You will find few full-throated defenses of modern monetary theory on Wall Street today, except when you turn to James Montier, the independent-minded strategist at GMO, the $67 billion Boston money manager. Montier’s view was refined amid Japan’s collapse in the 1990s; since then, he has found MMT to be a good model for governments’ interactions with the market. Recently, Montier provided Barron’s with a helpful definition of MMT, chatted about why he prefers Monty Python’s Eric Idle to former Treasury Secretary Larry Summers, and why he’s still waiting for a decline in the U.S. stock market. Read the following edited excerpts for more.
Barron’s: You’ve said that MMT has been dismissed by a range of critics as “mess, foolish, fringe, nonsense, and voodoo.” Your response?
Montier: MMT can be decomposed into a few simple statements. One, money exists because it’s created by the state. The U.S. dollar has value because you have to pay taxes in it. That’s what separates it from Bitcoin.
Two, if a country issues debt in its own currency and has a floating exchange rate, it is monetarily sovereign and can’t be forced to default on its debt. The U.S., United Kingdom, and Japan fall into that category. The euro zone doesn’t—France issues debt in euros and can’t just print it to repay debt.
Three, MMT has a [different] operational description of the monetary system. “Loans create deposits” is an expression you’ll hear a lot from MMT people. “Oh, no, deposits create loans,” other people say. But the way the world works is: Bankers make a loan, then gather the deposits to offset it, or go collect reserves. That has real implications for neoclassical economics.
Four, MMT is aligned with functional finance, which simply says fiscal policy should aim to generate full employment rather than a balanced budget. There’s this fallacy that what’s true for a household is true for government. So you hear from all sorts of policy wonks that the U.S. and XYZ nation are running out of money. Well, that’s just not possible.
What else stands out?
Five on the list is that MMT is very clear about the binding constraints on spending: You don’t have endless supplies of people, machines, factories, and at some point you push demand above productive capacity. That creates inflation. Yet MMT is often accused of ignoring inflation. Six: Private debt matters. A household can’t print its own money. Therefore, it needs to be able to repay debts. So we should worry about the level of debt that corporations and households have. Seven, in macro-accounting, the government’s debt is actually the private sector’s asset. You can reframe national debt as national savings. Those are the core points of MMT.
How did you come to be a fan?
At university, I was fortunate to encounter a pluralist approach to economics. Most universities today teach a very strict neoclassical framework. When I went to work in the early ’90s, I was surrounded by people who shared that very open, pluralistic framework.
The crystallizing moment was my biggest-ever investing mistake, in 1995, in Tokyo, when I wrote that, at 3%, Japanese bond yields couldn’t go any lower. I watched them halve, halve, and halve again. Suddenly, they were at 50 basis points [0.5%]. It was incredibly humbling. I’d used the standard tools of economics and debt sustainability that neoclassical economics trots out. I began to think about alternative frameworks. What offers more insight into understanding the world? MMT won hands down.
Whose critiques of MMT bug you the most?
Larry Summers. He said, “Contrary to claims of modern monetary theorists, it is not true that governments can simply create new money to pay all liabilities coming to you and avoid default, as the experience with any number of emerging markets demonstrates. Past a certain point, this approach leads to hyperinflation.” But, in 2014, he said that the U.S. has a “currency we print ourselves, and that fundamentally changes the nature of the macroeconomic dynamics in our country, and all analogies between the U.S. and Greece are, in my judgment, deeply confused.” You can’t say both those things. He was the most intellectually dishonest of the various critics that I saw. That kind of hypocrisy really sticks in my throat.
How does MMT shed light on global markets?
We need to understand that cash and bonds are not vastly different instruments, right? Bonds are really just deferred cash. You are paid a return for your willingness to hold them. When governments run deficits, they’re spending more than they’re receiving. The government transfers money from its bank account to the bank account of whoever’s goods or services it’s buying. That creates reserves at the bank of the person who is providing the service. Banks don’t like holding reserves, so it lends them on the interbank market. Ultimately, that government deficit puts downward pressure on interest rates.
Classical economics says the reverse. Look at Japan, which has had huge deficits, and where have interest rates gone? To zero. Oddly, fiscal deficits are actually good news from an equity point of view. The Kalecki equation says that corporate profits at the macro level are the result of net investment, plus dividends, minus various sectors’ savings. If the government is saving, or households are saving, that’s a drag. If governments are actually running deficits, it’s a boost to profits. This is interesting and not widely understood. Even with such an outcome, the pricing of the U.S. stock market is pretty damn extreme.
What’s your outlook for the U.S. economy?
