Economic Crisis

“Modern” money for nothin’

Buenos Aires, Argentina

“That ain’t working, that’s the way to do it

Money for nothin’ and your chicks for free.”

Money for nothing, by Dire Straits (1985)

“Modern Monetary Theory”, or MMT, keeps popping up in financial commentaries. It’s a theory that appears to be gaining ground among academic economists, in monetary policy circles, and…of course…among deficit-spending politicians.

MMT involves central banks creating new money to directly fund government budget deficits. It’s practically the same as quantitative easing (QE)…at least when QE money is used to buy government bonds.

But MMT removes some of the smoke and mirrors. Instead of laundering the money through the bond market, it’s handed straight to finance ministries to spend as they please.

There’s nothing at all “modern” about this. Places like Argentina have been doing it for decades. In fact, the Argentine central bank only stopped doing it last year (most recently), as the country battles to reduce high inflation. Last year, consumer prices rose around 50%. This year, most people are expecting 30-40%.

This funding of government budget deficits by central banks tends to have two results. First, deficits get even bigger, as politicians are let off the fiscal leash. Second, due to the inflation in the money supply, the currency is devalued and prices of goods and services take off like a rocket.

Here’s a chart which shows the size of Argentine budget deficits since 1961. The only time there was a surplus was in the early 2000s. That was shortly after a massive currency devaluation and during a huge commodity price boom. (It was also an opportunity that was squandered by the government, and the budget and trade deficits soon returned.)

Right now, we have very high inflation in Argentina. But the country also suffered from hyperinflation in the past. Between 1975 and 1990, the average inflation rate was 300% a year.

The guy who cuts my hair told me that, in the late 1980s, he would work in the morning. Even during hyperinflations, people still need a haircut. Then he’d go straight out after lunch to buy his daily groceries and other necessities, before prices went up. Any spare cash was converted into US dollars at the first opportunity.

This is the very definition of hyperinflation: wholesale currency dumping. The collapsing currency is like a hot potato that no one wants to hold on to. (Although that’s unfair to hot potatoes, which at least have nutritional value.)

Consider this. I’ve lived in Argentina for over ten years. When I arrived, one US dollar bought 3.2 Argentine pesos. Today, one dollar will buy 43.4 pesos. Put another way, relative to the dollar, the peso has lost a staggering 93% of its value in a decade. And the dollar has also lost purchasing power over that time.

(My kids, now aged 13 and 12, have learnt about this stuff early. They already know that they need to convert their peso savings – garnered from birthday gifts and unspent pocket money – into US dollars or British pounds.)

Ironically, the cost of living in Buenos Aires is now the cheapest it’s been since I’ve lived here, in US dollar terms. That follows last year’s currency collapse, when the peso was cut in half. That’s good news for people with dollar incomes, or for foreign visitors.

But, in the past couple of years, a great many local people’s peso wages have fallen way behind peso price increases. Life is tough right now for many Argentines.

(I always mentally price things in dollars here. Peso prices change so rapidly that you can’t keep up. A lunch at a decent restaurant 18 months ago could have cost the equivalent of US$40. Now, the same lunch is more likely to be US$20.)

In this world of QE and MMT, it pays to know something about what money really is, and how it’s created by banks (of either the central or commercial varieties). For example, many people seem to think that banks “look after their money” when they make a bank “deposit”. But, in reality, a deposit is just a loan to the bank. That’s why banks report customer deposits as liabilities on their balance sheets.

This progressive edging of developed countries towards a monetary cliff is a good reason to own some physical gold. With the dollar (and euro, pound, and yen) under increasing threat from trendy new-old theories, gold is the go-to inflation hedge. It’s a better alternative to the sanctuary that Argentines find in US dollars.

Argentines have placed their faith in dollars for decades. After all, the paper bills (which are VERY popular here) do bear a comforting message – “In God we trust”.

But trust in the almighty may not be enough to protect the dollar in the future. The Fed’s already got away with printing trillions under QE. When it started, everyone thought the policy was insane. It was only ever meant to be a temporary, emergency measure. But now it’s an accepted (and permanent) practice. Now that they’ve warmed everyone up with the foreplay of QE, how long until they go the whole way with MMT?

Of course, currencies may not collapse immediately. Most likely, nothing much will happen for years. But then bad things could happen quickly. As more and more politicians and central bankers believe they can print money for nothing, they’re edging closer and closer to dire straits.

Below is an article I wrote in 2016 about money – what it is and how it’s (usually) created. I recommend you read it or at least refresh your memory. Forewarned is forearmed.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.