stipulated that

“Money is a creature of law. It has occurred throughout history in various forms. A theory of money can therefore be only legal history.

The German repayments of war debt destroyed the authority of the German state and the validity of Knapp’s “charta”, but gold maintained its value. Therefore Knapp’s legacy got lost in Germany. But Keynes believed in his theory and led the translation of his main opera “The State Theory of Money” into English.

After the financial crisis some economists took up his theories in the form of “New Chartalism” or “Modern Monetary Theory (MMT)“. Still today Germans do not bother to translate the English MMT Wikipedia entry into their language, because they know that Chartalism had failed in their country.

Knapp simply advocated the replacement of gold by the state-backed fiat or “charta”. New Chartalists propose to monetize debt something that has a negative connotation today. In the positive formulation it implies that central banks should actively use their seignioriage advantage, ie. that ordinary people tend to save in low or near zero interest-bearing liquid assets (called “money” or “charta”) while central banks may gain income via higher-yielding long-term government debt.

New Chartalists base their synthesis on the analyses in Richard Koo’s Balance Sheet Recession and the argument that fiscal policy is more effective than monetary policy during balance sheet recessions, extended periods of insufficiently low inflation and potentially high unemployment (albeit not in the Japanese case) .

Moreover, MMT is of the opinion that:

The funds to pay taxes and buy government securities come from government spending.

(G – T)             =                      (S – I)                    +    (M – X)

Government budget deficit        = domestic private sector surplus + foreign sector surplus

The government budget deficit permits both the domestic private sector and the foreign sector to ‘net save’ in the government’s unit of account.  Only a domestic government budget deficit permits the domestic private sector and foreign sector to actualize their combined desired net saving.

Our main point is, in nations that include the US, Japan, and others where interest is not paid on central bank reserves, the ‘penalty’ for deficit spending and not issuing securities is not (apart from various self imposed constraints) ‘bounced’ government checks,  but a 0% interbank rate, as in Japan today. .. If the Treasury did not offer interest-earning bonds, the base rate on the currency would be zero.

Inherent in a fixed exchange rate is the risk of government not honoring its legally binding conversion features.  Historical examples of this type of default in fixed exchange rate regimes abound, and recent examples include Argentina and Russia failing to honor conversion of their currencies into $US at their central banks.  History is also filled with examples of default under various gold standards, with the U.S. itself technically defaulting in 1934 when it both devalued the $US versus gold and permanently suspended domestic convertibility.
This explains the very high interest rates paid by governments with perceived default risk in fixed exchange rate regimes

In recent history, today’s central bank systems with floating exchange rate policies have followed fixed exchange rate (mostly gold standard) regimes.  We suggest that policy makers used interest rate data collected under these fixed exchange rate regimes as well as their experience of using interest rates for reserve management and macroeconomic policy under fixed exchange rate regimes to guide them after shifting to floating exchange rates.  The various correlations between interest rates and economic variables were assumed to continue under the new floating exchange rate regime, including the current notion of ‘real rates’ versus ‘inflation,’ etc.

Mainstream analysis of the U.S. ‘twin deficits’ is but one example of being ‘out of paradigm’ with respect to exchange rate policy.  One reads daily of the U.S. facing a day of reckoning due to ‘borrowing from abroad’ to fund its imports.  While this may have had much validity under fixed exchange rate arrangements, with floating exchange rates a current account deficit is instead the result of nonresidents realizing savings desires of $US financial assets.  There is no ‘funding risk’ for the U.S. nor are U.S. interest rates per se a function of the trade balance.


via Warren B. Mosler

Some MMTlers want unemployment to be reduced until everybody is employed that wishes to work.

The following slides in favor of MMT show the importance of sector balances for the theory:


The main proponents of MMT are Bill Mitchell, Warren B. Mosler Stephanie Kelton and Randall Wray, a couple of them work at the university of Missouri in Kansas.

In this video Wray outlines the characteristics of MMT, but he also limits MMT, he says:

Limitation 1: I did not say that deficits cannot be inflationary

Limitation 2: I did not day that deficits cannot affect exchange rates

Limitation 3: I did not say that the government should buy everything that is for sale. Size of government is a political decision with economic effects.

In the context of this FX-related snbchf blog it is worthwhile to mention that MMT concentrate on the reduction of unemployment – so often does the Fed with its so-called “dual mandate”.  Both German and Swiss monetary policy have low inflation and rather the preservation of wealth as main target. The potential destruction of purchasing power via inflation and FX losses of financial assets are hence the main critique against MMT.

Find here a critique from the monetarist and Austrian view, that focuses on these limitation 1 and 2.

In the article “The Best Contrarian Investment, Russia?” we explain that the Russian Federation cannot default, because it generates (oil) current account surpluses in the global reserve currency USD, using some MMT arguments.

On the page German Economists and Merkel, the Implicit Followers of the Gold Standard we explain that the German strong desire to save may steer the whole euro zone into a gold standard and the implied consequences, namely low inflation. But it also implies low bond yields for Italy. This is another point against MMT, because Italy does not have its own currency.

More details on MMT via the Harvard Review on the next page.

George Dorgan
George Dorgan (penname) predicted the end of the EUR/CHF peg at the CFA Society and at many occasions on and on this blog. Several Swiss and international financial advisors support the site. These firms aim to deliver independent advice from the often misleading mainstream of banks and asset managers. George is FinTech entrepreneur, financial author and alternative economist. He speak seven languages fluently.
See more for 8.) Richard Koo and Sector Balances

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