Implications of Modern Monetary Theory, part 2

Massive fiscal stimulus could drive next market cycle

Last time, we looked at the growing interest in Modern Monetary Theory (MMT). It’s a new way of thinking about government spending, and a growing number of its supporters argue that fiscal policy should be the primary tool for macroeconomic growth and stability. Whether investors agree with MMT or not is irrelevant. Because the world’s leading monetary policymakers are steadily moving toward the adoption of its ideas, it only makes sense for investors to learn more about it and get ahead of the curve in terms of investment implications.

MMT and new realities

The Forstrong investment team has engaged in much spirited debate over MMT (all the while keeping the room’s temperature just right). Actively seeking information or views that are different from our own – and updating our beliefs when the evidence suggests we should – is hardwired into our investment process. Neither task is easy.

But why should investors care about economic theory? Admittedly, much of it is useless and has zero application in the real world. And the role of the money manager is not to prescribe government policy.

Yet, we must anticipate policy trends and their impact on financial markets.

To be sure, the idea of MMT leads to many questions. Most importantly, can governments rein in deficits in a timely manner when inflation starts to rise? How would this work in practice, and how reliable are future predictions of inflation? What’s more, politicians generally, to put the most charitable spin on it, do not have a good track record of reining in spending and cutting programs.

The fact is MMT is an untested theory. It has never been tried anywhere. Therefore, how can it be debunked?

But the other reality is that MMT arrives at a ripe time. An enormous appetite exists for new solutions to the issues facing modern economies. The rolling crises of the last two decades have shaken the public’s trust in established ways of thinking. Disinflation is still well-entrenched and growth, even before mass lockdowns, has been persistently weak. MMT provides support for a new policy approach.

Looking back, a new theory was destined to surface in this environment. MMT fits the times. And, while author Stephanie Kelton outlines MMT in her best-selling book, The Deficit Myth (2020), its prescriptions have not yet been widely adopted. But we are edging closer: look no further than the ongoing convergence of monetary and fiscal policy, where central banks play a passive role by buying up as much government debt as needed. MMT may not be here, but the world is steadily moving toward adopting its ideas.

Investment implications

The last decade was characterized by slow growth, deleveraging, disinflation, and skittish investor sentiment from 2008. With tepid inflation and scarce growth, investors aggressively paid up for assets not tied to broad economic growth: disruptors, bonds, and U.S. technology stocks. The problem is that these assets now trade at a large premium, also quickly pricing in their advantage in a Covid-19 world.

But what could change this situation? Growth – and even a little inflation. Investors should not lose sight that fiscal thrusts pack a bigger punch than the monetary variety. Money is channeled directly to households or businesses. Conversely, central banks can only inject more spending power into the economy via an indirect channel: the cost of money.

Looking ahead, there is broad enthusiasm around the world for more deficit spending. The spending driven by Covid is a mere trailer for a coming era of fiscal largesse. In the U.S., Biden has outlined a US$3.5 trillion stimulus package. Across the Atlantic, the eurozone’s previous fiscal caution (led by Germany’s inflation-phobia) has decisively turned. Crucially, they have taken a big step in the direction of more coordinated EU fiscal policy. EU-backed bonds are here. Even in Japan, Yoshihide Suga, Japan’s prime minister, has implied there’s no hard limit to how much his government can borrow.

It’s difficult to imagine with the backdrop of a pandemic, but we are at the beginning of the end of the deflationary era. New investment leadership will emerge. Cyclicals and value, nearly left for dead by most investors, are starting to show life. The U.S. stock market – long seen as the safest house in the neighborhood – is starting to falter relative to other countries (particularly those that do well when global growth is higher). This is the first crisis where Emerging Asian markets have outperformed their Western counterparts.

The period from 2008-2020 will come to be viewed as one of monetary fidgeting, scarcity…and of sobriety. “Austerity,” Kelton writes, “is a failure of the imagination.” Dang. You could just sit and let that line marinate in your head for hours.

And whether investors agree with MMT or not is irrelevant. The policy trajectory has already been set in favor of fiscal spending. The bar is finally open.

Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Aug. 31 edition of “Ask Forstrong,” available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.

Notes and Disclaimers

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.