One thing that worries me is people give productivity a causal meaning, so you hear statements like “growth is low because productivity is low.” That’s incredibly circular and not terribly helpful. What’s even worse is when people talk about total factory productivity, which is said to be a measure of innovation, even though it’s actually all about low wages.
How is productivity about labor?
Calling it innovation is shying away from the important question, which is, Why the hell have wages been so damned slow and low for so long? It has a lot to do with what one would call monopsony, or the power of a single buyer, rather than monopoly, the power of a single seller. Monopsony is what we’ve seen in the labor market. There are fewer new firms being created. It has translated into corporate power against labor, rather than corporate power against the consumer. That helps explain very low wage growth over time, despite a very long expansion.
Any sign of that changing?
It’s a dual economy: A group of sectors, like manufacturing and information, are doing fine, with reasonable productivity and output growth, but have held down wages. Then there’s another group, construction and health care, where there has been essentially no productivity growth and no real wage growth. That’s an unhealthy combination—and it’s one of the more distressing aspects of the economy today, which gives rise to the degree of inequality we observe.
An awful lot of the gains of economic expansion are captured by the top 10% rather than by the majority. That’s a big change. Up to about 1980, the majority of gains in economic expansions were captured by the bottom 90%. It breeds resentment, polarization of political opinion, extremist stances.
What about the things the market professes to care about—financial metrics like earnings?
One of the common beliefs is that during this long, slow recovery, earnings per share have been just fine. But the data show that earnings have just about kept up with gross domestic product because of massive buybacks. That’s another lesson from the MMT framework, which is that private debt matters. If I’m Apple, I can issue bonds at 1%. The problem is that everyone’s doing that at the same time.
I go to a lot of rock concerts with other reasonably old people. We tend to sit down. There’s always somebody in the front who stands up. Then everybody has to stand up. It’s perfectly rational for one person to stand up, but in aggregate, nobody’s view is improved. It’s perfectly rational for individual companies, but a huge amount of corporate debt creates a systemic vulnerability. Half of the outstanding corporate debt is now rated the lowest investment grade, which really is quite worrying. At some stage, we’ll encounter a downturn. As an equity investor, you’re junior to this paper that needs to be paid.
The Federal Reserve has reversed its rate regime. What happens next?
It’s a noticeable U-turn, which the equity market has almost double-counted. The most likely reason for rates coming down is a recession.
The founder of your firm, Jeremy Grantham, has been criticized for calling a downturn that hasn’t materialized. But you are even more bearish than him.
The market should trade on a cyclically adjusted price/earnings measure of about 17½ times, not the 28 times the S&P 500 trades at today. The U.S. market remains far and away the most expensive market in the world.
I was reading Eric Idle’s autobiography, which was hilarious, as you’d expect, and he talks about the song “Always Look on the Bright Side of Life” from the film Life of Brian. This is almost always what investors do during bull markets. During bear markets, they’re in the depressive phase of bipolar syndrome. I studied the visionary poems of Samuel Coleridge when I was a whippersnapper. He was high on opium, which pretty much accounts for what he wrote. When people asked him how he could get people to understand this stuff, he said, “What I require is the suspension of disbelief.” That’s what investors are extremely good at: the willing suspension of disbelief.
Even with the benefit of all these years of hindsight, I still can’t tell you why the market fell in March 2000. There were lots of straws in the wind. It was ludicrously expensive. The Fed had been raising rates. Barron’s ran a piece about dot-coms running out of cash. All I know is that when things are priced to perfection, any shortfall leads to rapid repricing. It’s second-guessing the herd.
How should investors be positioned?
It’s incredibly hard to build portfolios today. Some assets can give you really quite attractive rates of return, at least in expectation. And you should own them. These would be emerging market value stocks. They’re hairy, they’re scary, they’re often terrible companies in terrible countries, but they trade on single-digit P/Es, which makes for a big margin of safety.
Don’t get me wrong: If the U.S. goes down, emerging markets will go down, too. Will they beat the S&P 500 over the next 12 months? I have no idea. Will they do it over the next decade? Absolutely, because the pricing differential is huge. The U.S. is on a Shiller P/E of nearly 30 times, emerging markets are at 14 times, and emerging markets value stocks are even cheaper.
You have to look at alternatives, although most expose you to other deep risks. Merger arbitrage has equity-like risk, but a much shorter duration. Selling puts is another example. And with the world so damned expensive today, you have to own quite a lot of dry powder.
In some of our benchmark unconstrained products, we have 10% in Treasury inflation-protected securities, or TIPS, and another 5% in cash and cashlike strategies if equity markets dislocate. This is about making sure you’re being paid for the risks you’re taking.
Write to Leslie P. Norton at email@example.com